Seeing Greene: Retiring Early, ARMs vs. Fixed-Rate Mortgages, & When to Sell

David:
Repositioning equity when it’s worth converting a single family house into a multifamily property, or you should just buy more properties.
What’s going on everyone? This is David Granier, host of the BiggerPockets podcast. Join with my good friend and fellow co-host, Rob Abba Solo on a Seeing Green episode. If you’re listening to this podcast, you are part of the growing and thriving BP community, and this show is where we get to connect with community members like you directly by answering listener questions that everyone can learn from Rob. And I’ll be sharing our years of real estate experience, knowledge, and know how with all of you to help you build wealth through real estate. Rob, what can people expect out of today’s show?

Rob:
Alright, we’re talking about some pretty cool things here. We’re talking about how to get the most out of the BiggerPockets forums. This is just filled with five tips here that are going to help you really excel in your real estate career. We’re also going to be talking about gambling with interest rates and when you should take an adjustable rate mortgage and when you should pass.

David:
That’s right. And make sure you listen all the way to the end of the show where I jump in with Mindy Jensen answering questions from a gentleman who’s trying to get to financial independence faster so he can quit his job. So Rob, good news, you’re only going to have to be here for a short period of time and then you’ll be free to go get some Chipotle.

Rob:
Fantastic. Well, hey, one quick thing before we get started today. If anyone at home wants a chance to ask their question, feel free to head on over to biggerpockets.com/david. The link is in the description, so be sure to pause this, send us your questions and let’s hop right into the show. What’s up,

David Xavier:
David Xavier from Boston, Massachusetts at a question about equity. I’m currently set on about 300 to $400,000 of equity on a single family home and it’s this home right here. I’m currently in the process of doing a change of OCC from a single family to a three family home just to kind of get the rental property going. I was curious what you would do. Would you continue with that process to stay in the city while earning your income or would you take that equity, leave it as a single family, take that equity and you two invest in other properties? Lemme know what you think and let’s go Celtics.

David:
Alright, so Xavier here is faced with a dilemma. Does he keep his property worth about $300,000 of equity in it? Turn it into a three family or a triplex or basically a three unit property to increase cash flows, which I call forcing cash flow? Or does he sell the property and use the equity to buy additional properties outside the city limits of Boston? Let’s say you Robbie,

Rob:
I got to give me a second. I got to park the car first, before I can answer this question. I

David:
On Harvard Street by the har.

Rob:
Yeah, I got to pocket the car on Harvard yard. Okay, we’ve been faced with this question before. I think the hardest part about getting into real estate is picking the house, getting over your analysis paralysis and then buying the home. He already owns the home and he said in his own question, should I keep the home where I could earn higher cash flows because it’s in Boston or should I sell it and then go buy a property outside of Boston? Well, he already owns it and if he can get higher cash flows as a result, he should just do that for a couple of reasons. If he was coming to me and saying, Hey, should I buy a house in Boston where it’s really expensive in 2024 when interest rates are seven 8%? I’d be like, yeah, you’re probably not going to cash flow. But if he bought this property in the last say five to seven years, he’s got a three or 4% interest rate and as a result he’s going to cashflow a ton, then I think he’s going to have a really great equity play here in the future. I think he should hold onto it cashflow what he can. What do you think?

David:
I think if I gave him $300,000 and said, Xavier, do you want to use this $300,000 to buy this property and turn it into a three family or do you want to use it to invest outside of Boston and buy several properties? Which one would you do? So let me say, I’m asking you the same question, Rob, how would you consider that?

Rob:
I think it’s so much trouble to go out and buy property. I mean, I don’t know how much he’s going to cash flow on this, but he said higher cash flows, so if he’s going to have a higher cash flow as a result of having this house, I don’t see why he would sell it to then maybe go get maybe a slightly better return but less cashflow in a random market. Yeah, you

David:
Got to ask yourself which of the two markets are going to appreciate more? And we don’t know this market particularly, but typically inside the city limits is going to appreciate more than outside the city limits in the suburbs because that’s why they build outside of city limits is they ran out of room inside the city and so they’re going out. So usually keeping a property inside is better for long-term appreciation. Do you want to have one property with three units where you get more cashflow or do you want to buy more but you take on more debt? So if you’re trying to grow, you can take that $300,000 and put a hundred thousand dollars down on three different properties and you could be borrowing 400,000. So you actually could end up with 1.2 million worth of debt and three properties if you can find properties that will cashflow. And I think that’s the rub is you and I look at a lot of properties, it’s very difficult to find anything right now that’s going to cashflow anything near a big city. So what you end up with is the same problem you have with this one. It doesn’t cashflow much and I want to increase the cashflow.

Rob:
I don’t know. He says right here, should I keep it as three units where I could earn higher cash flows

David:
So he can keep it and convert it and do the work and make it cashflow better than it is, but he’s not adding to his portfolio, he’s not taking on more debt, he’s not growing the portfolio nearly as much with one property that has three units versus three properties that he may be able to add units to those ones too. So it’s really about do you want to go bigger,

Rob:
More leverage?

David:
Yes. Or do you want to keep it tighter and have a little bit less management, but more work to convert the properties?

Rob:
Yeah. Okay. So scenario A, keep it cashflow higher. I think scenario B, leverage, leverage, leverage, get into more real estate, possibly cashflow less in this market. I’m going to go cashflow always. I think I change back and forth. I waffle on the situation. I don’t know if he wants to grow. If he does go do that, go leverage. But if he’s like, Hey, I just want to make money, which it seems like that’s important to him, I take the higher cashflow route pretty much in most scenarios.

David:
I think that’s a safer route in today’s environment. I would rather see you get the highest and best use out of the property that you have and keep saving money and as you save up money, you can go buy more properties outside the city

Rob:
Limits and then if you can convert this from a single to a triplex effectively and get significantly more cashflow as a result, that to me is still less work in my opinion than going out and buying three properties, setting up the property managers, finding the handyman, finding all the pest control, all of the CapEx team, the core four if you will, assuming that they’re in different markets and everything, even if it’s the same market. I still think that’s a lot more work buying three properties versus just converting one. I’ll do that one 10 times out of 10 I think. Yeah,

David:
The only variable we haven’t discussed here is how much money and time he’s going to have to put into the renovation. We’re assuming converting this into three different units is not that expensive, but if you’re going to drop $200,000 to do this, that’s a different story. In which case you might be better off redeploying.

Rob:
Yeah, he didn’t mention it, so it makes me believe it’s maybe easier,

David:
Minimal.

Rob:
Yeah, exactly. If he was like, Hey, it’s going to cost me half a million, I’d be like, Hey, don’t do that. That’ll be a lot.

David:
Great point. Yep. That’s what we think. All right, Xavier, thanks for the question. It’s nice to be in a situation where you have a good decision or a better decision and you just have to pick between the two of them. So good luck with that and like you said, go Boston

Rob:
Up next. New investor contemplates, which rate options make sense for the short term.

David:
And we’re back with our next question from Kayla in Rhode Island. Rob, first question to you, does Rhode Island have an accent?

Rob:
I don’t think so.

David:
Have we stumped Rob, let us know in the comments on YouTube if you think Rhode Island does indeed have an accent if you’d like to replace Rob on the podcast. All right, so the background here, Kayla has been going crazy over the last year and a half reading all the BP books, listening to every single podcast network, getting events and starting her future in real estate investing. So she’s doing all the things that we tell people to do. Her question is we’re currently waiting to close on our first single family primary residence purchase in the next few weeks. We plan to live in it for the next one to two years and then turn it into a short or a midterm rental as we move into another primary residence. Rinse and repeat every two years over the next 10 years, we’re high income earners, so we plan to save money at higher rates and acquiring other investment vacation properties in that 10 year mix too every other year.
Our question is about financing terms. We currently have a 6.8 30 year fixed rate without points. We are anticipating rates to come down in the next year or two, in which case we would refinance. Is it a good idea to get into a lower rate at a five or seven one arm and refinance out of it before the end of the five year rates should rates lower since we would most likely be refinancing if rates decrease anyway, should we go with the lower rate arm right now? Thank you so much. All right, Rob, because you have huge arms, you’ve been in the weight room a lot. In fact, the last time I saw you I actually felt like incredibly intimidated by this.

Rob:
My arms are just horizontal at this point. I can’t put them down any further. So

David:
Rob hasn’t been able to scratch his own back since 2017. Define for our audience what an arm is

Rob:
An adjustable rate mortgage, meaning if it’s a five arm, they will keep this rate for five years, at which point it adjusts after the fifth year. If it’s a seven one arm, same type of thing, it changes after seven years. Right? That’s all Mr. Mortgage.

David:
That’s correct. The first number is how long it stays fixed for and the second number is how often it can readjust. So a five one stays fixed for five years and then every one year it can adjust. So they’re trying to figure out should we play mortgage roulette? What do you think?

Rob:
Okay, so I think five years, and this goes even my philosophy with a lot of creative finance deals and stuff, I think five years is a little risky. Younger me would do it, younger me has done it because in most circumstances back in the day I re-fi out before that fifth year ever came up, so it wasn’t a big deal. I start to feel a little better when it’s a seven arm or when it’s anything higher than that. I don’t know if there’s a 10 arm, but seven is when I’m more like, okay, I think a lot’s going to happen in seven years. I’d like to think there’s a window of opportunity that rates will come down in those seven years.

David:
Alright, so you think if you can get the seven one or a ten one or something like that, it’s worth getting the lower rate and then refinancing into a lower fixed rate mortgage if rates come down

Rob:
That That is my thought. Yeah. Again, a little bit more probably on the conservative side probably. I don’t know. I’m not going to advise a five year. Do you do a lot of these, do a people take you up on these over at one brokerage?

David:
Yeah, I did them at one point because I basically rates were really high and the arm was significantly less than the base rate and I was like, man, that’s a huge spread. I normally don’t do this but I don’t buy that brand but it’s on sale so I’m going to go for it today type of a deal. Here’s what I don’t like about this, especially at the five year thing, like you said, your upside is you get a slightly better rate. Your downside is rates just keep going up and up and up in the future, which we can’t predict or control. And every year your mortgage gets worse than it was the year before for an indefinite period of time. You could lose a property like this, but the gain of just getting a couple hundred bucks a month better or something doesn’t seem like it’s really worth it.
Now I do like what you said about getting into the seven or 10 year period because what you’re doing is hedging your bet, you’re giving yourself an two to five years that rates could come down. I think the reason that Kayla’s looking at it this way is we feel like we have high mortgage rates right now, and so if you feel like they’re high, it would reason to believe they will come back to normal because everything kind of reverts to the mean, but I don’t know that they’re high. What if this is normal? They were just stupid low before and we keep assuming they’re going to come back down, but they’re not going to come back down. What if 7%, 7.5% becomes on the lower side and they climb into the nine, 10, 11% range because inflation is just a stubborn problem for the next decade.

Rob:
Sure. Well hey, but they did say they are anticipating rates to come down in the next two years,

David:
Bro, you told me this on an episode in the past. Do you know that? I just saw an article today where Jerome Powell said we have to changed our mind about rate cuts for the rest of the year. We’re not, but everyone’s been saying, oh, they got rate cuts coming. Rate cuts are coming, but because inflation is high and the consumer price index is high, they don’t want to bring rates down and I am nervous that that’s going to just become standard operating procedure. Yeah,

Rob:
I have been a little, I don’t know. I do feel like a lot of people, they’re typically realtors they say, yeah, rates are coming down. You could just refi out whenever. I am not a believer of that. I’m just make it work with today’s rate. I would say if getting a seven arm is significantly cheaper than just a 30 year, then sure if we’re talking a 30 year is let’s say a 6.75 and a seven arm is going to get you I know a five, then I’d be like, okay, I think about it. But if we’re talking going from a 6.75 for a 30 year down to a 6.5, absolutely not worth the risk. Not worth the risk at all. So make sure it’s substantial if you’re going to go down this road. Otherwise I’d probably take the 30. I mean if you can get, I don’t even know with primaries right now. Someone told me they just got a six and a half and I was like, that’s good, keep that thing. It was like a local credit union or whatever.

David:
Yeah, that’s not normal. So if someone else got hired, don’t feel bad. That’s super low. The other thing that is influencing my decision in the algorithm of my brain is she’s talking about building a big portfolio. So as you just keep adding, what she’s saying is she wants to buy a primary every year and then an investment property every other year. No, a primary every two years and investment property every other year. So it’d be primary investment. Primary investment that is potentially 10 properties. All on adjustable rate mortgages. I get nervous about a normal person with a W2 job having that much exposure to interest rates going up on you. If it feels like one or two properties, if it goes badly, it just, it’s a bummer. But if it’s 10 that could tank you. I think that also weighed into where I was like, ah, I don’t really like this adjust rate mortgage gambling when you’re doing it at that level.

Rob:
Other things to keep in mind on this is how much are you putting down? How much equity will you have at the end of this seven year term? It’s going to be a little riskier in my opinion. If you’re only doing three, three and a half percent, they’re saying they want to do this for a primary. If they’re putting 20, 25% down, then I do think you could always refi out, I suppose pretty safely. But if it’s a little leverage then I feel a little iffy about it.

David:
Alright, so I was also trying to figure out where does that, we’re going to buy a primary every two years. That didn’t make sense because you can get a new loan every one year.

Rob:
I think they’re saying that they’re going to buy it every one to two years, then turn it into a short or midterm rental as they move into another primary residence.

David:
Alright, so Rob says if the juice is worth the squeeze, go ahead and drink. David says, maybe just sip a little bit, do some adjust rate mortgages, but don’t make that something you do every single time. Stick with the fixed rates for the majority of your portfolio.

Rob:
Wait, I think that’s what I said. I think I said take a little sip too.

David:
Oh, I thought you were saying that you’re okay with it if it’s a big rate difference as long as it’s a seven or a 10 year arm.

Rob:
Yeah, yeah, I did say that.

David:
So Rob says, Hey, drink the wine if the wine is good, and David says sip on the juice box, but don’t drink boxed wine if it ain’t a big, if it’s not worth it, don’t take that risk. But

Rob:
Make sure you’re 21 and older and that’s like you can handle the wine and you’re not going to get so tipsy that taking one sip is going to knock you out by the financial wins.

David:
We are significantly testing our audience’s ability to read into our analogies at a very high level right now. So if you’ve been following Rob and I, congratulations, you are smarter than the average bear. Let us know in the comments that you follow that entire thing. Well, we sure hope you guys are enjoying today’s show. We love that you’re with us, Rob and I have a blast doing this and we couldn’t do it without you. Remember to head to biggerpockets.com/david to submit your questions to be on the show. Coming up next, I’m joined by Mindy Jensen of the BP Money podcast to help with a BP community member who has six properties and is looking to shave off 24 years to his retirement, but he’s not sure if he can get there with the current portfolio. Up next, we’re getting into sharing straight from the starting out forum on bp.com. At this part of the show, Rob and I like to go through former YouTube comments, a past shows or answer questions directly out of the BiggerPockets forums. Alright, Jonathan Green who shared five big mistakes that new investors make in the forums. If you’d like to see the full forum, check out the show notes, but let’s get into it. Number one, Rob, why don’t you go ahead

Rob:
Writing too much or too little, give enough info or details and what you have done to this point. I think this is really big. We answer a lot of questions here on the show and half the times we’re kind of piecing together using whatever context clues we have, so the more context, the better. Number

David:
Two, asking for a mentor without giving anything in return.

Rob:
Ooh, this is important.

David:
Yeah, big faux pa. You would not give your phone number to some stranger that walked right up to you and said, Hey, you have something I want. Give it to me. Don’t do that. In the world of real estate investing, it gives people, as the kids say, the ick.

Rob:
Yeah, I think this was something, this is how Brandon found one of the people that worked for him. Brandon talked about how Brandon Turner, I would imagine everyone knows who he is if they’re listening to this. He said he wanted to surf. Some guy reached out to him, was like, Hey, I’ll teach you how to surf. And then they became friends, worker, they worked together stuff

David:
Right? Something like that. But Brandon loves surfing.

Rob:
That’s right. So for me, if you’re like, Hey Rob, I heard that you need someone to follow you around and buy you Chipotle burritos every day. I’d be like, that’s value. I could use you on my team.

David:
Really smart. If someone came in to me and said, Hey David, I’m willing to cut your hair every day. Probably wouldn’t get ’em too far. Number three, being

Rob:
Fragile when you don’t get the responses you want, how do you feel about

David:
That? If someone answers your question and you don’t like the way they did it, don’t be a baby, then people aren’t going to want to respond in the future.

Rob:
Yep, yep. Number four, asking questions without researching how often same question has been asked. There’s a very important little icon, little feature on the BP forums that it’s a little magnifying glass. If you’re saying, if you want to know, Hey, what property management software should I use for my rental? Maybe type that in the search form first and see how many people have answered that because the answer is probably dozens. So don’t make someone spend 20 minutes answering your question if they’ve already been answered.

David:
And number five, posting the same question in multiple forums. Rob, why is this a bad idea?

Rob:
Oh, because it’s annoying. I don’t know. Can I say that?

David:
No, it is annoying. That’s why we’re trying to avoid people from doing it. We don’t want you to be labeled as an annoying Andrew or a fragile Franny. We want you to have a good experience in the forums.

Rob:
Yeah, I see this oftentimes. Okay, here’s why it annoys me. Let me just give some context. I see this on Facebook all the time because I’m part of all the Facebook groups like the BP ones, rookie, all the Airbnb groups, and sometimes I’ll see that first person answer it or sorry. And sometimes I’ll see someone ask the same question in five of these groups. And the reason I get frustrated by this is because a lot of people in the forums in the community and these Facebook groups want to help you and they will spend 15, 20 minutes answering the question. And if you post this to five different places and you make 20 people answer the same question, it just isn’t really respectful of people’s time. So it pretty much goes into bullet point number four, asking questions without researching how often it’s been answered. Right? It’s really just about respecting other people’s time because we’ll help you, but just don’t make us help you if someone else already has helped you. Make sense?

David:
And that’s what Jonathan does best. He is one of the best commenters in the forums. He kind of runs that ship and he finishes the post by saying, if you’re an experienced commenter here, let everyone know what you think of these to help them even more and add some of your own. And if you’re new here, please use these pieces of to help yourself get better answers. I don’t know, I don’t want Scott to be like he said what he said. People are annoying for using the forums. Rob, I’m going to jump in with Mindy here. You are free to leave. Okay, bye. And as promised, Mindy and I are going to be joined by Derek who wants to cut 24 years off his retirement trajectory. Let’s see how we can help him reach financial independence with his current portfolio. You are not going to want to miss this deep, dark, and mysterious dive into the mind of David Green.

Mindy:
Derek, you posted in our Facebook group that you wanted to get to early retirement and $80,000 in cashflow a lot sooner than traditional retirement age. What is it that’s driving you to do this?

Derek:
I guess seeing my kids grow up in times kind of flying by and they’re not getting any smaller and I’m getting older, so I’d rather like to see myself in a place where I can retire if I want to earlier or at least be financially independent where I can decide on my own terms if I work or decide to travel with them or try and enjoy things a little more.

Mindy:
And you have a small amount of your net worth in a 401k. You’ve got a little bit in a Roth IRA some cash, which is awesome. But the bulk of your retirement plan or your assets is in real estate. So let’s start off, Derek. Your first question was, what are my best options to get to $80,000 a year in passive income by age 50 or sooner? So my first thought is well buy more rental properties, but we are in a market where prices have gone up, interest rates have gone up, and fighting a great cash flowing deal can be difficult. And with cashflow being your primary driver, I want to go in and look at your portfolio itself to see if there’s anything that maybe not be the best use of your money. David, what do you think about his portfolio? He has six properties with 13 total units including one short-term rental.

David:
First question, Derek. Well actually my first question before my first question, I see you have a family of six. We could tackle these expenses first. Are you willing to auction off any of these children because they’re expensive

Derek:
At times. Yes, but I think I’ll hold onto them.

David:
That’s going to make things a little tougher, but that’s okay. That’s why you got Mindy here. Alright, your short-term rental, do you enjoy managing it? Do you hate managing it? Are you willing to have more of those?

Derek:
That I’m still getting into that process. We kind of rushed to get it up and running for the eclipse. It was kind of right in line for the eclipse of the popular weekend, very in demand, but now it’s the slow season in Vermont, so I’m kind of waiting to see how things pick up once ski season starts here for Vermont.

David:
Okay. The reason I ask is you can increase cashflow by moving equity from traditional rentals to short-term rentals in most cases, but you’re increasing workload also. So if the goal is to have zero work, we don’t want to take that road. If the goal is to have more flexible work where you don’t want to be committing to an office, you want to be able to stay home, you can manage a short-term rental from your house. So first, when we tackle it from that perspective, are you open to managing short-term rentals or hiring an assistant who could help you manage short-term rentals?

Derek:
Yeah, I think that’s something that I’m open to. I mean, I’m not looking to retire and do nothing but some more flexibility in my life is kind of what I’m getting at. And I’m thinking that more cashflow would be the obvious answer. But yeah, another STR could be another option.

David:
Okay. But the SDR you have now, it’s newer, so you don’t have a lot of experience with it. Right,

Derek:
Right. Yeah, it’s new to me. I’m used to long-term rentals for the small multifamilies.

David:
And are you managing those yourself as

Derek:
Well? The one in Vermont where we used to live there, it has an in-law apartment, so I managed that one myself using Hem Lane, which has been great so far. And then I’ve got four rental properties in Connecticut that I grew that portfolio when I used to live there and I put that under property management.

David:
Here’s what we’re looking to do. We want to take your property that has the most equity or the properties that have the most equity and look at your return on equity and compare that to a return on investment. Have you done that yet?

Derek:
Not specifically, but I have been looking at possibly getting a HELOC on the STR that I recently bought since we bought that with cash. And so that has no mortgage on it right now.

David:
But you are familiar with the concept of return on equity,

Derek:
Right? Yeah, yeah, definitely.

David:
Okay. So for the audience, when we want to figure out how efficient an investment opportunity looks like, we calculate the return on investment. So we take the cashflow that it would make in a year. We divide that by the money we’d have to put into it, which is usually the down payment, the closing costs and rehab or furniture or whatever you’re going to do. And the number that you get is a percentage of the total number you put in, and obviously the higher that percentage is, the better. So if you get a 10% cash on cash return, we use that metric to compare this investment versus another one that might produce a 14% cash on cash return. So we know the money will be more efficiently used with the higher number From a cashflow perspective. Well, one thing investors don’t do once they’ve owned a property for 5, 6, 7, 8 years is they don’t think about the fact that the equity might have grown at a faster rate than what the cashflow did.
So rents go up, but they may not be going up at the same speed or pace that the equity in the property is. So you buy a property for $200,000, it gets you a 10% cash on cash return, five years of rent increases later you’re at a 20% cash on cash return and you think you’re crushing it, but the property went from 200,000 to 500,000. You’ve got $300,000 of equity. If you divided that same amount of cashflow, you make it a year by the equity in the property, not by your initial investment. You often find you’re sitting at a one, two, 3% return on the equity, which means your current equity is lazy. It’s not working very hard for you. And Mindy, I know you like it too, the richest band in Babylon, one of our favorite books talks all the time. You want those little soldiers of yours working hard. You don’t want lazy equity that just sitting on your couch eating your Cheetos and drinking your mountain dew without getting out there and putting in a solid eight hours of work. So if we looked at your portfolio right now, do you have an idea which of your assets have the most equity and the least return?

Derek:
Yeah, I have a general idea. I know some of them currently have rents that are below market, which some raising rents might get a better return, but I’m not sure if it’ll bring me all the way there to having an adequate return on equity, but it’s definitely a great point that you’re mentioning and it’s something to reevaluate

David:
And it will also change the way that you look at your portfolio. So we all have our favorites. I don’t have any kids. I’m sure parents, maybe they have that favorite kid. This one gives me the least headache. But when you start to look at the return on equity, you start to get an idea of what property was your favorite. Now maybe it’s not. You’re like, oh, I love this charming little bungalow, mid-century modern property, and you have these memories that you made in that house and then you’re like this little lazy son of a gun isn’t doing anything right? I need to sell this one and move that $300,000 into other properties. Now we do traditionally talk on this podcast about increasing cashflow by increasing the properties. However, in practical terms, sometimes that does the opposite for your cashflow. And here’s why I say that. When you first buy a property, you tend to also be buying a lot of deferred maintenance. Nobody sells their car when it’s running amazing and it’s giving ’em no problems. Think about every time that you’ve ever had the thought, I want to sell this car. Okay, taking out the fact maybe you had a kid, you need a bigger one. When’s the time that we think, Hey, I think I need to sell this car. Mindy.

Mindy:
Oh, I am not the right person to ask because I have the same car since 2003.

David:
Your car’s awesome by the way. You gave me a ride at that car and it’s super bitching. I really liked it. All right, Derek, have you ever had the thought I need to sell this car? What was going on?

Derek:
I think it was just getting too much maintenance and the cost was just too high.

David:
It’s a natural human response. Homes can work the same way. So when you first buy a house, you are often buying all the previous owners deferred maintenance, and then there’s some weird rule of real estate where that air conditioner that was on its last legs that they were barely hanging on, you get in the house, you start using it more than it was used to being used and boom, the thing craps out or that roof leak becomes a bigger problem. Now two, three years of cashflow is gone as you have to dump it into stabilizing the asset. This is even worse if you buy a property that has tenants in it. So I just made it a rule in my own investing. The first year I own a property, if I break even, I’m happy. That’s a win. I expect I’m going to lose money the first year that I own a property.
You’re just going to see all the stuff that slipped through the cracks of your due diligence, even the best due diligence. You can’t account for everything that can go wrong with a property. So scaling your portfolio in the short term will usually make you cashflow, but in the long term it will make you more cashflow and it will make you more equity, which is why it’s going to build you well. So part of what we’re also going to talk about is what’s your timeline? So are we talking about trying to get you out of not working in the next year, the next five years, the next 10 years? What’s your thoughts?

Derek:
Well, my thoughts conservatively, I think like seven years, 50 soms a good number to reach for. I’m 43 right now, but I’m sure my wife would say now, but I’d rather try and find somewhere in the middle

David:
If you could find a way. And what’s the current job you have right

Derek:
Now? Right now I do A-S-E-O-S-E-O work. So SEO specialist.

David:
All right. So I don’t know if you’re open to this advice, but the advice I give a lot of people in your situation is sometimes when we say I don’t want to work, what we’re actually saying is, I don’t want to work this job. I don’t want to work under these circumstances. I don’t want to commute. I don’t like this boss. This is mind numbing, soul draining work. But we’re not saying I don’t want to labor, I don’t want to spend energy. It’s more just I would rather do it with something else. Okay? And I say this for you and everybody who’s listening, I am not a proponent of get a couple rentals, equate your W2 and just throw a middle finger to the world and say, look at me. I am a proponent of get a couple rentals, get some stability, get a little bit of a buffer and move your energy.
Just like we’re talking about moving your equity from a job you hate to a career, a job, a business, a something that you would enjoy or at least doesn’t suck super bad. And then maybe you do it again into something else. So for real estate investors that love real estate, I’m frequently telling them, do you love people? Get your real estate agent sales license. We need better agents in the world. There’s not very many. Do you like numbers? Become a CPA. Do you like solving problems? Become a loan officer. Do you like design? Do you like construction? Do you like bookkeeping? There are so many meanings within the world of real estate that you can get a 10 99 position, start your own business work for a real estate investor. It’s not full-blown W2, I’m a slave to someone else, but it’s also not complete lack of any stability at all.
It’s a more happy medium that exposes you to the things that you enjoy doing, which I’m assuming is real estate if we’re talking on BiggerPockets. So that’s another thing that doesn’t have anything to do with moving your equity around that. I’d like for you to think about. What if you started your own business and did SEO work for other people once we got you to that $80,000 a year right now if it fails, that’s okay. You’ve still got money coming in, but if you enjoy it, it could actually turn into where you make $80,000 a year in your business and $80,000 a year from your rentals, and now we’re having better cooler conversations. But again, going to your portfolio, what we’re really looking at is what’s your laziest equity? So if you were to call out a couple properties, which ones do you think have the most equity that’s making you the least cash

Derek:
Flow? I’d say the property number two perhaps. And that’s a two family and let’s see, what else? And property number four.

David:
Okay, so property two has about 110,000 in equity property four a hundred and eighty six, is that right?

Derek:
Right. Yep.

David:
Okay. And so we could sell those. That would give you around $250,000 of equity to redeploy. I’m trying to see what the cashflow is on those combined right now

Derek:
Those are the ones that are below market, so I could probably get another 500, 700 a month for each one of those if that changes anything.

David:
Do you have a market that you like where you could buy a fourplex or a small multifamily?

Derek:
The place where I bought those first four properties in Connecticut, it’s been pretty good. I mean, I’m comfortable with it, but I just don’t know the way things are with the market and rates, how to approach things any differently than what it was like.

Mindy:
Have you been looking at listings?

Derek:
Not really in that area. No, not lately.

Mindy:
If you have a real estate agent that you like in that area, I would reach out to them and just ask them to send you listings, broad spectrum, give them the very bare minimum requirements so you get the most listings in your inbox and then just start looking and seeing, oh, I didn’t know properties were now 4 million, nevermind. Or, Hey, properties are still $70,000. I can get in on this, or something in between. Obviously I’m making those numbers up, but having an idea of that market and then you can say, yes, I want to sell these properties where my equity is just sitting there kind of doing nothing or have you considered raising the rent and why are they so far below market? You said you could get another five or 700 for each of these properties. There’s two units in each of these properties. So is it raising the rent two 50 on each tenant? Is that realistic?

Derek:
Yeah, that’s kind of the route I’m going with one of the properties maybe not as high as that, but I’m going to see if I can raise rents and if it forces some tenants to leave, then maybe I’ll do a turnover and get potentially more.

David:
But what’s the reason they felt so low, Derek? Because you have a property manager in Connecticut,

Derek:
Just the long-term tenant that I have. Yeah, I don’t think they’ve been raising rents every year,

David:
Bro. I just found out in Arizona I have five properties being managed by one person. I thought they were great. I never hear about it. He hasn’t raised the rent in five years
And it’s been a lot in Arizona of rents going up. So I found that out. He’s now fired. I hired a person to work for me to manage my own properties. She’s going to be managing those now and we’re going to make sure that that doesn’t happen again. But what I was just thinking with you is if you fired your property managers hired an in-house person to help oversee those and potential short-term rentals that you could be taking on. Have you looked at the management fees that you’d be saving and if that would offset a virtual assistant or a part-time assistant that you could hire to help you manage your properties and then you could also take on more short-term rentals with this additional help?

Derek:
Yeah, that’s something I think someone else mentioned in the comments in the forum, but I think, yeah, I mean around 11 or 12,000, maybe 10,000 potentially, and that’s not including leasing fees and that sort of thing, so that’s something I should definitely look at.

David:
Let’s say that you with leasing fees, those are expensive. Let’s say you’re at like $15,000 for management and you bring someone on part-time that you could pay like 35 $40,000 or something. Half their salary almost is covered just by that. Now if you move that 250,000 in equity that we talked about into two or three short-term rentals and you have this person screening calls from tenants before they get to, you have this person helping to coordinate with the cleaners. You’re not taking on a ton of the work, right? We were just talking about this on Seeing Green the other day. It’s not necessarily the time spent that I think makes people not like work. It’s the type of work you make ’em do. I’ve noticed this. My employees that really like to do deep work on complicated problems, if you ask them to take phone calls from a person that can’t find the TV control in a short-term rental, they lose their mind.
But then there’s other people that only want to help them find TV controls. If you’re like, can you put something in a spreadsheet? Then they lose their mind, right? If we find the thing that we like doing, you often can find that work is enjoyable and you like doing it. So for you, I’m assuming if you’re working in SEO, you’re a deep work person, you like to look at complicated problems, you like to see the big picture and you like to really drill down on what’s going to make this whole thing move. Do you need to hire somebody that does shallow stuff? You go inch wide and a mile deep, you need to find someone that goes a mile wide and an inch deep. They can handle all kinds of stuff going on. They’re answering emails, they’re taking phone calls. They’re shielding you from the little paper cuts that make you bothered, and then twice a day you check in with them and say, Hey, what’s going on? Here’s what I want you to do. They go back to work, they do it. You could probably move this equity and get three or four more short-term rentals, triple your cashflow from what they’re making right now, and you might find that you really enjoy doing short-term rentals as long as you’re doing it with leverage,

Derek:
Right? Yeah, that’s definitely a good point. I want to see how this short-term rental business goes and see if I can find a way to leverage it and earn more money without having to take up all of my time. But like you said, maybe hiring someone might be a good idea.

David:
You don’t need a full-time hire. I don’t think you have enough to need a full-time person.

Derek:
No, definitely not.

David:
So the main ways that you increase cashflow is going to be moving inefficient equity. So we’ve already talked about that. Where’s your return on equity the lowest and what could you buy moving from an inefficient asset class like long-term rentals where again, it’s only inefficient for cashflow. Long-term rentals may make you more money in the long-term if you buy in the right market, but in the short term, they’re going to make less cash flow than a short-term rental. So you want to move into more efficient way there and then paying off debt, that’s the other way you can increase cashflow. So another option we just haven’t talked about was what if you sold and you bought something in all cash? The reason I didn’t go first is you’re going to have capital gains hits if you do that, and that is an inefficient way, you’re going to actually be losing some of the equity that we’ve talked about that you can’t redeploy into more real estate.

Mindy:
And since they are long-term rentals, you haves depreciation, recapture on top of your capital gates and you’ve made a lot of money on these properties. But I also agree that property number two and property number four are my least favorite of your portfolio just by looking at these numbers. So David is a fan of the short-term rental. Looking at the numbers, you’ve got a fourplex four units kicking off approximately the same cash as one unit. That’s a short-term rental. So I’m going to send you this book by Avery Carl short-term Rental genius. It’s called Short-Term Rental Long-Term Wealth. It’s by BiggerPockets Publishing, and we are going to send a copy of this so you can read through this book and get some tips on how you can make your short-term rental even better. I’m also going to encourage you to go into the BiggerPockets forums biggerpockets.com/forums to talk to other short-term rental operators and see what’s working for them.
Another option could be midterm rentals, medium term rentals. I unfortunately don’t have that book at my fingertips to just show you, but it was written by Ziana McIntyre and Sarah Weaver, and it talks about the 30 day stays. A midterm rental can help you get around the short-term rental laws that some cities are starting to enforce more and more as well as generate more income than a long-term rental. So perhaps property two and property four could be reviewed to see if you could make more money as a midterm rental. Is there any opportunity from midterm rental? Is there any desire for midterm rentals? So these are digital nomads. These are people who are traveling around but staying in a long time. Travel nurses was a big one for a while. Corporate rentals. Some people really like to be in a house instead of in a hotel room if there’s no market for them in where property two and property four are, I really like the idea of potentially finding another property and 10 31 exchanging into that one. So you’re kicking the tax can down the road with a 10 31 David, do you still have depreciation recapture?

David:
No. If you do the 10 31, you basically just take what you would’ve had to pay back and move it into the next property and it rolls over.

Mindy:
Awesome. Okay, so now that is the best of all worlds. You have rules around your 10 31 first get a qualified intermediary. That’s the official name of the person who does the 10 31 for you and talk to them and follow every rule. There’s, what is it, 45 days to identify three properties and 180 days to buy close on that, one of those three properties within that timeframe. And if you don’t, then your whole 10 31 is blown. So you definitely want to be confident in your ability to close before you sell your other property, but that I think that’s a really great option for you because cashflow is what you are looking for. You could wrap both of these strategies in, take these two properties, 10 31 into a small multifamily or even a medium-sized multifamily, and then turn that whole thing into a short-term rental property that of course, it’s got to be near something where people want to go, but that could be a really interesting option as well.

David:
But that’s the reason I didn’t immediately go into, yeah, pay off some debt because those taxes can be so painful that it eliminates a lot of the benefit of paying off your debt. Another thing I thought of that I didn’t mention was some of the money that you have that’s not in real estate. So you’ve got some money in your 401k, I would look into seeing if you can take that money and buy discounted notes with it without getting a tax penalty. Now you’re not going to be able to touch that money. It’s probably going to go back into the 401k. I’m guessing you can pull that out at like what’s the age, Mindy? You would know.

Mindy:
You can pull it out at any time, but you can pay no taxes. If your plan allows you to pull out at age 55, you could roll it all over to an IRA and then kind of do whatever you want with it. A self-directed IRA does allow you to invest in rental properties, although I do believe you’re subject to ubit, and this is where I fall out of my area of expertise, and I’m just remembering random little bits. So

David:
You bitch,

Mindy:
You bitch, but if you have self-employment income, you could take your 401k and roll it into a self-directed solo 401k, and then you can invest in real estate. It’s not subject to ubit, but again, all of the money that you invest out, the money that comes back goes into the 401k. So that’s something to keep in mind.

David:
So if you could get your 401k into a self-directed IRA, that’s ideal. But even if you can’t, you might be able to still do it as long as the money stays in the IRA, I would look at the return I was getting on whatever you’re using it for, and if it’s less than double digits, I’d look into buying discounted notes. This was something I did a couple years ago. So basically what you’re doing is you’re buying usually a second position lien. Sometimes their first position lien that at one point was underperforming, somebody else bought the right to collect the payment from a bank or a lender because the person wasn’t paying on it. So in a sense, the bank didn’t necessarily foreclose on the property. They just sold the right to foreclose on the property to somebody else. That person steps in and they get the person paying again.
They renegotiate the terms of the note. They find out what was going on. If the person doesn’t repay, then they would just foreclose on the property. But in this case, these are the people that did repay you then buy the note from them so they get their capital back that they spent on the note, but you’re buying the note for less than what the principal balance owe is. So I did this with Dave Van Horn’s company, PPR Note co. I believe he wrote a book for BiggerPockets as well. So for instance, I think I bought a note that was worth 90 something thousand dollars and I paid around like $65,000 for it. I can’t remember the exact numbers, but it was about that. And then the person makes a payment to me every single month if they ever stop making the payment. There’s state laws regarding when you can foreclose, but you would just foreclose and you would take the asset that was worth even more than the value of the note was, right?
So the note was worth 90 something thousand. The property was worth 120,008 years of time later it appreciates to be worth $250,000. There’s a lot of equity in that property. Well, I just found out the person who owns the property that pays me the money is selling the house. So they’ve paid down what they owed me a degree. It was like 95,000. Maybe they paid it down to 80,000 or something, but I bought it for 65 and I’ve been getting years of payments on this. When they pay it off, they have to pay me the full amount that they owe. So it’s like equity in a sense from the note. You could do the money in your I in your 401k is probably not working as hard as you could get if you bought notes with it. So you do that, you put it to work harder.
You let the money from the notes go back into the self-directed IRA or the 401k, whatever it is. You’re getting a better return when those properties do sell off or refinance or whatever the case would be. It’s like the jack in the box pops. You get yourself a nice bump in equity. You use that to go buy more discounted notes and you just rolled over. We don’t talk about this on the podcast as often. I already know people are saying, why did nobody tell me about this? That sounds great because you have less control over the money. When you buy a rental property, you can improve the property, you can choose when to sell it. You can do a 10 31, you can refinance out of it. You can improve the performance. The rents are going up. When you buy a note like this, you’re actually exposed to inflation because that monthly payment I was getting was worth more seven or eight years ago when I bought it than it’s worth today, and I can’t do anything to fix that. You’re at the mercy of the person who owns the property, choosing to pay the note off or choosing to refinance the property or sell their property.

Derek:
What are your thoughts on ways to get equity out of my portfolio? I know you said I have some lazy equity sitting there besides doing a 10 31. I know my rates are really low right now, but I know I’ve seen the rates lately and they just seem so high. So how would you approach that?

David:
Yeah. The problem is when you try to get equity out, you basically can, A 10 31 is the most efficient way. A sale without a 10 31 is another way. A cash out refinance is a third way and a HELOC is a fourth. Those are your main four ways to get into the equity. You have The problem with rates being high, like you just said, is that whatever you buy is going to cashflow less. And if you buy it with the equity from the property, you just took on additional debt at those same higher rates, that becomes a problem. And so the reason I bring this up is I don’t see very many investors in most markets that are able to pull equity out of a property through a HELOC and use it as a down payment on another property That worked when values were going up and rents were going up and interest rates were low, you had the perfect trifecta that allowed you to just get a property, build equity, take the equity out, get the next one.
The snowball that we talked about, it’s like a hill full of snow, very steep, easy to make that work. That hill ain’t going down at the degree that it was before. It is a straight shot in a lot of ways. And so you already have to have some snow to be able to play the game that we were before. And I see a lot of people just butting their head into the brick wall trying to use that strategy and complaining it doesn’t work well. It’s because you didn’t actually create new wealth. You’re just trying to recycle wealth that you had previously. And that’s why, I don’t know, the only way I could see that possibly working is if you took the money out of a inefficient asset, like a long-term rental through a HELOC and put it into a short-term rental. And I don’t love you taking on the risk of doing that until you have a proven track record of managing short-term rentals and knowing that you do it well.

Derek:
Yeah, that’s a great point. I mean, it sounds like the easiest way to, well easy, but to try and get additional cashflow versus a traditional long-term rental, like you said.

David:
Yeah. That’s why I just said selling and redeploy is going to be your better option and you’re going to want to start with the houses that have the lowest return on equity because you’re probably going from a low interest rate to a higher one. So to balance that out, you need to make sure that you have the laziest equity possible that you’re moving.

Mindy:
Derek, what did you think about that note investing? Does that hold any interest for you?

Derek:
Well, it’s something I need to, I guess, learn more about it and wrap my head around to see how that would work. And I’ve heard some of the benefits of it before investing in notes. But yeah, it definitely sounds interesting. It’s not something I’d considered though in the past.

Mindy:
Okay. Well, I am also going to send you a copy of Dave Van Horn’s book. It’s called Real Estate Note Investing, using Mortgage Notes to passively and massively increase your income, which is something you’re looking at passively and massively increasing your income as well as you’ve got a hundred thousand dollars in cash. Is that your emergency fund or is that your, I don’t quite know where to put this yet fund.

Derek:
It sounds like the latter for the most part. I mean, we’re going to put some of that into education accounts for the kids, but that’s only a portion of it, but the rest of it’s kind of just sitting around for I guess, emergencies.

Mindy:
Have you ever considered lending that out? I do some private lending, and I think I’m charging like 12% right now. I’m only lending to people that I know that I know are going to pay me back who are doing super fun things with real estate on the East Coast because it actually exists. David and 12% comes into my bank account. They pay it off and then they borrow it again. And because I know them, I don’t feel like I am putting my money at risk because they then pay me back and want to borrow it again. I know that I now have a proven track record with them, and I can do it again with more confidence finding somebody to borrow money from you. That may be a little more difficult than I just blase recommended, is that a word? Blase. Anyway, but once you make it known that you have potentially have money to lend, people come and start asking you, oh, David Green wants to borrow money. I’m going to lend it to him. I know him and I know he’ll pay me back. But Rob Abba Solo wants to borrow money. Forget it, dude. Just kidding. Rob, I would lend to you too, but it can be a really great way to generate more income. And BiggerPockets also has a book about that. It’s called Lend to Live Earn hassle-free Passive Income in Real Estate with Private Money Lending by Alexandria Becher’s and Beth Pinkley Johnson. And I’m going to send you a copy of that book too.

Derek:
Awesome, thanks. Another question I had for you, Dave. I like the idea of a simple paid off portfolio when I retire. What are your thoughts on those people talk about maybe trying to pay it off with a snowball type of plan. What are your thoughts on that versus redeploying these equity?

David:
I’d love to see you start a business like we talked about doing SEO work for other small businesses or something that you figure out a way to make that profitable and put that profit directly towards paying off your debt so that you don’t have to pay taxes.

Derek:
Yeah, that’s a good point.

Mindy:
And I mean one of these properties, property number two, you paid $70,000 for, I don’t even know what your mortgage, oh, your mortgage balance. You’ve obviously refinanced that.

Derek:
Yeah, I did cash refinances on all my properties right before the mortgages climb, so I was lucky for that. But yes, that’s why,

Mindy:
And I think that’s kind of the only way to tap into some of that equity is to cash out refi when rates are low, which isn’t an option right now. Hey, David, can you write a mortgage for 3% for me

David:
As soon as Derek here builds a time machine? We’ll go back a couple years and I’ll absolutely do that.

Mindy:
Alright, Derek, what do you think of what David has been sharing with the debt equity and potentially 10 31 or getting more short-term or things like that?

Derek:
Yeah, I think the idea of redeploying some of that equity and maybe getting another short term once I have some more experience with that sounds like a good strategy for getting more cashflow. But as you mentioned, I think starting or working on another business that I could use that cash to help pay off rentals is another way that sounds appealing to me.

Mindy:
I love that, especially because SEO is your jam right now and starting an SEO company is not that cash intensive. You could probably do it with everything you have now. You need to buy A URL like derek seo.com or whatever, buy A URL and then just reach out to, I am not even going to tell you how to get business because you’re the SEO guy, so you’ll figure it out your own self. Use those SEO skills to generate some business, but it’s such a low cash intensive process for you because you don’t really have to learn anything. You already know it and you don’t really need to buy anything because you already have it. It’s a computer and your brain, and I’m not trying to downplay what you have. I’m just saying it’s so easy to start this because if it doesn’t go anywhere, what is it like $8 on GoDaddy for a URL?

David:
Fingers crossed for you, man. It was good meeting you. Thanks

Mindy:
David. Thank you so much. This was awesome. My

David:
Pleasure. Thanks

Mindy:
Guys. I’ll see you in Cancun.

David:
Alright folks, that was our show. Thanks for sticking around all the way to the end. We got into when adjustability mortgages are a good idea versus when they’re bad, how to reposition equity, how to get to financial independence faster, what portfolio architecture is and why Rob is a real investor and not a cheerleader. We sincerely appreciate you getting your knowledge from us. We love you a ton. Remember to head to biggerpockets.com/david to submit your question to Seeing Green. And if you’d like more information about Rob or I, you can grab our contact info from the show notes. Please do that. This is David Green for Rob, bring it on ABBA Solo. Sign up.