Paying Off a Rental Property vs. Buying More: Which One Wins? (Rookie Reply)

0:00Okay, 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. 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.

0:27So we're going to walk through exactly how to stress test that deal before anyone pulls it.

0:37This is the Real Estate Rookie Podcast. I'm Ashley Kerr. And I'm Tony J. Robinson. With that, let's get into our first question. So our question today comes from the BiggerPockets forums. 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 is 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.

1:17Is my friend right? Am I leaving money on the table? How do I think this through the right way? It's a great question. Paid for real estate is sometimes one of the best assets that you can have. But again, I think a lot of but 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? You know, what just kind of allows you to sleep at that? 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 were probably leaving cashflow on the table by having all of that equity tied up in one deal.

1:54And your return on your equity in that property is pretty low. Like you could get a better return on your investment by reallocating that equity across, you know, 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. Ash, would you agree with that? Like if we just look at the numbers, like that's probably going to be the case. Yeah. And I think what you could easily do is look at, okay, what could you buy with that down payment amount?

2:27So 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 like not only looking at the numbers, but also the management piece of it. Now that you have three properties, that's more to manage.

3:07You 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 setting? 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.

3:51I 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 isn't 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.

4:35I have several that are paid off free and clear and that 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. Yeah. I think you hit the nail on the head, Ash. Part of it is mathematical. Part of it is personal preference. And if for where you're 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 than stay there, right?

5:19Like to your point, I think sometimes we do get caught up in the unit count and like 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, right? And why overcomplicate it? So I think mathematically that 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.

5:47All right, coming up, we've got a rookie investor who just got hit with a repair bill that they were not 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 a quick word from our show sponsors. Most investors spend more time chasing deals than reviewing their insurance. But a quick coverage check can be fast, easy, and one of the smartest ways to protect and even improve your property's cash flow. As the months get colder, frozen pipes, icy walkways, and seasonal wear and tear can increase the likelihood of claims.

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8:31That's Indeed.com slash rookie. Terms and conditions apply. Hiring Indeed is all you need. 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?

9:11And what do I do going forward so I'm never 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 with the ages on the current HVAC, on the roof, on the hot water tank.

9:53And in his opinion, how long does he think it has life left in it? So does he think that, you know, 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 tune-up or look at it and go through it and kind of give an assessment of what it looks like, how well it's running.

10:41doesn't 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 can always have a certified HVAC technician come in and actually look at something and say, you know, 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, um, 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?

11:25Is there any, you know, 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, you know, the lifespan of it. And this was just for planning purposes for them. They weren't, 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. I think the other, you answered that perfectly. I shouldn't, I think just like, what, what can she do now?

11:56So she's short 2 ,500 bucks. I think the first thing I would do is I would shop, continue to shop around. She said she got two quotes, try and get like six, you know, and if you can call it around to as many HVAC companies as you can and just let them, let them, you know, kind of compete with each other to see who can give you the best price. Maybe another option is like telling them like, Hey, I've got 6 ,500 or can I split this up into two separate payments? I can give you, you know, half now and half later, you know, maybe use a credit card to kind of bridge that gap if you need to as well.

12:29But I would definitely first try and shop around a little bit to see if can get a better price because while two might be just a 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 kind of be a little 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. I just did that with an 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.

12:55Never heard back. So don't even know what that quote would have 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 like 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.

13:36Also, Daryl'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. And, or also, um, you know, the one that's maybe closer to retirement, like we're waiting for the HVAC to be put in on this rehab we're doing because our, our guy just bought a place in Florida and he'll be there for three weeks.

14:11And then when he comes back, he'll get to it, you know? So it's not, this might not work for you if you're having 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 you 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 like how much should they have had in reserves and I always like to say three to six a month of expenses so we don't know but I would especially your first property six months on the safe side we don't know what you know their monthly expenses were what the rental income was on this property to be able to gauge how much they could have had.

15:08But 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. And 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.

15:46OK, 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. When you're just getting started in real estate, it feels like every dollar has a job, down payment, reserves, repairs. And then summer comes and you're like, can I afford to take that trip? Or should my money stay in the deal? That was me recently. I didn't want to guess anymore, though. I wanted to know exactly where I stood before making any decision. Monarch is the personal finance app that tracks everything.

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20:15We're the Hartford, with decades of experience insuring millions of unique small businesses. When it comes to your small business insurance, Thank you. one size absolutely does not fit all. Get a quote or find an agent today at thehartford.com slash smallbusiness. 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 bells 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 forums, and it says, I found a small multifamily property, a triplex, listed at$185 ,000 in a Midwest market.

20:56The 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?

21:32And is a 50 % rule actually reliable here or am I using the wrong tool? Um, we'll talk about the 50 % rule in a moment, but, but I think one of the things I just want to highlight first is that I hear this often from Ricky investors where, you know, he says the property has been on the market for 47 days, which also makes me nervous. I think that's a common misconception. I'm curious if you agree with me or not, but I think that's a common misconception of Ricky 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 the 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 maybe there's a chance that the uh the the the agent when they initially listed it or the seller when they initially listed it maybe they listed it too high right maybe the the seller wanted three hundred thousand dollars and the agent would like you know the agent says no one's going to buy it at that price you're like i don't care i want to listen 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.

22:36So 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 out in terms of purchase price in order for it to make sense for you. But I don't know if your take is different from mine. Yeah, we don't know the exact same market. So like this could be typical that properties are sitting on the market that long. There's areas by me where things are flying off, you know, the listings, they're getting, you know, 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.

23:19So first, I would look at that as to what is the typical average days on market for this area? And is 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 ask, 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 getting a home inspection done. It's already been sitting for 47 days.

24:02You 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 sell 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.

24:38One 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. and they're going to, you know, 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. And I've got a lot of information about, they can tell you the gossip about the tenants. They can tell you about the owner, you know, they could tell you things they know of that happened at that property and things like that too.

25:17So I think, you know, 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. And I've had this, I've been told many times as to, I want you to know upfront, here are some things.