Afford Anything - Invest Anywhere: The 5 Ways Real Estate Makes Money

Episode Date: April 1, 2022

#373: How do people make money in real estate? Many focus on rental income, but this is only one of five ways that properties create wealth. We explain five surprising ways that real estate builds your balance sheet: cash flow, appreciation (market-based and forced), tax benefits, principal paydown, and instant equity at closing. Why does this matter for long-distance investors? If you’re investing out-of-state, you’ll need to choose a city or town. How do you decide? First, think about how you want to bias your returns. Do you want to optimize for cash flow? More appreciation potential? Identifying this will help you align your city/town selection with your financial goals. If you’ve been thinking about investing in real estate – especially if you might invest long-distance – you’ll love this episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode373 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to your time, your focus, your energy, your attention. Any limited resource that you need to manage saying yes to something implicitly means turning away other options. And that opens up two questions. First, what matters most?

Second, how do you align your decision-making around that which matters most? answering these two questions is a lifetime practice. And that's what this podcast is here to explore and facilitate. My name is Paula Pan. I'm the host of the Afford Anything podcast. Normally, we are a weekly show. But once a month on the first Friday of the month, we air a first Friday bonus episode. Welcome to the April 22, first Friday bonus episode.

Now, I have a special announcement. Are you ready? For a long time, I've been wanting to do something special with these First Friday bonus episodes. Historically, they've been just like our normal weekly episodes, but heck, it's First Friday. It's a special once a month treat. Why not do something thematic, something unique, something that makes these First Friday episodes stand out? And so, behind the scenes, we've been working on a special presentation that I am thrilled to be able to roll out today.

With me to talk about this new special series that we're kicking off in today's first Friday episode is Sonny Rao, my esteemed teammate and the muscle behind Afford Anything. Hi, Sunny. Hey, Paula. How are you? I'm great. How are you? I am so stoked.

to be recording this today. We've been working on this for almost a year. I think it was exactly a year ago you called me and asked if I wanted to be a part of this. Of course, I said yes. So to have it finally come to life feels incredible. I know. It's amazing. So I know we haven't actually told anyone what the special presentation is. But you know what? I'm going to drag out the anticipation a little bit longer. Before we do that, introduce yourself. I know not to give it away, but Yeah, I was just thinking, how do I do that without giving it away? My entire online identity is kind of around this. So I'll give away a little bit of it.

I am a real estate investor based out of Indianapolis, Indiana. I support, afford anything, and work with you on a daily basis. And I'm really, really passionate about real estate investing and how it can help people really accelerate their financial journey. actually build wealth. Suni, tell me about your real estate experience. How many units do you own? I own seven units and I've been investing for four years now, completed about a dozen transactions. I started as a long distance investor. Most of my units have been purchased at a distance. I've also invested a little bit locally. And I've taken on every sort of financing method available to any human, I think, at this point, to make that happen as a normal person with a single income to rely on.

And so I've invested in mostly single families and duplexes, mostly long-term rentals. I've dabbled in short-term rentals. I still have one. And my experience as a long-distance investor has really opened up my ability to take advantage of opportunities as they come up. For example, even though I'm in the single-family duplex space last year, I was able to to enter into an agreement for a mobile home park almost three hours away, which I ended up wholesaling for several grand, which was a really fun and interesting experience because of the

skill set that I built as a long distance investor. And you are also, I've heard that you've picked up a tennis racket once or twice. Yeah, I totally forgot that. You forgot that. I forgot many, many moons ago, I was a professional tennis player. I spent 10 years traveling the world, playing tennis professionally with some some of my highlights being some of the largest stages in the world, including the 2008 Beijing Olympics. That's kind of like my claim to fame. You've got a Wikipedia page, and I do not.

Okay. You know what? You're really letting the cat out of the bag now. I mean, you are literally an Olympic athlete, so I respect that a ton. Thank you. Briefly for the tennis enthusiasts in the audience, where else have you played? All of the slams. So that will, we have four grand slams, or the four biggest events of the year. within the sport of tennis. So that would be the U.S. Open in New York City, the Australian Open in Melbourne, Australia, the French Open in Paris, and Wimbledon in England. I didn't know you played Wimbledon. I guess that makes sense. Wow, you played Wimbledon. Okay. All right. Well, learn something new every day. This isn't something we talk about typically.

And now in your new life, you are here with us, so we're thrilled to have you. Do you want to talk about this concept that you and I started discussing about a year ago. You, when you began investing in real estate, you were a long-distance investor. You lived in Boston at the time. Tell me about that journey and particularly fears, hesitations. How from Boston could you start investing in Indianapolis? That is a really great question. So at the time, I was working in corporate finance, working 10, 12, sometimes hours a day, sometimes 100 hour weeks. And I wanted to better influence my financial journey. I found real estate investing, but I was so priced out of the market in Boston that it wasn't even funny. I would probably have to save 10 years to buy a single

property. So I did a bunch of research and took two years, honestly, to gather the information and the money I needed to invest. It took a while. I was terrified of losing all of it. I didn't have a background in real estate investing. No one I knew was doing it. The few people who I told at work, doubted my ability to do it openly. And overall, it was just terrifying to spend years of your life working for this little nest egg and then to dump it in a place you don't even know and don't have like friends or family and people who you truly trust and are able to lean on emotionally and financially, right? Right. So that was my start into it. However, almost four years later, it's the best decision I've ever made and really truly changed my life.

So I guess this is all leading to what this new First Friday series is about, this new series that we're kicking off today. The inception of the idea, it came from, you know, we've got this course, afford anything that has this course called Your First Rental Property, and we've had a couple thousand students go through it. And the most common situation that I encounter is that most of our students live in high cost of living areas like Boston, New York, Seattle, L.A., and they want to invest in real estate, but they know that they most likely need to do it long distance. and Sonny like you, the idea emotionally, the idea of spending years saving up for a down payment and then dumping it into a place where you don't know anyone, no family, no friends,

no prior knowledge of that city or state or location, that is a tough pill to swallow. It requires a lot of bravery, a lot of courage. It really does. And I think the tough thing is that without kind of that support system to lean on, you don't know if you're truly doing it right until you do it. And either you make money or you lose money. You know, so what if you buy the wrong property? You're putting all of this technical kind of abstract knowledge into practical real life application. And it's like, oh my gosh, what if I learned wrong?

What if someone told me something incorrectly? What if this doesn't work for me? Right. You can become paranoid. 100%. And so we wanted to roll out a special series that particularly addresses this. And so, Sonny, should we do a big name review right now? Yes, please.

We've been building this up for... I can't wait to hear this. Okay. All right. Afford Anything Presents. Invest. Anywhere. A new series that we are rolling out on the first Friday of every month in our first

Friday bonus episodes. And it's a monthly series in which we deep dive into how to invest anywhere, long-distance real estate investing. And Sonny is my esteemed co-host. Welcome, Sunny. Thank you. Thank you for having me. You and I have been putting this together. You've been doing a lot of the heavy lifting. We're building this information to be shared sequentially so that a person can go back and listen to these first Friday episodes, starting with today's, where we walk people through this sequential journey of how they can figure out how to invest in real estate long distance in a way that's smart and confident.

And I think that no matter where you are in your investing journey, you can hop into the series and find something that works for you. We are starting at the very basic building blocks of investing so that even if you're just thinking about it, you can learn about it enough to build those core basic fundamental blocks of knowledge and put it together to be successful over time. And even better, we are going to be strategy agnostic for actually quite a while so that if you love tenants and toilets, cool, this will be great for you. If you don't and you don't want to swing a hammer, that's okay too. What we are going to help talk you through is how to think about investing in different places. That decision-making framework and that thought framework. So here's what we're going to answer in today's inaugural episode. How do you make money from real estate? Is it by rental income or is it the property value shooting sky high the day after you buy it? Or do you buy property and maybe find some hidden treasures in the basement? What's the answer?

There are five ways that investors can make money from real estate. All right. What are the five ways? Cash flow, appreciation, tax benefits, super nerdy. Five is principal. pay down? No, four is principal paydown. That's amazing. Yeah. And then the last is instant equity. Awesome. Okay. So I know that there's some people who are listening who heard what we just said and it sounds like jargon. So let's break it down. Let's start with that first one, cash flow. What is cash flow? When we talk about cash flow, that's the difference between your rental income and whatever expenses that you have. And then conclude a whole bunch of things. It can include the mortgage payment.

It can include taxes, insurance, and then all the other things that a lot of people I think sometimes forget, like property management, especially if you're out of state. Utilities. Sometimes you have to keep the lights on. Sometimes you have to keep the lights on. Well, somebody's got to keep them on. Somebody does. Someone does. Yeah. So, you know, the tenants might pay the utilities when they're in there, but if it's vacant during a turnover, for example. So yeah, all of those expenses, so income minus expenses, that's cash flow. People talk about, yeah, my cash flow is $700 a month, which is super cool. But let's remember, we also need to save money, right, for the time when the fridge needs a new light bulb or something like that.

So you want to have that money ready and you want to be able to hold that in your savings. How much is the light bulb in a fridge? Isn't that like 99 cents? You know what? Yes, that's correct. That was a very simple and cheap explanation. We'll go into like other explanations later on. I wanted to keep this non-threatening things, Paul.

Do I have to depreciate that light bulb? All right. Let's talk about that second one, appreciation. Appreciation is when the property value increases over time. And a lot of people love to talk about this because it's how a lot of money's been made since the economy starts to recover in like 2010, right? All the property values have been going up. There's been low supplies.

So people buy a house. And the next thing you know, it's increased 20%, almost 20% in a year's time, kind of like it did last year. I think last year it was like 18% on average. There are two types of appreciation, right, Paula? Yes. There's forced appreciation.

And then there's market appreciation. And market appreciation is what you like to, what we like to call speculation and what cousin Billy likes to brag about, right? Right. Exactly. Exactly. Random cousin Billy. So in our course in your first rental property, we've created this like composite character

of all of the people who say really dumb stuff about real estate investing. And they're always cousin Billy. And cousin Billy is the one who gets super stoked about market appreciation because he's like, oh my goodness, my, I bought this property and it went up, blah, blah, blah. blah, blah, blah, blah, blah, blah, blah. You know, like the person bragging at cocktail parties about the fact that they happened to stumble into the right thing at the right time. But the thing about market appreciation is it's outside of your locus of control.

100%. And that is why we consider it speculation because you hope it's going to happen, but you actually have no influence over it, right? There's nothing you can do to make all the houses around you worth more. Right. So if we're going to talk about appreciation, I actually prefer force. appreciation. And that is when you make improvements to a property that have a positive impact on the value. An example of this is, let's say three-bedroom, one-bathroom homes are $100,000 in your area.

This is just an example. These aren't actual numbers. But three-bedroom two-bathroom homes are worth $120,000 in your area. So if you can figure out a way to add an extra bathroom in, and let's say maybe that costs $5,000, you've just appreciated your property forced it to be worth 120, which means you have forced an extra 15% of appreciation onto your net worth. Right. And oftentimes you can do this just by rethinking the square footage, right? You don't have to necessarily do a new construction, build, and add additional square footage onto the property. That can be very expensive. But if you can rethink the layout and add a bathroom in a space that's being underutilized, then you're making the existing footprint more efficient. Yes, and even adding a bedroom like you did in one of your

properties when you started investing, right, Paula? Right, exactly. Yes. I took a two bedroom and turned it into a three bedroom simply by reimagining where the partition walls would go. And partition walls, by the way, are different from load bearing walls. They are very, very cheap to build and remove because they're not supporting the structure, they're just some studs and some drywall. Does that mean I can come in with a hammer next time you have a partition wall to remove? That would be excellent therapy. I would Instagram the hell out of that. Yes.

Let's hold Paul accountable, everyone. She said yes. So let me pause here because we're talking about the five ways that real estate makes money, right? Cash flow appreciation. We've talked about those two already. And we're about tax benefits, principal paydown, and instant equity. That's what's coming next. But let's pause here.

Given that the topic is long-distance investing, why are we discussing something that's so general as part of our inaugural series? Because certainly everything that we've been talking about applies also, even if you're house hacking or investing in your hometown. It's really important to understand the levers that you can pull when you invest. And I think that there are things that even more seasoned investors sometimes forget about. For example, last year I sold a property, and I actually totally forgot about principal paid out in terms of being one of my like make my bank account happy kind of levers. You know, so I think it's really good to, if you already know this, it's awesome to have a refresher. And if you don't, these are the pieces you should be aware of when you're investing. So in other words, it's that foundation that all investors need to start with and need to revisit.

regardless of whether you're investing locally or out of state. And as we get later into the series, we'll relate these concepts specifically to out of state investing. 100%. All right, let's talk then about the third of the five ways that real estate makes money, principal paydown. Principal paydown is the amount that you owe on your loan reduced by each payment that you make. The great thing is that if you have a rental property, the rent that you get from the tenant, part of that goes to pay down that loan. So over time, the total amount decreases. And when you get to the point where maybe you want to sell the property, you get all of that money back because now you owe the bank so much less, thanks to your tenants paying down that loan for you. And so when people say,

hey, I've got this rental property, but the cash flow is only 100 a month or 200 a month. I mean, sure, maybe the cash flow is kind of low, but the total wealth building is that cash flow plus the 800 a month in mortgage principle that their tenants are paying for them, plus the appreciation and the instant equity and the tax benefits. Exactly. And that 800 a month, if you hold it for five years, you get all of that money back when you sell it or if you decide to hold on to it long term, eventually the loan gets paid down. And then the $800 a month that's going to pay down the principal just comes directly to you because you've paid the loan off courtesy of your tenants.

Yeah. And I know that that's been – because it's invisible, it's often overlooked. We tend to – like our cognitive biases tend to over-emphasize what's salient. And by we, you mean me, right? No, I mean, generally, humans. You know, I hear this in my – in the students in my course where they're, you know, they look just at the cash flow. and they're like, well, I could be a server at a restaurant one night a week and make more than this in terms of cash flow. So why would I not just do that instead?

And it's because there are all of these forgotten ways or invisible ways, ways that are not tangible, they're not salient. They show up on your net worth statement, but they don't necessarily show up in your checking account. Not right away. Exactly. And that's why investing in real estate is not a get-rich-quick strategy. It's very much of a get-rich slow. It takes time. But the long-term benefits outweigh many other options that we have available to us. Right. Okay, so let's talk instant equity. What is that? Can you define it? Let's start with equity first. Equity is the value of the home that you actually own in excess of the loan. So basically, it's what you own. minus what you owe. Let's put some numbers to that. If the property is worth $150,000 and you owe $100,000 on it, your equity in the property

will be $50,000. When we move on to instant equity, that is what kind of comes into play, basically on the day that you sign the papers. When I want to buy a property, I make sure I'm buying it for a lower price than what the market commands, which is what gets me. that instant equity. So the day you buy the house, you get equity immediately. Yes, if you buy it for less than the market price, right? So if a property is worth $150,000 and I'm able to buy it for $100,000, that means I just had a $50,000 day by closing on the right property. And in this example,

that means that $50,000 day is $50,000 in instant equity because I'm, I'm a $1,000. Because I I bought it at that price point. And one of the things later in this series that we'll talk about is how to buy properties for less than fair market value so that on the day you buy that property, your net worth shoots up. Real estate's amazing. I think we skipped one. Yeah, I was about to say, I think we skipped depreciation. We did.

Yeah. We skipped the tax benefits. The tax benefits in real estate investing are huge. and they are so impactful that many people will start investing just for the tax benefits alone. There are a multitude of various types of benefits. Of the different tax benefits, depreciation is the one that we will focus on today, and that is the ability to deduct a portion of your property's cost each year on your tax return. So let's just use the roof, for example.

Average life of a roof, 27.5 years, I did look this up. So let's say you just wanted to deduct the roof. The IRS would let you deduct one 27th, one 27th and a half of the value of the roof from your tax returns. Now, to make this more realistic, let's expand the roof to everything in the house, the total value of the house. And the IRS will let you deduct whatever they consider. You guys can't see this. I'm using air quotations. Air quotations, useful life.

So from your tax returns, and there's no money leaving your account, but you still get a tax break on it. Right. Exactly. So every portion of the house, the windows, the siding, the roof, the gutters, all of that slowly depreciates each year. And that results in a tax break, even though you're not spending money out of pocket in a given year. And even though we know that real estate prices tend to go up long term, the IRS likes people who provide quality housing. So they kind of help us out here. Right, exactly. And a big part of the thinking behind that is that the value of any given piece of real estate is twofold. There's the underlying land and then there's the structure on which it sits.

And so the structure is depreciated while the underlying land tends to increase in value over time. And that, as an aside, is part of the reason that multi-unit properties, duplexes, triplexes, fourplexes, often tend to have better rental returns, you're consolidating multiple units of housing and increasing the density on that singular piece of underlying land. We won't jump into this right now, but increasing density has a lot of pro-social benefits in terms of making housing more affordable and improving communities, making places more walkable and housing more affordable. Like, I can, I'll go into my density, my soapbox later, some other episode in this series.

But one of the legacies that I want to leave and what I hope to spread through rental property investing is the encouragement of dense housing units, including both multi-unit dwellings, duplex, triplex, fourplex, multi-unit residential, as well as, well as increasing the number of bedrooms per square foot, taking something that was once a two bedroom and turning it into a three bedroom, for example, there are many social and environmental benefits to that higher density. A lot of times on the local level, there's occasionally, unfortunately, a municipal fight that needs to be fought in order to get that to happen. And that is one of the messages that I'm hoping to spread. So we'll get to that later, but

How did we get to that through depreciation? I don't know. I don't know. But I actually really love that because I invest in Indianapolis, right? And a lot of the older built homes only have two bedrooms and one bathroom. How many families can that actually support? Not many. And people are going to grow out of that.

And there's a housing shortage as it is, right? So if you can come in and make that more feasible to more people, turn it into a three-bedroom, one bathroom, then there's more housing available that actually fits growing families. Exactly. And then when you can increase density, say put in a basement unit that is legal, has all the things that you need to make it safe and to code, then you've just increased housing supply in your area. So, yeah, I 100% love this because you don't see the hedge funds doing a lot of this.

It takes a lot of the grunt work that can only be completed on the local level by your mom and pop investors. And this is how we can make housing better, one of many ways we can make housing better by spreading our message. Exactly. This would be a good time to pause. We'll take a quick break. And after that, let's talk about how real estate compares to other forms of investing, including stock and equities investing. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology built to a with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses

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We're back. There is a second question, a very common question, that many real estate investors want answered. And this question, like our previous discussion, applies both to local and a long-distance investing. Here's how that question rolls. Oh, okay, okay, okay. I'm starting to get it now. So you're saying there are a bunch of of ways to make money in real estate that are legal, but how do I compare that to stocks? The reason we're talking about stocks is because that's another really popular place to park your money and invest for retirement. And we know historically the two asset classes that have beat the pants off of inflation

are real estate and stocks. And so particularly right now in an inflationary environment, real estate and stocks are historically the asset classes with the highest likelihood to be able to beat inflation in the long term. And to do this, I think we should focus on three big pieces of investing. There are many more, but three of the biggest ones where we can compare real estate and stocks would be cash flow, appreciation, and leverage. So I think it'd be really helpful to talk about how they play out between these two. All right. So three big pieces, cash flow appreciation and leverage, We'll talk about each of them one by one.

Let's start with cash flow. Cash flow between real estate holdings and stock. With real estate, you get cash in hand in your pocket every month. You can use it however you want. Go the movies? Cool. Go buy a meal? Cool.

The really awesome thing is that even as you get that cash and you can spend the money that the real estate paid you, you get to keep the asset that earned you the money in the first place. You don't have to get rid of it. The underlying asset, right? Yes. Versus stocks. With stocks, you do get a dividend payout and you can keep that dividend, but that dividend typically is going to be fairly small.

Other than dividend investing, there's no income stream that comes from stocks. The primary way to harvest the wealth building that comes from stocks is by selling the underlying asset by selling some shares themselves, and then you lose that underlying asset. And then there's no more money coming into your pocket once you lose the underlying asset, which is the sad part. Right. I mean, zooming out, broadly speaking, any given asset earns money in two ways. There's capital appreciation, and then there's the dividend or the income stream that pays out.

And so when you compare stocks in real estate, stocks historically, sure, they have a small dividend, but the bulk of the returns come through capital appreciation. Real estate, by contrast, is biased towards the income stream. It's biased towards that quote-unquote dividend payment or that income payment. And so the nature of real estate investing, specifically rental real estate, income property investing, is that the structure of the asset class is tilted towards an income stream. And historically, that's how many investors have made early retirement possible or financial independence possible is by tilting their portfolio towards an income orientation. And then we have appreciation. When a stock price goes down, you lose net worth. And it's probably

going to stay that way until you get, hopefully, you get lucky and it comes back up. You don't really have a way to influence it, right? Right. And in fairness, we know long term, long term buy and hold, it will go up. It will come back. Right. If a property drops in value, you've lost net worth, but you can still make money off the cash flow. And one of the kind of examples of this was the last recession. In 2008, property values plummeted. But rents actually increased because the renter pool got larger after people got foreclosed upon and others were hesitant to buy. So the demand for the rentals actually increased. And that cash flow means you can still make money and make positive gains while you're waiting for the market to come back. Right. So in the 2008 recession,

real estate investors, rental property investors who were able to hold their properties because they weren't over leveraged, they still enjoyed cash flow monthly and they enjoyed principal paydown as their tenants paid off their mortgage for them. And then they were able to wait it out And of course, if they're buy and hold investors, which I encourage a buy and hold investing philosophy, we all know what happened next over the next 12 years, 14 years at this point. Oh, geez. It's 2008, 14 years ago? Am I doing that math right? I believe so.

Yep, 2022. My goodness. Over the next 14 years, we know what happened. We know how it recovered. And the other thing that we really like is that you can actually have a positive influence on appreciation. by utilizing forced appreciation and knowing your market. On the other hand, if you buy a stock, unless you know how to get on the board of that company, it is really hard to influence that stock price.

Exactly. And maybe it still is really hard. Well, and that's why I say what I love about real estate investing is that it's a hybrid between owning a business and having an investment. Because when you own your own business, if you're a small business owner, you have autonomy and authority over how that business is run. and you can make decisions that, for better or worse, improve or detract from the value of your business, that power rests in your hands, and that responsibility rests in your hands.

When you own equities, there's nothing that you can do other than rebalance your portfolio, shuffle your asset allocation, maybe tweak your asset location a little bit in terms of which accounts hold what. Otherwise, there's really nothing that you can do to improve your performance or your returns. I like to redefine fire, the acronym F. Financial Psychology, I investing, R, real estate, e-entrepreneurship. And I think it's symbolically significant that the R of real estate is in between the I of investing and the E of entrepreneurship, because I do see it as that perfect Venn diagram intersection between the two. That's very poignant. I love that. So in terms of how stocks compare with real estate, we've talked about cash flow and made the comparison.

we've talked about appreciation and locus of control, and we've made that comparison. The final piece is leverage. Sonny, do you want to talk about leverage and how leverage compares when it comes to leveraging stock trades, i.e. buying on margin versus leveraging into real estate. Let's talk about how lenders classify mortgages, aka the leverage that is used to buy homes in the real estate market. There are three different ways that lenders classify. mortgages. One is primary or owner-occupant, and those are for the homes that the people that you

will live in for however long you hold the home. Then we have second home mortgages, which a lot of people use for vacation homes when they want to get away for a little bit. Lastly, and the one that we will be focused on are investment home mortgages. So if you think about mortgages on kind of a spectrum, lenders classify mortgages based on use because prime homes, they want people to buy homes to live in. And these are usually, these usually have the cheapest, the smallest, I should say, down payments and the lowest interest rates to help people. At the other end of the spectrum are investment homes. And these have typically the highest down payments and the highest interest rates. The banks charge more basically for the investment homes

because you're using their money to make money. And this is where long distance real estate investing comes into play because if you're buying a home for investment purposes and you need to have 20% of that down payment ready, 20 to 25% of that down payment ready to buy a home, it makes a big difference whether you're buying a million dollar duplex in Boston versus $150,000 duplex in Kentucky. And so lenders classify mortgages based on use, primary home versus second home versus investment. And how else do they also classify mortgages? This is an awesome question because they also classify mortgage based on duration and term. Those two pieces, the duration and the term, will impact how much you pay each month

and whether you'll be able to make a profit if you rent out the property. So what are examples of duration and of term? We'll start with duration. What are examples of different durations of loans? Duration of loan refers to how long the loan lasts for. Sometimes you'll have a 15-year loan. Nowadays, there are even options for 20 and 25-year loan periods. My personal favorite is the 30-year loan because if you buy a home and you have it paid off or you're planning to pay it off over 30 years, that's when your mortgage payment is the lowest, typically. So that allows for an easier arbitrage opportunity between your mortgage payment and the rent you will collect. Right, right. And of course, duration also does affect interest rate. Correct. With the shorter duration, typically having a smaller interest rate, but the payment might be a little bit higher because it's compacted into a shorter period of time.

Right. And the other piece is term, which is really interesting because term refers to whether the interest rate is adjustable or fixed. If it's fixed, that means that for whatever time period, the duration of a loan, you agree on one interest rate. So if you lock in a 4% interest rate in 2022 for the next 30 years, that means in 2040. If you're still paying this off, you're only paying on a 4% interest rate, even if the going interest rate at that time is 7%. That is your interest rate forever. Adjustable terms mean that at a certain period of time, as agreed upon by the bank, the bank

can change the interest rate to adjust to whatever is. happening in the market and whatever that going rate is at that time. Right. So there's a lot more volatility with an adjustable interest rate mortgage. And so those are the three classifications of real estate loans. There's classification based on use, primary second home and investment loan. There's classification based on duration 15 year versus 30 year. And there's classification based on term, adjustable versus fixed. And all of those have an impact in the down payment and on the interest rate. Now, given that we are speaking to aspiring long-distance real estate investors, we've just established that along the spectrum of use classifications, investment loans will demand

the highest down payment and also have an interest rate that's many, many basis points higher than what you would pay on a primary loan. Should that scare people away? I don't think so. It's all a cost of doing business. I think that when you run your numbers, when you try to understand whether X home or X asset makes money, you just want to include the assumptions for that mortgage if it is a little bit higher. It's all about the money that you can make and there is a way to make it. So that would just be included in the overall assumption. So the emotional hit of having to pay us a higher interest rate when you know that you could get a primary at a lower rate is just an emotional hit that you have to bear so long as the numbers make sense on the spreadsheet. Yes, exactly. It's all about the numbers when you're trying to assess that piece.

But Sunny, I think the notable thing is that banks recognize that long-term real estate investing is low volatility enough that they are willing to be. give 30-year fixed-rate loans to buy and hold investors. You know, they're classified as investment loans. Sure, they have a slightly higher interest rate than your primary residence mortgage, but banks aren't offering the same types of loan products for ordinary individuals who want to buy stocks. If you try to do that with the stock market, the stock market version of a bank loan is buying stocks on margin, which is so much riskier than taking out a home loan. It's riskier because

the stock market's more volatile than the housing market. And with home loans, you get into this financing agreement where you know how much you have to pay and you sign it off with the bank. So the bank tells you, okay, here's your payment every month. And that's what you're going to pay for the next 30 years. But if you buy a stock on margin, you might have to repeat. You might have to repay that whenever that margin is called. And that can happen on any day at any time. And no one's going to make that payment for you. Right. Exactly. So the lender can make what's called a margin call where you have to sell off your assets, often at a loss, because the fact that your assets are dropping is what triggers the lender to make that margin call. You have to lock in your losses

in order to meet the margin call. So stock investing on margin is never something that I recommend, which means that a stock strategy and all stock strategy, ideally, in my worldview, is a zero leverage strategy. I agree with that 100%. The safest way to do it is to come up with 100% of the funds to buy the stock. And then that means if you want to buy that $100,000 with the stock, you need to have that $100,000 ready, which is a lofty sum. Right. And to be clear, I'm not drunk on the pro leverage Kool-Aid. like some real estate investors are. But a moderate to conservative level of leverage is a huge step up and can help beginners get started.

If your goal is to build a legacy for future generations and to make sure that you and your kids and grandkids have a better life than the one that you were raised in, oftentimes a moderate, reasonable, wise amount of leverage, nothing too crazy can be the thing that makes that possible. And carefully calculated, I think, too, knowing exactly what goes in and what comes out, which kind of brings us back to the cash flow component, you know, when you're looking at an investment and you're going to take on leverage, it's not enough to look at, hey, they're pay me $1,000 a month, and my mortgage is $9.50. I'm great. I'm on top.

Right. Yeah, exactly. You need to know how to run the formulas, run the spreadsheet, make the calculations, do projections so that you know property by property, what's a good idea and what ought best to be avoided. And I think that might sound a little intimidating to someone who's new, but it's really attainable. There's a lot of material out. there and when and at some point we will also be reviewing that piece probably of how to think about the costs, et cetera, that come into say a buy and hold. But that's a little ways down the road because we're still strategy agnostic. Right. And can you explain what you mean when you say strategy

agnostic? Yeah. So within real estate, there are so many ways to make money when you talk about how to invest. We've talked about buy and hold a lot, which is really popular. So like you can, you can buy a property and hold it for three, four, 27 years and just have that rental income come in. If you don't like hammers or toilets, there's other strategies that you can take on like investing in notes. There are storage units if you don't want to deal with people, renters and overhead at all. There's hospitality, kind of a hospitality bend with like short-term units or that sort of thing. there's just so many ways to make money. And we will be going through the different strategies that are available to investors on a later episode.

It's just really important that you understand the levers first before you start thinking about, hey, should I buy land and flip it? Or do I buy a doctor's office? Right. Exactly. Yeah. Do I go into offices or mobile home parks or storage units? Do I flip? Do I buy and hold?

do I wholesale? Do I buy tax liens? Exactly. Exactly. There are the different niches of physical space and then there are the different strategies of how you buy and sell said physical space. And the first part to understand is how to make money before you start looking at the physical spaces and how each strategy differs slightly in terms of like the cash flow or the things that you need to think about. You need to understand the basic underlying fundamental principles first. And so to recap what we've talked about on this episode, since this is episode one of the Invest Anywhere series and the Invest Anywhere series will run on the first Friday of every month. So to recap, we've talked about five ways that real estate makes money and it's cash flow, appreciation, depreciation, principal paydown, and instant equity. Those are the five ways that real estate makes money. And we've also compared real estate against stock or equity investing. And we've discussed how they compare with regard to the bias towards income, the methods of appreciation that you can obtain, and the use of leverage, those three verticals. To clarify, we also strongly believe in diversification.

So at no point are we just saying real estate is the only way to go. it's really important because if a single market has a rough time, other non-related investments can help ride it out. So we just wanted to make sure that we share the options of long-distance real estate as part of a diversified and balanced portfolio. Exactly. We'll come back to the show in just a second, but first. Hack the holidays with the PC Holiday Insiders Report. Try this PC Porchetta. Crackling, craveworthy.

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Okay, okay. Try the season's hottest flavors from the PC Holiday Insiders Report. Please feast responsibly. Earlier in this episode, we established the five ways that investors can make money in real estate. I'd like to relate that knowledge. to the selection of cities or towns from the perspective of a long-distance investor. So if you live in a high-cost city, you live in New York, L.A., and you've learned about the five ways that you can make money in real estate.

And that sounds all well and good in theory, but you don't know how to apply that to picking a city. That's what we're going to discuss next. You ready, Sonny? I'm ready. As you and I, Sunny, have been talking through this behind the scenes, we've come up with four different overarching classifications of cities and towns. The first are large, stable cities that have diversified economies such as Austin, Texas. You know that that's a city that's going to hold

its value, but if you are a rental property investor, you are priced out of it. The cap rates, the price to rent ratio, none of it works in Austin. And if you're looking for cash flow, it's really hard to find. Exactly. What is good about a place like Austin is if you are an investor who is looking for maybe a legacy property that you can pass off to the next generation and will hold its property value and continue to just be a strong asset, a place like Austin would be a good option for the property value appreciation play because of the diversified economy, because of the growth. Right, right, exactly. And so as a real estate investor, if you're trying to play to a little bit of both goals, you want some cash flow, but you also want stability and appreciation. The age-old question, the trade-off. Right. Exactly. Exactly. In that event, the thing to do would be to look at outlying areas where Austin, people who are getting priced out of Austin are starting to sprawl into. So Bastrop, Texas. For example, I've got a few friends who invest in Bastrop, and the market appreciation there

has been relatively strong, largely fueled by all of the economic activity in Austin. And so to relate this back to the five ways that you can make money in real estate, if you're looking for a place that has potential for market appreciation, the outlying areas outside of a high-priced city that are continuing to grow and getting population spillover from people who are priced out of that city, those are the areas where you're likely to get market appreciation coupled with the stability of being relatively close to a major city. And an entry price point that is feasible for an early investor. So that is one of the four classifications of cities that,

you and I have come up with, these large, stable cities with diversified economies that have opportunities in the far, far outreaches, the far outlying areas. The second classification are also large stable cities with diversified economies, but these are places where the price to rent ratios are still landlord-friendly. Indianapolis is a perfect example. And probably because they haven't, these cities haven't grown yet to the point where they could compare with something like in Austin, Texas, where they have as many employers, as much diversification opportunities. It's not as air quotations hot. Do you think a place like Indianapolis would be better as a cash flow play or a market appreciation play?

I've been able to experience both in Indianapolis. I think with the market getting hotter, it's been a little bit more difficult to get those cash flow plays, but they're still around. It is slowly, I've seen more growth in my portfolio due to appreciation than cash flow in these last two years especially. So there are opportunities for people who don't want to invest in smaller towns, there are still opportunities of large stable cities like Indianapolis, like Cincinnati, like Tulsa, Oklahoma, large stable cities where you can still get a little bit of both. Exactly. And be closer to the action. Yeah, that hybrid of cash flow and market appreciation. Now, by contrast, the third classification are locations that are pure cash flow plays,

and those locations tend to have a declining population. So Montgomery, Alabama is an example of this. Montgomery is the third largest city in Alabama, so we're not talking about a small town, but it is shrinking. its population decreased by 4% over the past decade from census to census. And so the drawback to investing in a place like Montgomery is the fact that the population is declining. And so it's not likely to be a strong appreciation play, but the cash flow there is amazing.

By contrast, and this is the fourth classification, there are also smaller cities and towns with rapidly growing populations. One example is Kearney, Nebraska, where the population has increased by 12.65% over the past decade, census to census. And Kearney is not a tiny town. It has a population of 34,000 people. So it's a small town, but it's not so small

that you would be at a loss for getting basic services, such as finding an electrician or a plumber or a roofer when you needed it. And so those four classifications of cities, number one, large, but you're priced out so you go to the outlying areas. Number two, large, but the price to rent ratios are still good. Number three, small with declining population and number four, small with growing population. Those are four different classifications for different cities and towns, and each one will be better or worse for how properties there are likely to make money with some being better cash flow plays, some being better appreciation plays, and some being a hybrid of the two. Sunny, I think it's

notable that even though we talked about five ways that you can make money from real estate, we've only in this discussion compared cash flow to market appreciation. Yeah, I think, like, for example, principal pay down, that takes place no matter where you invest. It's just important to remember so that you can calculate your returns correctly. Tax benefits important. I think the assumption right now is that we don't want to teach just for tax benefits. It's there. If people will get there eventually with their financial journey, super cool.

But we want to teach people how to make money versus just write off expenses. And forced appreciation is more a question. That's property to property rather than location to location. So if you're touring a specific home and you notice that the layout of the home is inefficient and you can build a partition wall to create an additional bedroom or bathroom, then you know that you're touring a specific home that has high forced appreciation potential. But that home could be located anywhere. That's location agnostic.

Yeah. And that's very market specific. Exactly. So that's how our earlier conversation on five ways that you can make money in real estate, that's how you can take that framework and apply it to this other framework of how to classify different cities and towns as you're thinking through the landscape of where might you want to invest. Largely, it's a values question. Do you value cash flow first and foremost, in which case you might be drawn to a Montgomery,

Alabama, or do you value market appreciation even if you had to trade off some cash flow for it, in which case you might be looking at a Kearney, Nebraska, or do you want that hybrid? I agree 100%. It's about what you want to get out of life. How do you want your investments to help your quality of life in the near term and the long term? So in what we've discussed in today's episode, we've enumerated many of the benefits that apply to all real estate investments. whether you're doing it locally versus long distance. The issue that, Sunny, I know you also feel very strongly about is that if you happen to live in a high cost of living area, you may feel as though you are shut out of the opportunity to invest in real estate because of the fact that you live in L.A. or New York and your family is there.

And so you're not interested in moving. You're not interested in house hacking, right? we want to make sure that ordinary mom and pop investors everywhere, people like you and me, feel empowered to be able to invest in real estate, even if you live in Manhattan. And I think the one other piece, just going off what you're saying, is the ability to live your life, the life that you want and still make the kind of financial progress you would like. You don't have to sacrifice. It doesn't necessarily, it's a series of tradeoffs.

Right. Life is always a series of tradeoffs, right? That's what Afford Anything talks about in the very intro to the podcast. We don't believe that you should have to trade off where you want to live based upon whether you want to be closer to your family or whether you have a job you really like or a lifestyle you really like. We don't believe that living that life should preclude you from also investing in real estate and making the kind of financial progress you dream about. Right. It's another iteration of not letting the tail wag the dog. If you're making a decision that is so fundamental to your life as where you live, if you're making that purely for financial reasons, isn't that a little bit letting the tail wag the dog? And I say that as somebody who has made that mistake, where I've let reason and logic overpower what I actually wanted, I would rationalize and justify to myself that this decision to live in a certain place. made sense, and I'd have a long checklist of reasons why it made sense, but at the end of the day, it wasn't what I wanted. And ultimately, it was in the long term, more expensive to undo that and restart my life elsewhere. And so what I've learned, the hard way, is not to let the tail wag the dog to think of the life that you want to design, and then ask yourself, how do I design that life in a financially wise manner. For many people, that means living in a high-cost area and therefore learning how to invest in real estate long distance. It means house hacking

might not be on the docket for you, but there are many ways to get started that don't involve house hacking. And that's what this continuation of First Friday episodes is meant to illuminate. So the next episode, we are going to be focusing more specifically on long-distance investing. We're going to be talking about the benefits and the challenges of long-distance investing now that the basic building blocks of making money in investing have been kind of laid out. This is really important for investors and for us, because we want people to live their best lives. That means having the whole picture, knowing what you're getting into, knowing what's going to make you fist pump and yell, and then also maybe having an idea of what could keep you up at night

and potentially how to work through those issues so that you're not driven out of the game too early and you don't have unrealistic expectations. So we really hope that people can tune in to the next episode, which will be the first Friday of May to further their journey and continue exploring the possibility of investing in real estate at a distance. Well, thank you for tuning in to this special First Friday bonus episode, which is kicking off this new monthly series. So once a month, on the first Friday of every month, Sonny and I will be co-hosting these episodes on real estate investing long distance

through this new series that we're calling Invest Anywhere. please share what you think. Do you like the series? Do you have questions? Come hit us up and let us know. You can go to Affordanything.com slash community to share your thoughts with the broader community or ping us on any social media platform and let us know. Remember, you can subscribe to the show notes for free at Affordanithing.com slash show notes.

And if you specifically want to know more about real estate investing, we have a free online book. It's called seven expensive mistakes that real estate investors make. You can download it for free at afford anything.com slash mistakes, which is kind of a funny URL to give to something about real estate investing. But it's afford anything.com slash mistakes. The final note that I want to close out with, and Sunny, I know you and I have had many behind the scenes conversations about this, is that real estate investing has been hijacked by the hedge funds. particularly in the past couple of years. Sunny, when did you start investing? What year?

2018. 2018. So you came into the scene right around the time that the hedge funds also... Yeah, the first house I moved into that I bought in Indianapolis, a lot of the houses in the neighborhood were owned by a very well-known hedge fund. And we've seen that trend play out for the past few years. It started, I started noticing it during the Great Recession, but it's amplified in the past few years as stock valuations have grown high and hedge funds have looked to other asset classes, many of them have moved into rental property investing in low cost of living or moderate cost of living areas like Indianapolis. And when more homes end up getting

bought up by Wall Street, renters end up with less flexibility, less autonomy, a distant relationship with their landlord because rather than interfacing with a mom and pop landlord, they're now interfacing with a Wall Street hedge fund that is not going to work with them. So it's bad for renters. And it's also bad for ordinary middle class investors, mom and pop investors who want a small portfolio of income properties, maybe three or four or five properties, to help round out a well-balanced and diversified retirement portfolio. And so That's a big piece of what inspired us to make this. We want fewer homes owned by Wall Street and more owned by ordinary mom and pop investors.

Like us. We have the ability to make decisions that aren't governed by an algorithm. If anyone who's lived in a big apartment complex has probably experienced this at some point or another where you can't really have a conversation about rental increases or any flexibility in your lease. Whereas if you're not dealing with a hierarchy of employees and math formulas and you are able to reach the landlord or one step from the landlord, there's the ability to have those conversations which really help also better people's lives. It takes away some stress, some of the financial pressure sometimes. It's just a different and better business model for the people. Exactly.

And that's what we're hoping to create and encourage. Thank you, Sunny, for co-hosting this First Friday series with me. Thanks so much for the opportunity. It's been a blast. And thank you all for being part of the Afford Anything community. This is Paula Pant. You're listening to the Afford Anything podcast with our new First Friday special presentation, Invest Anywhere. I will catch you in the next episode. Here is an important disclaimer. There's a distinction between financial media and financial advice. financial media includes everything that you read on the internet, hear on a podcast, see on social media that relates to finance.

All of this is financial media. That includes the Afford Anything podcast, this podcast, as well as everything Afford Anything produces. And financial media is not a regulated industry. There are no licensure requirements. There are no mandatory credentials. There's no oversight board or review board. The financial media, including this show, is a very financial media. including this show is fundamentally part of the media.

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