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Seeing Greene: Climate Change, ADU Dilemmas, & Retiring with Rentals

Seeing Greene: Climate Change, ADU Dilemmas, & Retiring with Rentals

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Want to retire with rentals? Want more cash flow? Want to put up a lower down payment? What about building an ADU on your land? All of these questions (and more) are coming up on this episode of Seeing Greene. Unfortunately, this is the first time in BiggerPockets history that David Greene, master investor/agent, hasn’t been able to answer a question (and for good reason).

David tackles some challenging topics this episode, ranging from climate change affecting real estate values, what to do once depreciation runs out, and at what point should an investor take profits in the form of cash flow? While you may have heard varying opinions from other investing experts (or even other BiggerPockets hosts), David has a rather conclusive take on why you should NOT be retiring early with rental properties, but you should do something much greater instead.

If you heard a question that resonated with you or you’d like David to go more into detail on a certain topic, submit your question here so David can answer it on the next episode of Seeing Greene. Or, follow David on Instagram to see when he’s going live so you can hop on a live Q&A with the man himself!

Click here to listen on Apple Podcasts.

Listen to the Podcast Here

David:
This is the BiggerPockets Podcast, show 588.

David:
It’s like saying you’re going to plant a tree and live off the fruit forever. The tree needs time to produce fruit that’s mature. It needs time to mature itself. So you’re going to keep working while that tree is growing, but the important thing is that you’re planting trees while you’re working. What we don’t want is for people to just keep going to work every day and do nothing to improve their position so that five years down the road, you’re in the exact same position, but with a little less hair.

David:
What’s going on, everyone? It’s David Greene, your host of the BiggerPockets Real Estate Podcast here with a Seeing Greene episode where I take your questions and I answer them from the Greene perspective. You get to see it from the way that I’m seeing it.

David:
Today’s show is fantastic. We get into the question of should I or shouldn’t I build an ADU? How do I know how much an ADU is going to be making my property worth? We talk about should I put more money down on real estate to improve cash flow or save more money to buy more real estate? And I sort of walk that person through how much they’d be saving and what the better option would be in each circumstance.

David:
We talk about how to find real estate meetups in your area or how to start one. And we get into several times when to know it’s the right time to live off your cash flow. This question’s coming up a lot. A lot of people are asking it. There’s so much change that’s happening in the world right now and people are looking for certainty. And isn’t that something? We all want that certainty and we want to figure out when does cash flow become certain? Should I quit my job? Should I keep my job? Should I work part-time? Should I work [inaudible 00:01:34]? Should I work remote? Should I buy more real estate? Should I wait? We’re all thinking the same thing.

David:
So we get into that today. We have some really good answers. And then I also read some comments that you have all left on YouTube. So as you’re listening to this, if you hear something that makes you laugh, if you hear something that makes you think, if you hear something that you wish I would’ve dove more into, please go into YouTube, leave me a comment. Tell me what you thought about it so I can do a better job of answering.

David:
And the last thing I’ll say is I want to hear from you. So go to biggerpockets.com/david and leave your questions so we can get you featured on the BiggerPockets Podcast.

David:
Today’s quick tip is going to be consider how hard your equity is working for you. Many of you that bought real estate in the last two to five years, some of you did it through me, have way more equity than what you think. Prices are going up so, so fast. And in many cases, rent is not keeping up. So if you’ve got a property where cash flow is not keeping up with the equity that you’re creating, it’s a really good time to consider selling it or refinancing it and using that capital to buy more real estate.

David:
There’s lots of ways you could do this. Companies like mine can help you qualify off the income of the property you’re buying, not your own personal income. We can figure out ways to do refinances where you don’t and have to put any money into the refinance. We can figure out how to tell what your house is worth and what the equity that you have in it is doing. It’s called return on equity. So we look at it and see how much money are you making on the equity you have versus how much money could you be making if you reinvested it more wisely.

David:
So don’t play the set it and forget it game. If you already own real estate, make sure that that equity is working just as hard for you as you are to earn money to get the next deal. You better not be out working your real estate. Make your real estate work harder than what you’re doing for sure and message me if that’s something I can help you with.

David:
All right, without further ado, let’s get into our first question.

Suzette Haas:
Hi, David. My name is [Suzette Haas 00:03:23] and I live in New York where I invest in the Hudson Valley area. My question for you is why is no one talking about climate change? I know so many investors who are investing in Texas and Florida and Arizona and I know that you’re invested pretty heavily in California. And without getting too political, I do feel like these are the states that will most likely feel the biggest effects of climate change.

Suzette Haas:
And so my question for you is do you consider climate change when you’re investing? And if so, how do you protect your investments and how do you protect your portfolio for 10, 20, 30 years down the line when you’re either underwater or you have no water?

Suzette Haas:
Anyway, sorry if that’s really loaded, but thanks so much. I appreciate it. Bye-bye.

David:
All right, Suzette, thank you for this question. What a way to kick things off. I will admit I was waiting for when this would happen. I didn’t know when it would happen, but I was pretty sure it would, when someone would ask me a question that I literally would not be sure how to answer, and you win the prize for doing that.

David:
So I’m going to sort of talk myself through this out loud and share my perspective on it, but I want to highlight it by saying many times when I’m speaking, I’m telling people this is what I know or this is what I believe based off of what I’ve seen. This is not one where I’m doing that. This is just me sharing my thoughts. They could change at any minute, and it’s not something where I’m speaking with authority on.

David:
So you asked a really good question. You kind of caught me off guard, so let’s see if I can work my way through this.

David:
First off, I really appreciate you saying you’re not trying to be political, and I’m not going to answer it from a political perspective. I don’t know what’s happening with climate change to be completely clear. I hear conflicting science. I see that there’s things that are saying we’re headed down this road and I hear other things that say this is normal and it’s cyclical.

David:
So understand I’m coming from a position of where I’m just not sure what’s going to happen. And it’s really not a political issue when you’re looking at it from a real estate investing perspective, it’s just a practical issue, which also starts with P, so maybe that could be something we could say, move from political to practical.

David:
I do invest in the states you’re saying. I invest in Texas, I invest in California, I invest in Arizona, and I’m in Florida. I don’t remember if you said that one, but yeah, I’m in a lot of these states that are very sunny and warm for a lot of reasons that I like about them. And I can’t say I’ve never wondered what if Arizona runs out of water?

David:
I remember actually Googling that five or six years ago. I was really worried about it. I was reading all these articles. And some of them were saying Florida is headed for a cliff edge. They’re going to completely… Or sorry, Arizona is going to run out of water, and others said this is not a problem at all. There’s all these solutions if that did happen, but it’s not going to happen. Southern California itself is an area that I believe has to import water for what’s going on.

David:
So I can’t say it’s not going to happen, but I can say I don’t worry about it. I just don’t know if I’m right. Maybe I should be more worried about it. Maybe that’s what you’re… raising the flag.

David:
But here’s why I’m not worried about it. In the beginning of the pandemic when we had a shelter in place, most people in my position, whatever you want to call them, pundits or influencers or people with a platform or authority, were telling everyone sell everything you’ve got, we’re headed to a depression, you want to be cash rich. All of these deals are coming along because the whole country’s getting shut down. Nobody’s going to go to work. Everyone’s going to default. Tenants aren’t going to pay, landlords are going to get foreclosed on, regular homeowners are going to get foreclosed on. They were kind of painting the whole Chicken Little, “The sky is falling.”

David:
And I don’t know anyone else that was taking my position other than maybe Brandon, who I don’t even know if he actually agreed with me. Maybe he was just a good friend and he wanted to support me. I never talked to him about it, but I said I don’t think so. I think the government’s going to print more money because the politicians we have in place tend to solve problems that way.

David:
Lo and behold, I was right. We’ve had tons of appreciation since then. We didn’t see a dip at all. And if you invested in real estate, you did really, really well.

David:
So the reason I saw something that other people didn’t see was I wasn’t looking at logic, as weird as that sounds, which I prefer to do. I was looking at human behavior and I made my bet based on the fact that politicians want to stay in office and that if they give human beings what human beings want, they will get voted in, and what human beings was stimulus and money to come around and moratoriums and all these things.

David:
I’m kind of betting the same thing when it comes to climate change. Everyone loves living in Southern California. People love living in Arizona. They love living in Texas and Florida. There’s a lot of human beings that are there that would rather be there than North Dakota or maybe Maine.

David:
I think if we did hit a issue where if water became a problem, that we would put a lot of pressure on some of our best engineers and scientists to solve that problem. And I don’t want to sound like I am a scientist because I’m definitely not, I’ve just seen this happen time and time again, that when something goes wrong, human beings are wildly creative with coming up with solutions when it matters to them.

David:
As far as the property being underwater, I don’t think that’s a thing we can solve, right? That’s probably more of a legit concern if we are in a situation where the ocean is rising to a point where, in 30 years, some of this stuff would be underwater.

David:
So I guess what I would think is if I go back 30 years, were there properties that are now underwater, but weren’t back then? Have we been seeing that happen previously, right? Is there a track record I could see of the ocean rising at a certain rate so the stuff that was on the seashore is now covered? And if not, has something changed in the data to make me believe that that’s more likely to happen now?

David:
And to be frank with you, you asked the first question I’m not really sure how to answer. I don’t have that data and I am not sure. If I start seeing more and more information coming up about this, I would probably look to sell my homes, but at the same time, who’s going to buy them? Because they don’t want to buy a property that’s going to be made underwater as well. Maybe you put them on stilts or something like that.

David:
Okay, so I’ve admitted that I don’t really know what’s going to happen, but let’s talk about if I do, right? Let’s say in either direction if we think this is going to be a problem.

David:
Certain areas, like you’ll see in the Gulf Shore or in New Orleans, they’ll build properties elevated because floods are so common there. So that’s one solution, is if you’re going to buy a property in an area that you think might end up becoming underwater, you buy at a certain distance away from the shoreline. Don’t buy right on the beach, or buy a property that’s been built with a foundation that allows it to be raised so that if the waters do come in, it’s okay. You may have a city like Venice that could come out from something like that.

David:
Buy properties near an area where there’s golf courses or heavy populations where there’s already water present, right? Maybe if you’re in an area that might run out of water, make sure there’s a strong supply line of water coming in from a different area that’s not going to run out of water. Don’t buy in an area that’s dependent on another area for water if that area could run out of it.

David:
I suppose that this is probably worth looking into, I just don’t know how far out that would be from a reasonable perspective and I’m not able to anticipate what’s to be expected. I think what you said poses a really good question. I think I took way too long answering this because you caught me off guard, and I want to commend you for being the first person on this show to ask a question that I really was not prepared to answer. Well done, Suzette.

Garrett Ott:
What’s up, BiggerPockets? My name is [Garrett Ott 00:10:44]. I’m a newbie investor from the Chicagoland area looking to house hack my first multi-family property.

Garrett Ott:
To avoid any major headaches, I’d like to purchase something with minor necessary renovations so I can focus more around the fundamentals of investing, and right now I’m weighing two options, one, find something that’s more affordable and be able to put down 5% to 10% to decrease my mortgage and increase my cash flow, or two, buy something a little bit closer to my preapproval numbers and only put down 3.5% to 5%, but still have a cash flowing property with something that has greater value at the end of the day.

Garrett Ott:
Which option would set me up in a better position to buy my next property sooner and are there more options that I may be missing that would still stick to my criteria? Thanks for any help.

David:
All right. Thank you for that, Garrett. It’s nice to have a question I know I can answer. You’re allowing me to address a couple of misconceptions that are powerful that I am really appreciative that I get to do.

David:
This comes up all the time with me as an agent representing clients. People come and they say basically what I’m hearing you say, is, “Should I put more money down to increase cash flow or less money down to keep more money in the bank to buy more real estate?”

David:
Here’s the way that I’m going to answer that. The short answer is when rates are very low, putting more money down doesn’t help you, not nearly as much at least. When properties are appreciating faster, putting more money down is not as wise of a use of your capital.

David:
If rates are very high, putting more money down will help you. And if properties are not increasing in value, putting more money down doesn’t hurt you as much.

David:
In our environment right now, properties are going up pretty quickly in price and rates are still really low.

David:
So let me give you an example when you’re talking about the difference between should I put down 3.5% or 10%? At a 3.5% interest rate, if you borrow an extra $1,000, so look at that like if you don’t put down a $1,000, it’s going to cost you $4 per month more. That’s how low rates are right now. So for someone to say, “I’m going to save up 20 grand and I’m going to put it down on the house so that I can get more cash flow,” 20 grand at a 3.5% interest rate would work out to the difference of 80 bucks a month.

David:
How long is it going to take you to save $20,000? How much do you think property values are going to go up to save that $80 a month? Here’s the problem. In the time it takes most people to save $20,000, properties have appreciated so much that they have to borrow more money to get it. And that 20 grand, not only did the property go up more than 20 grand, but now they have to borrow more than they were going to so that they don’t actually end up saving that $80 month. It just isn’t worth it to do that.

David:
In this environment that we’re in right now when we’re recording this show, my advice is that you put less money down on the property and you keep more money aside. That’s assuming that $80 a month isn’t going to break the bank. If you’re thinking that it’s more risk to take on $80 a month, you might not be in a position where you should be buying real estate at all, just to be frank. You need to improve your financial position before you try to own your position owning properties in your portfolio. Most people, 80 bucks a month isn’t going to end the world. You could pick up a shift at a coffee shop or something one day out of the month and you can make up that 80 bucks a month if God forbid something terrible happened.

David:
Now, money in the bank is worth more to you. First off, it’s 3.5%. You can get a better return on that buying more real estate. Second off, you can put money into the house to fix it up to make it worth more. You’re going to get a better return than the 3.5% that you’re saving by putting it down on the real estate. Third, you can keep that money in reserves. That’s worth more to me than paying it down on a mortgage. If I have that money set aside for if something terrible that goes wrong, I feel way better about it than just putting it down when rates are already super low.

David:
If we get into an environment where rates get back up to where they were in the ’80s, you know, you’re in the 20%, 25% range, I think they got up to like 21% or 22% back then when they were trying to combat inflation, my advice will flip. I will be like, “Put more money down and only buy the best deals because we don’t know what’s going to be happening.”

David:
So I hope that helps. I hope that that number… I just keep this in mind. At 3.5%, it’s about $4 a month to borrow 1,000 bucks. So if I want to borrow five grand and more, it’s going to cost me 20 bucks a month. That is stupid low for what I can get with it. So I’d rather save five grand, borrow it from the bank instead, have my payment be 20 bucks a month more, and use that five grand to either keep in reserves, make the house worth more, or buy more real estate with it.

David:
All right, Next question comes from Ryan Hayes. Ryan asks, “Hey David, I wasn’t sure how to find out, but I’d like to come to your meetups. I’m right here in the Lodi area.” Little piece of pop trivia. If you watch that show Sons of Anarchy, that took place in Lodi, California, which is about maybe 20, 30 minutes north of Stockton, which is where I went to junior college and very close to where I grew up in Manteca. “I’m a big fan of BiggerPockets and I’m a real estate investor. How do I find out when they are and where?”

David:
Okay, so for me specifically, you could go to davidgreenemeetups.com. You can register. It’ll put you on an email list. We will tell you when I’m going to be having a meetup. You can follow me on social media, @davidgreene24. Typically on Instagram, we will post when we’re going to be having a meetup. You could go to davidgreene24.com, which basically kind of shows everything that I’m doing. So if you want to come to meetups, if you want to travel to hear me speak somewhere else if I’m going to be at a conference, if you want to sign up for my text letter to see what’s going on, if you want to come to a webinar that I’m going to do, there’s a lot of stuff that I end up doing and that’s a great place to kind of follow and get in touch.

David:
Now, some of you don’t live in Lodi. Some of you live in other areas and you’re probably not traveling from Bangor, Maine to come to California just to come to my meetup. So for those of you in that position, BiggerPockets actually has a place where you can advertise your meetups, and we advertise them on their pretty frequently too.

David:
So if you search BiggerPockets for meetups, you’ll find that there’s a page that people go to specifically to say, “I’m having a meetup and it’s going to be here. This is how much it costs,” or it’s free or whatever. Everyone should be doing that. Search to see if there’s a meetup in your area that you can go to. And if there’s not, guess what? You get to be the one to create that meetup. They’re pretty freaking fun.

David:
Now I don’t do meetups like normal people do where they typically just have a bunch of people come and just hang out and talk and drink, right? I always try to be more direct and give more value than that. So when I do a meetup, it starts with socializing. And then when I get there, I have a presentation planned. I’m teaching on a topic. I educate people so that it’s worth their time. Then I take questions just like I’m doing right now and people throw stuff at me all the time. And I sort of give as many answers as I can because everybody who’s listening gets to benefit. And then if they have follow-up questions, they get to ask it.

David:
I don’t think that everyone does it like me. I don’t think everyone’s an educator from the sense that I am and they probably don’t have the experience that I do to be able to. So some of them are just kind of chill places where you just meet people. That’s literally why it was called a meetup. It’s a very unorganized event. Mine are more like a minor seminar or something like that.

David:
But I’d love to have you come to mine. We’ve had people that come from out of state to go to them. I get really good reviews about when we have them and they’re really fun. I get to introduce people to real estate agents on my team, loan officers on my team. I get to talk about my own deals.

David:
So I advise everyone to go to a meetup. And if you’re not in an area that has one, start one of your own.

David:
All right, we’ve had some great questions so far. I like them. Again, I got stumped for the first time ever. I’m going to be thinking about this one now because I really haven’t thought about climate change in the overall plan of how I build my portfolio.

David:
In this segment of the show, we’re going to talk about some comments that people have left on YouTube. I actually got this idea from a comedian named Nate Bargatze. If anybody doesn’t know who that is, go check him out. He’s very, very funny. And on his podcast, they actually read comments from his viewers. And his viewers like comedy, so they leave really funny stuff and then he gets to read out loud what they’ve said.

David:
So we’re doing that. I want to encourage you to go leave comments on there, and the funnier, the better, I mean, don’t be too mean about it, but if you have a question about a specific thing that didn’t get answered, if you want to tell me that you’d like to hear more about a certain thing or if you just want to leave a funny comment, we’d love it, we want to read them, and this is the segment of the show where do it.

David:
The first comment comes from Helene Solomon. “‘It’s okay for things to get worse before they get better.’ Smart quote. Sometimes better to look longterm and try not to lose sleep if things are really bad now. Thanks, David.” Hey, I’m guessing that was my quote, so thank you for saying it.

David:
Let me give you an example of how this works out in real life. So my partner and I put a property under contract in Scottsdale. That would be Rob. And we actually have some episodes. I don’t know if they’ve been released yet, but if not, they will be, where we break down our process of how we come up with a plan, how we analyze deals, how we communicate with the realtors, how we make decisions, how we write officers, everything, we lay it all out there for you. I think I said write officers. I meant write first. Sometimes my brain works faster than my tongue does.

David:
And on one of those deals, we found out today that because we own so much real estate, the lender that we’re going to do the deal through wants a ridiculous amount of money in reserves, like $750,000 just for this one property. And it became one of those things where things got worse.

David:
So instead of just quitting or getting discouraged, I got on the phone with my lending partner, Christian, and I said, “Hey, Christian, this isn’t going to work. We have to figure out some way around it.” And he came back and he said, “Well, we could structure the loan a different way.” And the different way of structuring the loan is actually going to require 10% down, not 15% down, and the rate is going to be similar. It’s going to be a little bit more work on our behalf, meaning we have to get more documentation, but we’ll be able to refinance out of it later if we want.

David:
And that is a situation where things got worse before they got better. So it’s going to be a little bit more work for us to have to get the documentation together, but we’re saving 5% down on a $3.2 million property. So that’s a significant amount of money that we’re not going to have to raise or put down ourselves.

David:
And that’s just an example. Sometimes things get messy. You got to clean up your books before you get a real understanding of what you’re looking at, or you have to hit rock bottom with a certain strategy you’re using or way you’re living life, but it’s okay for that to happen. Don’t look at things and say, “I’m only going to keep going if I make progress.” Sometimes things go wrong.

David:
And I talk about this in the TED Talk that I did. So if you want to see that go to dgtlive.com/textletter. And you can sign up. We have a link in there to see my TED Talk. You might be able to find it on YouTube. I’m not sure if you can find it just by searching right now.

David:
But I talk about how many times in life when I’m trying to build a skill, things get worse before they get better and that it’s actually a normal part of life and it’s not something to be afraid about. So thank you, Helene, for sharing that.

David:
Next question from Billy [Cha 00:21:47]. “Something I love most about this show is that you have successful investors sharing free and valuable knowledge with zero Ferraris, Lamborghinis, or suits and ties. No flashy multimillion dollar mansions, no half-naked women, just knowledge. Thank you.”

David:
Well, thank you, Billy. That’s sort of the BiggerPockets culture and we do strive to do that here. I’ve actually been told that I probably should dress a little nicer, right? Like I’m in a t-shirt when I do these. I drive a Camry, a 2017 Camry. I probably could get a nicer car. And I’m not against those things, but yeah, when you’re around a culture where they’re taking half-naked women or Ferraris, they’re basically just appealing to your greed and your lust to get you excited about real estate. And at BiggerPockets, we want to appeal to a better version of you. We want to appeal to freedom, to family, to potential, right? We want you to follow your fire. We don’t want you to follow your Ferrari.

David:
And I think that that’s a stronger well to pull from. If you’re doing this to get your time back and to get passion back in your life, it’s going to sustain you, whereas the desire to have a really nice car or really nice clothes isn’t going to be enough to pull you through the work you’re going to have to do to get there. So thank you for that.

David:
Our last comment comes from [Arielle Kopinsky 00:23:00]. “I think one of the things I’d like to see discussed is cash flow management. People say they are living off the cash flow, but I can’t figure out how. Between repairs, CapEx items, et cetera, the cash flow isn’t smooth. Do they siphon off some funds every month and have this ever growing bank account? My goal is to get to $15,000 per door for larger items, the roof, the furnace, et cetera, and then I feel like I can reinvest the rest, but I still have other repairs. I also agree with others who say cash flow does matter. David used to say it’s the glue that holds deals together and is used to make repairs.”

David:
All right, Arielle, thank you for bringing up a crucial point in the conversation about real estate investing that we don’t talk about enough. Where do even want to start with this? Your answer is correct or your comment is correct, cash flow is very unreliable. And this is so important to me because I feel like it gets framed like cash flow is safe and appreciation is speculative. And I believe that comes from 2010 when we saw the market crash because people were betting on appreciation and not looking at cash flow. And they would’ve kept their home if they would’ve bought cash flowing properties.

David:
And so that stigma still exists today. The problem is appreciation is unreliable because you don’t know what the market’s going to do. You cannot control it. But cash flow is unreliable because you don’t know what your tenant’s going to do or your property’s going to do. You also can’t control that.

David:
And here’s the problem, I don’t like people saying cash flow is safe. It’s not. Any of us that own real estate know living off cash flow is incredibly risky and difficult to do because you don’t know when things are going to go wrong. It’s a very unstable foundation.

David:
Now, over time, so like the properties I bought in California in 2009, ’10, ’11, ’12, 10 years ago for some of those properties, they’re relatively stable because I’ve already fixed a bunch of stuff that has gone wrong and rents have gone up so much that if new things go wrong, it’s covered by the increase in rent. All right? But properties I bought a year, two, three ago, stuff keeps popping off and going wrong and I got to keep fixing those properties up, and the problem is if you think you’re a bad investor because you didn’t anticipate that.

David:
This is why I personally give the advice that for the majority of BP listeners, quitting your job and going full-time in real estate is not the best thing to do unless you’re starting a business in real estate, like you’re going to become a wholesaler or a flipper or a real estate agent like me or a loan officer or a construction person, you’re going to do some type of trade work or start a business that’s involved in real estate. Yeah, you’re full-time in real estate, but you’re not a full-time investor. You’re still sort of earning income. And that’s because the income that real estate provides, it’s like planting a tree. It’s not going to produce the fruit that you’d expect when it’s been around for 20, 30, 40 years.

David:
So the answer to your question, how are people living off cash flow? They’re typically living off cash flow properties they’ve owned for a lot longer than a year or two when they bought them. They’re also typically not living off all the cash flow. They’re setting aside a big chunk of it. And even then, sometimes you get hit with a bill or you get hit with a repair that’s more than you have and you got to take money from your personal account. It’s okay to do that.

David:
This is why I always tell people to take the longterm approach for real estate investing. It’s just, in my opinion, it’s unwise, it’s not prudent, and it’s frankly somewhat misleading to tell people, “Hey, you can buy a house and you can never work again,” or, “You can buy four houses and never work again.” It’s like saying you’re going to plant a tree and live off the fruit forever. The tree needs time to produce fruit that’s mature. It needs time to mature itself. So you’re going to keep working while that tree is growing, but the important thing is that you’re planting trees while you’re working. What we don’t want is for people to just keep going to work every day and do nothing to improve their position so that five years down the road, you’re in the exact same position, but with a little less hair.

Brian Smalls:
Hi, David. My name is Brian Smalls, long time listener of the podcast. I’m a new investor and my question is centered around cash flow. I hear about investors who use cash flow to be able to maintain their lifestyle, so to take care of their daily, monthly living expenses. But at what point is it okay to do that? I know that I’m supposed to be accumulating cash flow to have reserves and then also take care of capital expenditures, but at what point is the coast clear, is it safe to start utilizing cash flow from my rental properties? Thanks.

David:
Brian, thank you for this question. I sort of addressed it a little bit earlier in one of the comments from YouTube and so I won’t go into it as deeply as I normally would because I addressed it there.

David:
Just my opinion on this is you typically shouldn’t be living off your cash flow nearly as soon as what you would think. I think I’m sensing hesitation in your voice that it doesn’t seem wise to do it and you’re cautious, and I want to encourage that part of you. Have way, way, way, way, way more in reserves than what you think you would ever need, okay? We want to plan for the market correction.

David:
Now, I don’t wait to buy for the market correction, I just buy more aggressively when I see a market correction, but I’m still buying right now. I don’t think we have a correction coming anytime soon. My guess, because it’s all a guess, we’re all just betting if we think it’s going to go up, it’s going to go down, taking action is a bet, not taking action is a bet. You take where we were 10 years ago, we’ve gone up to here and people think that’s high, and they’re waiting for a correction where it might drop 50%. Well, it might go up twice as high, and then when it drops by that 50%, it’s still going to be higher than where we are right now.

David:
And that’s why I’m still buying real estate, but I’m not living off cash flow. I am one of the people who is financially free. I could retire and I could live off my cash flow and never work again, just like a lot of people say, but I don’t like that because it’s a shaky foundation. I’m actually starting companies and building businesses and training people to help create profitability.

David:
I’m in an expansion mode right now because I see that we’re in a high inflationary environment with a lot of opportunity to make money and I want to make hay when the sun shines knowing it won’t always do that.

David:
Now, some people think that’s greedy. Some people might say it’s greedy to not quit your job, to work a job and have cash flow coming in. I don’t think it’s greedy. I think that I am conservative. I think I’d like to have so much money put aside that I don’t have to worry about what happens if I have a vacancy. I don’t even even want that question in my mind, right? I will stop working when I get to a point that I don’t have to ask myself what something costs if I want to buy it. When I no longer equate time to money and I just have enough money that it doesn’t matter, that’s when I would consider, “Okay, I don’t have to work.”

David:
And I’m just not there. If I went to go buy a Ferrari right now, that would take a chunk out of what I’ve got. So I’m not buying the Ferrari, but I’m also not going to quit working.

David:
And I’m just giving this philosophy because I want everyone to understand that I have freedom in the sense that I can work from where I want when I want on what I want, okay? I don’t have freedom in the sense that I don’t have to worry about the economy shifting or property values dropping or a property having an issue, right? I don’t have that much and it’s okay to keep working, but I’m not working on stuff I didn’t like. I’m not working 20 hour days as a cop. I’m not working in the restaurant industry and then trying to go to school at the same time.

David:
It’s okay to work, but I get to do work I like. I get to educate people like this. I get to write books. I get to help people with selling their homes. I get to take the knowledge that I’ve built over the years and use it to help other people to build their wealth. So work isn’t bad when I like it.

David:
So what I would encourage you, Brian, and everyone else listening to this is when you get some cash flow coming in, don’t quit altogether, but do say, “All right, I don’t like this part of my job.” Let’s say you’re a sanitation engineer, you drive a garbage truck. You got to wake up at 2:00 in the morning and go to work. That’s probably not a lot of fun. When you have some cash flow, you can quit that job and you can go find a job with less stability, but more freedom.

David:
You’ve already taken a step toward freedom. You’ve improved your life, you just didn’t go cold turkey. And then when you get more cash flow coming in, you can take a position where you might just only work when you want to, right? That might be a place where you work sometimes and you don’t work other times. Maybe you take six months off of the year. Maybe you’re picky about what client you work with. Maybe you get into a commission-based industry like me where if for some reason commission stopped coming in, I’d be okay, but I still have the opportunity to make money when it’s there.

David:
I would just encourage you all don’t look at it like it’s this, then that, and that’s all there to it, right? It’s a spectrum. You’re kind of flowing in that direction.

David:
So the direct answer to your question, Brian, when you’re saying, “Hey, at what point can I live off the cash flow?” you should have so much in reserves, you should have your properties fixed up with new stuff, very unlikely anything’s going to go wrong, incredibly stable asset, then you can start living off the cash flow. But if you do things right, you don’t actually ever get to the point where you have to live off the cash flow. You can keep saving it and then have money from a job that you love coming in until you own so much real estate and you have so much cash flow that you’re okay to live off of it. Hope that helps.

David:
All right, next question comes from Amy who’s in rural Minnesota. “Hi, David, my husband and I are new investors, but I come from a family with a past in real estate investing. My grandfather, now deceased, had many rentals and eventually set up trust funds for several apartment complexes and storage unit sites with my uncle as the trustee and my siblings and I as beneficiaries. None of us have really taken a dive into all of this to see how to maximize the portfolio, we’ve just been enjoying passive income for years. My question is once a property no longer has the tax depreciation, what options to continue getting the maximum tax benefits of real estate investing? Should we sell the property? Should we use the equity to invest in something with a higher price tag? I am very curious how we can leverage equity to purchase more deals, especially since the 24 years of tax depreciation is up. One apartment building he bought over 40 years ago.”

David:
All right, Amy, thank you for leaving this comment. So let’s just explain what you’re actually getting at here. We talk about how there’s depreciation in real estate, and that doesn’t mean the value of the asset going down. What it means is you get a tax write-off for 27 and a half years of a equal part of what a property’s worth because technically it’s falling apart. Everything is that’s being built.

David:
At the end of those 27 and a half years for residential real estate, you no longer get to depreciate the assets. So if you made $10,000 in income, you’re going to pay taxes on that full $10,000. Otherwise, if your depreciation was say $7,500, you’d only be paying taxes on $2,500 of this real estate.

David:
So what I think you’re asking here, Amy, is, “Well, how do we get back into that cycle where we get the tax benefits?” I’m not a CPA. I’d have to check with a CPA before I gave a super firm answer, but my understanding is that you’d have to sell the property and buy a new one to get that depreciation and you won’t be able to do a 1031 exchange because that would keep the depreciation cycle where it’s at right now. So if you sell the property, you take your hit, you pay your taxes, then you buy a new one, you can start a new depreciation cycle.

David:
Another thing to consider though would be if you refinance the property, you increase the debt on it so that your profit is less on that property, okay? So let’s say it’s paid off and you’re making 10 grand a month on it, what if you refinance it and now you have an $8,000 expense because you borrowed money? So now you’re only making $2,000 that you’re being taxed on on that property, but with that money that you pulled out of it, you go by three more apartment complexes that all start a new cycle of depreciation that do have the benefit.

David:
So what you’re doing essentially is you understand this one that I own, I can’t get tax benefits from it anymore and I don’t want to pay capital gains, so I’m going to make this property less profitable by pulling money out of it and then I’m going to use that money to go buy three or four other more profitable properties that would maximize, increase the efficiency of what you’re doing like what you asked, and it would get you back on the depreciation schedule that you’re wanting to be on. If you want to message me about this refinance, I’m happy to look into it for you and see if we can do it, as well as give you some direction on what type of properties to buy. But that’s the way you solve the problem. When you feel like you can’t play any more defense, which is where you’re at, you play a lot more offense to make up for it.

Peter Amador:
Hey, David, this is Peter [Amador 00:35:45]. I’m based in New York and invest currently in the San Diego real estate market. My question for you today is related towards building an ADU on one of our properties.

Peter Amador:
So we currently own a single family home that is about a mile from the beach and is on an 8,700 square foot lot. It’s a perfect lot to build an ADU, and so we’ve hired a design and build firm and we’re moving forward with the permitting process.

Peter Amador:
My question to you is related towards what you see in terms of ADU values. It’s been difficult for us to get an idea of what the ADU will appraise at. We’re taking out a home renovation loan to do the build, and with that, we have to put in some of our own cash to finance the entirety of the project.

Peter Amador:
That’s totally fine because this is a longterm buy and hold play for us. And so as we start to think about what kind of appraisals we’ll get, we’ve been reaching out to appraisers as well as a couple different real estate agents. And the perspective has been quite all over the place, just because of the limited number of homes that have been built with an ADU and/or sold.

Peter Amador:
So my question to you is, one, what do you see as the best perspective in building an ADU on terms of that longterm value? And then two, how can we work and share information with the appraiser for them to evaluate the home, not only as a single family property as it’s currently zoned, but as a multi-family property because the duplexes in this area are selling for quite a bit of a premium. So thanks so much and look forward to your feedback.

David:
All right, this is a good question, Peter. I’m going to have to break this down into a couple different segments for my answer because you gave me a lot of information there.

David:
Let’s start with the beginning, why do we build an ADU? Well, same reason we invest in any real estate. We can simplify it by looking at the two ways that we’re going to gain. It’s going to gain equity, which in this case, it would make the primary residence where you’re building it worth more.

David:
The second reason is for the income, the cash flow, right? So your question of, “How much is it going to increase the value of my home when I get it appraised?” has to deal with the equity portion of it. “If I make this repair or if I make this improvement,” would a better way to put it, “by adding an ADU,” just like you make an improvement on your kitchen, “how much more does it make my house worth?” Let’s start with that.

David:
You’re on the right track. You’re asking agents and you’re asking appraisers. That’s the best thing that you can do. And what you’re hearing, it sounds like, is a lack of consensus. They don’t know. That would give me pause on if building an ADU is the right move to make.

David:
Primarily, if you’re looking at adding value to your property, you need enough comparables, enough data to be able to see, hey, these houses that have ADUs are worth this much more than those that don’t. And if they don’t have enough houses with ADUs, you’re not going to get that. You’re already entering into a place where you have less control and therefore more risk.

David:
The next reason that we build an ADU would be for the income. The problem with ADUs is you usually can’t finance them. So if you’re going to spend 100 grand or 150 grand to build this ADU, it will bring in more revenue. The question you want to ask yourself is, “Would I be better putting that 100, 150 grand into a whole new property, not an ADU on my property? Would I rather build a 900 square foot ADU or would I rather take that same money and buy a 2,400 square foot house?” That’s the question that you should be asking.

David:
And even if for some reason it looked like the ADU was going to bring in more income than the house, like it might cash flow more because there’s no loan on it, you have the fact that you didn’t take a loan on it. So if you go buy a whole other property with that same capital, you’ve now borrowed a lot of money that you’re paying off, or I should say you’re having your tenants paying off.

David:
If you do this with the ADU, you’ve in a sense just bought a property cash, which is rarely as good as financing it. Now, you can get away from the whole, “I just bought it cash,” if you can refinance and get the money back out. Now it becomes you financed the ADU, but that brings us back to the equity question of, “Is it going to make my house worth as much if I build this ADU to get the money out?” and you don’t know.

David:
So just as I’m hearing this right here, I’m not saying don’t do it, but I’m saying this is very uncertain. I don’t like it. If you’re in a position where you don’t have a ton of money, this could go bad for you in the sense that you sink a bunch of money in your property and you can’t get it back out.

David:
Now, another part of your question was, “How do I get the appraiser to look at it like a duplex?” because it sounds like duplexes in your area are selling for more. Yeah, I believe you did say that, the duplexes are selling for more.

David:
Here’s where I think you’re getting mixed up, the word duplex. Your definition of duplex is two properties together. So to you, “I’m building an ADU, I have a single family house, it’s now a duplex,” but to the city where the zoning is, is a duplex means one property split into two. It’s at a tax assessor parcel number for a property, but it’s still just one structure, and there’s only certain parts of town where they allow duplexes be built. That’s what you meant by the zoning.

David:
So if it’s zoned for multifamily, you may go to the city and say, “I built an ADU, can this be considered a duplex?” They’ll probably say no. That will be considered a single family house with an ADU. It is not the same as a duplex. And that’s where I don’t want you to get yourself in trouble because if duplexes are worth more and you think you’re turning it into a duplex by adding an ADU, you’re not. You’re taking a regular house and just bolting something onto it. That’s how the city’s going to look at it. It’s not the same as changing the actual title to a duplex.

David:
So before you go into this venture, that’s something you want to check with the city, “If I build this ADU, will you consider this a duplex?” And if they say, “No, that’s a single family home with an ADU,” you can’t call it a duplex, then you can’t sell it to someone else as a duplex, then the appraiser’s not going to give you the value of a duplex like what you’re thinking.

David:
I don’t want to see you go too far down this road to where it late and then try to make this into something that it’s not going to be, and I’m seeing some of those early signs right here.

David:
So I’m not going to say you don’t build the ADU, I’m going to ask you to stop and reconsider where you’re at. Before you go forward with this, see if the city will let it be considered a duplex or if the area you’re in is even allowed for duplexes. Typically if you’re in an area where it’s zoned for single family, it’s usually considered R1 or residential 1 unit.

David:
The next thing I want you to look at is, “Are there comps that would show I could get my money out of this by adding an ADU and then refinancing?”

David:
And the third thing that I want you to look at is, “If I do this, is the cash flow that I would get the same or better than if I just bought a whole property that I didn’t have to build this ADU from the ground up?” If the answer is not yes to all three of those things, I would look for a more efficient way to use your capital than building your ADU.

David:
Now, here is the ray of hope I’m going to give you if the answer is no to those three things. You don’t have to build an ADU from the ground up, a whole separate structure. You may be able to build out from the existing house that you already have and you may be able to do that from an area that has a bathroom very close or electrical already run so that you can create a studio or a one bedroom unit without building it from scratch. I do this all the time. If I have covered patios, if I have part of the basement that isn’t been developed, I’m looking at a house right now in Moraga, California that has this huge basement that has plumbing already run to it and electrical run to it, but it’s not finished.

David:
All that I have to do in that case is add finishings to it and build out a bathroom and frame up some rooms and I’m going to have added like 1400 square feet to this property with its own entrance to be able to go in. And I didn’t have to build it from the ground up. It’s going to be significantly cheaper because I’m not framing an entire property and pouring an entire foundation and I’m not putting a roof on and I don’t have to add windows because the basement already has it. All the things that make real estate expensive, I don’t have to worry about in this case.

David:
So look at your property and say can you do that? Can you make an ADU that way rather than building an entire new structure?

David:
And I’ll say this, if I was your agent, I would’ve had this conversation with you before you got in this deep. So maybe the next time you’re thinking about a venture like this, talk to some of these people first before you invest your time or your energy into the construction company that you have and make sure that there aren’t angles that maybe you’re missing.

David:
All right, that is going to wrap up another Seeing Greene episode. Now, I thought we had some really good stuff here. I got stumped on the first question that I just wasn’t sure how to answer. It was a bit of an eclectic question, so I’m not going to be too hard on myself, but it was definitely not something that I was expecting.

David:
We got to dive into the ADU dilemma, and this is a complicated situation, right? ADUs are not surefire things, but they’re also awesome in certain areas. So I kind of took a long time to answer that question, but I’m hoping that you all could see what my thought process was and how you should be looking at a situation when it comes to should I build an ADU or not build an ADU? It’s all about the most efficient use of your capital.

David:
In certain situations like that one, if you’re going to add value to the property by doing it and you’re going to increase cash flow and you’re going to get your money back out, it makes a lot of sense to do it, especially if you could build one for cheaper than you could build a new structure. And that question allowed me to kind of dive deep into that, so hopefully you all know should I build an ADU or not build an ADU.

David:
We got to talk about tax depreciation and some strategies you have if you own property for a long period of time and you’re no longer getting the tax benefits of it, how you can alter the way that you’re using the equity and I thought that that was a pretty cool solution that I hope would benefit you guys as well.

David:
And we got to talk about the cost of capital when it comes to loans and interest rates and if putting more money down actually benefits you instead of hurts you. I think a lot of people might have had their eyes open to what the facts and the numbers actually say when it comes to the decision of should I put more money down versus the psychology for maybe 20, 30, 40 years ago that was always like, “Put as much down as you can. It’s the safest road to go.” Back when rates were 14%, 15%, that made a lot more sense than what it does right now.

David:
I want to personally thank you all for joining me on this podcast. I want to thank you for the attention that you’ve given me and the time that you’ve given me. I also love the comments that you guys leave. So please, leave more comments on YouTube about what you’d like to see.

David:
I also want you to be featured on this show. So can you please go to biggerpockets.com/david and leave your question, and then let us know if you would be willing to be interviewed live on one of our live Q&A type shows. We want people that we can have show up and we can actually pick apart the situation they’re in and give them better advice for how to grow their wealth through real estate, as well as let all the listeners benefit from what’s happening.

David:
And lastly, if you want to get in touch with me, if there was something you wanted me to cover, if you’d like me to help you with your personal situation, maybe you own property and you’re trying to figure out how to use the most efficient equity in it, that’s what I love. I love when people already have properties and they want to know, “How do I get more cash flow, more appreciation, more efficiency, maximize the return I’m getting out of this?” please hit me up. That’s the stuff that we want to talk about. That’s where I want to help you.

David:
And then if you haven’t got your first property, BiggerPockets has tons of resources for you. Please consider going on the forums. Please consider looking into some of the boot camps that they have for new investors. Just type in newbie and see how many blog articles have been written and forum posts have been made for somebody just like you. It is so important that you get started on this journey. It’s a marathon. It’s not a sprint, everybody. And the sooner you start the marathon, the better.

David:
So let me personally encourage you to do that. I will open myself up. DM me or message me on BiggerPockets if you have a situation with a property and you want to talk about how you can maximize it. I’m happy to do that and I’m happy to connect you with my team to see how we can help you do the same. And then continue to give us great content so we can help you more.

David:
BiggerPockets is the best community for real estate investors out there. I want to thank you for being here. Check out the website, register for webinars, get more involved. Tell your friends about what you’re doing, and most importantly, take some action. Thank you very much. This is David Greene signing off.

 

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In This Episode We Cover:

  • How climate change will and won’t affect buying patterns for real estate investors 
  • Whether or not to trade a higher down payment for more cash flow or vice versa
  • Where to find real estate meetups to network with other investors
  • When the right time to pull out cash flow from your rental property is
  • How to maximize tax benefits after your property’s depreciation runs out
  • Building an ADU vs. buying another rental property with the cash
  • And So Much More!

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