Households of Fi-Zach and Marilyn
What You'll Get Out Of Today's Show
- Continuing the financial independence case study series, Households of FI family, Zach and Marilyn are a married couple with young kids. Using Dave Ramsey's baby steps, they no longer have any debt but have wondered what to do next. Looking to explore investing in real estate, ChooseFI connected them with real estate expert, Paula Pant.
- Though Zach and Marilyn once lived below the poverty line, they managed to pay off their debt, including student loans, a car loan, credit cards, and medical debt. During that time, they gained a little experience with buying and selling property. Since that time, Marilyn has gone back to work and their income almost doubled.
- Having earned a profit on some previous homes they flipped after living in and renovating them, it's encouraged them to use the skills they've acquired on future investment properties.
- Where they currently live in Cedar City UT, the market is a bit inflated and are concerned about the 1% rule where monthly rent should equal 1% of the total purchase price.
- Paula explains that if a property rents for 1% of the purchase price, that is 12% per year at full occupancy. Since it is estimated that operating costs will be roughly 50% of the monthly rent, 6% of the purchase price is what if leftover as an unleveraged dividend on the property. Assuming no increase in the value of the property, but keeps pace with inflation, that's roughly another 3% based on historical averages, the property gives a 6% dividend and 3% inflationary increase, for a total return of 9%. It is a rough way to determine if a property is worth looking into further
- Exceptions for the 1% rule of thumb may be made when operating costs are expected to be less than the 50% average, such as if property taxes are extremely low or if it is a newer home.
- Other exceptions to the 1% rule can also be made when buying a multi-unit home where you live in one unit and rent out the others. In those cases, personal criteria for where you want to live also come into play and the 1% rule can be thrown out the window.
- Because property values are a little inflated where they live, Zach and Marilyn are interested in buying properties in markets where they don't live. Paula believes that it's easier being an out-of-state landlord because it forced her to treat it like a business when she couldn't just pop over and take care of issues herself.
- Zach and Marilyn were also interested in what criteria they should consider regarding properties that are fixer-uppers versus being move-in ready. Paula says what she teaches the students in her real estate investing course includes a graph where on the x-axis represents a spectrum with “You Find Deals” at one end and “Your Create Deals” at the other. On the ends of the Y-axis are “Move-in Ready” and “Not Even Habitable”. There are tradeoffs between effort and reward, but as effort increases, generally, reward increases as well. If you don't have time to devote to the hardest quadrant of the graph, then it might be easier to find deals in the move-in ready quadrant instead.
- Since they are debt-free, Marilyn I feeling anxious about taking on additional mortgage debt, but Paula views the mortgage from an investment property differently from personal property. An investment property mortgage is a tool that allows you to cashflow positive.
- Paula doesn't have a specific price range she won't exceed but says there is a balance of equity to debt that she tries not to exceed across her entire rental property portfolio. She tries to keep a 50/50 ratio where for every $1 of debt she has, she also has $1 of equity which is conservative by most real estate investor standards.
- To ensure that enough funds are on hand to take care of emergency maintenance and other unexpected household repairs, Pauls advises having 3-6 months' worth of rent on hand to cover these expenses.
- Zach and Marilyn are wondering if they should cut back on retirement investments and divert to real estate to help them acquire property faster. Paula suggests instead look at how much from their overall budget they want to save and then decide how to divide up the savings.
- Considering what happened in 2008 with the real estate market, and unsure how the pandemic will impact real estate today, they are unsure when to jump in and purchase an investment property. Similar to trying to time the stock market, Paula encouraged them to look at the numbers to decide if it's a good deal right now. If in the future, the market shifts and no longer makes sense, then sell. When this is done repeatedly over a lifetime, you win.
- Since they have done well in the past with live-in flips, Paula cautioned them to be aware of their emotions and to be careful about separating what they want from a home they live in with what makes sense as a good investment.
- A 1031 Exchange allows you to avoid paying capital gains when selling an investment property and reinvest the proceeds from the sale within certain time limits in properties of like-kind and equal or greater value.
- Living in a property for two of the last five years qualifies you for a capital gains exclusion of up to $250,000 or $500,000 for couples filing jointly.
- Brad has been an out-of-state landlord like Paula for more than a year. He purchased a couple of properties in Georgia for $50-55,000. The market rent for these properties is about $750-800 so Brad is above 1% at around 1.4%.
Resources Mentioned In Today's Conversation
- Afford Anything
- Get the FREE ebook Escape by Paula Pant
- Get your first 90 days of advisory fees waived at Fundrise
- Create a new retirement plan and get 14 days for free with NewRetirement
- Get started on your path to financial independence at ChooseFI.com/start