Where to Buy Your First Rental (Rookie Reply)

Ashley:
Should you buy out of state for your very first deal? What if it’s your only way to get started, but the risk keeps you up at night?

Tony:
Today we’re tackling three new listener questions that cover exactly what new investors face, when to go remote, how to do your first bur, and how to manage from hundreds of miles a day.

Ashley:
This is the Real Estate Rookie podcast, and I’m Ashley Kehr.

Tony:
And I’m Tony j Robinson. With that, let’s get into today’s first question. So this question comes from David, me and my wife are new to this and are saving for our first property. Our goal is to start looking for properties within the next couple of months. We have a couple of questions. Would it be wise to invest out of state for our first investment where we can find places slash websites to analyze areas that will provide positive cashflow for us? And they said they do plan to go visit it in person. Would it be wise to use a HELOC on our current residence to use as a down payment for a new property? So a couple of questions here. Basically they’re saying A, doesn’t make sense to invest out of state. B doesn’t make sense to use a HELOC on their primary to fund the purchase of this investment property. And also, I guess some questions on where to get the data. So Ash, I guess I’ll kick to you first few questions here. Investing long distance versus investing in your backyard, what’s your take?

Ashley:
I think it is an advantage to invest in your backyard because you have a better knowledge of the streets. You are physically there to see what’s happening in the market and you probably have more contacts, vendors, real estate agents that you can lean on compared to going and finding a whole new market to invest in. But also really varies on price point. Can you afford something in your market? What can you get a return on for things in your market versus out of state? So I think if there is opportunity to make money in your market that I would start there. I’ve only invested in my market, I’ve gone out of state two times and that was it, but it’s definitely achievable to go ahead and invest out of state. I think for the HELOC part of that question as to should I use my HELOC to fund the deal?
First of all, find out what the interest rate is going to be on a heloc. So your home equity line of credit, this is your primary residence where if you have a mortgage on it or no mortgage, you can tap into the remaining equity into the property and some lenders will give you up to 80%, I’ve seen up to 95% and you’ll get a line of credit that you can go ahead and use. So the line of credit works as when making you want to use some of the money on it, you’re drawing money off that line of credit and the amount you draw off, that’s what you’re going to currently pay interest on. So as you pay the money back, you’re not paying interest on it. The line can sit there, still be available for you to use. That’s what I like about heloc.
The pros and cons of a HELOC is that you can use that money whenever you want, you can go and pull it off. You don’t need to get the bank’s permission to purchase a property with it. And the cons are that there’s no set repayment plan and you are just paying interest on it until it is paid back. And I think that as long as you’re diligent that you’re actually going to make payments. So more than just the interest payment because that’s what you’ll get the bill for. In most cases I have seen it where the line of credit will actually convert to some kind of amortization. So if you haven’t paid the line of credit off into years or something, whatever the balance due is, it will convert it into a 15 year fixed loan where you’re now making monthly payments of principal and interest.
I like a line of credit for full purchases of a property. So if you can get a line of credit big enough to actually purchase a property in cash, that’s a huge advantage to be able to make a cash offer, not have to go through the hoops of getting financing on the property. If you are going to use that line of credit for a down payment and then go ahead and get financing on the property, that’s where I don’t like it because it gets more risky because now you are 100% leveraged on this property. You have the line of credit debt, you have the mortgage on the property, and I like to see some kind of equity in the property. Maybe if you’re getting a slam dunk deal and you’re buying the property way under market value and there’s already going to be baked in equity, this can work.
But also you have to figure out some kind of repayment plan for that line of credit. So if you’re going to do a burr or you’re going to rent out the property, turn it into short-term rental, however that property is making money, you’re going to make sure that the actual rental income will cover repaying back the line of credit or repaying back the and repaying back, I’m sorry, the mortgage that’s on the property too. If you’re going to do a flip, the line of credit works great to purchase it in cash and then go ahead and refinance or I’m sorry, not refinance, but go ahead. When you sell the property to repay back the line of credit,

Tony:
Couldn’t agree more Ash. I think the lines of credit, whether it’s a heloc, a commercial line of credit, whatever it may be, short-term projects make more sense for that for all the reasons that you mentioned. But I think going back to the original part of the question of invest locally or in your backyard, again, agree with everything you share, but I think they’ve got to answer the question David does of what is his actual motivation for investing in real estate? And we harp on this a lot on the show, but only because it’s such an important question to ask because it dictates what strategy makes the most sense for you. David, are you looking for cashflow or do you want to maximize cashflow? Are you looking for long-term appreciation so that in 30 years when this thing is paid off, you’ve also appreciated massively? Are you looking for tax benefits?
What is your actual motivation for doing this and what’s most important? What’s second most important? What’s third most important because it’s very rare, but you’ll find a market that equally satisfies great cashflow, great appreciation, amazing tax benefits, class A neighbor. It’s hard to get all of those things in one market. So if you’ve identified what’s most important to you or once you do that, then you can just take that, compare it to your backyard and say, is it actually achieving what I want to achieve? If you’re most concerned with maximizing your cashflow and you just want to buy a single family, long-term rentals is your strategy, but you live in some super high cost of living market, California, New York, wherever it may be, then maybe your backyard doesn’t make a ton of sense, right? Because it might be hard to cashflow on a traditional single family home in a super high cost of living area.
But if your goal is appreciation and you’ve got the means and resources to actually buy in that market, then by all means go in your backyard. If your goal is appreciation and you live in small town USA, then maybe it’s a little bit harder to make that argument make sense as well. So it comes down to your motivations, why are you doing this? And it comes down to your resources. And I think the combination of those two things, why am I doing this? How much cash do I have? What kind of loan can I get approved for? Those three things together I think will help dictate what cities you should be investing in.

Ashley:
And also thinking about too that your first deal doesn’t have to be a home run deal, that you don’t have to spend all this time in analysis paralysis saying, okay, well this market, I can get this cashflow, this cash on cash return. Oh wait, this market, I can get a little bit more this market, I can get a little bit more. And trying to weigh out how you are going to maximize your money. We get questions all the time. I have $50,000, I have a hundred thousand dollars. What is the best thing that I can do with that money? What is going to give me the best return? There are probably a million different options, strategies that you could do with that money you could take by 10 properties by putting $10,000 down on each property. There’s so much different ways that you can implement that money.
And I think the biggest thing is just finding something where the deal works. And just like Tony said, what is your why? What do you want out of real estate? If a deal works for that get started, don’t try to overanalyze and find that perfect deal that you’re going to get the best deal that anyone has ever gotten with a hundred thousand dollars. And you got to shift your mindset to know that it’s okay if you don’t get the biggest return on your first deal. I didn’t. I gave away equity. I paid interest to my partner. I gave them part of the cashflow. I gave up so much just to get that first deal done, but it propelled me into my investing journey. Okay, we have to take a quick ad break, but when we come back, we want to talk about once you’ve chosen your market and your funding plan, how do you actually stack your financing and make sure the B math works?
We’ll break it down for you right after a quick word from our show sponsors. Okay, welcome back. Our next question comes from Aaron in the BP forums. There are so many loan options out there that I need help focusing my education to the most important ones. And that raises the first question I’m having a hard time understanding. For the experienced burr investors, are there typically three loans in play or just two? One is the loan to purchase the property, two, is the loan to rehab the property, three, the refinance loan? Or are the experienced investors typically seeking to combine steps one and two into a single loan, a fix and flip or some alternative? So one, a loan to purchase and rehab the property. And then the second one, just to refinance. This is actually a great question because there are so many different ways that you could actually do this.

Tony:
It could be split a million different ways, and I think we’ve both done and seen it done a lot of different ways.

Ashley:
I think I’ll start with what I typically do. And when I’m doing a burr on a property, I typically find a way to purchase the property where I’m not getting funding on the deal through a bank loan. I am finding a private money lender, I’m using a line of credit or I’m using cash that I’ve saved up to actually purchase the property. Don’t forget, I’m in a very, very low cost market. So this isn’t a million dollars I am spending here on a property, but I’ll do that. And then I will also do the same for the rehab where I’m using one of those three things. And then I will go and refinance, get an actual loan on the property, and I will pay back my line of credit or my private money lender or pay myself back. And that’s how I typically have done it.
But you could go out and do any of the ways that Aaron mentioned. So you could go out and get a property, you could put 20% down, you could go ahead and fix it up using, I’ve seen people use credit cards. I’ve seen people use money from their parents. I’ve seen them borrow money from their 401k to pay for the rehab. And then when you’re done with the rehab, you have it rented out going and getting a loan on the property, and then you are paying off that first loan that you had gotten. So doing that refinance where you’re paying back that first loan and then hopefully you have extra money left over to pay back however you did the rehab on the property.

Tony:
Yeah, I mean the paying cash for the purchase and the renovation is like the traditional burr. If you go back and you read David Green’s Burr book for BiggerPockets, that was his approach. He would save up a bunch of cash pay for both the purchase and the acquisition and the only loan that would come into play was the refinance loan at the end. So there is a situation where it’s just one loan. For me in my business, it’s been very similar to what Ashley said. Typically, if we’re doing some sort of renovation, we’re raising private capital to fund both the purchase and the renovation. So there’s technically, I mean it is a loan, right? I mean there is a loan there because we give a promissory note, we do all of the documentation, there’s just no bank involved per se. And then once we refinance on the backend, that’s when we go out to get traditional long-term fixed debt.
So really I think to answer the question, it really comes down to you, your resources and your strategy, right? So you, your resources and your strategy, and if you have enough cash to cover both the purchase and the renovation, you don’t need to go out and get debt upfront, just do it yourself if you have access to capital, because if your network, you don’t need to go to a bank, go to your network, have them fund the purchase and the transaction. If you have neither, right, where you don’t have enough to pay in cash, you don’t have a network, then yeah, going out and getting some sort of hard money, some sort of construction debt would be your best option to do the initial acquisition and rehab and yeah, go out and get permanent fixed debt from somewhere else. So there’s a million different ways that you can slice it. I think it comes down to, again, you, the project, your resources, your network,

Ashley:
And also really determining what the costs are to you for doing each of those options. So if you’re going out and you’re getting a mortgage on the property, you’re going to have closing costs. If you’re in New York, you’re going to have attorney fees, things like that to actually purchase the money with a conventional loan or bank financing. Then if you borrow the money for the rehab, and maybe you are putting all the rehab materials on a credit card, if you can’t get a 0% interest card, then maybe you’re paying that really, really high interest on the credit card that you need to factor that in when you go and refinance what are going to be the closing costs, the fees that are associated with that. And I think you have to look at all the costs that are associated with the type of money that you’re getting and how you’re going to fund the deal to actually figure out what your holding costs are and what actually makes sense if you do have different options to actually fund your deal.
So if I’m funding cash into my property and that’s how I’m using it to hold, my holding costs are a lot less than if I went out and used private money or if I used hard money or even just a bank to purchase the property. But also that means that I don’t have that chunk of money anymore. So there is, I’m putting a huge chunk of money in there myself where I could be taking that money and maybe doing something else with it that had a bigger return or earning interest on that money in a high yield savings account, whatever that may be. And then also, it goes opposite way too. If you get a private money lender or you get a hard money lender and all of a sudden your property isn’t refinancing like you thought and it’s not getting that after repair value, it’s done appraising for what you thought. There’s that risk in not being able to pay back the lender in full because the deal didn’t work out what you thought. So weighing out the cost of using the different types of funding and also the risk of the different types of funding that you’re doing too.

Tony:
And just on the risk piece, I think there is one part of the burr that some investors overlook, but regardless of what cash loan debt you use to purchase and rehab the property, oftentimes when you go to refinance, lenders want a seasoning period. Basically. They want to see you have owned that property for at least some period of time before they’ll allow you to refinance and take capital back out of that deal. Usually what I’ve seen is six months ash. Lemme know if you’ve seen something different. I know there are some banks, maybe local, regional, smaller ones that are a little bit more flexible there, but I believe for most it’s six months. And I dunno if that’s like a Fannie and Freddie thing where they want to see six months or if you’re working with a bank that keeps all their loans on their own books, and maybe they got more flexibility there.
But typically six months is what you see. So for example, let’s say that you buy a property, and I’ll use round numbers here. Let’s say the property’s RV is $1 million and let’s say that you’re all in cost to buy it, to renovate it, you’re holding costs, everything came out to $600,000 and the bank says, Hey, we’ll give you 80% loan to value, right? So they’re going to give you $800,000, 80% of 1 million, 800,000 you only owe, your costs are only 600. You’ve got a spread there of 200 K that you could tap into. If you do that refinance, if it’s been less than six months, oftentimes they’ll only allow you to refinance your total cost into that deal. So you could refinance, but it would be for 600 K, meaning you get no cash out. But if you wait the full six months, then you could access all the way up to the 80% or the $800,000 you pay off your 600 K of your costs, you get to keep that 200 K tax free and now you get some cash back for doing this burr.
So just know and ask those questions as you’re looking into your refinance of, Hey, what is the seasoning period that you’d be looking for? Alright guys, we’re going to take a quick break before our last question, but while we’re gone, be sure to subscribe to the Real Estate Rookie YouTube channel. You can find us at realestate Rookie, and we’ll be back with more right after this. Alright, let’s get into our third and final question. This one comes from Jay. Jay says, I’m curious if anyone has a checklist that they go through when evaluating a new property management company for out-of-state investing. Any questions you specifically asks, any questions you specifically ask, any red flags that you see away from, or any processes that you have in place? So he says, out-of-state investing, but honestly, I think this is either in-state or out-of-state. There’s probably some foundational things you should understand.
I’ll give my experience of finding my first property management company, and this was back in 2018, maybe even 2017 when I started looking for them. But they took over in 2018, nonetheless, my property management company by doing a few things. One, I asked my agent in that market for a couple of referrals. I just searched property management company, Shreveport, Louisiana. And then I think I had a list of three or five or so that I found, and then I just called them. And surprisingly out of the five that I called or tried to contact, I think I only heard back from two or three of them. So there’s a couple that didn’t even respond to me. And then of the ones that responded, I met them for coffee. I went out to Louisiana and I had coffee with them and tried to ask them to get a sense of who they are and what’s going on.
And I think through that I was able to understand, okay, who’s super responsive? What are their teams look like? Is this a one man or one woman show or is there an actual team behind them? What is their knowledge of the markets? I just ask ’em like, Hey, how long are your units sitting? Typically? What are you doing to actually market these properties? What does your process look like for turnover? Just trying to understand for me at the time is a rookie, what are all the things that they’re going to be handling for me that I should be aware of? I would encourage you to review their contract because every PM is going to have maybe a slightly different contract they’re stepping into and knowing what their fees and what their costs are, what are all the different ways they make money is important as well.
A lot of Ricks mistakenly assume that the only way that PMs make money is from their management fee every single month. And while that’s maybe the main way, they also make money from doing things like leasing your unit and they’ll charge you a bigger fee anytime there’s a turnover and they have to place a new tenant. If they’re taking care of your maintenance for you, maybe there’s cost associated with that. So if you get into short-term rental space, there’s even a lot more ways. There’s tech fees and pricing fees and different things they can add on. So just get a full understanding of their fee structure. That’s how I started. Ash, I’m curious for you, right, because you’ve done it yourself, you’ve used PMs, what checklists or how are you evaluating PM companies?

Ashley:
Yeah, actually I BiggerPockets. We have a article that was written that is literally 78 questions to ask a property manager, and I’m going to link it into the show notes for you guys.

Tony:
Not 70, not 80, but 78. Okay, there you go. Very specific.

Ashley:
So you can go ahead and go through this whole list and pick and choose what you want to ask, or you could probably send over the whole list of questions to a property manager. And the one that actually answers it may be the best one just by having them go through all the questions. But for me, I had a property management company for three years, and some of the mistakes I made when hiring them was I picked the company because of its marketing. They were so great at marketing that I was just like, wow, this must be the best company wrong mindset to have. Just like if you’re following someone on social media, oh, they must be successful. They have a lot of followers. That was literally my mindset on picking the property management company. And I only interviewed them. And so we did the interview process and the mistake I made was asking yes or no questions.
So do you manage apartment complexes? And it should have been how many units in an apartment complex do you manage? I think that I was working with a partner and we were both giving him our properties and he had a 40 unit apartment, and that was going to be way bigger than any other unit they’ve ever managed. And managing a 40 unit is completely different than managing a five unit. So that was a big mistake there. So not getting more specific. Another way to ask a question. Whenever you’re vetting anyone, like lenders, agents asking, how many investor deals have you done in the past month? So for a property management company, it could be how many turnovers or vacancies are you filling on average each month or something like that where they have to give you a specific number or how many apartment complexes that you have that each have how many units?
So tailoring questions more towards that. And then Tony had said the fees, that was a big thing that I did not understand as to how many additional fees for every little thing. And then just the maintenance cost and turnover cost process. So for example, partly through our management, they decided to implement inspections throughout the property. So twice a year they would go in to each property and do, it was supposed to be proactive. And at first this sounds like a great idea, but then the cost just started to add up so much. They were charging a fee to go and do it. I can’t remember. It was somewhere between $45 and $75 a unit to go in and to walk through it. Then they would make a list of things they think that needed to be done, maybe the furnace filter changed or batteries put into smoke detector, other things like that.
So then they’d make their list and then they would go ahead and schedule again to go ahead and fix these things and put them on all about being a proactive landlord. Here’s where I saw the problem is together we had about 130 units, me and this other investor, and we were under the same PM contract and they quoted us out for getting new smoke detectors for half of the units or something like that, just updating them, whatever. And all of them were at cost. And right there was like, okay, can we get the bulk order from? I’m looking at Lowe’s right now. If I get 10, I can get ’em for $2 cheaper for each of them, just me on the Lowe’s website ordering 10. So I think having an really good understanding of understanding what the costs are associated with maintenance and how they’re figured out. Are they getting discounts on materials? Are they doing those inspections? And what are the costs associated with that? What changes can they make to their actual process? So this was told this is happening, you are getting these inspections. What other things could you implement throughout the year that maybe we don’t have in our property management agreement that could come up? So I think I was really focused on, oh, I can’t wait to get this off my shoulders and have somebody else take care of all of this that I didn’t understand and ask enough questions.

Tony:
And I think the last thing you said, Ashley, is the lesson for all of the Ricky that are listening. Even if you hire a property manager, even if they’re handling all the day-to-day, you still have an obligation and a need to manage the property manager because no one’s going to look after your asset the same way that you do. Even in the world’s best pm you’re not their only client. They have hundreds, maybe thousands of other properties that they’re managing. So you’ve got to be your own best advocate. And part of that is managing the pm, asking all of those questions, holding them accountable, and then not being afraid to make the change if it’s in the best interest of your business.

Ashley:
And I think too is to, there’s just things that they don’t do that you want to do for your property too. They’re most likely not quoting out your insurance every year. They’re most likely not checking your water bill. The PM company I use, they just had a payables department where everybody’s bills got sent there for all of the properties they manage is just somebody scanning them in, setting them to pay, not actually looking and be like, wow, this person’s water bill is three times higher. Their toilet might be running and they haven’t told us, but the owner is paying it. So I think that was a big thing too, is you really do need to go through detail by detail your owner statement and seeing what you’re being billed for and seeing what your payables actually look like and just having that oversight on your property. Well, thank you guys so much for joining us today. I’m Ashley. He’s Tony, and we’ll see you guys on the next episode of Real Estate Ricky. I.