If a Rental Doesn’t Pass This “Test,” Don’t Buy It

0:00Henry Washington:If you are about to buy your first rental property or about to pick up another, I need you to stop and watch this. In today's market, investors are rightfully more nervous before dropping a down payment. Down payments can be tens or even hundreds of thousands of dollars that you've worked hard for. And if you put it into the wrong property, it could set you back years. But of course, if you put it into the right property, you could fast track your financial independence. So how do you know which one is which? In this episode, Henry and I are sharing these stress tests we run before buying any rental.

0:37Henry Washington:If a property doesn't pass, we walk away, no matter how good the deal looks on paper. So if you are nervous to put up that next down payment, this episode is going to help. Whether we give you the green light to relax and go out and buy that property, or give you the red light to stop you from buying a very bad deal. imagine just how much that peace of mind is worth.

1:03Henry Washington:What's up, everyone? I'm Dave Meyer here with my co-host, Henry Washington. Today, we're dipping into the BiggerPockets forums to answer a few of your questions about real estate investing. Let's jump right in to the first question. All right, Henry, this is a good question. Very curious, your opinion on this one. It comes from Kate Thomas, who says, we're looking at spending a hundred grand out of pocket to buy a 3-2 single family home as a long-term rental in Woodstock. She also says nerves are setting in because that's a lot of money. It is. Yeah, it is. But she wants to know, is this how everyone feels or is this my intuition saying, play it safe, leave the money in the stock market?

1:47Henry Washington:We've wanted this for years. What do you think? I mean, to give a true opinion on this, I would definitely need some more information. But on its surface, to answer her question, is this the way you always feel? Yeah. Yes, it is. I've done hundreds of deals and I still get nervous when I buy them, when I either use money, even when I don't use money of my own to buy them. I still get nervous. I still think, oh, should I do this? I don't know. Like to this day. So, yeah, that's pretty normal. Do you think there are people who don't? I get that way every single time. There's probably people who don't.

2:26I don't know. I'm just not that guy. I still get nervous.

2:28Henry Washington:You're writing a check for six figures. That's a lot of money. You're right about this, Kate. It is a lot of money. The one part of this, though, I would challenge is saying that playing it safe in the stock market is necessarily safer than real estate investing. I don't know if that's true. Yeah.

3:16Henry Washington:You know, like if you really think about how much money you can lose in a situation like this, buying a single family home, let's presume you're using fixed rate debt. Like I wouldn't say that's more risky than the stock market, but I do understand feeling a little anxious about it. The only way to really lose buying a property like this is if you sell it before it becomes profitable. So as long as you can hold on to this for 10 years at a minimum, you'll look like a genius at some point, I'm sure, even with modest appreciation each year. Plus, you're putting$100 ,000 down, which should, I assume, help with increasing the cash flow and hopefully putting money into your pocket.

3:58And you're buying yourself equity and hopefully you're buying with some sort of a discount and walking into a little bit of equity as well. So, I mean, it's a safe-ish place to put your money, given a lot of the assumptions you and I are deciding to make about this deal.

4:14Henry Washington:Yeah, we're assuming that you listen to this podcast and are going to buy this right. I do think, though, like one of the reasons why this happens so much where you get really nervous is because it's the normal thing is just to stick it in the stock market. If you go talk to your friends or whomever, you're probably your financial advisor. They're like, just stick it in the stock market. That's safer. It's less common to interact with other investors who write these kinds of checks and can tell you that this is actually normal. It's normal to feel anxious and that it's relatively safe. So my advice, Kate, is if you are nervous about this, go talk to other investors.

4:56Henry Washington:You're clearly doing that on the forums. That's a great place to do it in bigger pockets. But also come to BP Con, right? Like go to the BiggerPockets conference and interact with people who are in the same shoes as you. Go to a local RIA event and talk to other people about this. I think that's where you gain confidence in this industry where your average friend, your average cousin is not doing this. And so it can feel riskier than it actually is because it's less common. All you're doing is you're taking that$100 ,000 out of one account and you're putting it into another account. And that account in this case is equity in this property.

5:36And if you look back over history, home values typically go up in price. There's been some times where they go down in value, but for the most part, they go up in value. And so the expectation that this$100 ,000 is going to disappear and turn into nothing is pretty unlikely. It's going to be a little illiquid now. You won't just be able to get access to it when you want to. And with you putting so much down, it helps you to be able to get access to some of that or all of that money back when you need to via a home equity line of credit or a sale or a refund. It gives you some options. So I don't think it's as scary as it may feel taking the$100 ,000 and putting it into this property, but it's still going to be there.

6:21It'll just be a little less liquid.

6:23Henry Washington:Yeah, that's a really good point. I doubt you're putting 3 % down if you're putting 100 grand down, right? You're probably putting 25 % down. That really insulates you. It protects you a lot in that kind of deal, makes it a lot less risky. Before we move on to our other questions, though, just wanted to shout out. I did mention BPCon because it is on my mind, and we were sending out speaker invites. Henry, have you accepted? Hey, I got mine, and I signed my contract. so come see me speaking at BP Con. Yeah, it's going to be a lot of fun. If you guys have never been, BP Con is the best time. I look forward to it every year.

6:57Henry Washington:This year, October 2nd through 4th, you can get your tickets at biggerpockets.com slash conference. It's in Orlando, Florida, so it's going to be a lot of fun. Bring the whole family. Are you bringing your family? Yeah, we're planning on bringing the family this time. Look, Orlando, last time we did it there, it was, I mean, that's arguably probably the most fun BP Con I've been to. It was literally the best party I've ever been to my whole life. That was super fun. So excited to do that again. Last time in Orlando, you got to play golf, though, and I didn't. All right. I'm going to tell you a secret that I contacted the golf course closest to the hotel to see if we could buy it out and do a scramble with BiggerPockets members.

7:37Henry Washington:I'm so down. And it's not that expensive. It is a reasonable thing that we could do. So I guess it's up to our audience. It's like, if you want to do this, if you want to go golf with me and Henry, and I'll find other speakers to come to this too. If you want to do that, message me or Henry on Instagram. I'm at the Data Deli. You're at the Henry Washington. That's right. Message us and tell us that you want us to do this. If we can get like 50 people, we can definitely do this. It would be a great time. Yes. Anyway, I digress. BP Con is a lot of fun. Let's move on to our next question. But if you want to golf, also tell us.

8:11We would love to golf with you.

8:12Henry Washington:I'm so down. Moving on. Next question. Our next question comes from Todd in Santa Barbara. Man, I love Santa Barbara. What an underrated city. We don't talk about Santa Barbara enough. I love that place. Todd says he started running every rental analysis through a what if I'm wrong by 15 % filter. Oh, I like this. I like that. If the deal still works with rents 15 % below my estimate, it's worth pursuing. If it doesn't, I move on. It's a simple rule, but it's killed about 60 % of the deals I was previously excited about. painful, but probably saved me from a few disasters. What's your go-to stress test before making an offer?

8:50I love it, Todd. Good for you. Absolutely. Dave and I have talked about this many times where basically in underwriting, we're trying to talk ourselves out of buying a property by underwriting so uber conservatively. It's funny because I have an acquisitions manager who helps me field my leads and talk to sellers. and she'll call me sometimes and be like, Hey, look at this deal. I do this. If you do this and you do that and you get this just right, you can make, you know, 30 grand. And I'm like, nah.

9:21Henry Washington:Yeah, exactly. Right. Like I'm leaving money on the table in deals because I just want them to pay me so much better than what maybe somebody else is willing to work for a deal. And I think it surprises her sometimes cause she's like, you sure you don't want this one? Yeah. I'm pretty sure. We're going to leave that one on the table. I want doubles and triples right now. I'm kind of, I'm kind of leaving singles alone unless, unless there's some criteria that just make a lot of sense, unless the location is super amazing and I'm okay pivoting my exit strategy to keep it if I need to. Other than that, like I just underwrite so conservatively that if the deal still makes sense, I'm like, I guess I got to buy it.

10:04Henry Washington:Yeah, exactly. That's the approach to have. And I think I like what you said about wanting triples and doubles, because then if you miss, if you miss on a triple, you're still getting a double, right? If you miss on a double, you're still getting a single. If you miss on a single, you're out. That's not good, right? Like you don't want to do that. So that's 100 % why you just have to have high standards, especially right now, because the market is not going to save you. I think the rents stress test makes a lot of sense. I mostly stress that it's vacancy. Like what if you made 20 % less income?

10:37Henry Washington:That's really what it comes down to, whether it comes from lower rent or higher vacancy. I don't really care. But like, what if your income goes down 20 %? Very unlikely, right? Super unlikely. But what if? How bad of a situation would that be? I also pretty much always assume no appreciation. I'd put 2 % appreciation long-term, which is lower than the long-term average. So I'm very conservative about that. And then if I'm doing a BRRRR, just big contingencies in the renovation process, both in timeline and budget. So I think those are the main things. I think the other thing to consider on a BRRRR to be conservative is don't assume the lender will give you 75 % loan to value.

11:18Assume a lower loan to value. Or won't appraise for what you think it's going to...

11:22Henry Washington:Yes, that's a very good one. And then I'll talk about in terms of flips, how do I protect myself? So on the flip side, the things that I'm adjusting in my underwriting or being conservative about are the not fixed costs, right? Holding costs. Most people like to budget three months to renovate, a month or two to sell. I am adding an additional two to three months on top of my normal holding costs every deal I'm underwriting. So if I would typically underwrite it for six months, I'm doing it for eight to nine just because some deals we list and they get three offers in two days. Some deals we list and they get three offers in six months.

12:01And sometimes there's no rhyme or reason. Like I can't figure out why one versus the other. I'm stopped trying to figure it out and I'm just underwriting it into the deal. The other thing that we are doing to protect ourselves in the underwriting is we are not underwriting to sell at max ARV. We are underwriting to sell at mid ARV. And then And we're still reevaluating when it's time to list the property. And we're doing it very, very comp specific so that if I have comps and those comps are priced a certain way, I always want to be under what they're priced at so that I force everyone who's looking in that market to come see my property because more eyeballs equals more offers.

12:52And so that's that. Those are the things that are protecting us in the underwriting.

12:56Henry Washington:This is just a good philosophy with just like management in general. I think if you're working with on a flip or a burr or whatever, like the numbers you should be telling your team, your contractor, your agent, your property manager are the best case scenarios. Like that's what you want people to be shooting for internally. You have to know that there's a different number that still works, right? Like I think that's, you're not even being dishonest. Like you should say like, this is what I expect. I want to get 3 ,800 bucks a month. I want to sell this for $400 ,000. But you need to know, okay, if it sells for$370 ,000, we're going to be fine.

13:30Henry Washington:That cushion is super important. Yep. And I believe we said this on a previous episode. It's not that underwriting conservatively is the hard part. The hard part is seeing when you underwrite conservatively that the deal just barely doesn't meet your criteria and still walking away. That's the hard part. That's what you got to be able to do. And that means sometimes you're leaving money on the table. Like I was, I was talking with the seller and I, I'm, those of you who know me know I make very honest offers. I don't, I'm told sellers know what I plan on making. That's part of how I make my offer.

14:08And so when I told the seller, she had a higher end house in a more expensive neighborhood, very desirable neighborhood, but those properties take longer to sell. Buyers expect more to be done at a higher quality. And I just want to be paid for the risks that I take on. And so I told her, I was like, I just can't do this deal. There's not enough meat on the bone. And she was like, yeah, but you're still going to make 50 grand. And I was like, yeah, I can't do it. It just doesn't fit.

14:34Henry Washington:Well, good question, Todd. And please let us know if you need more advice on your portfolio, Henry and I are willing to fly to Santa Barbara at your expense and play golf with you. And play golf with you and talk it over.

14:50Henry Washington:No, actually, good question, Todd. I do respect this idea. This makes a lot of sense. All right. I'm curious your thoughts on the next question, but I'm going to have to wait to hear those until after the break. Finding great real estate deals is harder than ever. The investors winning today aren't working harder, though. They're working smarter with AI. And that's where PropStream comes in. PropStream gives you access to over 160 million properties nationwide. Plus, they give you AI-powered tools that help you find the best opportunities faster. Use predictive AI to uncover motivated sellers before the competition.

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19:12All right, we're back on the Bigger Pockets podcast and Dave and I are going through forum questions. These are questions that you guys have asked in the Bigger Pockets forums and we are here to answer them. Dave, what you got for us?

19:25Henry Washington:All right, next we have a question from a BiggerPockets community member named Eli who asks, I just turned 20 years old. Wow, forgotten what that feels like. And I'm finished. I got a remodel of my first home, which I recently moved into. I really fell in love with the whole process and I'm very confident that this is what I wanna do for my career. Anyway, I'm going to buy a distressed property around the 60 to 80K range and most likely going with the BRRRR. And I'm just wondering how much cash reserves I should have. Any advice is greatly appreciated for someone just starting out. And by the way, Henry, we did some research.

20:05Henry Washington:He is in Montpellier. I can't pronounce that. I took French for six years. I can't even say it. Anyway, Montpellier, Ohio is where Eli is. That explains the 60 to 80K range for the Burr property. What's your advice for Eli? If the property is already stabilized, I typically want to have between 10 to 15, maybe$20 ,000 on hand, because if a roof needs replaced for some reason, right, that's typically the price point that that's going to fall in. That may be probably the most expensive repair, right? But that's for a property that's stabilized. seeing as that this property is not stabilized. I think you need to have that on hand, right?

20:48What's it going to cost you for the most expensive repair? And then you need to have some cushion above and beyond your repair budget. So again, I'm making assumptions. I'm going to assume that your repair budget for this property is going to come in financed in with part of your loan because that's what most people do. So I'm assuming you're not paying for the renovation out of your pocket. So what I would do is I would make sure that you've got enough to cover maybe 15 to 20%, 25 % over your repair budget. Because if you've never done a repair on a property before, you've probably under budgeted it.