Finance Friday: Living Paycheck-to-Paycheck with 9 Rental Properties

Mindy:
Welcome to the BiggerPockets Money Podcast show number 322, Finance Friday edition, where we interview Pam and talk about taking a deep look at the true cash flow scenario of your rental portfolio.

Pam:
My husband and I, we talk a lot about, well, do we want to do the cash out or do we want to keep them paid off for increased cash flow. We do have four properties paid off right now. We were toying with the idea of refinancing two or three of them to help pay off the private lender.

Mindy:
Hello, hello, hello. My name is Mindy Jensen and with me as always is my sunshine on a cloudy day cohost, Scott Trench.

Scott:
That’s me beaming, Mindy.

Mindy:
Scott and I are here to make financial independence less scary, less just for somebody else, to introduce you to every money story because we truly believe financial freedom is attainable for everyone no matter when or where you are starting.

Scott:
That’s right. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business, or analyze your portfolio and consider selling some of that real estate, we’ll help you reach your financial goals and get money out of the way so you can launch yourself towards those dreams.

Mindy:
Scott, today we are talking to Pam and she has a very interesting set of circumstances with regards to her investment portfolio. She has been investing over the last three years, gathering, collecting real estate properties. And now it’s time to analyze those and see if they are worth holding onto.

Scott:
That’s right. Pam has a very, I would imagine, a very common situation for investors who have been using variations of the BRRRR methodology where they’ve got build up a lot of equity, but it’s a little hard to cash flow in some situations, and maybe some of the properties don’t cash flow because we haven’t been doing enough of a rigorous analysis on that cash flow and really accounting for things that are phantom expenses, that don’t show up every month but you have to plan for like vacancy, like maintenance, like CapEx. Run those numbers all the way through on every property in your existing portfolio and any property you’re considering buying and make sure that your cash flow positive. You don’t have to get a 10 or 20% cash on cash return, but you have to be positive in order to sustain it in this business with conservative assumptions over the long term, in my opinion.

Mindy:
Yes. And you said the V word, Scott, vacancy. We didn’t even talk about vacancy on this episode because she has really great properties that don’t have any vacancy. She said that she’s got people that have been there since 2015. But that is something that we forgot to talk about. Vacancy should be estimated at 8%. A lot of people will say 5%. It should be estimated at 8% because 1 divided by 12 is 8. I don’t know. A whole month’s vacancy is 8%. And hey, if you estimate high and then you come in a little bit lower, you win.

Scott:
Yeah.

Mindy:
If you estimate low, then you lose.

Scott:
And what do you do if you can’t get the numbers to work on a cash flow basis with conservative assumptions? You use less leverage. Or you wait. Or you pick your different market or different strategy with that. You don’t have to make, again, 10, 15, 20% cash flow each month to get into this game. There are appreciation and amortization benefits, but you can’t cash flow negative because it’ll just suck money out of your life and make things miserable in the downturns, the handful of downturns we are going to experience over the next 50 years.

Mindy:
You just said the G word, Scott. You said “This game. To get into this game.” Real estate investing is not a game. It is a business. And if you treat it as a game, you will lose every single time. But you’re not the only person who calls it a game. Everybody calls it a game and it’s a huge pet peeve of mine.

Scott:
I call it a game. I just am so competitive, I take my games very seriously, Mindy.

Mindy:
Okay. You know what? I will give you that, but everybody else does not get a pass on this. You cannot call it a game. It’s a business and you have to treat it as such. All right. Now, before we get into Pam, the contents of this podcast are informational in nature and are not legal or tax advice. And neither Scott nor I nor BiggerPockets is engaged in the provision of legal tax or any other advice. You should seek your own advice from professional advisors, including lawyers and accountants regarding the legal, tax, and financial implications of any financial decision you contemplate.
Pam is a real estate investor who’s been focused on increasing her real estate holdings the past three years. She and her husband have a great income and have been reinvesting their cash flow back into their real estate portfolio along with using a hard money lender to fund more purchases. But now they’re at a crossroads, continue with the BRRRR strategy in single family homes or pivot to multifamily. Pam, welcome to the BiggerPockets Money Podcast. I’m so excited to talk to you today.

Pam:
Hi, thank you for having me.

Mindy:
Thank you for coming on.

Scott:
Oh, welcome.

Mindy:
This is going to be so much fun because we’re going to talk about our favorite topic, money and real estate. So let’s jump right in. What do you make? Where does it go? And then let’s talk real estate.

Pam:
Okay. Well, I have a couple of businesses. I used to teach writing lessons. So I still have a little bit of that going on so it brings in a little money, play money, every month. I have a bookkeeping business that brings in net about 1,800, 1,900 a month. My husband and I work for a property management company. He does the maintenance. He’s maintenance director. I’m the CFO, so I do a lot of numbers. So together… Let’s see. He’s a 1099 pay. And then with my net that total’s roughly 12,000 a month. The average of the rental income as it stands now is about 7,500 a month. That increased. We just signed a lease, so maybe 8,500 a month. And then just sales. If we’ve decided to sell one over some time, I just averaged that out to be about 4,800 a month.

Scott:
Oh, you’re saying when you redeploy the proceeds, you might be able to generate an addition of 4,500?

Pam:
Well, I maybe I didn’t explain that well enough. Okay. So for the house sale, there was initially supposed to be a rental. But five months later of not being rented, the best strategy with the way the prices were, we decided to sell. So we made some money there and I just averaged that out to be about 4,800 a month.

Scott:
Oh, okay. What’s the lump amount of that sale proceeds? Is that sitting in your bank account?

Pam:
Some of it is. We paid a big chunk to our private lender, about 50,000. We walked away with 108,000.

Scott:
Okay.

Pam:
We bought another house. I’m sorry. We bought a rental. Turnkey. It had a tenant. That was 33,000. Paid our private lender 50,000. And then we paid a credit card off, the business credit card. That was maybe 10,000. And then we still have 20 left of it, which we are planning to purchase another property that will be a pretty big renovation project to be a rental.

Scott:
If I were to summarize your monthly income, excluding this sale, I could say that your wage income, the dollars you’re earning is $12,000 a month. Your bookkeeping business is bringing in $2,000 a month, and your rental business is bringing in $8,500 per month. Once you get that next place up with the new tenant. And that’s a net cash flow. That’s not gross rent. That’s the cash flow you’re able to spend on an average basis from the rental property portfolio.

Pam:
I believe so. Yes.

Scott:
Okay. That’s awesome. That’s $22,000, $23,000 per month pre-tax. That’s phenomenal. So big incomes.

Pam:
Yes, but I feel like we’re paycheck to paycheck.

Scott:
Well, that’s why we’re here.

Pam:
Yes, exactly.

Mindy:
Yes. I just want to point out before we go any further, if you’re spending every dime that comes in, you are paycheck to paycheck. It doesn’t matter how much of that is coming in. So let’s look at where that’s going and see. I saw something. So we do get your numbers ahead of time and I did see something that I’d like to maybe reframe as we’re going through your numbers.

Pam:
Okay.

Mindy:
So let’s look at your numbers the way that you’ve shared them and see if they still are how I am thinking about them. So what are your expenses look like?

Pam:
I separated it category, like personal and business, because that’s where it gets a little confusing. We usually always have some sort of remodel going on, which is where a big chunk of all that money goes. And like I said, we just recently finished one remodel. We have a signed lease. We did receive our first rent check from them that is through a management company. So I feel like the business miscellaneous category that I have will trim down quite a bit. So for personal side, our mortgage for our primary home is 1,400 and that’s taxes insurance. Our insurance bills every month are 1,475. Big one is health insurance because I’m a W-2, but they don’t have medical. My husband is the 1099 side so he doesn’t have medical. So that’s about a thousand. And the rest is life insurance which is we have the term policies, and that’s in car.

Scott:
Awesome.

Pam:
Travel’s a big one for us. I just averaged that out for the year and that was about 800 a month, mainly because we have properties in out of state. So we do go a few times a year. My general category needs to slim down. General merchandise and clothing, 866. Yes, it does include some Amazon. Also trips to, I don’t know, if we have to go get a card or just general items needed for the house. That’s my big lump category. We do have a boat that we own. Part of that boat money is where we house it at the Marina. It’s called the dockominium. I don’t know if you guys have heard of that, but it’s like a condo for the boat. So that monthly payment is in there. That includes dues. It includes property tax, our payment to the dockominium. We bought that on land contract. That ends in September. So that’s roughly about 750 a month for a year. It also includes other maintenance with it. It’s basically our cottage.

Scott:
So we were trying to tie this up, but we’re… How much is this coming out to per month?

Pam:
9,500.

Scott:
9,500 per month. Okay. And you’re bringing in 22,000 per month. So while there’s a lot there and there are things to cut, you should be not living paycheck to paycheck based on that spending and your income, which is what we’re going to investigate today with that. So you should be able to accumulate a lot of those things. Many of the things you said there are perfect. Like this is not a, “Oh, cut your boat” thing with that. You’re in enough income to pay for some of these luxuries with that because you guys are doing so well. Let’s go through your net worth and balance sheet here. And let’s start with cash. How much cash do you guys have?

Pam:
Personal cash, 12,000. I know we have about 18,000 to 20,000 in the business account, in the real estate account.

Scott:
And then is the biggest portion of net worth the real estate?

Pam:
Yes.

Scott:
Let’s walk through that. What does that look like?

Pam:
We have nine rental properties valuing 1.5 and it is equity.

Scott:
Where is it located?

Pam:
We have three in Scottsdale, two condos and a house that are Airbnbs. And then we have properties in Flint, Michigan that we use for long term rentals.

Scott:
And those are six properties there?

Pam:
Yeah, and counting. We are under contract for another one and just signed another contract today for a quick wholesale flip.

Scott:
Yeah, it looks like we’ve got about $200,000 in retirement accounts and then maybe another 5,000 to 10,000 in after tax brokerage accounts there. Does that sound about right?

Pam:
Yeah, I use personal capital, so I have everything in there. And yes, that sounds right.

Scott:
Before we get into what’s the best way we can help you today, I’d love to hear a quick story about how you got into this position. Can we do a quick background on your journey with money?

Pam:
We grew up not poor, but lower middle class. My dad was dealing with layoffs. I worked for the big three. So there were times where we had to pinch quite a bit. And then fast forward college, I went to college student loans, that kind of thing, got married quickly after school. And then that didn’t end very well. I did have a 401(k) at that time that I lost after the marriage. So I was starting over basically at 28. I did have my horse training business, which paid for my lifestyle, but I wasn’t able to put anything away. Then my husband and I met. He has a very similar money background as I, so we got along great. We decided we’d be a great team to do some real estate because he was a builder. So we loved all those shows that came out in 2005 and ’06. So we thought flipping was it, this was great. Then the market crashed. So we kind of lost that.
Got some very bad advice from our real estate agent that said, “Just let them go back to the bank like everybody else, because I can’t sell them. Had no clue about renting. No clue. No clue that there was even property managers that could handle everything for you. So that kind of was a harsh learning lesson. We had to file bankruptcy in 2011, but it’s kind of been the best thing that’s happened and we’ve learned from that. We lived with cash for forever. Gosh, probably until 2018. So we went seven years just if we didn’t have the cash, we didn’t buy it. We had no credit. We had no loans. We had nothing. We did start building from there with the prepaid credit card. We each had a $300 prepaid credit card and we lived off of that surprisingly. But he had done some car sales at that time while his remodeling kind of was going under with the economy the way it was during that time.
And then fast forward 2018, we decided… Actually let me back up. When we were going through that bankruptcy, we lost all of our properties. Our primary home, I had a condo that went back to the bank. We have this private lender who my husband had done some business with before. He was our saving grace. We were able to buy a home with him on land contract. So he paid cash for it. So we found a nice home and fixed it up, that kind of thing. We stayed there for three and a half years. Sold in 2013. Had a nice lump sum. Walked away with some money. So like our first live-in flip I suppose.
And then we found this great property, 2014, 2015. Also, our plan was a live-in flip because we did well with that other one. We had a five year plan for that house. And we stuck to it pretty well. We used that chunk from the first house, did the remodel. Lived there for six years. Sold that in 2020. And then 2018, ’19 was when we started buying real estate.
I learned about a thing called cash out refi. I had no idea what that even was. I had no idea if we could even qualify for a mortgage. And they qualified us and we walked away with a check of 230 some thousand dollars. We’re like, “I can’t believe that just happened.” So we paid our private lender off and we had money left over to buy our first rental. We bought a turnkey rental. It was the wonderful first property. And that’s how we got going. Our private lender said, “Why did you pay me off? Do you want more money?” So we borrowed more money and did it again. We bought some more turnkey rentals and that’s where we ended up here.

Scott:
Awesome. Has most of the rentals been financed with cash out refinances or have you been accumulating cash in a substantial way over the last 3, 4, 5 years as well from your saving and incomes and job?

Pam:
I would say yes to both of that. Yes to both of that. We did get a line of credit on those three properties because on paper we looked like we owned them all. And we bought some more properties, paid him off again. So a bit of the BRRRR strategy.

Scott:
Okay.

Pam:
I don’t know that a lot came from our income honestly. I think a lot of it was just the moving of the properties.

Scott:
Well, great. Well, let’s unpack this. That background was really helpful. I think we’ll have some clues in that background as to opportunity areas that we can begin attacking. My belief is that your situation that you articulated to us is one where you’ve got really strong income, you have all these rental properties, you’re living paycheck to paycheck and you can’t figure out why cash is leaking out of the system instead of depositing into the system on a regular basis. And I think I’ve got some hunches about why that may be happening. And let start with the real estate portfolio. Let’s talk about the types of properties you own. Are these properties in good condition when you buy them?

Pam:
Most of them no, which is why I think we had been leaking so much money into the renovations. For instance, the one we just finished, we paid 40,000. I think we only put maybe 15,000 or 20,000 into it. I don’t even think that much. 13,000 to 15,000. We’re in the process of refinancing that right now. And it appraised for 101,000.

Scott:
What would $101,000 property rent for in that area? This is Flint, Michigan, right?

Pam:
Yes. A thousand. We just signed the lease.

Scott:
Near Detroit?

Pam:
It’s an hour on 20 north.

Scott:
So you’re getting a close to 1% rule property here. How do you think about expenses on that property? What are you paying on a monthly basis?

Pam:
So before the refinance, all of my Flint properties are usually about 285 a month. That’s insurance and tax and utilities, because I had to pay the water and electrical. Maybe at the most in the summer 350. Actually the winter because that’s with the heat.

Scott:
So 285 to 350. Do you have a mortgage on these properties?

Pam:
When we do the cash out? Yes. And that payment will be 612 and that includes everything.

Scott:
Okay, great. And that includes everything, that principal, interest, taxes, insurance?

Pam:
Correct.

Scott:
And then utilities and water come on top of that. What are utilities and water?

Pam:
Well, that will be covered by… The tenant will pay that.

Scott:
Okay.

Pam:
But previously, winter is usually the most expensive at 130 a month. but most of these properties don’t have a lot of insulation so they leak hot air. So you pay for that. The water we generally don’t even use, but there’s a service fee. So our bill is always $57 a month.

Scott:
Any other expenses that go along with that property? So 612 in PITI. Insurance goes to the tenant. And then $57 per month for water. I’m sorry. Utilities go to the tenant. And then the water is $57 per month.

Pam:
So my expenses will just be the mortgage PITI, 612.

Scott:
Great. And then what do you pay your property manager?

Pam:
10%.

Scott:
10%. So we have a hundred bucks a month for the property manager. And what’s the placement fee on that?

Pam:
A half a month rent.

Scott:
Okay. So you’re going to place 500 bucks?

Pam:
I’m pretty sure.

Scott:
That’s only every two years?

Pam:
Actually, what’s interesting about this area, it’s so popular for rent that nobody moves. We have tenants that have been in those turnkey houses we bought, they’ve lived there since 2015, 2016. So knock on wood, we haven’t had a turnover yet, which is pretty amazing. So hats off to our property managers for finding great tenants as well because I think that has a lot to do with it.

Scott:
Okay, great. What do you budget for maintenance expenses?

Pam:
Well, I have a live-in maintenance guy. That’s my husband. So it’s just time really. Maybe materials.

Scott:
Okay. I would recommend you put 5% away for maintenance at the minimum. Maybe 10%. Go ahead, Mindy.

Mindy:
I was just going to say with a move planned in the next year or so, you’re going to need to have maintenance scheduled or accounted for. And also I would start looking for maintenance people now so you can have them working on your properties in conjunction with your husband so you can test them out because things will break. Things will break more frequently when your husband isn’t there to fix them it will seem and you’ll be like, “Why is this so expensive all the time?” Because on paper, $1,000 in rent and 612 in mortgage payment is almost $400 in my pocket, but it’s not. It is now you’re a hundred dollars for the property manager, “Okay, now it’s $300 in my pocket.” Well now you’ve got a hundred dollars for maintenance, “Now it’s $200 in my pocket.” These were rehabbed, right? These we’re turnkey. What is the state of the roof? The big systems? If everything’s brand new, you need a whole lot less in CapEx. But if the roof was 15 years old when you bought it, you’re going to have to budget for a roof a lot faster.

Scott:
Yeah.

Pam:
Correct.

Scott:
That’s a good thought exercise here. So we have maintenance, which is costing you something. It’s not nothing because you have materials that you have to pay for. But you will have to budget for the maintenance person when you move. And then the other part of this is CapEx. And this is what’s going to kill your cash flow when I tell you this. This is not going to be good news with this. On a property in Denver, Colorado, I would not estimate less than about $250 per month, per month, is a CapEx allocation because every year I’m going to have some problem with one of my units across my portfolio. And that problem is not going to be three grand. It’s going to be 5 to 10 grand, right? When I got to turn a unit because the tenant’s trashed it, it’s 10 grand to fix the floors and the walls or whatever with that.
And that’s going to happen every… In your case, let’s call it every five years because you have a long tenant. But you’re still going to have to plan for the 10 grand each unit every five years at the minimum, which will come out to $250 a month. And that I believe is what’s killing your cash flow here and why your business is not actually spitting out cash into your bank account on a regular basis and the way that you’re anticipating with it. Do you have a reserve for that? Do you account for that CapEx piece in the cash flow?

Pam:
I do have a reserve as far as we do have a line of credit that has 45,000 available if we need to tap into that. I do have my private lender and we do have some cash. But I do feel like I need a whole bunch more sitting aside for that kind of stuff.

Scott:
I agree with that and we’ll come back to the cash position in a second. But right now I’m trying to point out the cash flow on this unit. So let’s go through the numbers that we just put in place, right? We have a thousand dollars in rent. We have $612 in your principal, interest, taxes, and insurance. So now you have $388 in cash flow per month, right? A hundred dollars of that is going to the property manager. So now you have $288 per month. I would bet that between CapEx and maintenance, you should be budgeting $300 per month because I don’t think you can get away with less than that over the long term.
So right now your cash flow is not positive on this property. On an average basis over a three to five year period, you’re going to have many months where it will be positive and will deposit money in your bank account, but you’ll also have those big turns where $5,000 is going into that property and that wipes out all of that overall. And so that’s the major problem here. I would estimate that the same situation could be going on in other of your properties with that. Do you think that’s a… What’s your reaction to that?

Pam:
Well, that’s a very good observation because my husband and I, we talk a lot about, well, do we want to do the cash out or do we want to keep them paid off for increased cash flow? We do have four properties paid off right now. We were toying with the idea of refinancing two or three of them to help pay off the private lender. So that comes into play I would think based on the cash flow on the other properties. So so I just start analyzing each one like this and or do we do it as a whole?

Mindy:
I would analyze each one like this. And I would go a little bit further and say because the numbers that you shared with us were personal and business all together, I’m wondering if your personal income of $12,000 a month is subsidizing your rental properties and that’s-

Pam:
Oh, it does sometimes.

Mindy:
… also making you feel like you’re living paycheck to paycheck.

Pam:
Yeah.

Mindy:
Because $12,000 a month in a relatively low cost of area living should be… I don’t want to say knocking it out of the park, but it should be really, really comfortable. I think that each individual property should be… I don’t want to argue with Scott had totally derail this conversation, but I would challenge you to figure out CapEx for each one of your properties. What is 123 Main Street’s roof age and systems age and appliances and see, “Oh, okay. A roof is $15,000 and I have 10 years left on this roof. So 10 times 12 months is 120 months. And-”

Scott:
15,000 divided 120 is 125 bucks a month.

Mindy:
Yeah. So you need to save $125 a month for the roof. If the furnace is about to go out, that’s $5,000. Let’s say you have a year left on that, now you have 5,000 divided by 12. You need to save $416 a month to replace the furnace. I don’t know if you can get a $5,000 furnace, because do you have to have AC where you’re at? I’m not sure. I mean, you need it. Are you required?

Pam:
The furnace with most of our houses, they’re in really good shape.

Mindy:
Okay.

Pam:
We do have a few that need a roof maybe in five years like you’re saying. Several, we put in AC units, those were 1,600 new. So those are good for a while as part of our remodels. Also most of the furnaces are in great shape, but there are several properties that we need to start thinking about that in the future. But we can get a new furnace in them for… They’re not giant houses, so maybe 2,000, 2,400 is what I would start thinking about.

Mindy:
Okay. I think it’s a good thought exercise to see,-

Pam:
Okay.

Mindy:
… “I have nine rentals. Six of them are awesome and three of them aren’t.” Dump those three or think about dumping those three and looking at different properties that would be better for your bottom line. There is an investor out there who will think that those three are amazing properties.

Pam:
Yeah. That’s funny you mention that because there’s one condo in Arizona that we use. It could really use a remodel to really be attractive. I mean, it’s a little workhorse, but I feel like it is negative cash flow. And with the values where they are in Scottsdale, I was thinking about maybe listing that one. We do have some of our private lender money wrapped into that one at 10% interest only. So it’s very hefty, which is why we were toying with refinancing some of our paid off rentals in Flint to pay him down because of the interest rate.

Scott:
I think that what the homework assignment Mindy and I would have for you is to, one, analyze each of your properties for cash flow right now. Pretend you’re buying it and go through the exercise. When we go through that exercise, make an estimation for vacancy. I would recommend you estimate five to 10% vacancy or 5 to 7% if you think your market’s really good because that’s one month of vacancy per year with that. And I think that that’s a good conservative estimate. I would put in a thousand dollars a year at minimum for the home maintenance. These are not CapEx. This is like problems you’re fixing, ant infestation, AC broke, fridge, ice machine broke, whatever with that, right? You’re going to have to send somebody there once a year per unit, maybe once or twice a year to fix things up.
And then I would do the CapEx exercise that Mindy just suggested. Think about all the things you might have to replace in the property and back into them. It will probably come out to well over a hundred, $200 per month on the property for that. And that will inform you. So when you get that, and let’s just use those numbers, we’ve got a thousand dollars in rent, we’ve got $612 in principal, interest, taxes, and insurance. I think you’re going to be underwater from a negative cash flow perspective on at least this property and maybe some other ones. And that’s a really good thing to think about, “Okay, I want to own the property free and clear and not have a debt on it. And then that will improve my cash flow. That’s one way to resolve that. Or I can sell it and try to redeploy into a property that will cash flow on a standalone basis.” But I think this is a root cause of why you’re feeling like cash is never filling up the coffers on a monthly basis.

Pam:
In this property, during the refinance which was recent, I got hit with the interest rate going up. What I was usually getting these cash outs for 5.5 To 6%. They were tolerable for business loans. Now that one was 7%. In my mind, it’s still cheaper than the 10% I’m paying. So it was worth paying him a chunk, but we haven’t closed on that yet. But that is in underwriting.

Scott:
Yeah. Well, it sounds like you have some… I mean the financing situation is also a concern. So how much do you have in total outstanding debt across your portfolio to the private money lender?

Pam:
200,000.

Scott:
200,000? At 10% interest you’re going to pay $20,000 in interest per year on that.

Pam:
Correct. Yes. Our payment to him is 1,600 right now.

Scott:
Great. You said the asset value is 1.6 million?

Pam:
Yeah. Yes, of those nine. Yes. 1.5 and some change.

Scott:
How do you feel about that valuation? Are you being spot on? Are you a little conservative? Are you a little aggressive?

Pam:
A little conservative because I try to be conservative when it comes to that, but I don’t want to be over leveraged. I think the last I looked, that puts us at about 50% equity based on the liabilities that we have.

Scott:
Okay. So you have 200,000 in this private loan. And then you have how much in mortgages against those properties?

Pam:
690,000.

Scott:
Okay. So you’ve got $900,000 in debt, $890,000 in debt and 1.5 million portfolio. So you have 600,000?

Pam:
Yeah, that’s not 50%.

Scott:
Well, it’s a little over 50%. But you have hundreds of thousands of dollars in equity.

Pam:
Yeah.

Scott:
[inaudible 00:35:22] 600,000.

Pam:
Okay.

Scott:
So when you said that your business is generating $8,500 per month, how did you derive that number?

Pam:
I think it’s in my income statement. I did divided that out per month. So for the year, like for 2021, gross rents were 77,000.

Scott:
Okay. So you divided that by 12?

Pam:
Yeah. And then I was thinking more about… I think with that number I originally gave you on the spreadsheet was the rents coming in, like our net coming in from property management.

Scott:
Okay. So you have a certain amount of rent coming in each month and then your property manager is taking a chunk 10% out of that and then distributing the balance to you on a monthly basis. And that’s what you’re calling the 8,500 a month?

Pam:
Yes. Yes, that’s after property management. Correct.

Scott:
Okay, great. So here’s the issue with that. You’re not generating $20,000 a month in profit. You’re generating $12,000 a month from your jobs. And then you’re generating perhaps even a negative balance on these rental properties because we talked about how that’s $690,000 in debt that you have will easily be costing you 4,000 to $5,000 per month in the principal, interest, taxes and insurance payments. And then you also have $1,600 on top of that going to the private lender. So that leaves you with 6,000 or so in total expenses. And then you have $2,500 to cover the maintenance and CapEx and vacancy expenses on your nine property portfolio. So I think that my hunt share is that this portfolio is costing you money on a monthly basis, not putting money into your pocket on a monthly basis.

Pam:
That’s what I’m feeling.

Scott:
Yep. So what do we do about that, right? Well, what we do the first thing is go through the exercise that mind just described and get the CapEx allocation on each one of these properties. Then we will give you a free pro membership for BiggerPockets. Use the calculator. You can keep using your own spreadsheet or whatever, but use our calculator and run the numbers on each one of those properties with those CapEx assumptions and determine which ones are going to be cash flow positive and which ones are killing you. Because I bet you, you have two or three that are killing you and a handful that are cash flow positive.

Pam:
So I can do that in my accounting software per property.

Scott:
Okay.

Pam:
I can run a P&L on each one and then just add that CapEx. So I can do that as my exercise.

Scott:
I’d also encourage you to do it in the calculator because the calculator will be forward looking. It’ll allow you to make assumptions about that.

Pam:
Okay.

Scott:
And you can ask people about… Do it in both, but it’ll be easy there. And I think that will help you say, “Forget about what the numbers are telling me. Experienced investors say this is what it should be on a go forward basis,” right?

Pam:
Okay. Gotcha. Okay.

Scott:
And that will allow you to then take a, “Okay. That’s what I’m probably going to average, is that driving with the reality that I’m getting in my accounting software downstream here with that over time.” I think that will be helpful and that will give you a sell refinance or hold decision on each of your properties. And I bet you, you will sell several of them with that.

Pam:
Yeah. We have a lot of our own capital into the Arizona properties based on selling some… We had a few flips, sold a rental, and then deployed that into the Arizona properties. So I liked the idea of maybe selling the one condo, getting that money back and paying down that lender to get rid of that large payment. Because really, they only performed really well in February and March. The rest I thought was break even, but I don’t think they were break even when we add the portion that we pay our private lender.

Scott:
And their short term rentals, right?

Pam:
We were underwater. Yeah. Mm-hmm.

Scott:
I ain’t going to Scottsdale in July.

Pam:
Exactly. That’s three very slow months.

Mindy:
So another thing that I would challenge you to do is to completely separate your personal finances and your business finances. So your W-2 income, your husband’s 1099 income and all the personal expenses come out of your one bank account. And then all the business loans, the business expenses, the business everything, run those completely separate and see you do… Okay. I’m just getting the numbers that you shared and it’s like all at once. But like Scott said, I really think that these properties aren’t doing you many favors. And we’re still in a position with the real estate market that you could sell them to someone else and find a different property. If you purchase them as a rental, you could use a 1031 exchange to find a better property.
You had talked about continuing on with single families or transitioning into multi-families. Maybe there’s a really awesome multi-family out there waiting for you to buy it that will cash flow, that will be closer to where you want to live, that will be even with all of the numbers, work for you in a much better capacity. But I’m wondering… And you don’t have to sell all of your properties. If you’ve got one or two that are amazing or six that are amazing, keep the ones that really work well. But if they don’t work, get rid of them. You don’t have to keep a property just because you own it.

Pam:
Right. And I think the other flip side to that, we have a little internal debate, my husband and I. He thinks, “Well, even if they’re not really making much money, the mortgage is getting paid down and it’s our retirement plan,” you know? So is there truth to that?

Scott:
Yeah, it’s a true statement, but that’s not a good way to live your life, in my opinion, over the next five to 10 years, because this portfolio is going to be sucking money out of your life. And if you have a problem from a market perspective, you’re going to be sucking even more money out of your life on an ongoing basis. The way I would totally reframe the approach and say, “Guys, we’re doing great. We’re making $12,000 a year a month from our jobs here. We’ve got a couple of side hustles. We’ve got some properties. We’ve got some assets. We can play this game, right? Let’s sell off all the properties that are sucking cash out of our life and say, ‘Period. The property must, with conservative assumptions, put cash into our pockets on a monthly basis.’ We’re not going to lever up past the point that allows for that. We’re not going to take more debt against that property if it doesn’t at least conservatively put a few dollars in our pockets every month on an ongoing basis.”
“Let’s sell off a couple of these properties. Pay off this private money lender, which is killing us.” This is a great deal for your private money lender. He’s loving life right now. He has 1,600 bucks in passive income. You don’t with that.

Pam:
Right.

Scott:
So let’s pay him off with this. Let’s build a cash reserve. You don’t have enough cash, in my opinion, to capitalize your personal situation or your business in a comfortable way. You’re going to be very stressed month to month because you’re spending 9,500 a month, but you only have $12,000 in personal cash. And your business is spending 8,500 a month. And you only have two months of reserve there with 18,000, two and a half months.
So I would pile those up and I’d say, “I want to have three to six…” In your case, probably six months of expenses because you have so much going on in cash. That’s an absurd amount of money right now. That’ll be be like $120,000. So now, how do we fix that problem? We got to cut expenses. One way you cut expenses is by unloading a couple of your cash flow negative properties. So that will reduce that amount required to get to six months reserve substantially. The other way is to go into the personal life and groom the personal budget. So earlier I was saying you guys make good money, no need to cut these things. Well, I think we’ve said you’re making good money, but you’re not making $22,000 a month. You’re making closer to $12,000 per month because the portfolio is not actually putting that cash flow into your pocket. So let’s accept that reality and say what’s a reasonable spending amount on a $12,000 per month. Is that pre-tax or post-tax for 12,000?

Pam:
So my salary is post tax, but my husband’s is pre-tax.

Scott:
Okay. How much do you think you’re bringing in after tax between the two of you per month?

Pam:
Well, we’ve changed to a really great accountant that got us a nice tax return, maybe because we’ve been moving properties around. So it’s hard to say on his income what to budget for tax, because he could also qualify as the real estate professional.

Scott:
Yeah. You have real losses that are going into the rental property business. That’s why you probably had a great tax return.

Pam:
Okay.

Scott:
So just be careful around planning around that because you’re probably putting a lot of cash into the properties and your accountant’s able to either immediately depreciate all of that for some of those repairs or he is able to do that… And your income, your AGI based on that will probably be below 150. So you’re probably able to claim that all as losses against your ordinary income. So don’t count on that. Count on getting rich and say, “What’s my after tax income in that situation real estate separate?’ And then I’ll take those benefits downstream.

Pam:
Okay.

Mindy:
Pam, you just said that he qualified as a real estate professional.

Pam:
Yes.

Mindy:
But then he also has a 1099?

Pam:
Well, in the real estate world, yeah. Which is what I think they told me that he was able to do.

Mindy:
I only know enough to be dangerous. But in general, if you have a full-time job, you’re not going to qualify to be a real estate professional. Now, you said it’s in the real estate world, but is he working basically for himself as a 1099?

Pam:
Yes. Yes.

Mindy:
Is that how that works?

Pam:
Yep.

Mindy:
Okay. You know what? I’m going to check in with one of my real estate-focused CPA friends and just double check that this sounds cool because the real estate professional designation is awesome, but it’s so hard to qualify for. And that is one of the things that flags your tax return, is when you qualify for that, you could-

Scott:
But let’s assume that he is. I think that Mindy’s wise-

Mindy:
Yes. I want to assume that he is.

Scott:
Mindy’s wise to put a caution and go in there and get a second opinion. That’d be probably wise to make sure that you’re not doing that. But it sounds like your husband is doing a lot of work on the properties and doing some of these things, so you may be fine with that. But the reason you’re getting a huge tax break is because you are generating real losses that you are having to fund from your cash flow from your jobs, right? And so that’s not good strategy. That’s good that the accountant should absolutely do that. The accountant did their job it sounds like with that. Because not only are you losing money on your P&L, you’re also getting benefits from depreciation on these properties that are offsetting that. And because your husband’s a real estate professional, that’s helping you net all of that even if you were above the AGI threshold against [inaudible 00:47:17].

Pam:
We had several sales last year. And I think that’s on the income statement where that was. The gain on sales was 154,000 for ’21. But again, yeah, it’s offsetting the negative cash flow that you see.

Scott:
Let’s do some takeaways here and then see if there’s any other issues you want us to help with. So the take first takeaway is you guys are generating $12,000 a month give or take post tax. You’re spending $9,500 per month. You have to ask yourself, “Is that an acceptable savings rate?” It could be. That’s not bad. You could be saving more than 10% of your income excluding your real estate or other activities with that, with the spending you share with us. And that could be fine. If you want to save more and kind of approach that 50% savings rate, you might need to groom the budget on your personal expense side. And there are items there that appear like they could be cut if you wanted to make some changes.
So you can afford many of the things you want in there, but you can’t afford all of the things that you have in that list if you want to save a huge chunk of your income each month. Your real estate business is not generating $8,500 a month in cash flow. It’s probably sucking money out on a net-net basis. We can detect that by just doing very simple math with the PITI on a $690,000 mortgage. If we assume that was one big mortgage and you did PITI on it, it’d probably be like a 4,000-ish plus per month mortgage on that even at a 3 or 4% rate. And then you have the 1,600 on the debt on top of that, plus-

Pam:
That’s pretty good, because I think it was 4,600 actually with all the mortgage payments.

Scott:
Yeah, I’m a nerd. I’m sorry. So 4,600 plus 1,600 would be 6,200. That lays you with 22,000 before you even get to any other expenses. And you know you have a ton to unpack there in that. And so that’s the big problem there, is go unpack that property by property, CapEx by CapEx. It could be most of your properties, our sell situations at this point in time. And if so, that’s great. You guys just won. You bought a bunch of properties the last couple years, market appreciated a ton. You can cash out on those properties. It’s probably not the plan that you and your husband were initially coming in with. But guess what? Take your $600,000 in winnings and use that to be the seed for the financial foundation that will help you move towards your real long term goals.
So let’s assume that you were able to cash out 300 grand from that. I’m making this up. I would take that 300 grand and I’d use a chunk of it to fortify your financial position and get to a six month cash reserve on that. Maybe that’s 50 to a hundred grand. You’ll feel way better if you just have that sitting in the bank ready to be used for your personal life and those types of things. And now you’ll also have a business that is hopefully cash flowing positive on an average monthly basis.
Now, we got to figure out what to do with the other $200,000, plus the 25 to $50,000 per year that you’re generating from cash flow from your jobs and your business. That’s the question that I think we’ll have to leave dangling, well not dangling here, or come back to maybe another time because I think we’re running up on time here today. How does that feel? I rambled for a while there.

Pam:
Yeah, we’ve tried a couple of local lenders and they say we don’t cash flow and I’m like, “I don’t understand. Why?” They’re seeing something I’m not seeing and they don’t explain it at all. So hence why I filled out my application.

Mindy:
I would also go back to the personal spending. I have been publicly tracking my spending and I track it very granularly because I want to know all these different categories. I have basically necessary categories and frivolous categories. Some people say that travel is necessary and some people say that travel is frivolous. And in Maslow’s Hierarchy of Needs I don’t think travel appears at all. But you do have $800 a month in travel expenses. Those are business expenses if you’re visiting your properties. Of course I’m not a CPA. Talk to your CPA to make sure that you can write them off and that you are planning them properly so that they are write offs. But you have general as at 866. I would challenge you to go in and see what exactly are you throwing in that general category?
The last thing I want to bring up is the boat that we didn’t talk about. I used to live on a lake. I had a boat in my backyard and we never used it. The two happiest days in a boat owner’s life are the day they buy and the day they sell. I don’t have any judgment if you want to keep your boat because you use it all the time, but keep track of how frequently you use your boat. And at $750 a month, could you go and rent it on a weekend if you’re just doing it like once a week? Or once a month, could you rent it for less than that and not have your very own boat?

Pam:
Well, the ultimate five plan was that we will be living on the boat back in Michigan in the summers and [inaudible 00:53:01]-

Mindy:
Oh, how big is it?

Pam:
It’s got two berths they call them, like bedrooms.

Mindy:
Oh.

Pam:
So it’s like 35 foot.

Mindy:
Okay.

Pam:
It’s a cabin cruiser. It’s our mobile cottage.

Mindy:
Okay.

Pam:
And with the dockominium, that’s the summer home, the ultimate goal. And then Arizona for eight or nine months.

Mindy:
Okay. So then that is a conscious expense. Great. Perfect.

Pam:
It will go down as of September by 500 bucks.

Mindy:
So that’ll be 250 a month?

Pam:
Yes.

Mindy:
Okay.

Scott:
Yeah. I don’t know about the boat specifically with that, but I agree with everything Mindy just said there. I think the reality of your situation is you need to go back to fundamental analysis on each one of those rental properties and then your personal P&L, which is even more important. It actually generates way more. You can generate way more cash flow from your personal P&L than you can from rental property portfolio right now. So that’s the cash flow situation. And when you’re sitting on $50,000, if in a few months you’re sitting on 50,000 to $100,000 in cash in your bank account and you’re like, “I’m confident that I’m generating 4,000 to $5,000 a month in free cash flow,” I guarantee you, things will be much better from overall perspective. You’ll be like, “Okay, I have a path to doing this. I don’t have to get to fly tomorrow and live on the boat” but if this will automatically happen and life is good.
But there will be a lot of analytical homework that I think you should do this week because the market is turning right now, right? Some properties are going up and down. Do it now. Figure out those properties. This is not going to be a fun 40 hour week for you. Put your 80 hours or 100 hours in and get this done and then make some plans. Get your husband on the same page with that and say, “We’re not going to hold cash flow negative assets. That is not a good plan.” That’s a good plan if you can hold on for 30 years, but who knows what’s going to happen in 30 years? You know you can hold onto a cash flow positive asset for 30 years.

Pam:
Right. I think one big thing that you pointed out, we weren’t considering the CapEx in the future because what if we do reach our FI, but then five years in, we have thousands of dollars worth of expenses on these houses? So that was a good eye opener.

Scott:
As a real estate investor, your business is your properties, the debts, the assets and liabilities in that portfolio, the cash flow they’re producing and your reserve, right? Cash is the asset that is negatively correlated with real estate, right? When real estate prices are plunging, the value of your cash is going up in that case. So you got to capitalize the business conservatively. And I think a good rule of thumb… Everyone disagrees with this. You go in the forums and you’ll get 50 different people saying 50 different things. But my rule of thumb would be 15,000 to $20,000 for that first property in reserve and adding on a buffer of 5,000 to 10,000 for each additional property that sits in that business bank account. That’s comfortable capitalization for a rental property portfolio.
Go on BiggerPockets right now and ask, “Where can I find a HELOC on my rental properties?” Nobody can find one because the market is not there. So all these people who are like, “Oh, I’m going to capitalize my investment portfolio with a rental property HELOC.” Nobody can find one. If anyone who has a lender that can do a HELOC on investment portfolio, please send it to me at [email protected]. We’re going to make them rich, because no one can find a solution.

Pam:
Try to.

Scott:
Yeah. So you need the cash because it’s when the market is… That was all dry up when interest rates are rising with this. And that’s just part of your plan. So your five plan is, “I’ve got a hundred thousand dollars in cash across my 15 units, and then they produce as much cash flow and I take the cash out whenever it gets above a hundred grand. And that’s how I’m casual in my life.”

Pam:
Gotcha. Okay. Gotcha.

Mindy:
Awesome. Well, Pam, this was a lot of fun. I think this is going to be helpful for a lot of people. I think there’s multiple people in a similar position where they think that their property is a rockstar property, and yet they can’t really figure out why it’s not quite as rockstar in real life. I think you’re in a great position to sell. And 1031, I want to give you some words of caution. Get a qualified intermediary ahead of time. Do not close on the first property until you have found the second property. It’s still a hot property, it’s still a hot market, but really make intelligent choices with your 1031 because there’s very strict timelines. If you miss a timeline, if you take possession of the money yourself, there’s so many ways to below a 1031 exchange.
And then you’re paying capital gains taxes. Long term capital gains on the ones you’ve held for more than two years, shorter term capital… Or more than a year? Scott, is it more than a year? It’s more than a year. Short term capital gains on the ones that you have held for less than a year. And just if you can avoid those taxes and just kick that can down the road, do that instead. So yeah, lots of great people.

Scott:
I’d advise doing this quickly, this is overwhelming. You’re going to have a long week, maybe two, of figuring this out. Analyze those properties. Mindy’s absolutely right and I completely forgot about that. There are tax consequences of that. The tax and 1031 stuff should not wag… The tax tail does not wag the business dog.

Pam:
Plus buyback depreciation I have to consider as well.

Scott:
That’s right. So the 1031 exchange will help you avoid that.

Pam:
Oh, good. Okay, I see.

Scott:
Or at least defer it. But that should not affect your decision whether to sell or not. The decision whether to sell or not comes from your analysis. If it’s cashflow negative and it’s going to take significant money out of your life every month for the next 10 years, I would recommend selling that property regardless of whether you’re able to complete a 1031 exchange. But talk to the accountant to see if the 1031 exchange can be a beneficial way to defer those taxes.

Pam:
Okay. Yes. And he’s amazing.

Mindy:
Awesome. Well, thank you, Pam.

Pam:
Thank you so much for your word of advice here.

Scott:
Yeah. Hopefully this was helpful. I know it was overwhelming. There’s a lot going on here. We were trying to be as valuable as possible with that. I know there’s big changes there we’d be interested to see.

Pam:
Yeah, no, it was super helpful. The BiggerPockets community is, “Buy more. Buy more. Buy more.” Well, now what? We buy it. We bought a bunch. Now, what do we do? And it’s exactly that. Analyze

Scott:
You want to buy more when your financial position is strong, you’ve got a really good found foundation with that, plenty of cash, you can hold onto the asset for the long term and it produces… Yeah, there’s argument about whether cash flow or appreciation is more important. I invest in Denver because I believe that appreciation is more important over the long term. But none of my properties negatively cash flow. They just produce less cash flow than I would get in a market like Detroit perhaps, or the Midwest in a general sense.

Mindy:
Okay. Pam, thank you so much. We will talk to you soon.

Pam:
Thank you. Bye.

Mindy:
Okay, Scott, that was Pam. I thought you gave her some really excellent advice on just going through and making sure that the properties are actually cash flowing. I think people see the rent and the mortgage payment and think that what’s left over is their cash flow. And really diving deep into the numbers is so important to make sure that you’ve got a really great rental property.

Scott:
Yeah, I can’t stress enough that Pam won here, right? The market has carried up the value of those properties. Hundreds of thousands of dollars in wealth has been created. Equity has been created due to their activities. But the fundamentals are not, in my opinion, strong enough in that business where I would want to hold onto it for the next five to 10 years. I think that I would want to hold onto a business where I believe in the value of that property going up over time and where I believe that it will put money into my pocket on average every month for the next several years with a strong capitalized position, with a cash reserve that can hold the buffers for when I inevitably will have that. That roof is supposed to last me 15 more years. It may only last me eight. I need to have that cash ready ahead of time to be prepared for that event, right? It may go out tomorrow. I may have her leak tomorrow and have to fix it. So I think that’s really, really important when we go through this.
To recap the overall situation, Pam and her husband are making 12,000 bucks a month and spending 9,500. There may be puts and takes before and after tax. So on average, they’re probably only accumulating 1,000, $2,000 per month which would be fine except for their rental businesses probably taking that out of their position because of the negative cash flow. We said just from the debt we’re spending $6,200 a month in debt service. Principal, interest, taxes, insurance, and then interest payments on the private loan. And that doesn’t even account for the vacancy, CapEx, maintenance, utilities when they’re rent the properties aren’t rented. Those types of expenses that are definitely hitting them and sucking cash out of their lives. So the way we solve that is we do a unit analysis by each property and say, “What’s this property performing like today? What’s it going to perform like over the next couple of years?” And that will tell me to buy, hold or refinance each one of those properties. And I believe just at the highest level that they’re going to have work to do.
And then lastly, I think it’s important to have that framework in mind about what I want to do and what a strong financial position looks like, and then move quickly to get to it. Not because we’re terrified of the market or anything like that, but because that market volatility, they’re all dependent I guess because of the market, right? Because they’re dependent on the market to produce wealth gains or decreases, that’s a position that’s very volatile compared to the investor’s going to hold for 20 years a cash flowing asset. So I think they should move very quickly. I think there’s a lot of homework to be done there. And I’m excited to see how it turns out for them. So again, all in the context of a big win. Don’t want to overshadow that.

Mindy:
Yes, I think we didn’t do enough to celebrate the fact that she has done really well so far, but now is the time to reevaluate what she’s got. I will say that I think my advice might have been a little bit different if she was investing in a different market, but Michigan is not known to be a rapidly appreciating market.

Scott:
And the advice would be different if she had already refinanced those properties at low interest rates. So if these were on 30 year fixed rate mortgages at 3.5% because she refinanced or bought them in 2016, 2015 and we’re cash flowing, no way we’d be selling right now, right? I’m not selling property. That’s how my portfolio looks with that. I’m not selling that. But because she has to refinance the properties at probably 6.5, 7% interest rates at this point in time to pay off her 10% private loan, that’s where the sell decision I think becomes that much more of a factor.

Mindy:
Okay, Scott, should we get out of here?

Scott:
Let’s do it.

Mindy:
From episode 322 of the BiggerPockets Money Podcast, he is Scott Trench and I am Mindy Jensen saying stay out of trouble.