Why Buy a Rental Property?...and When Not To

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In this episode of Wealth Office Hours Live (Part 5 of our 8-part series), we break down the fundamentals of rental real estate investing—covering how investors build wealth through cash flow, appreciation, mortgage paydown, and tax advantages. We walk through a real-world deal analysis, explain cash-on-cash ROI, and highlight key tax strategies that impact your returns. We also cover when buying a rental property may not make sense and how to think about exit strategies like 1031 exchanges and capital gains. Stick around to the end where we’ll open it up for a live Q&A and answer your questions in real time.

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Transcript

SPEAKER_00 0:11

So excited to be back with you today. And we've got a really important topic today. We're going to talk about why you should buy a rental property and when you shouldn't buy rental property. A lot of people out there right now are given crappy analysis and are not excited about the rental properties they may already own or the opportunities out there. And rental real estate has been one of the most popular ways everyday Americans can grow and build wealth. So I want to dig into the topic and talk about when you should buy a rental property, understanding all the benefits of it, okay? How to look at it, how to analyze it, how to think about it. And then also contrast that to when you shouldn't do it. Because sometimes growing and building wealth is about the decisions you decide not to do as much as it is the things you actually do. So let's dig into it. And we're be showing the slides, of course, as we go through the day. So you'll be able to get those slides and make sure you're signed up for the newsletter so you get updates on the shows that we have. And for any of you that have questions, is you're on here live, I've got Jordan here. I've got the other team monitoring the chat. Um, give a shout out to Jordan if you want to get your question answered. But we'll be going to Jordan here to get your questions answered. But let me just do a little professor, you know, and speech here at the beginning just to get us started. And then I'll be coming back for questions as we go. Um, also, you can download the slides. Where do they get the slides from? Where do they download them?

SPEAKER_01 1:35

MattSorensen.com slash resources.

SPEAKER_00 1:38

Okay. All right. Was Jordan's mic on? Did everybody hear that?

SPEAKER_01 1:40

Yeah. One more time, Jordan. Okay. Uh MattSorensen.com slash resources.

SPEAKER_00 1:44

Okay. All right. Okay. That's where you can get it. All right. See, I don't know this stuff. I don't know. They just put me up here and they say, talk, Matt. Okay. All right. So let's talk about the power of rental real estate. And there are really four things I want you to think about when you're thinking about buying any rental real estate. All right. And this is the things that are going to make you money. Appreciation of the property. That is the number one way you're going to build wealth in real estate. You're not going to build wealth in cash flow. You're not going to build wealth in mortgage reduction. You're not going to build it in tax deductions, primarily. These are all little benefits and perks and massive considerations, though, that we're going to go through, particularly cash. But the primary way you actually build wealth in rental real estate is the appreciation of the property. And we're going to go into that. I'm going to throw real numbers on this, on some examples, and show how this stuff calculates out. Also, remember, when you own rental real estate, someone is paying rent. That rent is going to pay down any debt you've used to acquire the property. So even though you have rental income coming in sometimes and you feel like you're break-even in the sense that you don't have any cash flow going into your pocket, we're actually that mortgage payment that you're sending to your mortgage lender that helped you acquire the property, that's actually reducing the mortgage balance that you owe on the property, which is creating equity. Even if the property doesn't appreciate, we've got mortgage reduction. So that's going to help us. And that that matters more over time than it does at first because most mortgages, your mortgage pay down is low, but as you own it longer and longer, it could be 50% of your of the mortgage payment you're paying is going to be paying down the mortgage. Second, or excuse me, third, cash flow. This is critical in analyzing whether to buy a property. It's not necessarily the way you're going to make money on the property in the long run. It can be, and it's certainly helpful to have cash flow, but it's more about is it worth my time to invest in this? Can the cash flow cover my expenses so that I can make upside wealth on the appreciation? So there's a couple of ways to think about cash flow. We'll get into it. And then last, of course, is tax deductions. Unfortunately, too many people talk about why you should buy rental real estate and they say, because of the tax deductions. That's the dumbest thing I've ever heard. I'm a tax lawyer. I love the tax benefits from rental real estate. But that is like the fourth of all of these reasons on why you should buy rental real estate. It is not the primary reason to do it. Sure, there are some tax deductions unique to real estate. It's nice. We're going to go over it, but it is third or fourth in the list of why you should be buying any rental real estate. All right, let's talk about the first thing to consider, which is cash flow. The reason I want to start here on cash flow is this is something you should decide of whether you should buy a property in the first place. We need to look at will this property cash flow? Because if I'm going to take some of my money and I'm going to put my time into buying this rental real estate, I want to make sure this isn't a burden on me financially every month. I don't want to be putting money into this property every month. The concept of rental real estate is that the tenant is covering the costs of this property. Meanwhile, you get the appreciation over the long haul. So here, let's just look at a sample scenario here. And we're looking at a property that is $450,000 in value, assuming you put $50,000 as a down payment in. So it costs you $50,000 of your money you could have otherwise invested in the stock market or somewhere else. And then you get a mortgage from a lender at $400,000. Now, as that rental income is coming in, and we're going to assume here, um, what do we assume here? $3,200 a month, $38,400 for the rental income. Okay, that's $3,200 a month for $38,400 annually in rental income. Now, the the the debt on this, which is gonna be our first expense, we're gonna need to think about this is a $400,000 loan at a 6% mortgage under a 30-year term. Okay, a lot of rental property loans could be at 25 years, but maybe you just bought this like a personal residence or something. Let's just assume a 30-year mortgage. So your mortgage payment annually is gonna come out to $28,776. And that's a $2,000, basically a $2,400 a month mortgage payment. Now remember, that mortgage payment consists of interest and mortgage paydown. So we're gonna come to that here in a second. Now, uh, okay, so I've got $38,400 in rental income coming in the property. I've got $28,700 in mortgage cost, and I have other expenses on the property, $7,500 in other expenses. Maybe I'm paying a property manager. We've got some maintenance, some repairs. Maybe I got a month where it's not leased. There are other expenses on the property past the mortgage. Now you can get a lot more detailed than that. And my purpose here is not to show you how to analyze a rental property necessarily. There's a lot of other resources on that. My purpose here is to show you the whole picture of why you should be thinking about this. Okay, so I'm just giving some basic numbers here, but trying to stay in reality. Okay, I'm trying to stay in reality here with these numbers. All right, so after that's said and done, the we're looking at cash flow of $2,100 a year on the property. Now that's not that exciting, right? That that you might not be like, that's amazing, but hang on here. We only put $50,000 into this property. I know the property is worth $450,000, but it only cost you $50,000. So if you think of what's my return on that $50,000, well, that is a cash on cash return on investment of 4%. Okay. Now we're gonna add up here these different areas on how you're gonna make money on real rental real estate, but just from the cash flow here, that totals out to 4%. All right, so I'm making some money here on the cash flow. Now, when you look at a property, if the property doesn't cash flow, it's really hard to make an excuse to buy it. You've really got to be in some distress, turnaround market where you it's at the bottom of the cycle and you have strong conviction that it's gonna appreciate like crazy. But buying property that does not cash flow is creating a liability. That's not building wealth, that's creating a liability because if the property doesn't cash flow, I've got to put money in every month. Not only did it cost me 50 grand that I had to put into it, now it's a liability because I've got to put money in every month. Okay. We don't want that. We at least want to break even on the cash flow, and ideally we want to have money going into our pocket. All right, so that's cash flow. That's the first consideration, and it's really the threshold consideration of should I even buy this? Okay. And remember, if it's not creating cash flow, it's caused a liability. Stop, drop, and roll, don't buy the rental. All right. So um, so you got to know, of course, when you're looking at a property, what's the rent I could expect to get from this? What are the expenses I'm gonna have on it? And then, of course, what's the mortgage I'm gonna need to get and what's the type of rate I'll get so you can and run some basic math and do an analysis on this. All right, now that's just one factor there, and we got about 4% um rate of return on that annually. Now let's look at mortgage reduction. Now, if you run an amortization schedule over 30 years, 6%, that's gonna give me a $2,398 a month mortgage payment. Now, the principal on that, even though I'm gonna be spending, you know, 20, what was that total a year, $28,000 a year that's going to the lender, only $4,900 of that is actually paying down principal. The vast majority is interest going to the bank, going to the lender. Now you get to deduct that. So I'm gonna come back to this in the tax as we analyze the tax benefits. But for now, we know at least $4,900 is paying down the mortgage. This is not my $4,900 that I put into this. This was the tenant paying me rent that was going to the lender, paying down the mortgage. This is creating equity. All right, even if the price doesn't appreciate, this mortgage pay down is creating equity for me and the property. So here I have about $5,000 on $50,000 that I put in. I have $5,000 of mortgage paydown. I put $50,000 into the property. This is giving me a return on investment of almost 10%. All right. So mortgage reduction is very valuable. Remember, this is better so far than the cash flow. Um, the cash flow made me have confidence in buying the property, but the mortgage reduction is going to start to cause me long-term wealth building. That's gonna, that's gonna create wealth for me over time. Now, as we look at mortgage reduction, and if you look at an amortization schedule for a mortgage, what starts to happen is if I'm paying this $2,400 a month, um, which totals $28,776 a year, if I'm paying $28,000 a year to the bank on that loan and it's amortized over 30 years, at about, I don't know, halfway through at least, approximately, you're gonna be having half of your mortgage payment go to principal paydown. At first, right now, as you can see, 85% of what you're paying is just going to interest. It's going to the bank as interest, and only 15% or so is actually paying down the mortgage. But as you're in that loan longer, you have more money going towards mortgage principal paydown. And the value, and basically your ROI in this property starts to go up the longer that you're in it. A lot of times, and just from my own experience in owning rental real estate, the first year you buy the property from a cash flow and a mortgage paydown standpoint is actually the worst. Because what's going to happen over time, there's going to be two things that are going to happen over time as we look at these two factors. One, rents typically go up. Rents typically go up over time. So you will actually be able to raise your rent. But if you're in a fixed rate mortgage, your mortgage payment isn't going to go up. It's going to be the X exact same. What's going to happen on the mortgage over time is more of the payment you're sending to the bank is going to go to mortgage paydown over time than it is to interest. Okay. So over time, these two cash flow because rent can go up, and mortgage reduction because you have more principal pay down the longer you're in the loan on the same mortgage payment. These two will actually increase over time and not get worse. They actually typically get better. Now I know on cash flow, and there might be someone in the comments, but Matt, there could be a tenant that's out for six months. But Matt, you could have an AC unit that costs you five grand to replace. I know these are all unexpected stuff. I threw in a blanket $7,500 a year in expenses that could maybe be vacancy, an AC unit going out. Okay, other stuff. There's variables there. I don't want to get in the weeds too much on it. And so this is not a 100% complete analysis. I want you to get the big picture concepts. Okay, so we've got cash flow. That made us determine whether you can buy the property in the first place. We know that that rent check is paying down the mortgage. It's not our money, it's the tenant paying us, and we're using that to pay down the mortgage. It doesn't feel like you're making progress because it's not going in your pocket, but it is reducing the bounce on the loan, creating equity for you. All right, next is tax. We're gonna get to appreciation last year because that's frankly the best. Um, but the tax deductions are oversold typically on rental real estate. And this is me as a tax lawyer, and we talk about tax benefits if it's a rental real estate all the time. I use every angle of these personally on the rental properties I personally own. Um, but it it's like the dessert. Okay, this is not the main course. This is like the dessert. You don't show up at the restaurant just for the dessert. Maybe, maybe Jordan does, but you know, okay. You know, but we're we're here for the main course. And then there's just like an extra thing at the end that's kind of nice. All right, so let's look at the tax calculation. There's a couple things that are going to happen on the property. Um, and and after we get our cash flow, now cash flow is after all the expenses on the property, right? So we've got rental income here, and we've got some cash flow. We have annual mortgage interest. And when you're making that mortgage payment of $28,000 approximately a year, we don't get a write-off the whole mortgage payment. What's paying down principal on the mortgage, you don't get a tax deduction for. But the interest going to the bank, you get a tax deduction for that. That's really important because what that means is it's going to create money that I pick up that I actually put in my pocket, it can create a deduction. So um, so let's run through this. $38,400 going in rental income. I've got $23,000 that's that represents mortgage interest. Now I did have to send that to the bank here. I have some expenses on the property, but one thing that I have here that did not was not an outlay of money is depreciation. Now, depreciation is something you get on rental real estate. And you can we can see on the side here this depreciation. Let's assume that um, because because what happens on rental real estate is under the tax code, when you buy property, the tax code assumes that the value of property goes down over time. And that's true for most assets. You buy equipment, you buy a truck for your business or a delivery vehicle or a car, whatever it is. The value of that property in your business goes down over time. So the government lets you depreciate the value of it over time. Now, rental property and any property used in business or for investment here, actually goes up over time, but you still get to depreciate it. All right. It's one of those great things in the tax code. So, so what you do is you take the percent of the real estate that is proper, that is an actual physical building. You don't get to depreciate the value of the land. So let's say that 80% of this building here, 450 grand, that 80% of that value is the building, that would be $360,000. So I get to depreciate that $360,000. Now you take it over time typically. There's other ways to accelerate the depreciation, not for purposes of today, using cost segregation. But basically, I get to take that $360,000 over 27 and a half years. If you divide that $360,000 over 27 and a half years, the government basically assumes the value of that property will go to zero at 27 and a half years. Again, this is their thinking that property and building values go down over time, which is great. We love it, it's in the tax code. We take advantage of it and we get to take the write-off. So what does that mean? What I'm coming around to here is that means I get a $13,000 deduction every year. Just straight line depreciation. I get to take $13,000 as a deduction every year. What that means is, is if I have up to $13,000 of cash flow coming to me, I pay zero tax. I have $13,000 that went into my pocket zero tax. Or it's $13,000 that I sent some to the bank and the rest went into my pocket because I was paying down the mortgage, the rest I took and I was living on, or I was making other investments with it. But I have money in my bank account, I pay zero tax. All right. So it's like this phantom expense you actually didn't incur, you didn't spent send money out for that. It's this benefit you got from the property because the government assumes that the value of it goes down over time. So they let you take that 13 grand in this example every year. So if we apply that to this situation, um, what happens is we end up generating a loss. Now, it's kind of tricky on how this works because um we've got our cash flow, of course, on the property. We didn't that I actually got, which was what do we say? That was 20 to 2100 bucks plus the amend amount that I sent to the bank as mortgage paydown, because I didn't get a deduct interest on that piece of the mortgage payment, right? When I when I send my mortgage payment to the bank on the rental property, the part of that mortgage payment that's interest, you get mortgage interest deduction. All right. So I got a deduction for that, which effectively means I'm not paying taxable income on it. I get to deduct it dollar for dollar. But the part of that mortgage payment that paid down the lender, that's actually income to me. All right, because I don't get to deduct that. Only the interest part. So if I take that, that was $4,900. I got my $2,200 or so in cash flow. That's going to create $7,000 approximately in taxable income that I'm not taxed on. All right. I really got $7,000 of taxable income, but because of this depreciation, I didn't get any tax. Now I also created a loss because the balance of that $13,000, the other $6,000 is a loss. And you can use up to $3,000 of that against other income. Otherwise, you carry it forward every year and you'll use it later when you sell the property. Those losses can carry forward and add up. So just because you can't take it against your income now, if you're a real estate professional, you can, again, not for purposes of today. But the first point here is everyone that owns rental real estate, that depreciation loss can at least offset your cash flow and the amount of money you're using to pay down the mortgage, which means you're increasing your wealth, but sending nothing to the IRS on that cash flow or that mortgage pay down that you're getting the benefit of. Now, when we analyze that, if I assume the value of that tax deduction that I got $7,000 that I didn't have to be taxed on, the cash flow and the mortgage pay down that I sent to the bank that created equity. Usually when I'm making seven grand, if I'm in a 30% tax bracket, I have to pay about $2,100 in tax. If I got if I'm in 25% federal and 5% state, I'm sending $2,100 in taxes, but I didn't have to. So the value of that savings here, the tax deduction benefit in this example, without using the loss or using that loss to upset income, I'm just saying the tax deduction benefit on wiping out your cash flow on the property, that totals a 4% return on investment. The way I'm doing that is we put in 50 grand. It's generated a tax loss for me of 2100 bucks, which is a 4% annual rate of return. I'm trying to quantify the value of the deduction here on how it benefits you. So, all right, now if you made it through that, congratulations. I thought I explained it. I'll give myself a C on it. Passing, but not ideal. Did you get it?

SPEAKER_01 20:31

Did you follow the I would have given it a solid B plus.

SPEAKER_00 20:34

Okay, B plus. All right. Some things to work on, but not okay. So uh, but I don't want to oversell this. This is not the reason you're buying the property. All right. If this property didn't cash flow, by the way, you don't get a tax benefit right now. I'm giving losses carried forward. Um, so when you're cash flowing the property, putting money in your pocket, using some of that cash flow to pay down mortgage principal. We're getting a deduction, depreciation. That's this phantom expense. You're not actually sending money out of pocket to do that's gonna offset this. And that helps you save taxes that you would have otherwise had to pay. Okay, so that was the third reason you should look at buying rental real estate. Now, the last one, this is the primary one. This is the reason you will make money in rental real estate. From my experience investing in real estate, millions over my life, and when I've actually made money on real estate, it is when you sell the property and realize the appreciation value. Now, a lot of people say you don't make money on real estate when you sell, you make money on real estate when you buy. And that's true, but you realize the money that you can actually use when you sell the property. Okay. So we want to make good decisions when we buy, of course. And I think the first criteria is is this property going to cash flow? But over time, as you own that property, five years, 10 years, 20. This is when the appreciation starts working in your favor. There's an important thing I want you to think about here. When we talk about appreciation and the return on your investment, there's a really important number to look at. And that is 4%. 4% is the average single family home appreciation in the United States over the last 30 years. Over the last 30 years, this is just across the US. It's very generalized. Every market's different, of course. But the average single family home appreciated 4% annually. Now when I think of 4% and what's my return on investment, that 4% appreciation is not about the $450,000 I put in. I didn't put $450,000 in. It went up 4% of $450,000, but I didn't put in $450,000. I only put in $50,000. So if I get 4% appreciation on a $450,000 property, that is $18,000 of appreciation off of a $50,000 investment. I get the appreciation. All right. So now if I'm getting 4% appreciation on my $50,000 that I put in, that is $18,000 a year, creating a 36% return on investment annually here on the $50,000 of cash that I put in. Because it's if it's 4% every year, then we get the ROI of 37%. Again, we're focusing on the cash down because that's the money you had to put into the deal, 50 grand in this example. Now, when I gave that number of 4% annual appreciation, there are times in real estate where you actually make no money, where the property could actually go down in value. And over the last few years, we've had weird markets and every city has been different on this, but we've had some rental real estate go down in value, some single family homes go down in value, some stay stagnant. But if you look at it 10 years ago, you'll see years where there might have been 5 or 10% appreciation per year. So when we think of investing in rental real estate, you want to think of it for the long haul. If you want to have a good number and a way where to ensure you're going to make money, it is about weathering the storm in the down market. If I want to ensure that I'm going to get 4%, essentially is a general number here, the best way to get there is to have a longer hold period. All right. If you're investing at the bad time in a cycle, which it could be now, it could have been two years ago, right? And you're effectively paying at the height of the market, you may be in an era where there's going to be property values that go down or they stay flat. Maybe they're increasing one or two percent, and you're not getting the impact of appreciation you want. But what happens in real estate is it's always cyclical, and over time, it's gonna bounce back and we'll get it some window where you're normalized over that 4% approximately. So think of the appreciation as more of a long-term gain. Buying rental real estate is not a three-year or a five-year type look. In fact, if you're trying to make money and realize appreciation on a property and you're thinking in less than five-year increments, you're probably not gonna make money. You're gonna have to get lucky, actually. I want you to think in a 10-year window at least, maybe even 15 to 20. But if you can at least think in a 10-year window of can I make money on this property from appreciation, and we know that that first five might only be flat, maybe, and you might be making one or two percent. Of course, you never know that, but let's just assume that's your thesis. But in years five to 10, you might be getting 6%, 3%, 8%, 7%. You might over time you can win on it. All right. So right now, I know there's been a lot of dissatisfaction in how many people's rental portfolio has performed. And I've seen a lot of people out there talking about how they're selling their rental properties. And I get that. They're in way too many markets, they've acquired way too many doors, um, and they're really focusing on the properties they want to hold for the long haul. But as we're thinking about buying a small portfolio of single-family rentals to build wealth or to supplement all the other assets that we're accumulating in our retirement accounts and brokerage accounts and crypto and our businesses, the equity in your home, whatever things you're doing to build wealth, adding a rental property or two can be a great way to supplement that. All right, so those are the four. Remember, appreciation is where you're gonna make money at the end of the day. That's where you're gonna have hundreds of thousands in value and wealth added, not just thousands of dollars or tens of thousands that can occur from cash flow or mortgage pay down each year, but there will be a big payoff at one day. Again, particularly if you hold over 10 years, where you will see a $100,000 plus type payoff from appreciation. And that is wealth building that you will feel. Okay. But you've got to get through the hard part. You've got to get through some tenant turnover, you've got to get through a major repair or something, you've got to get through that stuff. And I know it can be painful, but I do think the payoff is there. And from my own experience on rental properties I own. And I am not a wizard at this, I am not a genius. If I've at least been in the property, 10 years, I seem to always make money. Okay, let's see where we're at for questions, Jordan. And I'll say this I'm gonna get to some things on when not to buy here in just a second. So, but I want to see if we have any questions here so far.

SPEAKER_01 27:38

We do. Uh, Stormbreaker is back. All right. And uh he asks, hi Matt from Orlando, Florida. In a self-directed solo 401k, I buy a property, rent it out, and wait for appreciation. How long do I have to wait before I can sell it and take the gains tax-free to reinvest? And can I have both a Roth IRA investing in the S P 500 and a self-directed Roth IRA investing in real estate? Thank you.

SPEAKER_00 28:02

Okay, great question. Let's take the first one. Let's say you're using a solo 401k to go buy rental real estate, as as was Stormbreaker? Stormbreaker. As was Stormbreaker's example here, is you could sell the property on day two in a solo 401k. Gains that are short-term or long term in a retirement account, you pay zero tax on. And even in a solo K, if you got debt on the property, there's no tax on the gains. So, so short-term, long-term, knock yourself out. Now, if you're flipping a lot of property in an IRA or 401k, your IRA or 401k could get this tax called UBIT. But that's if you're flipping like five or holding it less than six months. So for most people, you don't need to worry about it. But if you're making money and you want to get out of that property to realize the gain, you don't have to wait a full year. Otherwise, for people outside of a retirement account, keep in mind there are short-term and long-term capital gain rates. When you own any asset, stock, real estate, over a year, you get preferred long-term capital gains rates. Those go from 0% to 20% max. If you sell property, and this again can be real estate stock in under 12 years, you get short-term capital gain rates. The short-term capital gain rate is whatever tax bracket you fall into for regular income, which can go up to the maximum amount of 37%. So it's a general rule of thumb, it's best to hold properties for at least 12 months to get the preferred long-term capital gains rate. So again, that's stuff outside of your IRA. Now, to the second question, can I have an IRA that's self-directed that owns real estate? And can I have another IRA that is in the stock market? Absolutely. Many self-directed clients, and in fact, most self-directed clients do, where they have a portion of their money in the market, and this could be in a Fidelity IRA or TD Ameritrade or wherever, and they have their self-directed IRA with our company, directed IRA, that owns their real estate or their private fund or their startup or their crypto or their private asset, which is what we do at my company directed IRA every day. But also, I will say in your directed IRA account, you can own an ETF, mutual fund, and individual stock as well. You don't have to just do self-directed assets. We have some clients that just have their full IRA here, and it could be a mix of publicly traded assets and also private self-directed assets, such as real estate. All right, let me come back to the slideshow here and we'll queue up any other questions if we have anyone else live. But if we add up all those four things that I was just talking about, appreciation in the property, mortgage reduction, cash flow, and tax deductions, in the example I gave on a $50,000 investment in year one, we can see a total ROI of 54%. That sounds pretty freaking amazing, right? Um, and I know sometimes you might there's probably got to be someone about to comment or that already has of like this is BS mat. But I was trying to show you the math there, trying to show you the homework on how this works. And I know on the appreciation you don't always get that, but I'm just saying, and you can look it up for yourself. The average single family home in the United States has gone up 4% over time. We've got to nail the cash flow. If your cash flow can't cover the maintenance, vacancy, repairs on the property, this means you're gonna have to put money in. That means do not buy. But there are properties out there that will cash flow where you don't need to put money in every month, where the check from the tenant coming in is enough to cover the expenses on the property so that you can get the benefit of the appreciation. All right, so I think this is awesome though. This is why I love rental real estate. All these things combined. Um, I have actually had properties where I have done very well on cash flow. But again, the first year you buy the property in the first few years might be the hardest to get cash flow, particularly where rents are flat and you haven't been able to raise rents yet. But as tenants turn over or as you're able to raise rents over time, that cash flow number can get more meaningful, especially again as we're looking at this at five year and 10-year windows as to posed to one or two year type windows. All right, let's come back to questions here. And what then after after any questions, I'm gonna come, unless we don't have any.

SPEAKER_01 32:17

No, we we've got a live question. Actually, I like this question a lot.

SPEAKER_00 32:20

Okay.

SPEAKER_01 32:20

And uh I want to reiterate get it, get your questions in now because if you wait till the very end, yeah we're gonna we're gonna cut it off. Look at this list.

SPEAKER_00 32:27

I got this, yeah, I got this list of other people's questions that are already in.

SPEAKER_01 32:31

And when you start going rapid fire, yeah, I mean, sometimes that's momentum that we can't. That's true.

SPEAKER_00 32:36

Yeah, you don't want to get me off track.

SPEAKER_01 32:38

So, all right, I like this one. This is from Joel 383. Can you speak to inflation and how it affects your purchase price? We just purchased a house last year and probably paying about 25k too much. I was willing to take that hit because it's about a 3.5% interest rate of the purchase price and how much uh I expected inflation to be. So this is about just a home or a rental property? I take it as a home that he's renting. Okay, all right. And they got it at 3% mortgage? 3.5%.

SPEAKER_00 33:08

Three and a half percent. Sorry, what was the question on it?

SPEAKER_01 33:13

So it's it's basically just asking you to speak to inflation and how it affects your purchase price.

SPEAKER_00 33:19

Okay. So let's say inflation is three percent, right? The Federal Reserve is trying to target inflation at 2% to 3%. They're trying to keep inflation low. Um, but one of the biggest drivers of inflation is housing costs. All right. That's one of the factors that goes into the number where you get inflation. Here's why inflation can work for you when you buy property with good low-rate debt like you did. Remember, you're getting, let's say, 4% appreciation on the property itself. And so as you put in, if let's say I just run my numbers, okay. Just I don't know all your details here, and I'm probably not good to get into it. But let's say again, a $450,000 property, you put $50,000 into it. Well, you're getting appreciation on the whole $450,000 on the property. And so that what the bank has said is, hey, um, you pay us three and a half percent as a mortgage interest rate. Well, that that rate is incredible, first of all. And the inflation, basically, you're getting the appreciation of the property. The big nugget, the value of the appreciation go up. The bank doesn't get that. Is that property appreciates? Which why does it appreciate? Inflation. Inflation is the number one reason that the that the property is going up in value. That's how you're getting appreciation. Okay, but you're getting that on the 50 grand you put in and on the 400,000 the bank put in. Now the bank charges you for that. So the bank knows that. The bank knows that if they give you 400,000 now, that they have to charge you interest because $400,000 later is less worth, is is worth less, right? That's why they have to charge interest on it. Now, at a 3.5% rate, the bank is barely making money over inflation. So I think that is actually awesome. Okay, and that's why many people who are buying rental real estate at before real estate prices went on a went on a rip, but they were getting at low interest rates. You were in an amazing position to make money on that property, particularly if you bought it before rates went up and and then you were able to refinance to a low rate. So you got it at a low purchase price. Now you're really sitting pretty. So um, so I think that's great. Even if you feel like I don't know that's what was the 25,000 issue. They talked about the 25 grand, it was 25 grand.

SPEAKER_01 35:51

I think they they felt like they they paid 25,000 more than they should have. Oh, okay. Yeah, they overpaid for it. Right.

SPEAKER_00 35:58

Yeah. Um what I would say is factor in what the mortgage is at 3.5% versus say six or six and a half, whatever market is right now. And even if you overpaid 25 grand, you probably make that up in two years in what you would pay overpay in more in mortgage interest otherwise. So I think if the rate is right, um, and a type of rate we're probably never gonna see again, or it'll be a very long time. Um, overpaying couldn't could make sense, but you've got to hold it for a long enough time to get the benefit of it. You can't sell it in one or two years. You need enough time where you start making money and you're benefiting from that lower 3.5% rate. So I can see some good angles on that. Great question. Um, and this let's talk about when not to buy rental property, though. Okay, and it's kind of if you take some of my comments here and flip them around, you'll see that's pretty much when not to buy rental property. So the first thing is is you need the cash. If that 50 grand in the example that you needed write back out, that is not the time to put 50 grand in. If you don't have some type of emergency fund or other savings or a stable type income, you should not be investing in real estate and dropping your available cash. Make sure you have available cash and an emergency fund first. Generally, I would say about three months of expenses in some type of emergency fund. Second, you can't weather the storm. It is very possible that over the next five years, as you own this rental property, you will have some tenant turnover. There might be a time period where two, three months pass where there's zero rental income on the property. Can you cover those months? Can you come back out of pocket to go in the negative before you get a new set of rental income coming up that you can rebound for? So make sure that you're able to weather the storm, any negative cash flow situations, particularly tenant turnover. Have you done the math on this? Have you really analyzed this property to ensure it can cash flow? So this property isn't a liability. It's actually an asset that you're benefiting for. Nobody wants to buy a rental property, you got to put money into every month. Okay. It's possible to make money that way, but very hard. That's doing real estate the hard way. Okay. Um, and what I've seen a lot of people do is they get a little emotional in real estate. Okay. They they look at a deal and they kind of fall in love with it. Um, but um, you know, properties you fall in love with do nothing for your wealth. Okay. You need properties that actually make money. Okay. That's how you're gonna grow and build wealth. So be analytical about the property. Um, next, are you the type of person that doesn't want to be a landlord? Be honest with yourself about that. Um, now maybe there's enough cash flow in here, you can outsource all the duties, the property management, the repairs, and all that. And a lot of people do that. That's what I do. I don't buy a property unless I can have a property management, some other handyman maintenance person handle things. I am not gonna go to the property. I'm not gonna talk to a tenant. I don't even want to bother them about anything. I just want zero to do with it. Okay. And so now that costs money. Now, some of you like doing that, some of you like being involved with that. You feel more connected to your money. And that's cool. And you can be a little more tight on your cash flow, but be honest with yourself and who you are. Um, if you're someone that doesn't like dealing with that, make sure you've put in enough expenses there where you don't have to be involved and you can outsource those costs. Um, make sure the numbers pencil out. Um, right now it's a hard, it's a more difficult time to make sure deals pencil out. You might have to run numbers on three, four, five, ten properties before you find one that actually pencils out and is gonna cash flow over time. Also, be careful in overpriced markets. We talked earlier about you make money on the appreciation. One of the things you might be thinking of is well, how what markets are appreciating, Matt? Like what market in five or 10 years are we gonna see 10% annual inflation instead of just four? Right? Now, that's a good thing to be thinking about. And you should be thinking about locations that are gonna appreciate over time. Where are people moving to? Where's their job growth? Where's their population demand? That's where you've got the supply and demand working in your favor, and that's where rental properties will succeed. So make sure you're going to cities and you're building a rental portfolio or buying any rental property in an area that has growth. If you're buying in cities that are declining, that have high unemployment, um it's very hard to see appreciation follow because what's going to happen is you're gonna have too much supply. There's not gonna be enough demand, and rents are gonna stay flat or come down. Okay, so just run the numbers here, of course, on the cash flow, but also think of the appreciation. Now, appreciation is really hard to know. It's it's it comes eventually, but it's hard to pencil out and know what markets are gonna overperform others. And then last, if you have high interest debt, don't be investing in real estate yet. Pay off your high interest debt. If you've got credit card debt, stuff at 15, 20% interest rate, that is you've got to pay that off first before you get into committing to a rental property, real estate investing. The burden of that high interest debt and the trap that you're in with your creditor is not worth now trying to make money in real estate. So focus on paying that off first, get that high interest debt paid down or find a way to get that to low interest debt, either by using equity in your home or taking a loan from your 401k, whatever we can do to pay off that higher interest debt, which frankly, if you're having a 15 to 20% credit card debt type interest rate, a lot of those compounding monthly, it's impossible to find an investment that's gonna get you that rate of return guaranteed every year. It really is. So the best investment you can make is paying off that debt instead of investing in something else. All right, now if you've thought about all those things and we've gone through the four different areas, I think that's how you're gonna be successful in making the decision on whether to buy or not buy rental real estate. All right, what do we got? Any live questions? Are we ready to get them hit the list?

SPEAKER_01 42:26

Let's uh let's do one more live question. So uh from Lucini. No, I'm sorry, maybe it's Lu Cincy. Sorry, 3922. Do expenses on property include the mortgage?

SPEAKER_00 42:37

Yes, only the interest part, though, of the mortgage. So again, when you're paying the mortgage, let's we had that example earlier that um we're paying $28,000 a month on the mortgage, or sorry, $28,000 annually to the mortgage. But that mortgage payment, just like your home, same as a rental property, a portion of that mortgage payment is paying down the principal, portion of that is interest that the bank just collects. So, in the example here on that $28,000, we had only $4,900 was paying down the mortgage principal. The other $23,000 or so is just going in interest to the bank. So I get a write off the interest part as a deduction. I don't write off the mortgage pay down.

unknown 43:24

All right.

SPEAKER_00 43:24

Okay, let's hit some of the questions that came in before the show. Thank you. We pulled these questions, by the way, from YouTube comments or stuff that you send in in advance when we see the show title. So thanks for sending these in. The first questions came from HC 4357. Can you do any of this for rental arbitrage where you're really only renting the property, not owning the property, but you are re renting it? Okay, yes, there is something called rental arbitrage, where you go get a lease on a property and then you go sublease it at a higher rate. Now, this was particularly popular in short-term rentals. A lot of investors would go and they would say, I'm not going to buy that property and turn it into an Airbnb. I'm going to lease it for five years from the current owner. And then I will short-term rent it on Airbnb or some other short-term rental platform in, you know, daily, weekly, monthly rent, whatever the strategy is, at a higher rate. And I arbitrage it. So I'm paying, let's say, $5,000 a month in a lease to the owner of that property, but I'm really making $12,000 a month because I'm doing short-term rental on it to other individual people paying at a daily or weekly rate. And I get to keep that $7,000 spread there. Okay. And that's possible. Now you have an expense, of course, for the rent you're paying of $5,000, but you have taxable income of the seven. You're not paying mortgage interest. You're not paying the property taxes. So all those expenses that you might have if you own the property, you're not actually taking. You're expensing the rent, and then, but then the rest is going to be taxable income to you, any of that arbitrage that you get on the property. So yeah, you could do it. I would think in that strategy, though, the reason I haven't loved the arbitrage strategy, even when it first came out, is that is strictly a cash flow game. You're not getting appreciation. You don't own the property anymore. I mean, in this strategy, when we talk about buying a rental property, you own the property. You get the appreciation. And the rental arbitrage strategy, the person you rented it for under the long-term lease, they're getting the appreciation. You're really just getting the cash flow. So in order for that to work, you've really got to have a good arbitrage on the cash flow. The most common of this, again, is going to be the short-term rental. Another example of this would be executive office suites. You'll see this in the office leasing area where, say a we work or something, whatever, you know, that's just the most common one. But they basically will go lease a floor in an office building. They will have one lease with the owner of that building. And let's say they're paying 20 grand a month in rent to lease that floor. Well, they then chop it up into small little offices that they rented a premium to that, so that they're collecting, say, 30 grand a month. And they're making the arbitrage there on the higher rent for smaller leases. There's some management involved in that, of course, um, on the difference. So um, so I like the strategy. It's just a cash flow strategy, though. So we don't get all the other benefits we talked about, primarily appreciation. Um, all right, anything else live? You just interrupt me if there's live. Okay. I will. All right. Crass Crassimi Georgie.

unknown 46:47

Solid attack.

SPEAKER_00 46:49

Solid attack. He shoots and he misses. Uh all right. Question is my spouse and I plan to start eBay resale and expand into real estate. Please share any insight or give direction on what to watch out for next. We are going to live in Virginia but have family members in Delaware too. Okay, let's say you're gonna do an eBay eBay reselling business. The first thing I want to think about is this business is gonna be separate from your rental real estate business. When I think of how your tax and legal strategy is gonna look, that eBay business is a separate business and it will have a separate entity from the entity you do rental real estate in. Now, if you live in Virginia, I would probably do a Virginia LLC for the eBay business, the reselling business. And if you're making more than 50,000 net income a year, we would likely do an S-selection on that. When you're doing an eBay business or a resale business, you're gonna get ordinary income from that business. Ordinary income goes on just whatever the regular tax bracket you fall into based on your taxable income. Plus, because you're self-employed, you have your own business, you also have to pay Social Security and Medicare. That's called self-employment tax when you're self-employed. It's 15.3%. Now, that's on top of your income tax. All right. Welcome to America. But in the S corporation strategy, once you're making more than $50,000 a year, you can minimize that self-employment tax. You may be able to cut it in half. That's a massive benefit to using an S corporation. Now, if this is more of a side hustle, less than $50,000 net income after all your expenses, the S corporation and the cost and the tax return on it, the juice isn't worth the squeeze, don't worry about it. But if it's more than $50,000 of net income that you'll make on that eBay resale business, then I would do an LLC taxes and S corporation. Now, when you talk about doing rental real estate, I want to shift gears here and say that will have absolutely nothing to do with that LLC that is doing the eBay resale business. If you're gonna buy rental real estate, we want a separate LLC. Okay, I want to have that LLC, and in fact, I can whiteboard, right? Let's see if I can get the whiteboard up. All right. Okay, so this is you down here. Okay, this is your LLC for your eBay business. Okay, this is the resale business down here. Excuse me. Now this is your other LLC that's gonna own the rental property. All right, so we're making money over here. Again, if it's more than 50k, we will do an S-election and that LLC will be taxed as an S-corp. Okay, it's gonna save you taxes based. It's gonna save you self-employment tax. But over here on this left side is if I'm making money, I'm selling goods or services, I'm consulting, I'm getting commissions, I have a product, a service I'm offering. This is on this left side here. This is what we call our operation side. This is our asset side on the right. Okay. Operational businesses are taxed differently than asset and investment businesses. Okay. Over here again, I'm paying ordinary income tax and I got to pay into Medicare and Social Security, which is self-employment tax. This S corporation can save me. This tax selection, which I can just make to an LLC. And again, if this is side house, you're making five, 10 grand a year. This is just gonna go on Schedule C. You may not even need an LLC. The LLC could help for liability protection, but for taxes, you don't have to do it. Um, so that's that left side. Right side, let's say you go buy a rental property. And by the way, I would do this in Virginia since you're doing business in Virginia. Over here on the right side, um, let's say that this rental property is in Virginia. We would set up a Virginia LLC for the Virginia rental. Let's say that this rental property is in Florida. Then we would do a Florida LLC for the Florida rental property. We're always setting up the LLC in the state where the rental property is located. Now, what is the reason we're using the LLC? Does the LLC on this rental property save me taxes, Matt? It does not save you taxes. It does not cost you taxes. It is tax neutral. The reason real estate investors use LLCs for their rental properties has nothing to do with taxes and everything to do with asset protection. Here's why you're gonna use here's why you're gonna use an LLC for rental real estate. If a tenant slips and falls on this property, they cannot sue you. You don't own the property. The LLC owns the property, the LLC leased them the property. They are forced to sue the LLC. Now, when they sue the LLC, they can get what the LLC has, maybe money in the bank account, maybe some equity in the property, but they can't go over here to your other business, they can't get over to your other LLCs that might own other rental properties, and they can't come down to you personally. The liability is contained in the LLC itself. That's why it's called a limited liability company. The liability of the owner is limited to what's happening in the company itself. Okay, so they can't get over to your other businesses, they can't get down to your personal assets, they can't come out for your home, they can't garnish your bank account, they will not get a judgment against you personally. This is called the corporate veil. It protects your personal assets from the liabilities of the business. So the reason we're using an LLC for rental real estate is for asset protection.

unknown 52:26

All right.

SPEAKER_00 52:28

Live question. All right, let's hit it.

SPEAKER_01 52:31

So for a primary home, can you use the same logic for ROI with tax deductions on interest paid and appreciation and mortgage reduction?

SPEAKER_00 52:39

Read it again at the beginning. Okay. I always missed the first part for some reason. Sorry, go ahead.

SPEAKER_01 52:43

For a primary home, can you use the same logic for ROI with tax deductions on interest paid and appreciation and mortgage reduction?

SPEAKER_00 52:52

Okay. Yes and no. It's a little different analysis. Okay. Here's, and we've got a video on this. In fact, we can share the video in there. I did an analysis on whether to rent or buy a property. And it's getting into this question of what is the benefit of owning real estate? Okay. And what are the benefits of owning real estate that you live in, not a rental property? Well, the one of the benefits is what we've already talked about appreciation. So when I talked about that 4% annual rate of appreciation, again, this is nationwide over a 30-year window, but let's let's go with that 4%. You get the benefit of that if you own a home as your own person residence. Now, the second piece of that though, let's look at cash flow. Well, I don't get cash flow on my own residence, right? But you are solving a housing issue. You need to live somewhere.

unknown 53:44

Okay.

SPEAKER_00 53:45

The question is, are you paying rent to someone else, or are you living in the property and you're getting the value of the appreciation? So if we look at the cost of the mortgage, what is the cost of the ownership versus the cost to rent a property? We got to factor that in. There might be a premium to owning a property, depends on your location and the area you want to live in versus where you would rent in. So we got to take that into account. It could be you're paying more than what it would cost for the rent. Now, again, we'd offset that with the value of the appreciation of the property going up over time. The third thing to consider here is also the mortgage paydown. Remember, I have to have a housing situation. Everyone has a housing problem they have to solve. We're either going to rent somewhere, own somewhere, or we're going to freeload somewhere. Okay. You're either in your mom's basement, you're renting somewhere, or you own the property that you're in. So if I own the property that I'm in, I do get the mortgage pay down. All right. So that other benefit that we talked about on rental property, I'm getting the mortgage pay down too. Again, that's creating equity for me over time, which goes up the longer I own the property because more of what I'm paying in mortgage is going to pay down the mortgage. If you contrast that with rent, that rent is just going directly to a landlord. Okay. Not benefiting me at all. Last thing I will say on this, and this is in that video that it's on my YouTube channel about whether to buy or rent. We're kind of looking at these different things. And I actually analyzed two different properties here in the Phoenix area, similar type properties. Should I rent this one or buy this one? The last thing I'll say about this, and this is something I just over time, I don't know. Lately I just feel old. I don't know why. I've been to the doctor lately, and it's just, you know, I like old guy stuff I got to deal with. And uh sorry, a little TMI there. Um that was a little cryptic too. Nothing, nothing crazy, all right. I'm just like you know, and I I I strained my abs playing tennis. I thought I had something called a sports hernia, and um, I just have some strained muscle in my abdomen. Okay, it's nothing big. I can still play tennis, but uh I had I needed some prescription strength anti-inflammatories, and I have to do stretching, you know, and some physical therapy. So, all right, there you know. All right. Okay, back to what I was trying to say is the older I've got, I've realized a couple things. One is if you're a renter and a tenant for 20 years, the cost of your housing is always gonna go up. Your rent's always going up. If I decide to buy a property now in 20 years, that is a fixed cost. If I got a fixed rate mortgage, the mortgage payment I'm paying now is the same mortgage payment I'll be paying in 20 years. And that matters in terms of what is my monthly cost of housing, because I need somewhere to live. I've got to solve my housing problem. All right. So that's just another thing to think about. If we think about it from a long-term perspective, homeownership tends to win out. If you think about it from a short-term perspective, renting actually wins out because the costs of buying and selling a property are quite significant, moving and all that. And renting can actually make more sense in a short-term window. So go check out that video. I think it was really good. Um, we've linked it below in the comments, and that'll help answer that question. But great question. There's a lot of crossover reasons there on buying and owning a property because we've got mortgage paydown, we've got the appreciation factor. The tax deductions, I would say, are minimal here, but there's this additional factor of you have to solve your housing problem. And this is one reason why I don't like Grant Cardone when he talks about this. He tells everyone they're an idiot if they think that their home is an investment. And he's like, you should just rent. Your home is not an investment. And he'll go on and on about this. Is everyone has a housing problem? You have to live somewhere. The question is, is that money I'm expending to living somewhere working in my favor or not? And I'm not saying buying a home works in every scenario. If you live in LA or New York and these places where homes are ridiculously expensive, it likely makes sense to rent and otherwise use that money to make other investments otherwise. But in a lot of places in the middle, the flyover states, it probably makes sense to rent if you have a long-term mindset to be in that property for at least five years. So again, some generalizations there, but I like the appreciation over time, I like the mortgage pay down, and we do have a housing problem we have to solve. And for those of you also have kids, I'll just say one other thing, like go on and on about this, obviously. If you have kids, you want to live in a neighborhood, you want some stability. I mean, when you're renting a property, you can't guarantee you're gonna be able to be there forever. Um, you might have to move even when you don't, but when you own it, you have some certainty about where you are in the neighborhood you want to be in that you've decided to be in. Okay. All right. Well, thank you everyone for joining. Any other live questions? No, we're good. Okay. All right. Well, thanks everybody for tuning in. Wealth Office Hours is live every Thursday at four o'clock Pacific time. Please make sure you're subscribed to the channel and that you turn on the notifications. That way you're reminded when we're actually going live. Also get over to mattsawensen.com. You can download the slides here. It's mattsawensen.com slash resources. Okay, you can also sign up for the letter. And last but not least, the third edition of the self-directed IRA handbook is out. That's the third edition of my book. It's sitting over there somewhere. It's a great book. All right. Um, but this is for any of you that self-direct your IRA. I felt like Donald Trump there for a second. It's great. You know, this can be this is amazing. Yeah, this is great. Yeah. Um, but seriously, it's uh been a resource for many self-directed investors. If you're someone that uses your IRA to invest in real estate, rental real estate, or you're someone looking to get into that and how are creative ways I could use my retirement account funds beyond just buying an ETF or a mutual fund. Check out the book, The Self-Directed IRA Handbook. When it came out, we've been the number one hot new release in the retirement planning category, real estate category, investment category, number two overall on the bestseller list for real estate. The book has sold over 50,000 copies, the first two editions. The second edition has been out for a little over a week right now. So go check it out. It's on Amazon, the self-directed IRA handbook. Thanks again for everyone being on. We will see you next week here at Wealth Office Hours Live. See you then.