Don't Buy a House Hack Until You've Checked These Numbers (Rookie Reply)

0:00One of the hardest parts of being a rookie is that every strategy can sound like the right strategy. House hacking, long-term rentals, short-term rentals, duplexes, out-of-state investing. It's so easy to get stuck comparing paths instead of picking the next move. Today's questions come from the BiggerPockets forums, and we have a Southern California investor wondering if long-term rentals even make sense, a rookie trying to analyze a first house hack, and someone deciding between a duplex rental and a vacation.

0:32this 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 today's first question comes from brian and brian says i'm just starting to seriously look into long-term rentals and would appreciate some guidance from folks who have experience i have a good amount of money in savings and i'm trying to decide if putting some of it toward a long-term rental makes sense i'm not in a rush i want to be intentional about how to get started. I'm based in Southern California, which brings up my main question. Does it generally make more sense for a beginner to pursue long-term rentals in California, or is it better to look out of state due to pricing and cash flow?

1:09Mainly looking for advice on whether long-term rentals are so worth getting into right now, in-state versus out-of-state, how beginners typically structure their first long-term rental mistakes to avoid when starting out. My goal is long-term wealth building and learning how to do this the right way from the beginning? All right. So great question. And he actually hit, I'm glad he mentioned that. He said, my goal is long-term wealth building. Now, assuming that we define wealth in terms of real estate is like, you've got a lot of equity and appreciation built up inside of your portfolios you can then access at a later point in time.

1:47Honestly, depending on how much cash you have set up, it might not be a bad idea to go buy something in California because generally speaking, if history repeats itself, if you look up in 20 or 30 years, the real estate will have appreciated quite a bit. And if you've got a small but mighty portfolio of properties in Southern California that have appreciated massively while your loan pay down has happened, you're going to end up with a massive amount of equity and therefore wealth inside of those properties. So I think the strategy is how can you take the cash flow or the cash that you have, deploy that into a property maybe, and it doesn't have to be maybe in the exact part of California that you're in.

2:22Like if you're in LA proper, go out to the suburbs, right? But can you find some properties in Southern California and then apply maybe a strategy that at least gets a deal to slightly break even or better, and then keep repeating that same process. So again, maybe instead of a traditional long-term rental, maybe you rent by the room. Instead of a traditional long-term rental, maybe you do a sober living facility or an assisted living facility or something to that effect. Or even if you don't do those things, maybe you rent to someone who's doing those strategies and they're just paying you a slightly higher rent amount, right?

3:01And you're getting longer term lease. So you do something like a midterm rental where it's not quite to the extent of a short term, but you still get the increased cash flow. So if long-term wealth is a goal, that's what comes to mind for me. One thing that I've really noticed too with, as far as like buying on appreciation is I don't think that you should have negative cash flow and just bank on appreciation. But if you're going to want both, one thing that I've found in my own investing journey is that a single family home is going to appreciate more than a small multifamily. And I don't know if this is market specific to me, but that is something that I would look into in whatever market you plan on investing in and purchasing a property if you want that long-term wealth.

3:45So for example, if I had two very comparable properties, one was a single family home and one was a duplex. I have a very limited buyer pool for that duplex compared to a single family home. A single family home, I'm attracting all types of buyers. A duplex, I'm attracting someone who wants to house hack or an investor. That diminishes my buyer pool by the property type. So that's one thing that I would look at in your market. Go back and look the last 10 years, the last 20 years, the last 30 years, what type of property has appreciated the most and maybe tailor your buy box to that type of property.

4:29I also think a single family home is easier to exit out of because of that bigger buyer pool than a small multifamily property is too. So not only thinking about what, you know, what market, what type of strategy, but really being conscious of the type of property that you are also purchasing. So like a condo, a townhome, So how is the appreciation compared to single family, to small multifamily in that area too? Coming up, a rookie in South Florida wants to house hack, but is trying to figure out what numbers matter first. We'll talk about how to analyze a house hack without getting lost in every possible metric.

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8:19Our next question zooms into one of the most common rookie strategies, house hacking, and what numbers actually matter when you're buying a duplex or a single family home. So his question says, good afternoon. I'm looking for my very first deal to be a house hack. I'll be using a conventional loan with three and a half or 5 % down. What's the best way to analyze a house hack deal? What numbers should I be looking at first in both a duplex and a single family home option? If it differs, I am in South Florida. Duplexes are ranging from roughly 300 to 500 K depending on the area. Okay. So here we go again, the single family versus multifamily, um, you know, difference here.

9:02Once again, the first thing I do is look at the appreciation of the property. Okay. Which appreciates better in that area. The second thing is, do you have a personal preference of having roommates or not? So, uh, if you're going to buy a single family home, you're going to be renting by the room house hacking, uh, compared to if you buy duplex, you could live in one side and then you can rent out the other. What I love is the super max house hacking where you have the duplex, you are renting out one side, and then you are also renting out the rooms in your side of the duplex. So that I think is like the max, and that is you're going to get the biggest benefit from doing it that way with a small multifamily property.

9:47So one of your questions is what's the best way to analyze a house hack deal? you're going to do it the exact same way that you would if you weren't living there. So what rents can you get for the rooms? What rents can you get for the other unit? You're going to put in all of your expenses. You're not going to say, oh, well, I'll be living there. So, you know, I'll just pay the electric. I'll just pay this. I'll just pay that. No, you're going to add every single expense for that property in there. Property taxes, insurance, the full amount. And you're going to analyze that deal. And if you come out with negative cash flow, okay, so say it's going to be a negative$400, that could probably still be a great deal.

10:31And that's because you are living in one of the units or one of the rooms. And here's how you compare. If you were to go and rent a room that was of comparable size, would you be paying this$400 for that room? Would you be paying more? Would you be paying less? If you were going to go and rent another unit, would you be paying more? Would you be paying less? If you are going to be paying less than you would be in any other apartment that you'd rent in the area that was comparable, you might have yourself a win here, okay? Because you are reducing your living costs. That gives you extra money to save for your next deal.

11:13Another thing you're going to look at is mortgage pay down. Your tenants are going to be making your mortgage payment and they're going to be paying that mortgage down for you. So over time, you're going to have more equity built up in that property just from your tenants paying the mortgage. If you were renting somewhere, you would not have that built-in equity every single year. And yeah, the first year, trust me, it's not going to be a lot of money, especially if you're doing a 30-year fixed rate loan. It's probably going to be, you know, compared to the amount of interest, it is going to seem very insignificant that amount of principal pay down.

11:50But over time, that increases and that adds up. The next thing is you're going to just look at appreciation in general in the market. And so those are three factors that you should look at as if this is a good deal. You're going to analyze it just like you would a regular property. Then you're going to look at what you would pay to live somewhere else, what your actual living cost would be to live somewhere else, what the mortgage pay down is going to be, and what the appreciation is going to be. And then I think you will have a better idea as if this is a good deal that will work for you. I think the only thing I'd add too is that it's maybe even okay if you are spending as much as you're spending right now because at least that money's going directly to your own loan pay down as opposed to your landlord's, right?

12:36It's like, even if it's the same amount that you're spending, like there's still a net positive there to you. And I think maybe the only caveat is also underwrite the deal to understand what happens once you move out. Because you want to at least be in a situation where when you move out, that the property is self-sustaining, that it's breaking even. So let's say that you do move out and the property's losing, you know, a thousand bucks a month, maybe it's not a great deal, right? But if it can at least break even once you rent out the space you're currently occupying, and the cost is somewhere near what you're already spending on your living expenses, it's a pretty good house hack these days, right?

13:10To Ashley's point, you're getting the asset, loan pay down, appreciation, all those things. So only caveat I'd add to Ashley's point. After the break, we'll look at a different first investment fork in the road. Should a rookie buy a duplex for long-term rentals or a vacation home that can double as a short-term rental? We'll cover that after the break. I just booked a trip to the coast and I cannot stop thinking about it. Waking up early, walking somewhere I've never been, finding a little cafe with no plan except to see what the day brings. A few days to explore, try new restaurants, smell the salt and citrus in the air, and remember why we left to travel in the first place.

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18:22Bitcoin Services by Block, Inc. See the Bitcoin disclosures at cashapps slash legal slash podcast. All right, guys, welcome back. So our last question today comes from Chris. And Chris says, I have a feeling this is a common question, but interested in feedback on my personal situation. After sitting on the sidelines for the last 20 years, I'm finally ready to deploy some capital. And it seems like I've narrowed down to two options. Number one, purchase a rental property, preferably a duplex or triplex for long-term rentals. Or number two, purchase a second home an hour or so away from the mountains or lake for short-term rentals.

19:00Looking for any opinions on pros, cons of each of these options based on the timing in my situation. So background, early 40s, divorced, older kids, W-2 employees, 35 % tax bracket. I own my own home, but I'm about to rent it out and downsize into a smaller rental. I have 50K available for down payment and adequate emergency savings. I have a commercial real estate background. I'm handy. Not a lot of equity in the house, but the rate is 3%. Option one, there were a few duplexes within 20 minutes of my house that need minimal work, but could be improved to increase rental rates. Seems like most would cash flow within the 5 % to 15 % annual ROI.

19:41My understanding is I would most likely need to take out a rental mortgage for this option. Option two is that I've thought about getting a mountain or a lake house that I'd use three or four weeks a year, and then short-term rent the place the rest of the time. I would probably use a property management company for this. I think I can get a second primary mortgage for this option. I need help finding the properties. I could not scout this myself. Bonus consideration, if I don't purchase beforehand, I'll have to rent out a house in this area for Thanksgiving to host my folks. So that'd be money out of my pocket anyway.

20:11All right. So we've got a lot of context here from this question from Chris. I think the first thing that I learned something new on this podcast today f w i w stands for what it's worth and it was commonly used in the 90s in chat rooms online ah commonly used in the 90s in the chat room and email so i said either i'm too old or i'm too young for that one so i think we're maybe just a little bit too young for that one let's bring it back yeah f w i w for what it's worth we won't even type it we'll just say it on the podcast like lol exactly that was really funny funny lol fwiw yeah we'll just start dropping that all right you heard it first guys we're bringing that back here on the rookie podcast episode 772 um but chris you gave us a lot of good insight and um i think the first thing that i'd say is that after 20 years don't overthink it anymore like like the goal at this point should just be to get off the sidelines and get proof of concept in some strategy.

21:13Because honestly, there's merits to both. You can be successful going either path. I think the bigger thing that I tell you and anyone else who's listening is that if you've been waiting five years, 10 years, 20 years to get into real estate, the question right now isn't really about which strategy makes the most sense. It's what can I do today to get into the game? So I think my initial gut reaction, and we can talk X's and O's here in a little bit, but my initial gut reaction is whichever strategy you can execute on faster. Because I think the speed at which you get your first deals can have a bigger impact than how that deal actually performs.

21:52Obviously, we don't want you to lose money on either of these deals. But like I said, I think you can be successful with both. But whichever strategy allows you to get into the deal the fastest is one that I would probably focus on first. I am going to say the short-term rental. And Tony, I thought that you were definitely going to say this and you were going to steal my answer, but it says that he is single and he's in the 35 % tax bracket. And I believe that's like$250 ,000 to like$600 ,000 for his yearly income, which I would consider a high income W-2. And with a short-term rental, he can use the short-term rental tax loophole to have a cost segregation study done on the short-term rental to offset with bonus depreciation, offset his W-2 income.

22:44because he can qualify since it's short-term rental as a real estate professional and be able to write it off against his W-2 income. So I think right there is one huge benefit of drastically decreasing his tax bill. And then the second thing is he said that his kids don't come and visit often, so he doesn't need a bigger house. You get that lake house and your kids will come and visit a lot more. It's super true, right? You get the place that everyone wants to hang out at. But Ash, you bring up a great point. And I think mathematically that might actually make the short-term rental work in his favor.

23:26The only caveat though is that he said that he'd want to hire a property manager. In order to qualify for the short-term or in order to take advantage of the short-term rental tax loophole, you have to qualify for what's called material participation. And there's several different ways you can qualify, but the two most common paths are the 100 hour test and the 500 hour test. And the 100 hour test is that you've invested at least 100 hours into that property and no one else has exceeded that combined. So like if you add up the time, your cleaner's spend or your handyman or all these different people, no one else combined has spent more time than you have, or you've done at least 500 hours over the course of a year.

24:10And at that point, it doesn't matter how much time anyone else has spent on your property. Those are the two most common. So if you have a property manager, sometimes it can get pretty hard to prove that they didn't spend more time on that property than you did. So that's one thing to consider. But I agree, Ash. That is a great point. I did not think of, I didn't register that he had asked for a property manager. I didn't remember that piece of it. But what about like if he was his handyman? Like it doesn't matter which, what work you do on the property. Right. So if he renovated a room, he did the maintenance, he did all that.

24:46And that added up to that 100 or 500 hours, then that would work then. Right. But also too, that's, that would mean giving up his time and whatever, having to put those hours into the property. So I think really the next step would be to, okay, how much would you actually save in taxes? And would that be worth a hundred hours of your time? And then, you know, talking to a property manager that's in that area and getting an estimate of how much time they allocate per a property, you know, per a week, per month, or for the whole year on average to give you kind of an idea. if you would be able to meet those requirements.

25:30And of course, talk to a tax professional. I did take one course and one test for the CPA license, and I failed, okay? So this is not professional advice is what we're saying here, Chris. And I've taken zero tests, and I probably failed even if I did. But yeah, definitely go talk to a CPA. But I think the last thing I'd share, and this is really for everyone that's listening, that like Chris is considering buying a short-term rental, but you're nervous about the management side. The first Airbnb that we purchased was 3 ,000 miles away from where we live. And I've worked with a lot of different Airbnb investors who buy nowhere near their current residence, and yet they're still able to effectively give their guests a really good experience.

26:20And you're able to do that when you set up the right tools, systems, processes to automate a lot of what it means to be an Airbnb host. And guys, it is not uncommon for us to have someone check in to one of our 20 plus Airbnbs across the country, say three or four days, and we never have to actually talk to them. They're just like going back and forth with the automations that we set up. They check out, they leave a five-star review and they talk about how great my team was at communicating. So when you set up the proper tools and systems, a lot of folks are able to do this themselves while juggling busy full-time careers and families and all those other commitments as well.