This Real Estate “Rule” Is Costing You Wealth! (Rookie Reply)

Ashley Kehr:
You’ve got cash ready but can’t make the numbers work for a house Hack. High interest rates are shaking your bur plans and your tenant wants out of their lease early. What now?Today we’re unpacking three pressing questions that many Ricky are facing right now with real solutions that you can apply immediately.This is the Real Estate Rookie podcast. I’m Ashley Care.And I’m Tony j Robinson. And with that, let’s get into our first question. So question number one today comes from Ben. Ben says, Hey everyone. I’m 26 years old, my wife is 29. We’ve been travel nursing for the last two years and have a pretty great cash pile to get started in real estate investing. We were planning on traveling longer, but just found out that we’re expecting. Odds are we will need to reel in our wonderlust and settle back down where all started, which is Akron, Ohio. The main goal for us is to find a two to four unit, preferably turnkey and at live in one side for a year or so before refinancing and scaling. An issue I’m running into in my market though, is high listing prices and lower rents not meeting the 1% rule. Those that do not meet the 1% rule are value adds that will need more work than I can put in right now. Looking for input though on a duplex I found in a great area, it’s listed at 285,001 side is already renting for $1,100. It’s newly renovated and turnkey. If we live on one side, we’ll still be paying $835 per month plus utilities. This seems like a lot for a house hack. Is the asking price outrageous? Is the rent too low or are these situations the new normal? Alright, so house hacking and what actually makes a house hack a good deal? So I guess what jumps out at you first, Ashley, as we hear that question?Yeah, well, I think bringing up the 1% rule, I think for several years now, it’s been hard in a lot of markets to hit the 1% rule, but that shouldn’t be the only metric that you are looking at. There’s other metrics that make you money and the 1% rule doesn’t always mean that it’s a great deal. For example, in Buffalo, New York, I for a very long time could very easily hit the 1% rule, sometimes the 3% rule, but they were on duplexes that were in lower income areas. They actually, I found out became the headache properties and the property taxes were so high on them that they beat the 1% rule, but they didn’t make the 50% rule where your expenses should be 50% of the rental income. So I would definitely take the 1% rule just like any other metric with a grain of salt and make sure that you’re looking at other metrics of the property instead of just the 1% rule.I think we should also reframe what makes a house hack successful and much like the 1% rule and being able to hit that has changed I think. So two has the perfect house hack where you’re getting paid to live somewhere. Living expenses are typically one of the biggest expenses after taxes for the average American. And if you can reduce that even by some percentage, I think you’re still getting ahead. And in this scenario they said that they’re paying $835 a month for their side of that duplex while the side right next to them is renting out for $1,100. So they’re saving close to $400 on their rent every single month or 300 I guess in the scenario, several hundred dollars every single month on what they would be paying in rent elsewhere. So I think in theory you’re still winning on this deal because you’re getting reduced housing expenses, you have a tenant already placed on the other side, you have the ability to build equity with this property over the next however long you tend to hold it. And then when you move out, if you’re renting both sides say rent doesn’t even increase, you’re renting both sides at 1100 bucks, that’s $2,200 total. So now you’re netting, right now you’re cashflow positive on that deal. So I think there’s more to look at than just are we getting paid to live here or are we able to live here rent free and making sure that you’re taking into account all of the other factors.Yeah, I couldn’t agree more with that. My sister, when she first did her house hack, she was paying $45 to live there in an apartment that was, she could have rented for around $900 and she’s owned that property I think for five years now, and she’s been able to increase the rent in the other unit. Her mortgage payment has stayed the same, so she’s paying nothing to live in there now. And also it’s become a more expensive apartment where if she went and lived in a very similar apartment to that one that she would be paying a lot more in rent. So I think you have to look at the long-term result of house hacking too is that your mortgage payment stays the same, you can increase the rent as time goes on, and if you did rent somebody else, your rent most likely would continue to go up to where your mortgage payment will go up slightly due to insurance and property taxes. But most landlords raise their rent to cover and still profit above and beyond that. So you’re still making out that way.I think one last thing that I’ll comment on is in the question they say our main goal is to find a two to four unit, preferably to turnkey live in one side for a year or so before refinancing and scaling. And that before refinancing I think is a very important caveat. Let know what you think Ashley, but I feel like buying a turnkey duplex and being able to refinance in a year is probably going to be tough because there’s no value add, right? What you bought it a year ago is probably going to be pretty close to what it’s worth in 12 months from there. So if that is the goal to be able to refinance and scale, you’re basically asking about buring, I might almost focus on something that needs a little bit of love where you can do some value add so that way when you do refinance a year, there’s some room there. So just a very important piece to call out.I actually just had a refinance done on the property and literally the first question, and it was a very short time period, it was bought the property and within a month was refinancing. And the first thing the appraiser asked was what did you do? What were the improvements? So even if we didn’t do anything and we had bought the property below market value, the appraiser was still wanting to know, obviously she’s looking at the purchase price, what we bought it for. She wants to know what those improvements were, where we added the value to the property that she’s out here appraising it for. So I think yeah, definitely going the value add route. Also they’re saying Akron, Ohio is look at what the appreciation is in that area. If you’ve watched the news, you’ve seen that the market is shifting, it’s becoming more of a buyer’s market than a seller’s market, which could lower the sales prices of properties in that area and appraisers appraise the property based on comparable sales in the area.
So a year from now, that house could potentially be worth less. So that’s always a risk. So one thing I always like to be cautious of, if you are not putting in any value, you either have to buy the property below market value, get a deep discount on it, and maybe the way the market is changing, that will happen. Or you have to be okay that in a year you might not be able to refinance the property and pull out more money. Two other considerations is looking at the closing costs on these properties for doing two mortgages back to back. So if you did one mortgage, what are your closing costs going to be when you purchase it? And then what are the closing costs? What amount does that equal to and does it offset what you’d actually get back in the refinance to you? I think weigh out those two scenarios and run the numbers on it. House hacking might have changed, but what about refinancing your burr at today’s higher rates up next? Let’s unpack if waiting is worth it, but first we’ll take a quick break to hear a word from today’s show sponsors.
Okay, welcome back. So we got our second question today and this question comes from Amos. My partner and I have successfully used the Bur method gaining us five doors in the last five years. Congratulations. However, this last project has posed a dilemma. In short, we went over budget on the rehab and the proposed interest rate is 8.75%. If we move forward with financing, we used our own cash to buy it and fully renovate as the property required Going down to the studs, our forecasted rental income of $2,145 per month will cashflows about $200 per month based on the interest rate as high as 8%. Additionally, going over budget with a higher interest rate at 8.75% made us pause to reconsider other options. We are totally against analysis paralysis, so we need your help. Could or should we consider delaying the refinance for at least another year if we can likely get cash from other sources for the next rehab, which is currently in the demo stage, what would be the implications, good or bad, in regards to taxes, cash on cash return or anything else? Mind you, my partner and I have decided against personal financing at 7.65% as we prefer to not risk our other assets. I think this is actually a dilemma a lot of people have run into over the last year or so, or maybe even a little bit longer as rates have shifted as to having that interest rate shock of, oh my gosh, this is not what I expected.Yeah, I think there’s a few options, right? One you’ve got, I guess they didn’t say how much they purchased it for, but however much they bought it for. All of that is just cash, right? That’s sitting in that deal. So you’ve got a good amount of equity right now tied up into this single property. So I think you have to ask yourself what kind of return on equity are you getting, right? What kind of return on investment are you getting with all of your cash sitting in this deal? Rents is going to be 2145, maybe you’re netting after expenses a little less than 2000 bucks, 1500 somewhere in that ballpark after you pay out all of your expenses. So is that 1500 bucks per month? Is that a good enough return for you and your partner to say, yeah, we can write it out for another year. If it’s a 50% return, yeah, obviously it’s a no brainer If it’s like a 2% return, well now you got to ask, okay, can we actually go out and get a better return on that capital even with the eight and three quarter interest rate, can we go and get that cash back and redeploy it elsewhere to get a better return? So I think there’s something to be said about how much cash do you have stuck in that deal right now and what does that return look like?Yeah, I’m seeing two other options. One is you look at selling the property, what would you make if you sold the property? Would that be a large amount of money that it’s actually worth it to unload? And then you’re just adding to your capital pile. The second thing is to refinance, but don’t pull all of your money out, maybe do half so your mortgage payment is lower, you’re still recouping some of your funds and you still have some of that money for the next rehab. So that’s honestly probably the route I would take if you bought this property to have it as a buy and hold, I would look at refinancing but not taking all of my money out. And then at a future date you could refinance, which stinks having to pay include the closing costs twice. But you could also look at a commercial line of credit too.
So you could do the commercial line of credit now even and or you could do the commercial line of credit in the future and still have the mortgage on the property too. So I think there are certain options. The biggest recommendation right now is what you’re going to do is talk to under other lenders and figure out what other options do they have, the commercial line of credit, things like that. And then I would run the numbers on if you didn’t pull all of your money out, but you just took some of it back out.Yeah, that’s a great point. Ashley, on talking to more lenders, I wonder how many folks Amos actually talked to and is 8.75 the best rate or is that the only rate that you’ve seen so far? Because to Ashley’s point, every lender could look at this same exact deal and give you a completely different menu of options in terms of what financing looks like. So actually that should be the very first step is go shop this deal to 50 other lenders and see who can maybe give you better terms based on what you’ve done because your cashflow positive, newly renovated, I’m assuming maybe it’s stabilized already, so you’ve got a good asset. So can you get someone else to maybe give you better terms? The last thing that I would call out is maybe also look into an adjustable rate mortgage. I’ve personally never done one before, but if you can get the rate down to somewhere below eight for the next three to five years, does that give you enough to say, okay, cool, now we can refinance, get our capital back. And to Ashley’s point, if you need to refinance again later or sell later, that’s an option, but at least you’ve freed up some of that cashflow in the short term. So I think maybe even exploring some different loan products, which again, you’ll have those brought to you as you start talking to different lenders.Yeah, we actually had Dave Meyer on recently on an episode and he’s doing an adjustable rate mortgage right now on a property and he ended up getting another interest point off because he already had a relationship, he had a brokerage account, I believe with this bank and they actually gave him another percentage point off of the interest rate because of that relationship. So I think that’s another avenue to look into too, if you already have even just money sitting in a savings account, banks want those deposits, they want your money. So if you have something like that, talk to that bank and see if they do have options for you or consider moving your money to a bank that does do something like that where they give you a discount on lending because of your current relationship already with having money with them.So talk to more lenders feels like the big solution here to get more insight. But there’s actually one part though actually this question that we didn’t really address and it was the fact that they actually already have another demo going on. So they said get cash from other sources for the next rehab, which is currently in the demo stage. So they’ve already committed to this next deal and if you are able to get sources cash from other sources, then maybe that gives you some more time to figure this out. But if time is ticking and you guys are out of cash, now you’ve got another deal that maybe it’s going to end up sitting, maybe you’ve got hard money on that, who knows where you guys are at with that. So maybe you’re almost forced into some sort of refinance in this deal to free up that cash and get into the next one. So I wouldn’t look at it in a vacuum and make sure that you’re taking into account this deal that’s already started the demo stage as well.Yeah, and I think the commercial line of credit would be a great option for that too, is having the line of credit to use towards at least getting that on the property and using those funds towards the rehab until you decide what to do with this other property or wait to rates go down. I saw an article the other day stating that it’s projected there might be two more interest rate cuts this year, so wouldn’t that be nice? But we’ll see.Alright guys, we’re going to take a quick break before our last question, but while we’re gone, be sure to subscribe to the Real Estate Ricky YouTube channel. You can find this at realestate Rookie. And if you’re listening to this in podcast form, be sure to follow us on your favorite podcast player, subscribe that way you guys are notified anytime we drop a new episode. So we’ll be back with more right after this. Alright guys, let’s jump back in. So our next question comes from Garrett. Alright, Garrett says, I have a tenant who wants to break her year lease five months early. She has offered to pay three of the five months but keep her deposit and last month’s rent if we let her go. Having some buffer to find a new tenant would be nice, but the fact that we need to find one during the holidays and leading into winter distilled not sit well with me, plus she’s breaking her lease.
Should I negotiate the amount with her and let her go and hoping we can find someone for Jan one or do I play hardball and hold her to the lease? Now there’s some additional context here which I think is important for how we answer this question. So they go on to say some backstory. She paid her first six months upfront because she sold her house to get out of debt. She did not have a job but paid upfront to build trust and assured us that she would have a job in six months time. Last week she sent a picture of a small hole in the linoleum floor and crack in the trim, which looks like she dropped some heavy piece of furniture. She said it happened while she was out of town and now she does not feel safe in the house. December was the first month she was supposed to pay after her six month prepayment, but I knew right away she was going to use the strange hole in the floor to get out of her lease.
Now that she needs to start paying, she did pay December’s rent and then waited a week before she said she wants to leave. Any suggestions on how to handle this? The house in North Carolina. So just to recap here, I know there was a lot, but basically this tenant is unemployed, has a big chunk of cash, they move into garage unit pay several months upfront, six months upfront, and then the first month that she’s supposed to start paying again, she pays and then makes this big claim about her not feeling safe and wanting to break her lease. And Garrett’s assumption here is that maybe she hasn’t gotten a job, maybe she doesn’t have enough to keep paying rent. So hearing all that, Ashley is our resident long-term rental tenant management queen. What’s the advice?I have to say that my opinion on this has changed over the years. I would’ve been posting the same thing as to I am not, and basically I would’ve been like, I am not letting this person leave. They signed a year lease with me, blah, blah, blah, blah. I have completely shifted after having a ton of tenant experiences. I would let them go if this is already a headache, if they don’t have the money, if they didn’t get a job, you don’t want them anyways, you’re just going to have to evict them down the road. I wish that some tenants would say, I need to get out of my lease. I need to move before I actually had to spend $2,500 to evicted them. So I think even though this person obviously isn’t being honest, if that’s the case or whatever it may be, if either way, I already see this tenant as being a problem and I would rather let somebody out of their lease.
Here’s a big mindset shift that I have had. Being a landlord should be customer service to a sense there is a line, but you want someone to be happy in your property. It is first of all such a good feeling when somebody is telling you they love living there, blah, blah, blah. But you are providing someone a home and it will make your life so much easier if they love where they live. You want somebody to love where they live and providing a nice safe house for them. If they don’t want to live there, it is just going to be a headache for you. Why make somebody stay in the lease? And I get your point of having to fill the vacancy that is expensive. Okay? I’m also saying all this from the state of New York where it is very, very difficult to evict someone.
And if someone doesn’t want to live there and they feel forced to live there, there may be the chance that they just stop paying. And if you already think she doesn’t have the money, let her out of the lease because it could be way more expensive to go through an eviction, collect that unpaid rent than it would be to get a new tenant in place. One thing I would do though is I would do a move out inspection with her and I would go ahead and charge her for that damage on the floor. Even if it happened while she was out of town. It is her property. She should have went and filed a police report then that somebody obviously came into her property and did damage in her floor. And if she doesn’t have that, then you are entitled to her that. And so I think looking at the scenario as if I was in this situation, I would let the person out of the lease because they’re going to be a headache going forward, especially if you think they don’t have the money to pay, let them out because then you’re going to be stuck with them.
I would take their security deposit and I would use that to fix the floor though I would not let them give you an excuse for that. It happened while they were occupying the unit. And if it was some kind of damage, they should use their renter’s insurance policy to replace it themselves. Or they should file a police report and have the police investigate who broke into their apartment and did this damage. And then they can take that person to small claims court. So three of the five months, but keep her deposit in last month’s rent. Okay, first of all, I think that’s great that she’s already offering to pay three of the five months. That gives you three months to find a tenant. That should be plenty of time to get somebody else in place. And as far as her deposit, I would still weigh that out as to look at, I’ll have to do a walkthrough of the property to see if there’s any damage in place on the property before you agree to give her deposit.
I also recommend in the future, in your lease agreements you put in, what happens if somebody does break their lease. So in most cases, a common clause is stating that they will, if they decide to break their lease, they will be charged one month’s rent, their security deposit will be retained. Another one is that they will be charged until the unit is filled. And a lot of state laws have it as to you have to, as the landlord, actively list the unit and try to get someone in it. So look in your lease agreement too. Do you already have something in there that states some of this?And that, ladies and gentlemen, is why Ashley is our resident tenant relations queen for the podcast.It’s just because I spent a lot of time crying holding my hair.But I love the point of the police report because it really forces them to either A, admit that they were maybe lying or b file, a false police report, which is a crime in and of itself because what are the chances that there’s some burglar who’s breaking into apartment units, not stealing anything, but just poking holes in people’s floor. So I love that approach, but I appreciate you saying that your philosophy, this has changed as you’ve matured as an investor. And I think that’s the cool part of doing this multiple, multiple, multiple times, is that you start to identify the assumptions you made when you were starting out and how some of those assumptions were true. And you can keep those ones. And then how some of your other assumptions were false. And this one, I think it’s more of a pride thing than a truly logical thing because mathematically, if we just looked at this question, the answer is black and it is plain and clear, right?
Okay, cool. She’s offering three months at the five months that are left. That’s more than enough cash for me to go out there and find a new tenant for anything. I might end up making more money if I can turn this shooting and get it re-rented in less than three months. So mathematically it’s easy. I think the bigger part is just like, and you kind of feel like this person’s taking advantage of you maybe in a way. And I think that’s the point that I’m trying to make is that as a real estate investor, we have to sometimes separate our emotions from the facts of the situation. And if we can look at the facts objectively and say, what is the actual best decision for the business and not for my ego, you can tend to make better decisions. So I appreciate you sharing that. I think a lot of rookie need to hear that.And that’s my point of view. And I’m going to give you the other point of view that most other investors would have, as they would say, stick to the lease, tenants will start to walk all over you. If you give to this person, maybe you have a multi-unit and this person, oh, they got to leave early, the landlord will let me do this too. So there investors will have two very different takes on this as to how to handle it. I’m just giving you my opinion. I don’t like stress, I don’t like headaches. I would rather just be done with this person and move on. And I think the fact that they’re going to pay three months rent, I don’t think I’ve ever had a tenant that has tried to break a lease that has offered that upfront. I had to negotiate something like that with them. So I think that’s great. But yeah, there are other investors that say, no, stick to the lease agreement. They sign the lease, you sign the lease. So whatever is in the lease agreement is fair. And if you don’t have an early termination clause in there, then look at then you have a one year lease and you should stick to that. So do what you think is best for your business. But I at least wanted to give you that other viewpoint because my opinion is not what every investor would do.But like you said, your sanity and your peace of mind, it’s hard to put a price on that. And we’ve had guest ask you who’ve checked into our short-term rentals and just start complaining about everything. The last guest just checked out, they left us a glowing five star review. Hey, we love the place. Exact same property, someone else checks in and they’re just complaining about everything. And we’ve had situations where we’re like, Hey, look, if this place doesn’t meet your standards, unfortunately there’s nothing we can do to change that. We’d be happy to give you a full refund if you leave the house tonight.I learned that from you, Tony, and I’ve done that two times. And it was like, I don’t care about the money. Yes, that’s going to hurt us, but having to deal with these people for another four days and getting a bad review, not worth it. And both of those times they left good reviews. They were so thankful. They said, we will leave a good review. And they did.So yeah, it’s hard to put a price on peace of mind. So I agree with you, Ashley, and obviously I think there’s something to be said about sticking to the lease, but when you compare the pros and cons to your point of having to deal with this person for another four months, I think the benefit of just letting them leave far outweighs the, Hey, let’s stick to the six to the lease piece. So anyway, hopefully people got some value from that. I appreciate hearing your insights on how to deal with the tenant relations. As always, Ash.Well thank you guys so much for joining us today on this episode of Ricky Reply. I’m Ashley. He’s Tony. And we’ll see you guys on the next episode.