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Real Estate Rookie
Should I Keep or Sell My Rental Property? (Huge Equity Gains) (Rookie Reply)
00:25:49
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- [00:00]
A
What if the deal your mentor told you to buy is actually a trap? A cheap property in the wrong neighborhood that eats every dollar you thought you'd cash flow.
- [00:09]
B
Or maybe you're house hacking and your roommate just trashed the place, but you never had them sign a lease so now you have zero legal protection.
- [00:17]
A
And what if you're sitting on three rentals with $700,000 in equity and sub 30% interest rates? Is it smarter to sell, borrow against them or just let them ride? Today we're breaking down all three of those questions. This is the Real Estate Rookie podcast and I'm Ashley Kerr.
- [00:40]
B
And I'm Tony J. Robinson. And with that, let's get into our first question which comes from the Bigger Pockets forums. This question says I'm looking to acquire my first property in 2026. I've been eyeing a few markets in the Midwest and came across this deal. The purchase price is $70,000, so closing costs are just over $1,000. My down payment is 30% which is $21,000 at 7 at a 7.1% interest rate. Property taxes are $612 annually. Insurance is $276 annually. That is a crazy low insurance cost. The rental income, it's currently occupied at $750 per month. It's about a 7% cash on cash return. Home is turnkey with the option to do a slow burr. Looks like it could use some basic cosmetic updates. It's located in a C class neighborhood in Indianapolis. I have my vacancy rate higher than I would expect due to the C class neighborhood. Even at 15% occupancy, it still cash flows solidly at 5%. Anything as a beginner that I'm missing. As an FYI, I would be an out of state investor as I live in California, Florida, I always get the California investors looking to invest elsewhere with with the questions. But I think a few things jump out to me on this deal. Number one is First Insurance at $276 a year. That seems super cheap. Ash, have you ever had a property where insurance for the entire year is only $276?
- [02:14]
A
No. And that was going to be my first thought, thought or question too as to where did this number come from? Is it an actual quote? Is it from the seller or you know, where did that come from? Because in my experience I've, you know when I was looking at buying a campground I asked you know, what was your insurance you pay each month? And he told me or whatever and he sent me the policy in every single cabin was A wood burning stove. And this policy did not cover wood burning stoves. And if any of those wood burning stoves caused a fire, they wouldn't have covered a thing. So I think one important thing is like, if you are getting that information from the seller, ask to look at the policy and see what is actually covered on the policy. Like maybe it's just a liability policy. Maybe they don't have a mortgage on the property. So they don't have any like property coverage, which I've bought in houses like that where people, the investor just says, I self Insure, it's a $30,000 duplex. If it burns down, it burns down.
- [03:16]
B
Yeah, that's, that's a great point. Yeah, but I, yeah, I, I just, and again, I've never invested in Indianapolis, so I, maybe I could be wrong, but that feels incredibly, incredibly low for any piece of real estate to be, be insured for an entire year. I think the other thing too is that when we talk about like class of neighborhoods, right, and they're, you know, A class B class C class D class, we're talking about a few things. Sometimes it's, you know, you can look at things like the average income of folks in that area, the, the school ratings in that area, and just the general kind of demographic makeup, socioeconomic makeup, maybe of the folks who, who would be coming into those units. And in a A class neighborhood, we're talking premium rents, typically higher income earning individuals. And in a D class neighborhood, it's the inverse of that, right? It's typically lower income individuals, lower end of the rent spectrum. And the kind of wear and tear on the property is, is, is kind of higher on the low end if you're in a D class neighborhood. And it's, you know, maybe a little bit easier in an A class neighborhood. So I just, you know, I, I guess I just want to make sure that we're accounting for the fact that, that if this is a C class neighborhood, A, can you validate that it actually is, given that you're in California and that you're not actually walking into like some kind of war zone in Indianapolis. And then B, if you have valid, validated that it is a true C class neighborhood, just making sure that you're actually accounting for some of those things that, you know, he did say 15% vacancy rate, which, you know, maybe that's enough, maybe it's not enough, but just making sure that we're accounting for the fact that different class neighborhoods operate in different ways.
- [04:54]
A
This is one mistake that I made when I first started investing was I was only looking at cash flow. And I realized 10 years later that the real wealth is from appreciation in that mortgage pay down in the equity you're building up in the property. And you can get a lot farther over time by also focusing on appreciation. I bought it first, really, you know, small duplexes for 20, 30, $50,000 in these class C neighborhoods. And they cash flowed pretty good, but they were headaches. There was the, you know, the tenant pool wasn't as great. A lot of people in these areas struggled to have a great credit score. So it really made it hard to screen someone that, you know, had great credit already, lots of turnover. Then these properties, you know, they had cosmetic updates, but just like this property, you know, over time it's going to need repairs and maintenance because it was just never done correctly. A lot of DIY behind the scenes on these properties. So in that scenario, like it sounded great. I'm getting these cheap properties. I'm getting into real estate investing. And yes, they were the foundation for a long time of my real estate portfolio and got me to where I am today. But they saw very low appreciation. So for example, I One of the $20,000 duplexes I bought, I was able to sell it for four years later for 20 or for $40,000. So I doubled my money on it. Like, wow, amazing. But that's only $20,000 I made on that. Another property the same time period got over $100,000 in equity because it was in a better area, better class of tenant, and just a better property overall. And looking back now, what I would have done different is I would have not as bought as many properties, but bought better quality properties and not have had as many. But I was too focused on cash flow and not thinking about appreciation at all. And I missed an opportunity there. And the only reason that my class properties sold for double is because the market was perfect and there was no timing on my part. That just happened to be. I got to buy my properties from 2013 to 2018, and then I was able to offload a lot of those dumpy duplexes, I call them in 2020, 21, 22, when the market was super hot. And that was the only reason I probably ended up making money on them.
- [07:19]
B
Um, great, great point, Ash, about like quality of the portfolio versus quantity. Um, I, I also just want to quickly cover the math, right? Because if we look at the numbers that this person gave on the rent amount of what did they say, 750 bucks per month, principal interest Taxes and insurance again use the numbers that you gave us is about 400 bucks per month. Uh, vacancy uh, at 15% is just over a hundred bucks. Repairs 10% another 75 capex even if we're being like conservative at 5% which I feel like you might need more is 30 is about 40 bucks per month. And then a property manager at at maybe 10% is 75 bucks. So the actual cash flow on this thing is when you account for all of those expenses is like 50 bucks a month. So you have to ask yourself if 50 bucks per month on a $21,000 investment is that worthwhile to you. Oftentimes, rookie investors, they just think about principal, interest, taxes and insurance is all of their expenses. But you've got to account for everything as well. Maintenance, capex, property management fees as well.
- [08:23]
A
Coming up if you're house hacking and your roommate isn't on a lease, he might already be in legal trouble. We'll break down how to protect yourself. We'll be right back.
- [08:33]
C
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- [10:44]
A
Our second question today comes from a SoCal investor in the Bigger Pockets forums. I have four rentals, all single family homes bought starting in 2013. Three are in Southern California and have appreciated quite a bit. In the three SoCal houses total, I'm now looking at $703,000 equity split among the houses 162k to a 4k and 336k. Okay, the cash on cash return is good compared to my original investment, but if I do an ROE Cal return on investment it's really only around 3.5% to 4%. All of them were refinanced and have 30 year interest rates between 2 1/2 to 3 3.5%. This was a VA home loan. I've considered lots of options selling and getting something local in SoCal 1031, exchanging into out of state cash flow markets or cash out refinancing. I feel like the big equity gains are already realized here so there isn't much point holding up for more. What would you do? I think before we even get into answering this question we need to break down a little bit of the metrics here. Roi, roe, cash on cash returns. So let's start with return on investment. So this measures the total return that is relative to your original investment put into it. So he bought it in 2013, the property has doubled and he's earning cash flow on top of it or tripled for some of the properties. And so for return on his investment, this actually has been a great decision on his part to buy these properties
- [12:26]
B
and return on equity or ROE as he said in the question, measures what your trapped equity in this property is actually earning you right now with $703,000 in equity sitting in these properties generating three and a half to 4%. The question is, is that the best use of this $700,000. And I think that's what we're trying to answer here. Right? So like the, the key point here is that ROI looks backwards. Was this a good deal? Roe looks forward saying, is this still the best use of the equity and the money that I've generated? Both matter, but the return on equity helps you drive or helps drive your next decision.
- [13:07]
A
So let's look into one of the scenarios here. What if he decided to sell one property and 1031 it into another property in the Midwest? So let's, for example, take the 336k equity property. We're going to sell it for 500,000 and we're actually going to net 460,000 after cost. Okay? So we're going to do a 1031 exchange. A 1031 exchange is where you sell the property and you're deferring your capital gains tax. So not eliminating tax, you're just deferring it. So you don't have to pay any tax on that gain when you sell the property, but you have to follow the 1031 exchange rules. Okay? So you have to identify another property that you're going to purchase with those funds. Okay, so we're going to say he does the 1031 exchange and he's going to go ahead and buy two $230,000 properties each in the Midwest with putting $115,000 down on each of them, which will give him 50% loan to value.
- [14:09]
B
And if we look at the midrest rents, and I'm using just some examples obviously, right. But let's say that they rent between 1800-2000 bucks per month at 7% interest rates. We're probably seeing today the cash flow per property, after all expenses might be somewhere around between 300 to 400 bucks per month.
- [14:24]
A
Month.
- [14:25]
B
That's 6 to $800 per month in total versus maybe the, you know, 200 bucks per month the SoCal property was generating. So the return on Equity jumped from 3 1/2% all the way up to maybe 7 to 9% on the, on the deployed capital, so that the cash flow basically triples or quadruples from this decision. Now, the catch here is that, you know, we're, we're giving up a almost irreplaceable two and a half percent, you know, 3% interest rate. You know that, that sucks, right, because that debt is locked in for 30 years. But you have to ask yourself what makes more sense, right? Is it maybe losing some of that, that interest advantage on that deal over the long term or is it getting the additional cash flow and better return on the investment today?
- [15:11]
A
Okay, let's look at scenario two. And scenario two is where he's going to take a line of credit to actually tap into the equity of these properties without selling. Okay. So on the $336,000 equity property, most lenders will go and lend you up to 80 to 85% of the loan to value minus the balance you already owe on the mortgage payment. So your Property is worth 100,000, they'll lend you up to 80. But say you have a mortgage of 40, that 80 minus 40 leaves $40,000 of a line of credit that you'd be able to get on that property. Okay, so for this one he might be able to access between $120,000 to 150,000. Now he's going to use that as a down payment on a new property in the Midwest and he can keep his 3% mortgage on that other property and add a new cash flowing asset by using the line of credit. So interest rates on lines of credit between 8 to 9%. Actually I just got a notice in the mail that my one line of credit went down to 7.75%. I was so excited. I was like, oh my God, is it that low forever? I think when I first got that line of credit was like 6.5 my line of credit. So it's working its way back down me hopefully. Okay, so 8 to 9% in this scenario we're going to say 130,000 borrowed for that down payment and that would be about $870, maybe a little more.975 per month in interest only payments. Okay. So your new rental has to cash flow enough to cover that payment and still leave you positive. Plus you need to have a plan in place to actually pay off that line of credit. So I would look into it to make sure that you're going to be able to make some principal payments on that line of credit also.
- [17:02]
B
Yeah, I think the other thing too, we didn't like model the math on this one. But as you're talking, as you came to mind, I think the other scenario that will work here as well, and this kind of ties into the first question is well maybe you use your, your line of credit and the funds from that to not, you know, not, not to put it directly into a down payment but to put it into a brrrr opportunity and maybe you're taking that money, combining that with some hard money and now you're going out there and you're burying properties in the Midwest. And now every time you close on that refinance for the bird property, you can pay back your line. So now it becomes this almost reusable source of, of, of funding that you can use to continue to build your, your portfolio. And I mean, and with 700k in equity right now, I mean that's a lot that you can go deploy from these different lines to hopefully burr a lot of properties in a short period of time as well. So the upside there, right, is that you keep all the SoCal properties, but then you're leveraging that equity to burr additional properties in these other markets. And every time you close on a refinance, you're paying back that line of credit. So it could be maybe the best of both worlds. You get the SoCal properties, equity continues to grow there, you keep the super low rates, you get the appreciation and the portfolio grows without actually selling anything.
- [18:09]
A
Okay, so let's go to scenario three where it's just, you hold everything and let it ride. So SoCal has averaged 5 to 7% annual appreciation if you're looking at the past 30 years. So on 703,000 in equity, that's about 35 to 49k in annual wealth building just from appreciation alone. Okay. And that's also tax deferred. So now if you add in mortgage pay down across the three properties, that's, you know, every year you're going to increase more equity, maybe 5 to 8,000 per year in cash flow. You're also getting and plus tax benefits of owning real estate. So your total annual return of just looking at that may be 55 to 75,000.
- [18:57]
B
Yeah. So, so there is kind of an argument for doing nothing as well. Right? You're, you're sub 3% debt on strongly appreciating assets in California might be the best financial position. Right. And trading that for 7% Midwest cash flow might look smart on a spreadsheet today. But you're trading an asset that builds long term wealth for one that just pays you monthly. So I think a lot of it depends on what this person actually needs. Right. Do they want monthly income right now, you know, portfolio growth without necessarily messing up their, their current equity or, or just continuing to build long term wealth. Right. And I think each one of those kind of lends itself to a different situation. All right, we're going to take a quick break before our last question, but while we're gone, be sure to subscribe to the RealEstate Rookie YouTube channel. You can find us at RealEstate Rookie. And if you want to be a guest on the Real Estate Rookie podcast, head over to biggerpockets.com guest be sure to apply and we'd love to get you as a guest on our next episode. We'll be right back after this.
- [19:49]
A
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- [20:56]
C
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- [21:37]
A
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- [22:55]
C
to call real estate passive income, which is interesting because most of the investors I know are very busy. Busy finding deals, busy managing teams, busy worrying they picked the wrong market. Rent to Retirement flips that model. They help investors buy turnkey new construction homes, often 10% below market value, in top rental markets across the country. Their local teams handle the build, the property management and the details so you don't have to. In some cases, Investors even receive 50 to 75% of their down payment back at closing. And there are interest rates as low as 3.75%. They've been trusted partners with BiggerPockets for over a decade, and if you want to learn more, visit biggerpockets.com retirement There's a point where basically every investor realizes traditional financing stops scaling with you. At first, it works. You qualify with your income, your job, your tax returns. But as you grow, that model starts to break. Now it's not really about your personal income, it's about the income from your properties. That's where DSCR lending comes in, and it's why a lot of investors end up working with lenders like Host Financial. Host Financial qualifies deals based on property income, not personal income. So you're not dealing with W2s or tax returns or DTI constraints. And with 80 to 85% LTV, you can stay more flexible as you scale, it's just a different flow framework, one that tends to align better with how investing actually works. If you're buying rentals, refinancing, or growing your portfolio, go to host financial.com that's h o s t financial.com and see what you qualify for.
- [24:31]
B
All right, guys, welcome back. We're jumping in with our final question and this is one that almost every single house hacker should be hearing, because if you get it wrong, it could cost you big time. So this question says, when house hacking, do you have the hackie? I haven't heard that phrase yet. The tenant who would be staying with you sign a rental agreement? If so, does anyone have advice on where to get one drawn up or have an example of one that they have used? Now, Ash, I know you haven't house hacked with roommates. In this sense, I haven't either. But I'm assuming both of us would have a very strong answer to this, which is yes, even if you are house hacking, there is still a landlord tenant relationship and because of that, you should 100% still get them to sign a lease. The lease is the backbone of that relationship between you and the tenant. And you said hacky, but they're still your tenant, right? So all of a lot of those laws still apply. So the short answer is yes, go out, get a lease. We've got so many episodes in the archives. Like if you just search real estate rookie and house hacking, you'll see so many different folks who have come on, shared their stories, shared their experience about how they put together their leases from. From a house hacking perspective, I think that'll give you a lot of the insights you need about what to put into that. And then go sit down with an attorney, let them review it, and give you the once over and the final approval on what that lease should look like.
- [26:00]
A
Tony, I'm honestly shocked and maybe a little disappointed in you. You're entrepreneur, businessman, and your son just turned 18 and you do not have a lease agreement with him yet to be renting a room in your house.
- [26:15]
B
That is very true. I need to get him on a lease. My first house hack.
- [26:19]
A
Just so we have content for the podcast, you need to now have experience house hacking by renting to your son that he's 18. BiggerPockets. If you go to BiggerPockets.com there's lease agreements that you can use that are state's specific. If you're a pro member, you'll be able to access those for free, or you can pay for whichever state that you need. But I think that's a really great starting point is looking at those lease agreements that were drafted by attorneys in your state that you're investing and then reading through every single thing. And I want you to think of like outside scenarios that may not be in there, especially with house hacking as to like, what are the rules of the kitchen? What are the rules for parking, you know, or do they have a parking spot? Do they, Is it shared parking with you? Are they parking on the street? Like, try and think of different pain points and just draw it out as to, you know, put it into the lease agreement so it's just clear, it's clarified even how should rent be paid? You know, if they say, oh, I left it on the counter for you and not on the counter, you know, like, that's not the best way to, you know, receive rent. So. So if you can think of every little scenario and add them in. AI put the lease agreement into AI say, this is my situation. I have a roommate, we share a two bedroom house. What are some things that I should be putting in this lease agreement to avoid conflict with each other and to protect myself? And just see what it says, put it in there and see what feedback it gives you. And there might be some things that you find useless and things, some things you think like, yeah, actually that is a great idea. And go ahead and plug it into the lease agreement and then final thing, I would send it to an attorney and ask the attorney to review it. So much cheaper than asking an attorney to draw up something for you from scratch. They usually have a template anyways, but this way you're not paying for them to send you something and you revising it all so that it fits your property specifically. But actually drafting it up and then sending it to them to review will be a lot cheaper to ash.
- [28:31]
B
You made a really good statement about like, reducing conflict. And I think that's a big value prop of a strong lease, is that it does reduce conflict because you've already outlined how certain situations will be handled if they arise. And I think the better job you can do of communicating the lease clearly, I think the easier it becomes. And you know, we've had so many folks who we've interviewed on the podcast. Dion McNeely, Grace Gutenkopf, Amelia Grayson. Amelia, like, and they talk about how they have those conversations with their tenants when they first become their tenants to make sure that there's clarity in what the lease actually expects of them and then what they can expect of, you know, for them as a landlord as well. And that helps reduce a lot of that, that conflict and friction. So I just want to highlight that because it was really well said, but
- [29:20]
A
it's from my own experience not wanting to have to deal with conflict between tenants. Thank you guys so much for joining us for this episode of Real Estate. Ricky. I'm Ashley Hughes. Tony. And don't forget to check out becoming a BiggerPockets Pro member. You can go to biggerpockets.com pro and check out our pro perks. We'll see you guys next time.
- [29:41]
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 at 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
- [30:00]
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.
- [30:13]
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.