Which One Wins? (Rookie Reply)

Ashley:
Okay, rookies. Today we’re pulling three questions straight from the BiggerPockets Forums and I have to say this batch is a really good one. We have a question about whether to pay off your rental mortgage early or use that equity to buy more properties.

Tony:
We also have a question from someone who just got hit with a massive unexpected repair bill on their rental and they’re trying to figure out how to handle it without derailing everything they’ve built so far. That one is super real for Ricky listeners and the third question is about analyzing a deal that looks almost too good to be true on paper. So we’re going to walk through exactly how to stress test that deal before anyone pulls the truck.

Ashley:
This is The Real Estate Rookie Podcast. I’m Ashley Kehr.

Tony:
And I’m with Tony J. Robinson. And with that, let’s get into our first question. So our question today comes from the BiggerPockets Forms and it says, “I currently own one rental property free and clear, no mortgage. It cash flows about $1,100 per month after all expenses. A friend of mine told me that I’m leaving money on the table by not leveraging that equity to buy more properties. The home was worth about $280,000. I could pull out roughly 200,000 through a cash out refinance and use that as down payments on two or three more rentals. But the idea of going back into debt on a property that is paid for makes me really uncomfortable. Is my friend right? Am I leaving money on the table? How do I think this through the right way?” So great question. Paid for real estate is sometimes one of the best assets that you can have.
But again, I think a lot of it does depend on the person on where that person is at in their investing journey. Are you closer toward the beginning? Are you closer toward the end? What just kind of allows you to sleep at? So there’s a few things to talk through. I think first, just like mathematically. If we were to look at the math, I think your friend is right. You are probably leaving cashflow on the table by having all of that equity tied up in one deal and your return on your own equity in that property is pretty low.You could get a better return on your investment by reallocating that equity across. Instead of one deal, having it across, you said you could buy two or three more properties. So instead of one deal having four. And if you look at your return now across all four of those and the actual cash flows, I would assume that if we look at the numbers that that part is true.
Ashley, would you agree with that? If we just look at the numbers, that’s probably going to be the case.

Ashley:
Yeah. And I think what you could easily do is look at, okay, what could you buy with that down payment amount? So you get 200,000. Say you’re going to use $100,000 each on each new property as a down payment. What would those properties cash flow and what would your current property cash flow? So what would be your total cash flow across the three properties? I mean, it honestly could add up to exactly the same as what you have now, but now you have three properties to manage and three different types of overhead for three roofs, three HVACs, things like that. So I do think not only looking at the numbers, but also the management piece of it. Now that you have three properties, that’s more to manage. You have three more tenants in place. Then you should also look at the equity and the appreciation.
So look at maybe your property as an example. How much appreciation has it seen within the past five, past 10 years? Now, if you have three properties, are you able to get more appreciation across all three of them than you would with just this one property sitting? So I do think that you’ll probably end out better in the long run if you have three properties as an appreciation play than just keeping this one that’s paid free and clear. I do think a big warning caution is that you use the word uncomfortable to describe yourself leveraging this property. I think if anything, don’t go for the full max cash out refinance. Maybe do something that makes you more comfortable. Maybe you just do 150,000, maybe 100,000 just for one property, or maybe you go and get a line of credit on the property instead of putting a mortgage on it.
So I think don’t always let the numbers be the best decision for you because money is in everything and you don’t want to not sleep at night because you’re worried or over leveraged because you put financing and debt on this property and now you have three properties with mortgages when you just had one with none. I always like having a paid off property. I have several that are paid off free and clear and it helps me sleep at night and then the rest do have mortgages on them. And maybe one day I would go and pay them all off. Right now, I definitely cannot do that, but I do think it would be a really, really nice feeling. Is that probably the best use of your money? No, probably not. Debt is a tool. It is a way to build wealth for sure.

Tony:
Yeah. I think you hit the no on the head, Ash. Part of it is mathematical, part of it is personal preference. And if for where you are at in your investing journey, you feel that having a paid off property is what will make you happier and feel less stressed and enjoy real estate investing more, then stay there. To your point, I think sometimes we do get caught up in the unit count and squeezing every dollar out of our investments, but you have to ask ourselves, what was the reason that we started investing in the first place? And if for you, it was the idea of appreciation and it was the idea of cashflow with very little effort, well, then you’ve checked that box with this deal and why overcomplicated. So I think mathematically there’s probably a high likelihood that yes, you can get a better return on that equity, but you’ve got to also pair that with your own personal preferences.
All right. Coming up, we’ve got a rookie investor who just got hit with a repair bill that they were not expecting and they’re trying to figure out how to handle it without blowing up everything they’ve worked so hard for. We’ll get into it right after quick word from our show sponsors.

Ashley:
Okay, rookies, welcome back. So our next question comes from the BiggerPockets Forums. I am six months into owning my first rental property, a single family home, and I just got a call from my tenant that the HVAC system completely failed. I got two quotes and the cheapest one is 8,500 to replace the full system. I only have about $6,000 in my reserves right now, so I am $2,500 short. I am panicking a little. I did not expect something this big this soon. My questions are, how do I cover the gap? What should I have had in reserves to begin with and what do I do going forward so I’m ennever in this position again? I feel like I made a mistake buying this property before I was really ready. This is, I think literally every new investor’s worst nightmare is buying the property and finding out they have a huge repair bill right after they purchase the property.
So I think the first thing is I would recommend going forward is having an inspection on the property if you didn’t already, but during that home inspection, asking the inspector to kind of lay out the life use of each of the mechanics in the property. So have him state what the ages on the current HVAC, on the roof, on the hot water tank and in his opinion, how long does he think it has life left in it? So does he think that in one year, what does he think that you’ll need to replace? In two years, what does he think you’ll need to replace? In five years, what does he think you’ll need to replace? And then in 10 years and have him laid out. If there’s anything below the five-year mark, you can ask, especially now since in a lot of markets, not all of them, that it is a buyer’s market, you can ask for more time with your due diligence when you go under contract and you can not just only have the home inspector come, but you can have an actual HVAC guy come and actually do a tuneup or look at it and go through it and kind of give an assessment of what it looks like, how well it’s running, does it need any repairs or anything coming up because your home inspector is not going to be looking in the parts and pieces of the HVAC unit and they’re not going to be, I guess, an expert in all areas of the home and the mechanics.
So you could always have a certified HVAC technician come in and actually look at something and say, “Tell me about this, what needs to be done.” And I have a tenant that’s actually buying a property from me right now and they asked to have that done. They asked for to do, and they had a home inspection done on the property and they just wanted to find out what is the life use of the HVAC? Is there any problems that might be coming up on it? And they asked to have an HVAC tech come and actually look at the system and give them an assessment of what he thought the lifespan of it. And this was just for planning purposes for them. They made it very clear, “We’re not going to ask you to replace it. We’re not going to ask you to fix anything or do anything that.
We just want this for our own assessment so that we can prepare for when we would need to replace this HVAC unit.”

Tony:
I think you answered that perfectly, Ash. And I think just like, “Hey, what can she do now?” So she’s short 2,500 bucks. I think the first thing I would do is I would continue to shop around. She said she got two quotes, try and get like six. And if you can call around to as many HVAC companies as you can and just let them compete with each other to see who can give you the best price. Maybe another option is telling them like, “Hey, I’ve got 6,500 or can I split this up into two separate payments? I can give you half now and half later, maybe use a credit card to bridge that gap if you need to as well.” But I would definitely first try and shop around a little bit to see if you can get a better price because while two might be just the going rate in your area, who knows?
You might be able to find the person who just started their HVAC company and they’re looking to be a litle bit more competitive on pricing and they can give you maybe a break on what that is. So shop, shop, shop, see if you can find someone that can do it for a better price.

Ashley:
I just did that with it HVAC. I got three quotes. One guy never got back to me. I followed up with him. He’s like, “Oh, I should have it for you this week.” Never heard back. So don’t even know what that quote would’ve been. Another one, 30,000. Contractor, we use all the time for HVAC for plumbing. Next one, 20,000. And that is $10,000 difference. And I think part of that difference was the other one, one was a company. They have a lot of overhead, they have employees, they have insurance for their employees. They have a lot more overhead. This other guy was just a single guy, just had his own business, things like that. He has less overhead because he doesn’t have employees and payroll to cover and things like that. So I think that definitely played a difference is the actual labor piece. Also, Darrell’s going to help him too.
He said, “Hey, I’ll be there the whole time to be your extra hand,” which that goes a long way when installing something is just having somebody to run down and get the next piece or whatever. So yeah, I think definitely shopping for options and maybe looking at, like Tony said, the smaller contractor that maybe just got started or something, or also the one that’s maybe closer to retirement. We’re waiting for the HVAC to be put in on this rehab we’re doing because our guy just bought a place in Florida and he’ll be there for three weeks and then when he comes back, he’ll get to it. So this might not work for you if you have an urgent dire situation to get something replaced. But I’ve also had a lot of luck hiring contractors that are kind of in that semi-retirement era where their prices are more affordable because basically they do it when they can.
So maybe not this situation, it may not work out for you where you may need someone immediately available, but that’s also a way I’ve found great contractors.
And then I think the last question to address here is how much should they have had in reserves? And I always like to say three to six months of expenses. So we don’t know, but I would, especially if first property, six months on the safe side. We don’t know what their monthly expenses were, what the rental income was on this property to be able to gauge how much they could have had. But I think Tony gave some great options to make up for the difference in the money that you needed. And there’s probably a lot of companies too that offer payment plans, I would think, because I would think this probably isn’t typical of just an investor, but I think the average homeowner, I mean, you see all this data and statistics that an average American family does not even have $8,500 in their savings account anyways to cover an expense like this.
So maybe there’s some kind of payment plan. Man, I feel like you can get a payment plan for anything these days where you could look into doing something like that through some of the companies. Okay. We have one more question after the break and this is for anyone who has ever looked at a deal and thought, “Wait, this is too good to be true. Is it even real?” We’re going to walk through exactly how to find out and we’ll be right back.

Tony:
All right, welcome back. All right. Our last question today is one I think a lot of rookies will relate to because finding a deal that looks great on paper is exciting, but it might also set off some alarm bills for a lot of people who are not sure whether to trust what they’re actually seeing. So this question also comes from the BiggerPockets forms and it says, “I found a small multifamily property at Triplex listed at $185,000 in a mid-west market. The current rents are 550, 575, and 600 per month totaling 1725 per month. The seller says the expenses are low because the building was fully renovated three years ago. When I run the numbers using the 50% rule, the property seems to cash flow around 450 to $500 per month after a 20% down payment and at current interest rates. That feels almost too good to be true for this price point.
My concern is that I’m wondering if I’m missing something. The property’s been on the market for 47 days, which also makes me nervous. What should I be stress testing before I make an offer? What red flag should I be looking for and is a 50% rule actually reliable here or am I using the wrong tool? We’ll talk about the 50% rule in a moment, but I think one of the things I just want to highlight first is that I hear this often from Ricky investors where he says, “The property’s been on the market for 47 days, which also makes me nervous.” I think that’s a common misconception, Asher. I’m curious if you agree with me or not, but I think that’s a common misconception of rookie investors where they look at days on listing as a proxy for whether or not a deal is a good deal or a bad deal.
The days on market is a combination of so many different things. First, this is a triplex. Maybe there just aren’t a lot of people shopping for triplexes in whatever market it is that you’re shopping in. Maybe there’s a chance that the agent, when they initially listed it or the seller when they initially listed it, maybe they listed it too high. Maybe the seller wanted $300,000 and the agent says, no one’s going to buy it at that price. They’re like, “I don’t care. I want to list 300.” And it sits. And there’s also the fact that 47 days, five weeks isn’t all that long for a small multifamily property to begin with. So I think I would maybe deprioritize or put a little less emphasis on how long it’s been sitting and put a little bit more focus on your own underwriting and where does the deal need to land at in terms of purchase price in order for it to make sense for you.
But Ash, I don’t know if your take is different from mine.

Ashley:
Yeah, we don’t know the exact same market. So this could be typical that properties are sitting on the market that long. There’s areas by me where things are flying off the listings, they’re getting under contract right away, they’re flying off the market. But then other areas, like there’s a ski resort town where stuff is just sitting and sitting, sitting where 47 days actually isn’t that long for properties that are sitting in this market right now. So first I would look at that as to what is the typical average days on market for this area and is that a long time? And then this is also a multifamily property where there’s also a limited buyer pool compared to a single family home too. So again, in my area, multifamily tends to sit longer than single family just because there is a limited buyer pool too. And then I think you’re really not going to know, like you asked, are there any red flags you should be looking for?
And I feel like that’s very, very hard to actually know until you go and see the property, walk through it and actually get a home inspection done. If 30 been sitting for 47 days, you can probably put into your offer that there can be an inspection or when you actually go to the showing, take a contractor with you to look at different stuff. One red flag may be maybe these people aren’t paying rents and instead of going through the eviction, they’re just going to put the property up for sale and just sell the property even though these tenants owe them a lot and they don’t want to be stuck with them anymore and they want to sell the property. So there could be other things like that that’s coming up that could be red flags, but you’re not going to know and don’t assume until you’ve actually gone and looked at the property and walked to the property.
One thing that has really helped me in the past is going to the town. So this really is beneficial and easier to do when you are in smaller markets, but going to just the town clerk that knows a lot about what’s going on with different properties, they have their own water system in the town, the property tax bills, all that, usually a lot of that stuff goes through them. The planning board meeting minutes, things like that is go in and ask about that property. I’ve got a lot of information about, they can tell you the gossip about the tenants, they can tell you about the owner, they could tell you things they know of that happened at that property and things like that too. So I think making relationships in the market that you’re investing in too and then you can even reach out to the selling agent and just say, reach out to them directly, not even using your agent and just reach out, give them a phone call, send them an email, say, “I’m just curious, why has this property been sitting on the market for 47 days?
Is there anything that I should be aware of? ” And a lot of times agents will be upfront with you because they know you’re going to find out anyways and they’re going to tell you the issue. I’ve been told many times as to, I want you to know upfront, here are some things that’s why we haven’t had somebody buy it. These are the things that you need to know that they may not put into the listing agreement. So I would try some of those things, but don’t assume that something is actually wrong with it without actually going and looking at it.

Tony:
And I think I would just try and really go a little bit deeper on the numbers that the seller’s providing as well. Was that just a verbal thing that they gave you or was there a P&L this year? Was there even a tax return? Maybe that’d be the most, I think, concrete, but call your local utility providers and maybe tell them like, “Hey, I’m looking at buying this property. I’m just trying to get a sense of, hey, what was the average electric bill on this property for the last 24 months? What was the average gas bill? What was the average this bill, the water bill? What’s the trash bill look like? ” And you can start reconstructing some of those expenses yourself. And then if you’re really still questioning even after all that, well then just kind of stress test the deal a little bit further.
What happens if the expenses are 10% higher or 15% higher than what this person said, or maybe 20% higher? Does the deal still at least break even if your numbers are way off? So I think anytime you underwrite a deal, obviously have your most likely case scenario, but then also stress test in a maybe worst case scenario and see, okay, if things really don’t go according to plan, how bad could things get? And for me, I typically would like to at least be able to break even in a worst case scenario. So man, if I completely missed the mark, can I at least still break even on this deal? And if I can, that’s what gives me the confidence to move forward.

Ashley:
Well, thank you guys so much for joining us for this episode of Real Estate Rookie. I’m Ashley and he’s Tony. And if you guys aren’t already, make sure you are subscribed to our YouTube channel @realestaterookie. We’ll see you guys on the next episode.