Rental Property Café™ Episode 6: Are You Financially Ready To Buy Your First Investment Property?

In this episode, Cynthia Meyer and Veronica Woods discuss the six questions to ask yourself to know if you are ready to buy your first real estate investment property.

 In this episode of the Rental Property Café Video Podcast they cover: 

 “You don't want to spend all of your available cash on a down payment because you need to keep back at least three months of expenses for the property in reserve for those "what-if-scenarios”- Cynthia Meyer

About the Rental Property Café™

 The Rental Property Café™ podcast offers a real estate tool kit for busy professionals who are building a real estate portfolio. In each episode, co-hosts Cynthia Meyer & Veronica Woods explore ways to grow a successful real estate business while growing your career.

 About Cynthia Meyer

 Cynthia Meyer is a financial mentor, CERTIFIED FINANCIAL PLANNER™, CFA® Charterholder, real estate investor, blogger, and the founder of Real Life Planning. She offers unbiased financial planning and learning resources to real estate investors. Cynthia is a first-generation rental property owner, who built a rental property portfolio with her husband, Steve, while they were both building their careers. She lives in NJ, where she balances teenagers, her financial planning practice, and rental property business.

 About Veronica Woods

 Veronica Woods of Daniel Woods Real Estate, real estate advisor and investor, is passionate about helping her clients create wealth, legacy, and lifestyle through real estate. She works with people to buy, sell, rent, and develop residential and small commercial real estate in Delaware County and Philadelphia, PA. An MBA in finance from the Wharton School, Veronica also shares her real estate wisdom with new investors on her YouTube channel.

Do you have a topic suggestion or want to be a guest on future episodes? Email your ideas to podcast@reallifeplanning.com

Transcript - Rental Property Café™ Episode 6: Are You Financially Ready to Buy Your First Rental Property?

[00:00:11] Cynthia Meyer: Welcome to the Rental Property Cafe. I'm Cynthia Meyer with Real Life Planning.

[00:00:15] Veronica Woods: Good morning. I'm Veronica Woods of Daniel Woods with Real Estate and we're so happy for you to join another session where we talk about how to grow a profitable rental property portfolio.

[00:00:28] Cynthia Meyer: That's right. And to do that while you're building your career at the same time. And this morning, we're going to talk about: Are You Financially Ready To Buy Your First Investment Property? This is a question that we both get all the time in our businesses and we're going to go through the questions that you really need to ask yourself to know if you're financially ready to buy your first investment property.

[00:00:50] By the time somebody gets to the Realtor®, she assumes that you are already comfortable with these decisions. So there's some things that you should work through in advance. Questions [00:01:00] that you can ask yourself. Questions that you can ask your tax advisor or your financial advisor. We're going to go through six tips that we have to help you figure out if you're ready.

[00:01:10] Veronica Woods: If your Realtor® or real estate professional who helps you look at properties, doesn't ask you any of these questions, we really assume that you're comfortable with what your financial objectives. I can't tell you what's a good financial objective . I can only find you the real estate investment that meets that objective.

[00:01:33] Cynthia Meyer: What's important for people to know who are doing this for the first time is that your Realtor®, who is your real estate investment professional, is going to be able to help you find something that meets your investment objectives, but you have to be clear about them and communicate them.

[00:01:49] Veronica Woods: To take care it a step further, it's really important for you as the investor to figure out what your financial objectives are before going to the [00:02:00] Realtor®, because they're going to assume that you know what you want. Their focus really is to find the investments that are going to match your objective, not the other way around.

[00:02:10] That's why we feel like it's really important to give you all questions that you can ask yourself so that you can be more prepared to get started.

#1 Do You Have The Funds Available For Down Payment, Closing Costs And Initial Expenses?

[00:02:18] Cynthia Meyer: The first tip that we want to share with you is: Do You Have The Funds Available For The Down Payment, The Closing Costs And The Initial Expenses?

[00:02:27] That seems like a no-brainer, right? Of course, you need to know if you have enough money to put down on the property. Often people don't think of the ancillary costs that come with buying a new property. If you've owned your own home before, you know that there are closing costs, there may be points on your mortgage, you may have renovation or rehab that you want to do, or some supplies to buy when you move into the property. Perhaps a new washing machine or dryer or something like that. So all of that has to figure into the initial cash balance that you'll need to be able to make the purchase. [00:03:00] Now typically in a single-family home, a lender is going to expect you to put down 15 to 20% on the initial purchase. A multifamily purchase might be anywhere from 15 to 30%. It depends on the type of loan that you get. A commercial loan, generally 20 to 30% down is going to be expected. House hacking would be the exception to that. Veronica, tell us a little bit more about house hacking, meaning buying a property that you're going to live in one of the units and rent out the other ones. How does that work in terms of loan structure?

[00:03:33] Veronica Woods: House hacking is the only opportunity to put down less than the percentages that you've mentioned, the 15 to 20%. If it's an FHA type loan, for example, you could put as little as three and a half percent into a new duplex, but it is also important to think about all the down payments and the fees in terms of if you have $30,000, what can you buy? This is how people come to [00:04:00] me. I have $30,000. What can I buy? And you have to think about it in terms of that 20%, let's say down payment that you could afford. Which means, if you have 30,000, you can roughly afford the $150,000 house.

[00:04:14] If you have $10,000, you roughly could only afford the $50,000 house. This perspective of like how much money, it also dives into how much you have to put the down payment, not to even mention repairs. I always like to give people those rough numbers when they tell me I have X.

[00:04:33] So I'm like, all right, you need to be looking in this range. It's funny how people quickly come to me saying, "Oh, I want to buy a multi-family. I have $10,000." I'm like, all right, this $10,000 is going to buy you this. So we really have to either get a partner or come to a reality check about what you can afford.

[00:04:51] Cynthia Meyer: Yeah, I think that's an excellent point. Because unlike investing in securities, for example, where you could do a mutual fund or an exchange traded fund for a relatively small amount of [00:05:00] money, buying a direct property is a very expensive transaction. So I think that's an excellent point.

#2 Do You Know Your Credit Score And Profile And What That's Going To Mean For Your Mortgage Rate And Your Insurance Rates?

[00:05:06] Cynthia Meyer: Adding onto that is point number two, which is: Do You Know Your Credit Score And Profile And What That Means For Your Mortgage Rate?

[00:05:16] I encourage everybody who's buying for the first time or who is taking a loan when they haven't taken one in a while is to make sure they know all the elements of their credit score. There's lots of great ways to find that out now. Because your credit score affects your rate. Most credible lenders have a minimum credit score. It is a continuum. If you have less than perfect credit you may get a loan, but you're going to get a higher mortgage rate. Better credit also means lower insurance rates on your landlord policy and umbrella liability, if you have one. I really want people to be cautious about all those education programs out there that tell you that it's really easy to buy property with no money [00:06:00] down and poor credit.

[00:06:01] Generally, I don't agree with that. It's not easy to buy property with no money and poor credit. As Veronica mentioned earlier, it really does take a fairly substantial amount of money to get started. If you have poor credit or no credit, you're going to pay an outrageously high interest on a private loan and that may make the investment not profitable. What's been your experience with that question, Veronica?

[00:06:24] Veronica Woods: Just realistically, would you lend somebody money with no money? No credit? And the last piece is experience that kind of weighs into the types of rates that you can get. Ultimately, the bank is trying to be in partnership with you and they're betting on your success.

[00:06:45] The other thing that I've learned is the more experienced you are, the better rates that you will qualify for. For a newbie out there, I wouldn't get discouraged that in generally you are paying more to do a deal then the more [00:07:00] experienced people. Straight off the rate sheets that most lenders have, they are categorizing you by how many rental properties you own, or how many deals and flips that you've done. That's pretty standard across the board.

#3 Do You Have A Rental Property Budget Before You Buy?

[00:07:14] Cynthia Meyer: That brings us to our third tip. Veronica, do you want to take that one?

[00:07:17] Veronica Woods: Tip number three is, Do You Have A Rental Property Budget Before You Start? We have a great video where we go into the details of each budget not for the purposes of this video, I do want to emphasize that it is important to run the full numbers before you make an investment, not afterwards. Generally, the picture starts out rosier. Only as you gather more information and refine your assumptions, usually it goes in the other direction. So you want to be prepared for that. I do want to speak to the make-ready budget. So if you're talking about rental properties, [00:08:00] generally you have to do some work in order to have the property ready for rent or be able to refinance if you're doing some strategy where you're doing some cash-out refinance. A lot of times people gloss over those expenses either because they don't have a good contract to walk through the property with them. There's just surprises. From my experience, it's hard to pinpoint your make-ready budget. Is it $10,000? Is it 20,000? Hopefully that range you can get between a couple of thousand. It's not uncommon that you're a couple of thousand dollars off from the hot water heater that you couldn't predict when it would break. So it was always good to pad that budget. That's the point of being prepared in terms of your ongoing expenses and just being conservative to have like a miscellaneous line item for your make-ready budget in the beginning.

[00:08:56] Cynthia Meyer: I think that makes a lot of sense to me. Both in our personal [00:09:00] experience in our rental property business, and working with clients in different parts of the country, I've noticed that one of the places where people underestimate the most is in maintenance and capital expenses.

[00:09:12] They think because they didn't have a lot of maintenance expenses in a given year, they aren't necessarily reserving for them. But in fact, you need to reserve for those expenses because when they come and they're going to be large. For example, a new air conditioner or even a new roof, repaving the driveway, or major tree work. Those are all going to be big costs out of your cashflow and so reserving for them a little bit over time is going to help.

[00:09:40] Veronica Woods: I would add one more about the cash reserves, in terms of who could help you prepare just for the ongoing expenses. That's one good thing about a property manager, they probably manage a lot of similar types homes in the area. Some things are predictable. The appliances, if they're older [00:10:00] or, the hot water heater is only good for a certain amount of years. So you can plan for those things. The property manager can help you be realistic about what those numbers are. It's just something that help you as you go along.

[00:10:14] Cynthia Meyer: Yes, I agree with that. We used a professional property manager in our real estate business and they've been an integral part of helping us build a profitable real estate business over time. I definitely have two thumbs up for using professional management when it makes sense for you.

#4 Do You Have Sufficient Emergency Cash Reserves And Reserves For Capital Expenditures That Are Gonna Happen In The Next Couple Of Years?

[00:10:29] Cynthia Meyer: Do You Have Adequate Cash Reserves Beyond The Initial Down Payment? You don't want to spend all of your available cash on a down payment because you need to keep back at least three months of expenses for the property in reserve for those what-if scenarios.

[00:10:46] Things happen. You don't know exactly what's going to happen, but things will happen and it's going to cost you some money out of pocket. If you're someone that has substantial assets or perhaps something that they could liquidate, for example, a [00:11:00] mutual fund portfolio that you could access in an emergency. That may help if your house hacking. It may take you a couple of months to save the money for that initial three months of expenses. But if you can have that upfront, that is definitely a good thing. More is generally better. So making sure that you have a plan to create and maintain cash reserves for your rental property operations is an important component of managing the risk, especially in the first property.

[00:11:29] Most of the risk in real estate investing is concentrated in that first property where you don't have much diversity in terms of your overall investing and you may not have built up the cash that you need to manage your liquidity.

[00:11:43] Veronica Woods: Yeah, that's a good point. To my clients that have five or six rental properties, if there's an emergency in one property, they have the cashflow from the other properties to pay for that. It's very rarely that all five properties have major [00:12:00] repairs at one time. There's one other thing I meant to say related to, I guess it blends in with the budget as well as the reserves.

[00:12:09] A lot of times, newer investors have a comfort if the property is occupied already. They think, "Oh it's was occupied." They didn't have to budget for a lot of large repairs up front, but they noticed there are things that they wanted to work on eventually. And maybe they glossed over it once they get in.

[00:12:26] They're like, "Ah, maybe that will be five years down the road." And they don't keep those funds in reserve that they know they wanted to address. A lot of times, tenants are living in conditions that maybe need to be addressed sooner rather than later. I think it's important to have your make-ready repair budget. Even if you don't do it immediately, I think it's important to keep that in reserves, if you know that maybe there'll be turnover in a year or two, and you're going to need to tap into that budget.

[00:12:56] Cynthia Meyer: Yeah, I think that's an excellent point. When [00:13:00] I give new investors a spreadsheet template, I actually include a separate worksheet just for renovation cost and repairs for the initial make ready budget, and then think future capital expenditures and try and get them to pinpoint when those things are gonna happen.

#5 Do You Have A Good Team In Place That Is Real Estate Savvy?

[00:13:15] Veronica Woods: That's important. Going to number five, the team in place. Having a team in place and for a team, a lot of emphasis is on the contractors and the kind of the operational team. But it's important that think about upgrading kind of your professional analytical team in your investment journey as well.

[00:13:37] People may think like I want to get the cheapest insurance. I want to get the cheapest team legal advice, or maybe I want to Google it and download the form and I don't want to even talk to my financial advisor because they're going to tell me that I'm doing something wrong. It's really important to make sure that you have the right people to think through the various scenarios that over the long term could help you [00:14:00] grow your portfolio.

[00:14:01] Sometimes people either are afraid to go down that route because it may be more money. Or they're not used to having people that they can have the kind of broader business conversations with. The accountant that might've helped you when you were just a W2 employee and you had no other investment income besides your interest from your 401k is one person. You may have to consider that you need a new person that can help you as your assets grow. I don't know if you have a way to help people figure out if they need to upgrade or not.

[00:14:37] Cynthia Meyer: Sure. The conversation I think I have the most with people is around if they're already working with me, they are working with a financial planner who is real estate focused. There aren't that many of us. Many of these questions are tax planning questions that need to happen regularly throughout the year.

[00:14:54] Make sure that you have a tax advisor. A CPA, for example, who [00:15:00] understands real estate, hopefully own some themselves and can help you plan for decisions before you make them. A 1031 tax-deferred exchange, for example, or how to treat the income from a vacation rental property. Or in a house hacking situation where you are treating your property both as your primary residence and as a rental. Those all can benefit from professional tax advice. So thinking about how you're going to upgrade your team, if you're not already there, as you become a real estate business owner is going to be a very useful exercise.

[00:15:33] Veronica Woods: Yeah, I think something you said should be emphasized, ongoing conversations. I think that's the biggest upgrade. You go to them when there's a trigger event and as your portfolio grows then you may want to have ongoing tactical advice about, " I'm thinking about doing this in six months. What does this look like? Should I change legal? We didn't talk too much about legal, but does it make [00:16:00] sense now to move things into an LLC? What are the steps for that? What are the implications for that?" Again, this is not necessarily about the money in the bank, but just the financial savviness increase that we're talking about.

#6  Are You Prepared To Manage The Long-term Time Horizon For Building Wealth?

[00:16:14] Veronica Woods: Which leads to the last one in terms of being financially savvy is understanding that this financial real estate investment game is a long term play.

[00:16:26] Understanding what that time horizon is. That varies from market to market, but in general, people talk about real estate cycles as lasting 10 to 20 years.

[00:16:36] People are still talking about the last major real estate recession and how that's different than what's going on now. Basically the people who bought properties in 07', they were able to cash out now and be able to fully realize appreciation because they've lived through a full market cycle.

[00:16:57] But if you're getting investments and saying, [00:17:00] "Oh, I want to cash out in two years." you have to understand that the real estate investment process isn't designed for you to have some kind of get rich quick scheme in two years. We both talk about some of the gurus out there alluding to one in a million haste success stories that it seems like that's what they did within that really being truly honest.

[00:17:26] I think that there's a lot of people who are very successful by, using a baseball analogy, you can get a number of base hits, and be able to grow a very profitable portfolio.. You don't have to always go for the home run. Sometimes people don't want to take any action because they want everything to be this massive success. That's not really realistic. We really are proponents about buying right and holding, as long as it makes financial sense. Then go on to the next investment from there.

[00:17:58] Cynthia Meyer: We invite you to think [00:18:00] of your real estate as a small business. So even though there are elements of the tax code that treat real estate investments as passive investments. There are still, operationally, real estate is like a small business. You wouldn't think about getting in and out of a small business in a couple of months, right? You would think about building something over a long time horizon, 10 plus years. Having that business mindset as you approach, watching your first direct property investment is really going to help you put things in context.

[00:18:32] So what would you say, Veronica, to get somebody who's not ready to buy yet? What would you tell them?

[00:18:38] Veronica Woods: One thing to think about is working with someone else that has more experience. A lot of people have gotten their start by pooling their money together with someone else that maybe has more experience. Either you have experience or money, but it's a good partnership between the two to get some experience with other people or another person before trying to [00:19:00] start everything on your own, is one. We have a few.

[00:19:02] Cynthia Meyer: Yeah. So looking for something with a smaller initial renovation budget. That it's a little bit more of a turnkey situation. Doesn't require as much cash that has to come from you. You just have the mortgage that comes from the bank.

[00:19:15] One thing that you could think about is maybe not buying in an expensive market. If you're in an expensive market, you are not necessarily limited to your own expensive Metro area. You and I are in very expensive areas, New York city, you're in Philadelphia. You might look at a less expensive market, especially if you're willing to have a property manager.

[00:19:32] Veronica Woods: I would also say within the market, there are a lot of sub markets that I think a lot of people aren't aware of. There is something to be said with Investing on the way up or investing on the way down. Maybe you can't afford to invest in the area that's hot right now, but look at a town or two over from there that may still have some of the economic benefits of those people may work in the same place where you [00:20:00] thought you wanted to invest. Different sub-markets, even within your one Metro area. I think we did want to explore out of town or long distance investing in another podcast. I know that's something you have firsthand experience. On the first level is just being a little bit more open about a town or two over that may be less expensive.

[00:20:23] Cynthia Meyer: So just to summarize for everybody our six tips are: Do You Have The Funds Available For Down Payment, Closing Costs And Initial Expenses?

[00:20:32] Do You Know Your Credit Score And Profile And What That's Going To Mean For Your Mortgage Rate And Your Insurance rates?

[00:20:39] Number three: Do You Have A Rental Property Budget Before You Buy?

[00:20:43] Number four: Do You Have Sufficient Emergency Cash Reserves And Reserves For Capital Expenditures That Are Gonna Happen In The Next Couple Of Years?

[00:20:52] Number five: Do You Have A Good Team In Place That Is Real Estate Savvy?

[00:20:57] And number six: Are You Prepared To Manage [00:21:00] The Long-term Time Horizon For Building Wealth?

[00:21:03] So anything you want to add before we finished up here Veronica?

[00:21:07] Veronica Woods: I know in the beginning, I mentioned that you should ask these questions of yourself before getting started. Real estate professionals on your team will also ask you those questions before they start sending you properties.

[00:21:20] I know, I always tell people to pump the brakes. Okay. When you want to get out of the investment? How long do you see yourself holding the property? I'm always surprised by the answer sometimes, but at the same time, I think people are appreciative of putting the real estate journey in context. Again, tip number six, this is more of a marathon or mini marathon. Not a race. Having people like Cynthia and I to get tips in terms of how the kind of look at your big picture to be successful is very important.

[00:21:54] Cynthia Meyer: So if you have. Questions or comments on this particular video [00:22:00] podcast or something you'd like to hear Veronica and I talk about in future video podcasts, we'd love to hear from you. Please email us at podcast@reallifeplanning.com and subscribe to this channel for more releases of future video podcasts. You can see at the end, if you'd like to go back and watch some of our previous episodes, including the one about budgeting for your rental property that is pertinent to this conversation. We invite you to do that and see us in the show notes if you want to connect.

[00:22:31] Thanks for having this great conversation this morning, Veronica. I hope you have a wonderful day.

[00:22:36] Veronica Woods: All right. See you next time.

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