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Paying Off a Rental Property vs. Buying More: Which One Wins? (Rookie Reply)
00:23:21
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- [00:00]
A
Okay, rookies, Today we're pulling three questions straight from the BiggerPockets forums. And I have to say, this batch is a really good one. We have a question about whether to pay off your rental mortgage early or use that equity to buy more properties.
- [00:12]
B
We also have a question from someone who just got hit with a massive unexpected repair bill on their rental, and they're trying to figure out how to handle it without derailing everything they've built so far. That one is super real for Ricky listeners. And the third question is about analyzing a deal that looks almost too good to be true on paper. So we're going to walk through exactly how to stress test that deal before anyone pulls a trigger.
- [00:37]
A
This is the Real Estate Rookie podcast. I'm Ashley Kerr.
- [00:40]
B
And I'm Tony J. Robinson. And with that, let's get into our first question. So our question today comes from the BiggerPockets forums and it says, I currently own one rental property, free and clear, no mortgage. It cash flows about $1,100 per month after all expenses. A friend of mine told me that I'm leaving money on the table by not leveraging that equity to buy more properties. The home is worth about $280,000. I could pull out roughly 200,000 through a cash out refinance and use that as. And use that as down payments on two or three more rentals. But the idea of going back into debt on a property that is paid for makes me really uncomfortable. Is my friend right? Am I leaving money on the table? How do I think this through the right way? It's a great question. Paid for real estate is. Is sometimes one of the best assets you can have. But again, I think a lot of it does depend on the person on where that person is at in their investing journey. Are you closer toward the beginning? Are you closer toward the end? You know, what just kind of allows you to sleep it out. So there's a few things to talk through, I think first. Just like mathematically, if we were to look at the math, I think your friend is right. You are probably leaving cash flow on the table by having all of that equity tied up in one deal. And your return on your equity in that property is pretty low. Like you could get a better return on your investment by reallocating that. That equity across. You know, instead of one deal, having it across, you said you could buy two or three more properties. So instead of one deal having four. And if you look at your return now across all four of those and the actual cash flows, I Would assume that if we look at the numbers that that part is true. As would you agree with that? Like if we just look at the numbers, like that's probably going to be the case.
- [02:22]
A
Yeah. And I think what you could easily do is look at, okay, what could you buy with that down payment amount? So you get 200,000, so you're going to use $100,000 each on each new property as a down payment. What would those properties cash flow and what would your current property cash flow be? So what would be your total cash flow across the three properties? I mean it honestly could add up to exactly the same as what you have now. But now you have three properties to manage and three different types of overhead for three roofs, 3H vacs, things like that. So I do think like not only looking at the numbers but also the management piece of it. Now that you have three properties, that's more to manage, you have three more tenants in place. But then you should also look at the equity and the appreciation. Okay, so look at maybe your property as an example. How much appreciation has it seen within the past five, past 10 years? Now if you have three properties, are you able to get more appreciation across all three of them than you would with just this one property setting? So I do think that you'll probably end out better in the long run if you have three, three properties as an appreciation play than just keeping this one that's paid free and clear. I do think a big warning caution is that you use the word uncomfortable to describe yourself leveraging this property. I think if anything don't go for the full max cash out, refinance, maybe do something that makes you more comfortable. Maybe you just do 150,000, maybe a hundred thousand just for one property. Or maybe you go and get a line of credit on the property instead of putting a mortgage on it. So I think don't always let the numbers like be the best decision for you because money isn't everything and you don't want to not sleep at night because you're worried or over leveraged because you put financing and debt on this property and now you have three properties with mortgages when you just had one with none. I always like having a paid off property. I have several that are paid off free and clear and that it helps me sleep at night. And then the rest do have mortgages on them and maybe one day I would go and pay them all off. Right now I definitely cannot do that, but I do think it would be a really, really nice feeling. Is that probably the best use of your money? No, probably not. Debt is a tool. It is a way to build wealth for sure.
- [05:02]
B
Yeah, I think you hit the nail on the head, Ash. It's part of it is mathematical, part of it is personal preference. And if for where you're at in your investing journey you feel that having a paid off property is what will make you happier and feel less stressed and enjoy real estate investing more, then stay there. Right. Like. Like to your point, I think sometimes we do get caught up in the unit count and like squeezing every dollar out of our investments. But you have to ask ourselves, what was the reason that we started investing in the first place? And if for you it was the idea of appreciation and it was the idea of cash flow with with very little effort, well then you've checked that box with this deal, right? And why, why overcomplicate it? So I think mathematically there's probably a high likelihood that yes, you can get a better return on that equity, but you've got to also pair that with your own personal preferences. All right, coming up, we've got a rookie investor who just got hit with a repair bill that they were not expecting and they're trying to figure out how to handle it without bl everything they've worked so hard for. We'll get into it right after a quick word from our show sponsors.
- [05:59]
A
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- [08:27]
A
g.com bppod okay rookies, welcome back. So our next question comes from the Bigger Pockets forums. I am six months into owning my first rental property, a single family home and I just got a call from my tenant that the H Vac system completely failed. I got two quotes and the cheapest one is 8500 to replace the full system. I only have about $6,000 in my reserves right now, so I am $2,500 short. I am panicking a little. I did not expect something this big this soon. My questions are how do I cover the gap, what should I have had in reserves to begin with and what do I do going forward so I'm never in this position again. I feel like I made a mistake buying this property before I was really ready. This is I think literally every new investor's worst nightmare is buying the property and finding out they have a huge repair bill right after they purch property. So I think the first thing is I would recommend going forward is having an inspection on the property if you didn't already. But during that home inspection asking the inspector to kind of lay out the life use of each of the mechanics in the property. So have him date, you know, state what the ages on the current H Vac on the roof, on the hot water tank and in his opinion how long does he think it has life left in it. So does he think that, you know, what in one year, what does he think that you'll need to replace in two years? What does he think you'll need to replace in five years, what does he think you'll need to replace? And then in 10 years and have him laid out. If there's anything below the five year mark you can ask, especially now since in a lot of markets, not all of them, that it is a buyer's market, you can take, you know, ask for more time with your due diligence when you go under contract. And you can not just only have the home inspector come, but you can have an actual H Vac guy come and actually do a tune up or look at it and go through it and kind of give an assessment of what it looks like, how well it's running, doesn't need any repairs or anything coming up because your home inspector is not going to be looking in the parts and pieces of the H Vac unit and they're not going to be, I guess, an expert in all areas of the, the home and the mechanics. So you can always have a certified H Vac technician come in and actually look at something and say, you know, tell me about this, what needs to be done. And I have a tenant that's actually buying a property from me right now and they asked to have that done. They asked for, for to do and they had a home inspection done on the property and they just wanted to find out what is the life use of the H Vac, Is there any, you know, problems that might be coming up on it. And they asked to have an H Vac tech come and actually look at the system and give them an assessment of what he thought, you know, the lifespan of it. And this was just for planning purposes for them. They weren't, they made it very clear we're not going to ask you to replace it. We're not going to ask you to fix anything or do anything that we just want this for our own assessment so that we can prepare for when we would need to replace this H Vac unit.
- [11:42]
B
I think the other you answered that perfectly, Ash. And I think just like, hey, what, what can she do now? So she's short 2,500 bucks. I think the first thing I would do is I would shop, continue to shop around. She said she got two quotes. Try and get like six, you know, and if you can, call around to as many H Vac companies as you can and just let them, let them, you know, Kind of compete with each other to see who can give you the best price. Maybe another option is like telling them, like, hey, I. I've got 6, 500, or can I split this up into two separate payments? I can give you, you know, half now and half later. You know, maybe use a credit card to kind of bridge that gap if you need to as well. But I. I would definitely first try and shop around a little bit to see if you can get a better price. Because while two might be just the going rate in your area, who knows, you might be able to find the person who just started their H Vac company and they're looking to kind of be a little bit more competitive on pricing and they can give you maybe a. Maybe a break on. On what that is. So shop, shop, shop. See if you can find something that can do it for. For a better price.
- [12:40]
A
I just did that with an H Vac. I got three quotes. One guy never got back to me. I followed up with him. He's like, oh, I should have it for you this week. Never hurt back. So don't even know what that quote would have been. Another one, 30,000 contractor we use all the time for H vac for plumbing. Next one, 20,000. And that is $10,000 difference. And I think part of that difference was the other one. One was like a company, they have a lot of overhead. They have employees, they have insurance for their employees. Like, you know, they have a lot more overhead. This other guy was just a single guy, just had his own business, things like that. He has less overhead because he doesn't have employees and payroll to cover and things like that. So I think that definitely played a difference. Is actual labor piece. Also. Daryl's going to help him too. He said, hey, I'll be there the whole time to, you know, be your extra hand. Which, that goes a long way when, you know, installing something is just having somebody to run down and get the next piece or whatever. So, yeah, I think definitely shopping for options and maybe looking at, like Tony said, the smaller contractor that maybe just got started or something and. Or also, you know, the one that's maybe closer to retirement. Like, we're waiting for the H Vac to be put in on this rehab we're doing because our guy just bought a place in Florida and he'll be there for three weeks and then when he comes back, he'll get to it, you know, so it's not. This might not work for you if you have an urgent, dire situation to get something replaced, but I. I'VE also had a lot of luck hiring contractors that are kind of in that semi retirement era where their prices are more affordable because you basically they do it when they can. So maybe not this situation. It may not work out for you where they, you may need someone immediately available. But that's also some a way I found great contractors. And then I think the last question to address here is like how much should they have had in reserves? And I always like to say three to six months of expenses. So we don't know but I would especially your first properties, six months on the safe side, we don't know what you know, their monthly expenses were, what the rental income was on this property to be able to gauge how much they could have had. But I think Tony gave some great options to make up for the, the difference in the money that you needed. And there's probably a lot of companies too that offer payment plans, I would think, because I would think this probably isn't typical of just an investor, but I think the average homeowner, I mean you see all this data and statistics that an average American family does not even have $8,500 in their savings account anyways to cover an expense like this. So maybe there's some kind of payment plan. And I feel like you can get a payment plan for anything these days where you could look into doing something like that through some of the companies. Okay, we have one more question after the break and this is for anyone who has ever looked at a deal and thought, wait, this is too good to be true. Is it even real? We're going to walk through exactly how to find out and we'll be right back.
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- [17:34]
A
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- [18:51]
C
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- [20:00]
B
All right, welcome back. All right, our last question today is one I think a lot of rookies will relate to because finding a deal that looks great on paper is exciting, but it might also set off some alarm bells for a lot of people who are not sure whether to trust what they're actually seeing. So this question also comes from the BiggerPockets forums and it says, I found a small multifamily property at Triplex listed at $185,000 in a Midwest market. The current rents are 555, 75 and 600 per month, totaling 1725 per month. The seller says the expenses are low because the building was fully renovated three years ago. When I run the numbers using the 50% rule, the property seems to cash flow around 450 to $500 per month after a 20% down payment. And at current interest rates, that feels almost too good to be true for this price point. My concern is that I'm wondering if I'm missing something. The property's been on the market for 47 days, which also makes me nervous. What should I be stress testing before I make an offer? What red flag should I be looking for? And is a 50% rule actually reliable here or am I using the wrong tool? We'll talk about the 50% rule in a moment. But. But I think one of the things I just want to highlight first is that I hear this often from rookie investors where, you know, he says the the property's been on the market for 47 days, which also makes me nervous. I think that's a common misconception. Ash, I'm curious if you agree with me or not, but I think that's a common misconception of rookie investors where they look at days on listing as a proxy for Whether or not a deal is a good deal or a bad deal, the, the days on market is a combination of so many different things. First, this is a triplex. Maybe there just aren't a lot of people shopping for triplexes in whatever market it is that you're shopping in. Maybe there's a, maybe there's a chance that the, the, the, the agent when they initially listed it or the seller when they initially listed it, maybe they listed it too high. Right. Maybe the, the seller wanted $300,000 and the agent will like, you know, the agent says no one's going to buy it at that price. Or like, I don't care, I want to list at 300. And it sits. And there's also the fact that 47 days, five weeks isn't all that long for a small multifamily property to begin with. So I, I think I would maybe deprioritize or put a little less emphasis on how long it's been sitting and put a little bit more focus on your own underwriting and where does the deal need to land at in terms of purchase price in order for it to make sense for you? But Ash, I don't know if your take is different from mine.
- [22:18]
A
Yeah, we don't know the exact same market. So like this could be typical that properties are sitting on the market that long. There's areas by me where things are flying off, you know, the listings they're getting, you know, under contract right away they're flying off the market. But then areas like there's a ski resort town where stuff is just sitting and sitting. Sitting where 47 days actually isn't that long for properties that are sitting in this market right now. So first I would look at that as to what is the typical average days on market for this area and is that a long time? And then this is also a multifamily property where there's also a limited buyer pool compared to a single family home too. So again, in my area, multifamily tends to sit longer than single family just because there is a limited buyer pool too. And then I think you're really not going to know. Like you ask are there any red flags you should be looking for? And I feel like that's very, very hard to actually know until you go and see the property, walk through it and actually get a home inspection done. It's already been sitting for 47 days. You can probably put into your offer that there's, there can be an inspection or when you actually go to the showing, take A contractor with you to look at different stuff. One red flag may be maybe these people aren't paying rents and instead of going through the eviction, they're just going to put the property up for sale and just sell the property. Even though these tenants owe them a lot and they don't want to be stuck with them anymore and they want to sell the property. So there could be other things like that that's coming up that could be red flags, but you're not going to know and don't assume until you've actually gone and looked at the property and walked to the property. One thing that has really helped me in the past is going to the town. So this really is beneficial and easier to do when you are in smaller markets, but going to just the town clerk that knows a lot about what's going on with different properties. They, you know, they have their own water system in the town. They're going, you know, the property tax bills, all that. Usually a lot of that stuff goes through them. The planning board meeting minutes, things like that is go in and ask about that property. And I've got a lot of information about. They can tell you the gossip about the tenants, they can tell you about the owner. You know, they could tell you things they know of that happened at that property and things like that too. So I think, you know, making relationships in the market that you're investing in too, and then you can even reach out to the selling agent and just say, you know, reach out to them directly, not even using your agent, and just reach out, give them a phone call, send them an email, say, you know, I'm just curious, why has this property been sitting on the market for 47 days? Is there anything that I should be aware of? And a lot of times agents will be upfront with you because they know you're going to find out anyways and they're going to tell you the issue. And I've had this, I've been told many times as to, I want you to know up front, here are some things that's why we haven't had somebody buy it. These are the things that you need to know that they may not put into the listing agreement. So I would try some of those things, but don't assume that something is actually wrong with it without actually going and looking at it.
- [25:37]
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And I think I would just try and really go a little bit deeper on the numbers that the seller's providing as well. Like, like, was that just like a verbal thing that they gave you or was there A PNL this year. Was there even a tax return? Maybe that'd be like the most, I think concrete. But you know, like call your local utility providers and maybe tell them like, hey, I'm looking at buying this property. I'm just trying to get a sense of, hey, what was the average, you know, electric bill on this property for the last 24 months? What was the average gas bill? What was the average, this bill, the water bill, what's the trash bill look like? Right? And you can start reconstructing some of those expenses yourself. And then if you're really still questioning even after all that, well, then just kind of stress test the deal a little bit further. Like what happens if the expenses are 10% higher or 15% higher than what this person said, or maybe 20% higher. Does the deal still at least break even if your numbers are way off? So I think anytime you're underwrite a deal, like obviously have your most likely case scenario, but then also stress test it and maybe worst case scenario and see, okay, if things really don't go according to plan, how bad could things get? And for me, I typically would like to at least be able to break even in a worst case scenario. So, man, if I, if I completely missed the mark, can I at least still break even on this deal? And if I can, that's what gives me the confidence to move forward.
- [26:48]
A
Well, thank you guys so much for joining us for this episode of Real Estate Rookie. I'm Ashley and he's Tony. And if you guys aren't already, make sure you are subscribed to our YouTube channel at realestate Rookie. We'll see you guys on the next episode.
- [27:01]
B
Hey rookies, if you're watching this, we want you to apply to be a guest on the Real Estate Rookie podcast. That's right. Ashley and I are looking for amazing stories just like yours to be a part of our Real Estate Rookie podcast. Now look, you don't need to be an expert. You don't need to have done thousands of deals. Even if you've done one deal, your story could help inspire the next listener
- [27:19]
A
as a rookie investor. Especially if you just got your first deal. It is all fresh in your minds and you are the best person to tell your story, give your experience on how you got it done to help someone else get their first deal.
- [27:32]
B
So head over to biggerpockets.com guest if you want to be a part of our show. Again, that's biggerpockets.com guest and we'd love to have you on.