Why Interest Rates Don’t Matter As Much as You Think
How important are mortgage rates to real estate investing? Should I take out as much depreciation as possible to lower my taxes? And what should I do when my DTI (debt-to-income) ratio is too high? You’ve got the questions, and David Greene has the answers! On this episode of Seeing Greene, David goes high-level, getting into the topics like real estate tax benefits, return on equity (ROE), and why loans and leverage are riskier than most rookies think!
We’ve got questions from house hackers, BRRRRers, multifamily and commercial investors, and more on this week’s Seeing Greene. First, we hear from a college student trying to house hack in an expensive housing market. Then, a family who has outgrown their space and wants to use creative financing to buy their next primary residence. And finally, a mother concerned that real estate investing could affect her children’s stability. Don’t know what you’d do in these situations? Then, stick around! David’s got the answers!
Want to ask David a question? If so, submit your question here so David can answer it on the next episode of Seeing Greene. Hop on the BiggerPockets forums and ask other investors their take, or follow David on Instagram to see when he’s going live so you can hop on a live Q&A and get your question answered on the spot!
This is the BiggerPockets Podcast show 720. Leverage is great. It’s not great for everybody. It’s meant for people that understand how to use it. There’s a lot of things in life that are like this. Okay. Cars are great, but we don’t let nine-year-olds drive them. We don’t even let 25-year-olds drive them if they haven’t passed a driver’s safety course and passed the test and understand the rules of the road. You got to earn the right to drive. You got to earn the right to play with fire, right. There’s people that use fire in their jobs. There’s welders. There’s different types of people that use heat to conduct certain things, but you don’t just give them the tool and let them go play with it right off the bat. You got to earn that right. Leverage is very similar.
What’s up, everyone? This is David Greene, your host of the BiggerPockets Real Estate Podcast, here today with a Seeing Greene episode for your viewing and listening pleasure. If you’re listening [inaudible 00:00:50] on a podcast, that’s awesome. I appreciate that. But you can also check us out on YouTube, if you want to see what I look like. I’m often told that I am taller in real life than what people thought. I don’t know if that’s a compliment or if what they’re trying to say is I have a shrill tiny voice that makes me sound like I’m four foot two. Not sure which way to take it. So let me know, when you watch me on YouTube, do I look like what you pictured in your head? It’s always fun when you see what someone looks like, and it’s very, very different than what you were expecting, and you can never really look at them the same way again.
In today’s show, we’ve got some really cool stuff. We talk about how to continue house hacking even when your debt-to-income ratio can start to shrink from owning all the new real estate. We talk about if a property that is currently owned should be rented out or if they should stay in that property and not buy a new one. We get into if someone should save $300,000 in taxes or if they should avoid that and save that money in the future, all that and more in today’s Seeing Greene episode. Now, if you’ve never listened to one of these episodes, let me just break it down for you real quick. In these shows, we take questions from you, our listeners, we play them, and then I answer them for everybody to hear with the goal of helping increase your knowledge base and real estate so that you can be more successful on your own path to financial freedom through real estate.
Before we get into today’s show, one last order of business are Quick Tip, and that is 2023 is now here. 2024 is not going to be better than 2023 if you don’t make intentional changes to do so. And 2023 is not going to be any different than 2022 if you don’t make intentional changes to make it that way. So spend some time meditating on what you would like your life to look like. And more importantly, who you would have to be to make that happen. Sometimes we make the mistake of asking, “What do I have to do, or what do I need to accumulate to get what I want?” It’s much better to ask, “Who do I need to become?” Because when you become that person, those things will find you. All right, let’s get to our first question.
Hi, David. Excited to have you answer my question. My name is Shalom, and I’m an avid listener of BiggerPockets. My question is as follows. So currently, I’m a college student in New York City, and I will be graduating soon with an income of $85,000 a year. I’m wondering how I can start house hacking or how I can continue my real estate journey. So currently I have one parking space, which I do arbitrage on. I lease it out for 275, and then arbitrages sublease it to someone else for 335 a month.
Now I’m looking to expand, but I don’t know how to house hack or how I can grow without… because my market is so expensive. So in New York City or in Brooklyn or in the outskirts in New Jersey, duplexes go for a million and a half, two million plus. So how can I house hack or expand in this market with such limiting constraints with… of income and other kinds of things? Thanks.
All right, Shalom. Thank you very much for asking that question. I appreciate it. Let’s dive into this because there is an answer to what you’re asking. You’re talking about house hacking, which is probably my favorite topic in all of real estate to get into. There’s so many ways to do it. It’s such a superior investing strategy. It could be a… It’s flexible. It should be a part of everybody’s strategy, even if they buy properties using different means. House hacking is great.
What you’re talking about is a commonly encountered problem in high-priced areas, more expensive stuff. Like what you’re talking about, New Jersey, New York, you’ll frequently see this. The reason that duplexes sell for so much is someone will buy it, and I know that sounds silly, but think about it. If you’re normally going to be paying four grand a month for your mortgage, but you could buy a duplex and rent out one side for 2,500, it’s a huge win if you only have to pay 1,500.
So if you’re trying to get cash flow, it’s not going to work, but if you’re trying to save on your mortgage, it is going to work. So, unfortunately, all your competition is okay not getting cash flow, which creates more demand. The supply stays the same. Prices go up. That’s what you’re facing with. So if you want a house hack in an expensive market, which you should, there’s two things to think about. The first, well, are you currently paying rent right now?
If you factor in the rent that you’re paying and include that as income in the investment, you might find the numbers look a lot better than what you’re thinking of not doing that. The second thing is you probably aren’t going to be able to buy a duplex because the higher the unit count in the property, the more likely you’re going to make the numbers look better.
The other thing is that you could look into non-traditional house hacks. So we always describe the strategy of house hacking. Brandon Turner and I would do this all the time by talking about, “Buy a duplex, buy a triplex, live in one unit, run out the others,” because it’s very simple to understand the concept. But that doesn’t mean that the execution needs to actually be done like that. It’s kind of hard to make it work that way, to be frank.
It’s easier to go buy a five-bedroom house with three bathrooms, add another bedroom or two to it, so you have six or seven bedrooms, rent out those rooms and live in one of the rooms yourself. Now, this isn’t as comfortable, but that’s what you’re giving up. You’re giving up comfort in order to be able to make money. Now you’re a young guy. You’re making 85K a year, which is not bad at all.
You can take some risk by buying real estate. I think that’s a smart move. You should be investing your money but sacrifice your comfort. You don’t have to just buy a duplex and rent in one side of it. If you were going to do that, I’d buy a duplex that had two to three bedrooms on each side and rent those out individually. You’re always going to increase the revenue a property brings in by increasing the number of units that can be rented out.
This can be done by going from a duplex to a triplex or a triplex to a fourplex or a fourplex that has two bedrooms instead of one bedroom and renting the bedrooms out individually or converting a family room into a bedroom and renting that out. Now, this doesn’t work at scale. It is very difficult to build a large portfolio doing this because now you’re renting out 10 to 12 bedrooms on every single unit. It’s very hard to manage that.
But when you’re new, and you’re just trying to get traction, and you’re going to be building appreciation, buying an expensive market, this is probably the best way to do it. You’re also going to decrease your risk while learning a little bit of the fundamentals of investing in real estate. So that’s the advice that I’d have for you. Stop looking at duplexes.
You got to look at triplexes or fourplexes, and you got to look at single-family homes that have a lot of bedrooms and a lot of bathrooms with sufficient parking and neighbors that aren’t super close because you don’t want them complaining and putting your tenant’s parks in front of their house. So you’re going to have to be looking on the MLS and looking more frequently for the right deal, but be looking for a different kind of deal, and you’ll find that house hacking works a lot better.
All right. Our next question comes from Jesse Goldstein. “Hey, David. Thank you for creating what is clearly the best source of real estate content available. Your show is packed more full of real estate protein than my family after Thanksgiving dinner. My question is about how to apply creative financing strategies used for investment deals to the residential real estate space. As a background, my wife and I are expecting our fourth child and are quickly outgrowing our 2300-square-foot townhome.
Our plan is to rent it out if we can find a bigger place, but since we have not been able to find one price right in the few months since we have been looking, a colleague is relocating out of state in December, recently listed her beautiful home, but with today’s interest rates, it is significantly more than I feel comfortable spending. I was chatting with her a few weeks ago after I heard her saying they had no bites after two price reductions and were considering renting the property out.
It seems both of us have been hurt by higher interest rates. I think we may now be in a situation where they might entertain some creative financing ideas to potentially solve both of our problems. They are set on their 1.3 million market price but currently have a very low-interest rate in the twos and are now getting quite motivated rather than renting it out. We have spoken briefly about a subject to loan installment, land sale contract, lease option, or potentially holding a second mortgage, and we are both seeking advice from real estate attorneys.
What is your impression on employing these strategies in the residential space? None of the local Pennsylvania realtors have been speaking with have heard of this approach. If we proceed down these paths, how might both parties compensate our respective agents for their hard work over the last several months? Thank you.” Okay, let’s dive into this one, Jesse.
First off, when it comes to compensating the agents, that’s something that the seller is going to be responsible for. That needs to come from the seller side regardless of how the transaction is structured. Now, the title and escrow company can handle this for you. They’ll just take out the commissions that would’ve gone to the agents and pay them even if you’re not doing the transaction at what we call an arms lengths deal where you didn’t put on the MLS. They didn’t just find a buyer they don’t know. They’re selling it to you.
Your question comes down to structuring this creatively, and it sounds like what you’re thinking is you can get a better deal if you do that. Based on everything that I’ve seen here, the only part of the deal that sounds better is the interest rate you’ll be getting. You’ll get it in the twos and not in the sevens or the sixes or wherever they are.
You’re not actually getting a better price. They want that 1.3 million. One thing to be aware of is if you take this over and you’re not getting your own loan, there’s a little less due diligence that’s done. So you’re going to want to get an appraisal to make sure you’re not overpaying for that property unless you’re okay paying 1.3 and you don’t care what it appraises for. But odds are, if it’s not selling, they probably have it listed too high, and they’re considering selling to you because they want to get the same money.
Now they’re not actually losing anything here other than they’re keeping that debt on their own book so to speak. So they’re still going to be responsible for making the payment even though you’re the one making it for them, and if they try to buy their next house, they’re going to find that that’s difficult. So, sometimes because the sellers don’t understand the downsides of a subject to, you do all the work, you put it together, maybe you even close on the home, they go to buy their next one, and their lender says, “You can’t buy a house. You still have this mortgage on your name.”
And they say, “Well, no. So-and-so’s paying it.” Doesn’t matter. Still shows up as lean on the property under you. Subject to is not this like catch-all that fixes every single problem. It can work in a lot of cases, but in other cases, it doesn’t. I don’t know that this sounds like one where it says an immediate, “Oh, subject to will make the deal work.” You didn’t mention what the numbers are running it at an interest rate in the twos. Okay, people fall in love with the interest rate. It’s an ego thing. “My rate is high. My rate is low. I’m in the twos.” That doesn’t mean anything.
If the property loses money every month or you could have a cheaper payment if you bought somebody else’s house that you didn’t do subject to. It doesn’t matter what your rate is. It matters what the property’s actually producing. You could theoretically buy a house with a interest rate in the 40% if it cash flowed. If it brought in enough money, that’s what really matters. So you need to do a little bit of homework here, run some numbers and see, “If I buy this property with their mortgage, is it going to perform the way that I want it to perform?”
If it doesn’t just stop looking at it. The purchase price is going to be the problem here, not just the interest rate. If it does work, there’s your answer. Now all you have to do is figure out how to structure it if you’re going to buy it. Part of the problem is you’re going to have to come up with the difference between what they owe and what they’re asking for. So let’s say that there’s a mortgage on this thing for 700,000, and they want to sell it for 1.3.
Well, that $600,000 difference you would have to put as the down payment, or you’d have to pay as a note to them, or you’d have to get from another lender, and that lender’s not going to want to give you the loan because they’re going to be in second position behind the loan that’s already there. See, when we get a loan to purchase a property, we’re paying off the existing liens with the money from the new loan, which puts the new loan back in first position, which is where they’re always going to want to be. This is another complication that comes up with the subject to strategy.
So if they only owe 1.1 million, and they’re trying to sell it for 1.3 million, and you have the $200,000 that you were going to put as a down payment anyways, that could work. But everything’s got to line up for you perfectly if you’re going to make something like this work. My advice is to not look at creative financing as a way to make a bad deal seem like a good deal. It almost sounds like you’re trying to talk yourself into this deal because their rate is in the twos, or you’re like, “Hey, we know each other. Here’s my chance to use all the cool stuff I learned on BiggerPockets.”
I really like the excitement, but that’s not what creative financing is ideally designed to be. It’s more when someone’s in an incredibly distressed situation, and they are very motivated to sell, and they’re willing to do creative financing even though it’s usually not in their best interest. Now, if you’re looking to buy this house for yourself because you mentioned replacing your townhome, so maybe this is a primary residence, then your due diligence is even easier. Look at what your mortgage would be on this house, if you assume their mortgage.
Compare that to what your mortgage would be on a similar house that you might buy if you bought it with today’s interest rates and see which of those situations feels better to you. Do you like this one more at this price, or do you like that one more at that price? And if you like this house more, the only thing you got to work out is that situation with the seller where there may be the discrepancy between how much they owe in their old mortgage that you’re taking over and how much the purchase price is that you’re going to have to pay the difference. Good luck with that.
Hey David, thanks for taking the question. My name is Guy Baxter. I’m 26 from San Diego, California. I’ve been listening to the podcast for almost three years now and just this year bought my first property in San Diego. I bought it in May.
I’m coming up on the sixth-month mark and have a few questions about BRRRRing, just with the current market conditions. Since I purchased the property, interest rates have gone up quite a bit, and I’m just trying to decide if I should continue on the path of the BRRRR and kind of bite the bullet with the higher interest rates and pull all of my cash out so I can put it and deploy it somewhere else, or if I should maintain the lower monthly payment and just save up a little bit more for next year to house hack again.
Luckily, with the rising interest rates in San Diego, the prices haven’t quite dropped yet, so I should be able to get most, are all of my money back, maybe a little bit more, and yeah, hopefully, that makes sense. I can’t wait to hear the answer. Thanks.
Hey, thank you for that, Guy. All right. This is a commonly asked question, and I’m going to do my best job to break it down in a way that will help everyone. When trying to decide, “Should I refinance out of my low rate into a higher rate,” which is what you’d have to do to get your money out of the deal to buy the next deal. The wrong question to ask is, “Should I keep my low rate or get a higher rate?”
The right question to ask is, “How much money would I have to spend every month if I refinance to pull my money out more than what I’m spending now?” So let’s say that your debt is at three grand a month, and if you refinance, it’s going to go up to 3,500 at the higher rate with the higher loan balance because you’re pulling the money out. Okay. So now you have a $500 loss if you do this.
You want to compare that to how much money you can make if you reinvest the money that you pulled out. So if you’re pulling out $250,000, can you invest $250,000 in a way that will earn you more than the $500 that it costs you every month extra to take out the new loan? So now you’re comparing 500 extra to what I can get extra somewhere else. That’s the right way to look at this problem. Now, of course, this is only looking at cash flow, whereas real estate makes you money in a lot of different ways.
But if you can get the cash flow somewhat close, it’s a no-brainer to buy the new real estate because you’re going to eventually get appreciation. You’re going to get a loan pay down on a new property. You’re going to get rents that go up on the new property while your mortgage stays the same. So every year, it’s going to theoretically become more valuable to you, and over a 5, 10, 15, 20-year period, having two properties instead of one is almost always going to be a superior investing strategy. So most of the time, most of the time, pulling the money out to buy more real estate, in the long run, will be better, but it’s not always the case.
All right. If you’re cash flowing incredibly well on the San Diego property, maybe it’s a better quality-of-life move for you to just live off of that and not reinvest. If you’ve got a bunch of real estate and you don’t want to buy more, maybe it’s a better move to just stick with where you’re at. But what I want to get at is don’t ask the question of, “Should I get out of the 4% to get into a six and a half percent?” It just doesn’t matter. It matters what the cost of that capital is.
How much does it cost you to pull that money out, and how much can you make with the money if you go reinvest it, or are you going to lose money if you go reinvest it? What if there’s just no opportunities out there? That’s a realistic scenario for a lot of people. There’s nothing to buy that they like. In that case, it doesn’t do you good to do a cash-out refinance and have capital if you’re not going to go spend it on anything. Okay.
So ask yourself the right questions. Think through this. Maybe give us another video submission with some different investment opportunities that I could compare. And then, I can give you a better answer on if you should take the money out of the San Diego house and put it back into the market in a different property.
All right. Thank you, everybody, for submitting your questions. If you didn’t do that, we wouldn’t have a show, and I really appreciate the fact that we’re able to have one. And I want to ask, “Do you like the show?” At this segment of the show is where I read comments from YouTube videos on previous shows, so you get to hear what other people are saying. And here’s also where I would ask if you would please like and subscribe to this video and this channel and leave your comments on YouTube for us to read possibly on a future episode.
All right, this comes from episode 699, tip from a listener regarding an unsafe tenant from Ariel Eve. On question two, call Adult Protective Services to voice your concerns. They will conduct an investigation regarding her safety to live alone. Our next comment comes from Iceman Ant. Ariel’s comment there was from a person who had a tenant and they were concerned about their safety. They were afraid that the person might pass out or possibly even die in the unit that they had, and they wanted to know if they had any actual obligation to care for the person or any liability in that scenario.
Our next comment comes from Iceman Ant. “LOL. He said, programs. It’s cool, David. I also grew up in the VHS area.” All right, this is some criticism that I deserve. I made a comment when referring to old TV shows, and I called him programs because that’s what my grandma used to call them, and it was stuck in my head, and it came out when I was talking. And Iceman called me out on it. It used to be, “Are you watching your favorite program?” I know somebody out there remembers that people used to call TV shows, programs.
There’s certain things like that that we just still say. Like someone will say, “Are you filming?” And I’m like, well, we don’t really use film anymore. Nobody’s used film for a long time. Like now, we would probably say recording, but you’ll still hear people say filming. All right. Our next comment comes from Brie. “I’m concerned about the first viewer’s question as serial house hacking was also going to be my strategy getting started. However, if you cannot apply rental income from the property you’re currently occupying to debt’s income ratios, that presents a huge barrier to qualifying for that second house. This is my first time hearing of this. So the alternative is to move out by either renting or increasing W2 income to afford the two houses without counting the rental income. Any other tips?”
All right. Brie comment and question have to do with the fact that when you’re house hacking, you can’t take the income that you’re being paid and use that towards income for your next property. You’re not allowed to use income from a primary residence to qualify for more properties and your next property in most cases. Now, I believe if it has an ADU or sometimes if it’s a duplex or you’re living in one unit renting out the other, you might be able to. But many times, lenders say, “Nope, that’s your primary. You can’t count the income that’s coming in from it because we can’t verify it.”
This is also a problem when people don’t claim that income on their taxes. If you’re not claiming the income on your taxes, you’re definitely not going to be able to use it to qualify for the next house. And I’m frequently telling people to house hack every single year. The key is when you move out of the last house, it now no longer is a primary residence. It does not matter if your loan is a primary residence loan.
And by the way, if you are wondering, no. If you move out of a house, it’s your primary residence, it doesn’t just automatically adjust to a investment property loan with a higher rate. The bank doesn’t know, doesn’t care, doesn’t matter. You got that loan as a primary residence and those loan terms, if you got a fixed rate, will not change for the next period of time, usually 30 years that you have that loan.
So when you move out of it, you still get a loan that’s a primary residence loan, but now on your taxes, it is now claimed as an income property. You’re now claiming the income that it makes, and you can now use that income to buy additional properties. So sometimes you buy a house, you house hack it, you move out of it into something else, then you start claiming that income on your taxes as an investment property, which won’t hurt your DTI. Then you can buy your next house. You can repeat that process indefinitely. So it slows down how quickly you can acquire new house hacks.
But in a worst-case scenario, you can still do it every two years, right. And once you get to a certain point, you’re not going to need the extra income to qualify. Your debt-to-income ratio is going to be good from the rent that you have of all the previous houses that you bought being counted towards your income. So it can make it a little bit slower to get started, but long-term, it’s not going to hurt you all that much. Thank you for that, Brie.
Next comment comes from Austin. “I think there is something Eli, who asked the house hacking question, could do. You can buy a primary house once every year. So if he’s coming up on that year, let’s say his one year into his house is 12/11/22, he can get the roommates to sign a new lease that just isn’t a rent-by-the-room lease, but the entire house lease. Then get the roommates to sign it for, let’s say, January 1st, 2022. Even though it’s December now, they can agree to a new lease now. So he can be living in the house from 12/11 to 12/31, trying to find a new house.
He can go to his lender now and show his January 1st lease, and they will count 75 or 80% of the rent as income. Or if all his roommates want to move out December 31st, he could just rent, pre-lease the entire house to a family and get a signed lease. Take that signed lease to lender, and they will count 75 or 80% of the rent as income to help the DTI. The other thing Eli could do is to try to buy a duplex. Let’s say the duplex has side A rented at a thousand and side B is vacant. The lender would count 75 or 80% of the rental income from side A towards his DTI. Curious if anyone has other ideas. I am house hacking as well and looking to scale.”
All right. Well, thank you, Austin, for your contribution there. I would… It may be right, but we would need to verify this before we assume that any of the advice you’re getting would just work. So whenever I’m in a scenario like this, I just go to a loan officer, and I say, “Hey, how does this work?” Now, most of the time, the loan officers aren’t going to know either. This is just way too granular. So they’re going to go to the lender, and they’re going to say, “Hey, I need to talk to an account executive. What are your rules for underwriting when it comes to these scenarios?”
And they’re going to go talk to an underwriter. They’re going to wait to hear back. The underwriter’s going to look up the conditions that they have for all the different loan programs and let you know can it work, or can it not work, or what would work. And then we get back to you. This is why I have a loan company, the one brokerage, and this is why I go to them and say, “Hey, this is my problem. How can we fix it?” And I let the professionals work it out. It is tempting to try to figure all this out on a YouTube column, but it’s not wise. There’s no way that anybody here is going to be able to know, and these rules shift all the time.
So your best bet, if you have questions, is to actually contact a loan officer or a loan broker and ask them, “Hey, this is my problem. How can I fix it?” Let them come back to you with some answers. And our last comment comes from Kelly Olson. “David, you keep saying, accountability partner. Try saying accountabilabuddy. It rolls off the tongue and is fun to say.” Accountabilabuddy. Okay, that is easier to say, and it is also a little cheesier, and I don’t know how well green cheese is going to come across. So, for now, I am going to use the very square-ish accountability partner, but I will say, Kelly, accountabilabuddy is probably going to take off. It’s going to be very popular.
And if you guys prefer accountabilabuddy, please let us know in the comments by just writing in accountabilabuddy. All right. We love and we appreciate your engagement. Please continue to do so. Like, subscribe, and comment on this YouTube channel. And if you’re listening on a podcast app, take some time to give us a five-star review. We want to get better and to stay relevant, so please, drop us the line if you’re at Apple Podcast, if you’re on Spotify, Stitcher, whatever it is. We will not stay the top real estate-related podcast in the world if you guys don’t give us those reviews. So that’s why I’m asking for it. Thank you very much. All right. Let’s get back into the show. Our next video comes from JJ Williams in St. Louis, Missouri.
Hey David. I’m under contract with a seller finance property. It’s a historic home that we’re going to look into turning into… It’d be three units in the main house, and then there’s also a tiny home associated with it. It is zone multi-family and commercial. So we’re looking to do two Airbnbs on the lower level as well as the tiny home. And then we’re looking to do either an office space or long-term rental in the upper level.
The deal it’s 125 doing 10% down seller finance, and then it’s going to cost about between 70 and $80,000 to rehab everything. I’m just curious. I have stocks to pull all the money out of to do the rehab. Is it smarter to take out a loan against those stocks, or should I just pull them out, use the money, and then, that way, my cash flow’s a little bit better? Let me know what you think. Appreciate you.
Wow, JJ, this is a very interesting question. I don’t get these very often, which is funny because you started off your question giving me all the details of the deal itself, and then when you ask the real question at the end, I realize none of those details are actually relevant. But congratulations on the deal you’re putting together and for explaining how it’s going to work. That’s pretty cool.
All right. The real question here is, “I have stocks. Should I sell the stocks and use the money towards the down payment, or should I take a loan against the stocks to do this?” This is going to come down to how strong your financial position is. If your position is strong, it might be better to take the loan against the stocks. Now, of course, this is assuming the stocks hold their value or go up. If the stocks drop and you take a loan against them, you just went into double jeopardy there. You lost money on the stocks, and you’re losing money on the loan you’re having to pay, right.
And we don’t ever know exactly how it’s going to work out. So most financial gurus like myself are going to give you advice that’s conservative. Almost everyone’s going to say, “Don’t do it.” Okay. This is put on my little Dave Ramsey hat here. “Don’t ever leverage against stocks. In fact, you shouldn’t have leverage on anything. Sell it all and pay cash for the house, sell it all and pay cash for the house. Don’t be stupid.” Now, he might be right because I don’t know enough about your situation to be able to tell you. But I will say if you’re in a strong financial position and you believe in the stocks, it’s not a terrible idea, in my opinion, to take a loan against him to go buy the property.
It is a terrible idea if you can’t make both the house payment and the payment on the loan against your stocks, assuming everything goes wrong with this rental. All right. Now, this is advice I would give to everybody. Assume the worst-case advantage. You can’t rent the property out, nine months go by where it’s vacant. You have to make the loan payment to the person that sold you the property, and you got to make the loan payment against the stocks, and the rehab goes high. Can you still cover all of your debt obligations with the money you have saved up and the money you’re making at work?
If the answer is no, don’t borrow against the stocks. Don’t do anything extra risky if you don’t have that extra money. If the answer is, “Yes, David, I’ve been living beneath my beans for five years. I save a lot of money every month. I work really hard. I’m good with cash.” Well then, my friend have earned the right to use leverage, and that’s just the way that I look at it. Leverage is great. It’s not great for everybody. It’s meant for people that understand how to use it. There’s a lot of things in life that are like this.
Okay. Cars are great, but we don’t let nine-year-olds drive them. We don’t even let 25-year-olds drive them if they haven’t passed a driver’s safety course and pass the test and understand the rules of the road. You got to earn the right to drive. You got to earn the right to play with fire, right. There’s people that use fire in their jobs. There’s welders. There’s different types of people that use heat to conduct certain things. But you don’t just give them the tool and let them go play with it right off the bat. You got to earn that right. Leverage is very similar. Be wise about it. If you can handle it, use it. If you can’t, just wait and use it in the future.
Let me know in the comments what you guys think about my approach to using leverage. All right. Our next question is rad, and it comes from Claudia Dominguez in Coral Springs, Florida. “I purchased a property in late 2021 serving as my primary residence until I can rent it out later in 2022, one-year owner occupancy requirement per the association.” So it sounds like Claudia here bought a property in HOA. “Being that this will be my first rental property, I have several questions I would love help with.”
All right. It’s a three bed, two bathroom, 1800 square foot house. It is a corner unit, single-level townhome with a two-car garage purchased for 322 with 10% down on a 30-year mortgage. Claudia believes that it could rent for 2,500 to 2,800 per month. “Our monthly expenses, including association fees, are 2100.” So what we’re really looking at is 400 to $700 a month in cash flow before we look into maintenance and everything else. All right. Question. “How would I calculate my potential ROI on the property? Our down payment and closing costs came to 50,000. We spent another 5,000 on new floors after move-in before there was damage to laminate that was there before.”
All right, let’s start with that. You don’t calculate the ROI because you’ve been living in it for a year, and it doesn’t matter what you put down. It matters how much equity you have in the property right now. So subtract the realtor fees, the closing costs, any cost of sale from selling this home, and find out how much money you’d have left. All right. You’re then going to take the 400 a month that you’d get if it rented for 2,500. We’re going to go conservative. We’re going to multiply that times 12. Okay. 12 months times 400 a month is $4,800 in a year.
All right. You’re going to divide that by the amount of equity that you have in the house right now. So it’s purchased for 322 with 10% down. So you really don’t have hardly any equity at all, most likely. Okay. Because if you sold the house, your closing costs are probably going to be close to 6%. So that leaves you with only 4% equity in this property, which is probably 12 grand. So let’s say it’s gone up a little bit, and let’s say that you have say… Man, let’s be helpful to you here because Florida had a good year, and let’s say you’ve got $40,000 in equity in this property.
So if we divide the 4,800 by 40,000, that gives us a return on equity of 12%, which is pretty good in today’s market. Okay. But let’s say that you don’t even have 40,000 of equity. If we divide that 4,800 by… Let’s say your house hasn’t got up at all, and you only have about $12,000 in there. Well, now the return on your equity is going to be 40%. So the less equity you have in the deal, the higher the return on your equity is, which means the more sense it makes to rent it out rather than sell it and put the money somewhere else.
So, before I get deeper into your question, it’s already looking like moving out of this property and renting it out is going to be a no-brainer for you, but let’s keep going. “How can I confirm if it makes financial sense to update the bathrooms?” It probably won’t. Just the amount of money you’re going to have to spend update bathrooms isn’t going to increase your rent by as much as you’re thinking. But your question wasn’t, “Should I?” It was, “How could I know?” And so my answer to you is going to be if updating the bathrooms is going to increase the rent that you can bring in by a positive return on investment, it makes sense to do it.
So if you could bump up the rent from 2,400 to 2,800 just by updating the bathrooms, and it was only going to cost you, say, 15 grand to update the bathrooms, and you’re going to hold it as a rental for enough period of time to make back the 15 grand, that’s how you determine that question. “I’m struggling with my own bias that I would not rent a property outdated bathrooms. I’m considering a low-budget remodel because I can get more modern used vanities, and I found that tubs can be painted. I’m just not sure if I should keep spending money on this.”
Okay, first off, good job on you for recognizing your own bias. It probably isn’t as big a deal as you think. However, you’ve swayed me. If you’re looking at doing a low-budget remodel, some of it yourself, where you’re just getting new vanities and painting a tub, yes, that can actually make sense for you to do. I assume this was an entire bathroom remodel that we were talking about.
“If the market continues as it has been the last few quarters, it will mean spending considerably more on the next property I purchased with the intent to rent it out. What criteria should I take into consideration to assure I am purchasing a good investment at what feels like inflated prices? I believe I’ve heard that appreciation should not be an immediate, or do I rate factor for long-term holds? I’m not sure how to estimate the increase in rental rates that might otherwise support purchasing the next property in a tight market.”
Again, the interest rates don’t matter when you’re making this decision. I know that feels weird to hear, and the purchase prices don’t matter. What matters is it going to go up in value from when I paid for it and is it going to cash flow? Now, interest rates and purchase prices do affect cash flow, and they’re relevant for that purpose only. Meaning the higher the purchase price and the higher the rate, the harder it is to cash flow. But in and of themselves, they’re not important. So the criteria that I think you should take into consideration is it will be more of your time and more of your effort spent looking for another deal to replace the one you have.
And this is not uncommon in real estate. In fact, this is probably closer to a healthier market than what we’ve been seeing since the last crash. I know that sounds crazy, but we got spoiled. We got used to buying a property that appreciated every single year that needed very little work that wasn’t intended to cash flow in the first place. This was mostly residential real estate. We’ve all been buying. That cash flowed from day one, and not only cash flow, but cash flowed in double digits. That’s just us being spoiled. And now that we’re not spoiled anymore, we’re angry about it.
But traditionally, the way that real estate is structured, it’s meant to make you money over the long term, not over the short term. So it’s okay if it’s harder than what we thought to make it work. Real estate is still a good investing decision. Question two of three loan options. “What are the best loan options for purchasing a property? I have a W2 job that pays above average for my area. And I have good credit, but I only have enough for about a 10% down payment on the next property. Since I already own one property, I believe that will be forced a conventional loan requiring 10% down.”
All right. So the best loan option for you is to do the same thing on your next house as this first one that you did that we just talked about. You want to use a primary residence loan and put as little down as possible. You don’t have to put down 10%. You can actually put down 5% in a lot of instances or three and a half percent if you don’t already have an FHA loan. If you’re not buying it as a primary residence, meaning you’re moving out of the one you’re in and you’re not going to buy another house to live in, you’re going to go live somewhere else. You can put 10% down many times as a vacation home. Okay.
So these are like a house that you’re going to rent out some of the time. But you’re going to rent out to other people, or you’re not going to live there as your primary resident. So hit us up if you want us to look into finding a vacation home loan for you or go to somebody on BiggerPockets, use their tools there and find a person that’s a member that does mortgages and ask them, “Hey, what options do I have if I don’t want to burn my vacation home loan? I want to buy a primary residence.” But I don’t assume you got to put 10% down. You can very likely get into something for three and a half to 5% since you’re moving out of your current primary residence.
A lot of people think you can only have one primary residence loan at a time. That is not true. You can usually only have one FHA loan or one VA loan at a time. But you can have more than one primary residence loan at a time because not all primary residence loans are VAs and FHAs. You can get a conventional loan, often with 5% down on a primary residence. Question three of three. This is a family-related question.
“I’m house’s hacking to start. I live with my kids in the property that will be rented. We just moved from an apartment that we were only in for seven months after moving from the house we sold in 2021. My intent is to purchase another property and live in it for a bit before renting that one out and then ultimately purchasing my long-term home. I feel as if forcing my children to move every one to two years might negatively affect them, but I don’t want to use my kids an excuse for not carrying out my goals. How do you reconcile some of the demands of real estate investing, in my case, house hacking, where I move my kids around every year to a new place with what feels like shortcomings while raising family?”
Ooh, this is a good question here. And, of course, you’re asking a guy that doesn’t have a family and doesn’t have any kids, and yet I’m still going to sit here and do my best to mansplain away this difficult conversation. First off, I just want to say I understand actually, I can’t literally understand, but I empathize with what you’re going through, and I think you’re a good person for even asking this question. Because, on podcasts like this, we always talk about the financial components to real estate. It is why people are here to listen. However, we’d be foolish to not acknowledge that there’s an emotional component to real estate as well.
This is a part of the process, and if you want your subconscious to get behind what you’re doing and support you in it, you got to satisfy the emotional side of you. So I’m glad you’re asking this, and if other people have been wondering the same thing, don’t feel bad about it. This is totally normal and something that all of us have to work through as investors. In fact, one of the reasons I think I took longer in life to go start a family was because I knew how difficult my law enforcement career, my hundred-hour work weeks, my commitment to building businesses and making money through real estate would affect a family negatively. It is harder, and I think that was in the back of my head, and I just pushed off starting the family because I wanted to build success in this arena first.
It’s obviously a different position I’m in now. So now, if I wanted to start a family, I think I could without some of that guilt. But you’re right there, smack dab in the middle of some of this mom guilt. So let’s work our way through this one. Claudia, the first thing I think about is you want to have an honest conversation with your kids and share why the decision will be a benefit to the family in the future. It’s a teaching tool, right.
So maybe your kids aren’t old enough to understand math, but if they are, you could explain to them, “This is what our house payment is. Now, if we move into the second house, it’s only going to be this much. That means mommy doesn’t have to work as much at work, and I’m able to be home with you more if we move again.” I wouldn’t say, “This means mommy makes this much more money,” because if I was a kid, I heard that, I’d be like, “Oh, cool, so you can buy me more toys now,” which isn’t where you want the conversation to go. So make the correlation between the more money you save, the more that you could be with them.
The next thing that I would do is I would try to find a way to make it fun. Nobody likes moving. It’s a pain, right. So can you make it fun? Can there be some kind of reward that you could give these kids that doesn’t cost money, that will make this less of a… I don’t know if traumatic is the right word, but less of a negative experience. Can you guys all get together and have pizza or popcorn on the floor when moving, sit on bean bags, and share stories of your favorite part of the new house?
Can you take an adventure as a family and walk around the neighborhood and point out the houses that you like the most or see how far away the restaurants are, the ice cream shop, or the movie theater? Can you take them to the new movies and say, “Hey, kids, let’s compare this to the other movie theater and see what about this one might be better.” Right. Can you turn it into a game or a system or a pattern where, every time they move, they learn what it takes to move and so they get better at doing it? Now, I don’t know that if it’s a moving that’s super hard on kids as much as it is changing schools, that’s what I would think. It’s having to lose some of their friends.
So if you’re able to house hack in the same school district, that would definitely be better. If not, I would have a lot of conversations about what they’re going through at school. A lot of parents make the mistake of assuming that everything is good for their kids because their kids aren’t saying anything. But when I was a kid, I wasn’t going to go home and talk to my mom or my dad if I was getting bullied or if I had a issue going on. That didn’t happen very often, but I definitely wasn’t going to go talk about it. And the times I did try to talk about it with my parents, they sort of dismissed it because they had other stuff going on in their lives that they were more stressed about.
So I was like when we did move, it was a very, very, very hard move for me. I was going into seventh grade, so I went into junior high at a new school with a bunch of kids that had way more money than the kids at the last school. And I didn’t dress very good, and I was getting teased, and I had never been teased because I was very popular at my first school. I just didn’t know how do you handle this type of a situation. And there was no one to talk to.
So I would be open with them about are they extroverted? Do they make new friends? Are they introverted? Are they having a hard time making friends? And just give them some advice of what they can do to be more likable in general so that the transition isn’t as difficult for them. Of course, I want to recognize you’re making some sacrifices here. It’s going to be harder on them because you’re doing this. So kudos to you for putting your family first, even though it’s going to be difficult in the short term. All right, our next question comes from Jack Graham.
Hey, David. My name is Jack Graham, and I have a big question for you, which is, should I bonus cost segregate some of my properties, so I don’t have to pay income taxes on my regular income? And just for context, I have about five properties worth about 2.5 million in value total. About 40% of that is in equity, and I’m trying to get some of these properties, which two of them I purchased this year, and I looked into YouTube, some videos, everybody brings up a bonus cost segregation.
Being a full-time realtor and ultra investor, I do work more than 75 hours a month in real estate. So I could technically use that part of the tax code to offset my personal income. And this year, I’m supposed to pay about probably 300 to $350,000 in taxes, and I really don’t want to. So my question was for you, “Hey, should I do this? Should I use those two properties that I purchased this year to bonus cost segregate them so I can keep the money in my bank and hopefully purchase new properties in the future, and I could make better use of my money right now versus keeping it… giving it to the government?
And what are the consequences? Do I pay more taxes in the future? If that’s the case, is that something I should still do?” Let me know what your thoughts are. Big fan of BiggerPockets, big fan of you and what you guys do. So thank you so much for everything, and looking forward to your response.
All right, Jack, thank you very much for this. What a great question here. So I’ll give a gist of what you’re describing for anyone that’s unfamiliar with bonus depreciation, then I’ll do my best to answer your question. What Jack is talking about here is, normally, when you buy a property, let’s call it a residential property, the government lets you write off a portion of that property every 27 and a half years because it’s going to be falling apart. So they’re saying the useful life of this property is going to go over 27 and a half years. So you take the total price of the property, divide it by 27.5, and you get to write that off against the income that property generates. So if it makes 500 bucks a month, but the number that I just described is 400 bucks a month, you only pay taxes on $100 a month.
If you are a full-time real estate professional, they will let you take the losses. So sometimes what happens is you get to write off 700 a month, but it only makes 500 a month. So you have $200 a month that is extra that isn’t being covered. If you’re a full-time real estate professional, you can take that $200 and apply it against other ways that you made money through real estate, commissions, income-flipping houses, I believe. Pretty much all the ways that you make income, you can shelter against that 200%. Now, when you combine that allowance with bonus depreciation, you’re actually able to not wait 27 and a half years to take that money. You can do a study where they let you take it all in year one. It’s called a cost segregation study. It’s a little bit more complicated than I’m describing, but I’d be here all day trying to talk about it.
So without giving you the details, the overall strategy is that you look at a property. You determine, “Okay. Well, this much of it is going to wear out much quicker than 27 and a half years, so I’m going to take the loss from that all off the upfront in year one.” When you combine the strategy of taking all your losses into year one with the fact that you’re now able to shelter income from other things full-time real estate professionals can end up avoid paying income taxes. Now, this is how people like Robert Kiyosaki and Donald Trump and me when we say, “I don’t pay any income taxes. I don’t pay taxes at all. I’m not stupid.” This is really what they’re getting at. Okay. It’s not that they’re avoiding taxes like they’re breaking the law is that they’ve reinvested all of their money into new real estate, so they have all these new losses to take against the money that they’re making.
Now, it sounds great, and that’s why we do it because we don’t want to pay taxes. Jack here, you don’t want to pay taxes either, but there is a downside. There’s actually a couple of downsides that I’m going to describe before we know if this is the right move. First off, you can never stop buying real estate when you do this. I say it’s like taking the wolf by the years. As long as you’re buying new real estate… Like I got to buy real estate every single year to offset the money that I made, and sometimes I have to spend close to or sometimes more than 100% of the money that I earned has to go back into real estate to not pay taxes on it. Okay. So if your goal is to save up a big nest egg, this doesn’t always work. Sometimes if you just want cash in the bank, it’s better to pay the taxes.
Second off. It’s not free. Actually, when you take it all upfront, you lose the ability to take it over the next 27 and a half years because you took it all in year one, so that depreciation is gone. You don’t get to shelter any of that income after you’ve taken it right off the bat, which means you’re going to pay higher taxes on the future income that that property makes. Now, as long as you take that future income, included in all the money that you’re making as a real estate professional, and keep buying more real estate, you won’t pay taxes on it. But do you see what I’m talking about here? You’re getting sucked deeper and deeper into this world where you can never stop buying more real estate.
And when you do stop buying more real estate, you’re going to pay taxes on the money you make, and you’re going to make taxes on the income that those properties are making, and that income is not going to be sheltered by depreciation. The last downside that I can think of off the top of my head is the fact that this isn’t free. You actually have to pay for cost segregation studies, which can be anywhere between six and $10,000 a study in my experience. So not only are you not getting to take the depreciation forever, you’re only getting to take it right off the bat. You had to spend six to $10,000 for the luxury of doing that. So yes, you will save $350,000, but you will also take some losses in some of these other ways I describe.
That all being said, if we’re going into a market like right now where I’m expecting to see better opportunities than we’ve been able to see, that extra 300 to 350,000 that you would be spending in taxes is going to do you more good than it normally would. If we were going into a market where prices just kept going up, up, up, up, up. And it didn’t matter how much money you had. You just weren’t going to be able to buy anything, and if you did, you were going to lose money when you bought it, or it might be crashing. That’s a different story. But we’re in a situation now where you could take that 350,000 and wait out to see is it going to dip more. Is it going to, quote-unquote, crash? Having capital right now is more beneficial than having capital in other scenarios where real estate just keeps exploding because of all the money that the government is printing.
So I kind of do lean towards the fact that I think that you should do this, right. Another thing to think about is that if you’re investing for the future wisely and you are growing your equity, there’s ways to make money in real estate that are not taxable, that are not cash flow. So you have to report your cash flow as income because it is. This is why when people are like, “Cash flow, cash flow, cash flow,” and they just get the little dollar signs in their eyes like Scrooge McDuck, and they’re just obsessed with cash flow because it’s going to solve all their problems. It doesn’t. It doesn’t. Now, it’s great. I’m not saying avoid it, but I’m saying it’s not as good as we hype it up to be.
When you get equity, you can do cash-out refinances that are not taxed, not at all. And the cool thing about a cash-out refinance is usually it takes you a long time to build up equity. So usually, during the time you’ve been building that equity, the rents have been going up on the thing you bought. So by the time you do a cash-out refinance, the rents have increased enough to support the additional debt you’re taking out on the cash-out refinance. So you don’t actually take any danger. You don’t lose money when you do it. The property continues to pay for the loan that you took out. You get a cash-out refinance, which is not taxed. You can either live on that money, or you can reinvest that money into the future real estate that you have to keep buying if you’re going to use cost segregation studies and bonus depreciations.
The very last point that I just thought of that I’m going to throw as a little cherry on top for this for you, Mr. Jack Graham is that bonus depreciation will not be around forever. In fact, I believe in 2023, it is set to scale back to where you can only take 80% of the value and in 2024, only 60%, and so forth, until eventually, it’s at zero. So if you’re thinking about doing this, I would say you should do it now because every year, it’s going to get progressively less beneficial until it’s not there at all. Thank you very much for your question. Please let us know what you decide.
All right, and that was our show for today. But what you guys got a little bit of high-level stuff right there at the end with some fancy words like cost segregation, bonus depreciation, some cool stuff there, and then you also got some stuff from beginners like, “Hey, what loan can I use to buy my next house, and should I buy a house at all? How can I keep my debt to income high if I keep house hacking?” And that is what we’re here for. We want to give you as much value as we possibly can so you can find financial freedom through real estate just like many of us, including me, did. And we would love to sit here and root for you guys, guys to watch you on the way.
So thank you very much for following. If you want to know more about me particularly, you could follow me on social media @davidgreene24. Go follow me on Instagram right now. You could also find me on YouTube if you go to youtube.com/@, little @ sign, davidgreene24, and subscribe to my channel and check out the videos that I have there where I do a little bit more personal stuff. You can also follow us at BiggerPockets on YouTube as well. You can follow us on Instagram. You can follow us all over social media. So look us up there and follow as well.
Look, get rid of some of the crap in your life. Okay. Get rid of some of the stuff that isn’t helping you with anything. Just the mindless scrolling or the doom scrolling that you do, and start actually listening to stuff that’s going to give you a better future than what you have right now. Thank you very much for your time and attention. I love you guys. If you have some time, check out another video, and if not, I will see you next week.
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