Hello friends. And welcome to another episode of Ask Marco on the Passive Real Estate Investing show. Well, we are now officially into the fall. Summer is over whether it’s still warm. It’s nice outside. I’m still traveling a whole heck of a lot. And so if I’m delayed in putting out these episodes, you will know why. Anyway, it’s been an interesting year. You know, supply is very low. Demand is very high. The real estate’s been on fire. This is not a normal year. It has been an anomaly appreciation rates are very high. We are seeing in our top markets, the 63 markets averaged out with appreciation rates in the 20% range year over year. And that is just not normal, certainly not sustainable, but we will see that taper off considerably going into 2022 and 2023 as a supply slowly catches up to the demand and we see just a slowing down a breather if you will, in the markets, but that’s to be expected.
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So today I want to cover two or three questions that have come in with people, submitting their questions on the website. For me, there’s an Ask Marco button or link on the website. So I just randomly picked these. I took a quick look and then I thought, okay, these are good. The first question is from Eric and Eric is writes in and says, hello. I’m in the process of buying my first home. I currently live in Sacramento, but I am considering a few different places to move to. I want my first home to eventually become a rental property. So I’ve been researching how to do that. Good for you. That’s great. One thing I keep hearing is ROI, which is an acronym for return on investment. My question is how would I go about finding the potential ROI of my first home and what is a good percentage?
Thank you, Eric. Okay. Eric. Well, interesting question. I guess the first thought that goes through my mind is always be careful mixing business with pleasure, meaning your personal life with your business life, meaning your principal residence with it being a rental. If you like where you live and your principle residence, your home can make a good rental property then great. You’ve married the two, but what I find is often people want to live in places that don’t make for good rental property. And this is where my trademark line or slogan came up many, many, many years ago, and it’s live where you want to invest, where it makes sense. And it’s because often those two things don’t mix. And even if they do mix, you may find that where you want to live is not good for rentals or where it’s good for rentals may not be where you want to live.
So keep that in mind, but you know, if you can marry these two and make them work together, fantastic, then live in a home that you enjoy and an, a market that you enjoy and then turn your rental property or your home into a rental property. So with that in mind, it all comes back to the numbers. Again, I’ve said this many, many times, it all comes back to the numbers. So I guess there’s two ways to look at this one is, you know, from a very high level, it’s a quick litmus test. And then second is getting into the weeds and looking at the details. So the litmus test version of this is what I call the rent to value or rent a price ratio. And what you need to do is look at what your purchase price is at the time of acquisition, relative to what you can get in gross rental income for that property.
So again, you know, simple numbers, if you bought a hundred thousand dollar home and you’re able to get eight, nine or $1,000 per month in rental income, then you’ve got a 0.8% 0.9% or a 1% rent to price ratio. So what does that tell you that basically tells you at a first glance, whether that property will be able to carry itself and generate passive income. In other words, cash flow. If you have a property that’s at 1% or close to odds, are it will. In most cases, it will, even if you get down to 0.9 0.8%, even 0.7% generally speaking, you’re going to have a property that generates positive cashflow. Again, this is going to be priced specific and market specific because different states will have different property tax values and other expenses that might come into play. And also are you looking at a property that has an HOA homeowners association that will certainly cut into your rental income?
So keep in mind that doing a rent to value ratio is just a quick litmus test. It’ll tell you pretty quickly whether it will cashflow, but if you really want to break it down and look at it at a deeper level, then get into the weeds and look at what the market rent is for that property today. And do your proforma, you know, run your numbers, take your rental income budget for vacancy. So deduct about 5% or more, if you want to be more conservative, but at least 5% from that rental income for your vacancy allowance, and then deduct your expenses, which are your property taxes, insurance HOA. If you have one, hopefully not budget for maintenance and repairs, again, minimum 5% more. If you want to be more conservative and that’s your minimum, and if you’re not going to be managing your property yourself, also budget for property management.
So those are the key expenses you want to deduct, and that leaves you with your net operating income. So if you’re going to be financing this property, you’re deducting your mortgage payment, your debt service from that net operating income what’s left over is cashflow. That’s your spendable cash. And so that’s the income that the property will generate on a monthly and annual basis. So, you know, when you ask about ROI, your return on investment, I don’t know if you’re talking about your cashflow and your cash on cash return, because a lot of people refer to the return on investment as the cash on cash return. It’s a common mistake, but it’s so common that I’m not even going to call it a mistake, but the way I define return on investment is all of your returns combined. So that would be your cashflow, which is your cash on cash return.
Plus the amortization of the loan, the mortgage each year, plus any appreciation you have on the property. Those three are your realized and unrealized gains. Your realized gains is the cash flow. The actual spendable cash that you have, your unrealized gains is the equity growth over time. If you combine those altogether and you compare that or divided into the down payment that you put on the property, that is what is going to give you your ROI, your return on investment. So you can do this quite easily. If you’re looking at a property that you’re going to say, Hey, that’s going to be my principal residence, but I’m going to turn it into a rental down the road. Then you can look at what that would be as a rental property today, by looking at this market value today and the rental income from today, as well as the property taxes and insurance from today, that’ll give you a very good picture.
You need to do a little projecting. If you’re going to go down the road three or five years or more. And again, the further out in time you go, the more assumptions you’re making, because you don’t know what the property values are going to do over the next 3, 5, 7, 10 years. You can make some assumptions, but you don’t know for sure. So again, you’re going to have to make some assumptions, but that will give you a pretty darn good idea of whether that home can be turned into a rental property profitably. All right. Well, I hope that answers your question. This is not something complicated. You just have to like where you’re going to live and make sure the numbers work out. All right. The next question comes from Adam and he writes in and says, Marco, thank you for the straightforward way you engage with the questions that beginners like myself, have it lends confidence as opposed to a Google search.
My question is specific to 0% down, investing with a HELOC, which is a home equity line of credit. Our primary home has about 800,000 in equity. Sounds like you live in California or maybe New York. I would love to grow our portfolio at an accelerated rate. I am concerned about the strategies of paying off the HELOC. If I access $300,000 to purchase 10 single-family home properties that are cash flowing, what would your plan be in regards to the $300,000 utilized for the down payments? Would you treat it as a mortgage and pay down the principal and interest on a monthly basis? Would you only consider the interest and plan on a cash out refinance at some stage years down the road, hoping for appreciation to catch up before the 10 year draw period ends any insight or elaboration would be helpful as I go through the numbers.
Thanks Adam. Okay, Adam, great question. I’m sure a lot of people think about this because they are, you know, equity rich, maybe not necessarily cashflow poor, but they have equity that they can tap into and repurpose. Uh, I guess the first question is, is the HELOC your best option or would it make sense for you to refinance possibly, and hopefully at a lower interest rate, increasing the mortgage on your principal residence to pull out that $300,000 still have one mortgage on your property, hopefully at a lower interest rate and then just work it that way. The issue with a HELOC is that typically they have a 10-year term sometimes, and often you can extend that you could renew it. You could work with your lender or your bank to extend the term of your HELOC, but that’s potentially the downfall. The upside is that you can get interest-only payments on your HELOC and at very low aggressive rates.
So this is where the math comes in. You got to figure out, you know, what is the best option? And the more you pencil it out, the more math you work out, whether it’s a spreadsheet or a calculator, the better off you might be, but your strategy is not bad because if you can borrow 300,000 of equity, and this is of course happening, tax-free and use that to acquire a portfolio of tensing family homes, especially if they’re in good markets, which you expect based on the fundamentals that those markets will continue to grow and appreciate at more normal rates of appreciation, not what we’ve seen over the last 12 to 18 months, then you should do well because you’re going to have unrealized gains. That will certainly keep pace. If not outperform what you’re paying on your HELOC. Now your real question is about repaying it.
So yeah, I guess it really is going to depend on what happens with those 10 properties over time. Because if you’re able to keep servicing the debt and paying it down, using the cash flows, that would be one way to pay it down and service it. Second is if you have enough appreciation, whether on your principal residence, where you have the HELOC and or on those properties, some of the 10 properties you buy to refinance and pull a little bit of equity out on each one to cover the 300,000 you borrowed in the HELOC, then you can pay down some or all of it. And that would certainly help because now you’re lowering your debt service. So that would be the second way to tackle it. Third would be to recast that HELOC, in other words, renegotiate it with your lender and extend it for another 10 years.
So you buy yourself time for the appreciation and equity growth in your properties to happen. So you can reposition your equity through either revise, well, mostly a refinance to pay off that 300,000. You could do it that way. What else can you do here? I guess if you make a ten-year forecast or even a 15 year forecast of where your properties are going to be in terms of cashflow and equity. So really you’re building out yourself a projection of a ten-year proforma of your portfolio to see what your debt service coverage will be, as well as what your equity position will be in. Let’s say five years, 10 years, and 15 years down the road, then you’ll have a better sense of where you stand in being able to repay that 300,000 or maybe that 300,000 has been paid down because you’re not just paying the interest, but you’re paying interest in principal.
And so you have less of a repayment. Of course, then there’s always the option of refinancing your principal residence to include that 300,000 with your new first mortgage. So this is a math question. You need to look at the cash flows, your ability to service that HELOC in terms of interest payments, as well as bank enough, over the 10 years to repay it in full, as well as the potential equity in the different properties, including your principal residence, to be able to refinance it down or completely out after that 10 year draw period ends, and also check with your lender, ask your bank what options you have when the 10 year term is up. If you have the ability to extend it, renew it, or whatever options they may offer you, sometimes there’s some, you know, some options that you’re not even aware of that are in your HELOC documents that become an option for you after the 10 years.
So look into that. I know this is not a super detailed answer to your question, Adam, but at the same time, you’ll probably find most of the answers you’re looking for by building out your proforma and also talking to your lender about the options with that HELOC. I hope that helps last question here. Um, Steve, he writes in, I’m not sure I completely understood this, but Steve writes and says, should my rental income be a business or an LLC, or just 14 rental producing income properties? I don’t know what is the best strategy for tax purposes dot dot, dot new loans, et cetera. So Steve, I’m going to do my best to take a stab at this. So I think you’re probably separating how you’re looking at your rentals. They’re either 14 that you own personally, that are generating income, or you’re looking at it as 14 rentals in an LLC and calling that an LLC with these assets, or you’re calling it a business and looking at it a little differently.
Really these are all the same. You’re calling these three different things, different things, but at the end of the day, they’re actually the same. And here’s why I say that if you own for 14 rental properties, not legal advice, I’m not an attorney, but if you ask any asset protection attorney, they’re going to tell you not to hold it in your name, which means that those 14 rentals are going to be in one or more LLCs as title holding entities, they’re disregarded entities. So the income and expenses just flow through the LLC holds title, but it’s not really an operating business. So that income flows directly to you or whatever holding company you have that are holding those LLCs. But all of that, the entire structure, those 14 rentals in your LLCs that are generating income and flowing up to you or your holding company is a business.
You should look at it as a business. You should treat it as a business. You should operate it as a business because it is a business. So really these are all the same. And from a tax strategy, you are probably structuring yourself and mind you, you know, this is something you do want to talk to a knowledgeable qualified tax advisor, someone who understands investment real estate and ideally some asset protection along with that. And if you need some references, you know, contact my team of investment counselors will certainly help you out there. But when you structure this properly, you’ll get not only the best and most efficient tax strategy because you have it set up with the entities like the LLCs that are necessary to hold title, but you’ll also have asset protection to go along with it side by side, it’s like two sides of a coin.
And so when you’re looking for the best tax strategy, it really comes down to your personal situation and what you have set up and how you generate your income and what businesses you may or may not have, and what tax structures you have in place right now. That is a complex question that is case by case and requires a deep dive into everything you have going on, but at a high level, from looking at this, just on the real estate side of the equation, having those rentals in their own LLCs that are state-specific, that whole title and a flow of the income through up to you or your holding company is the best way to structure it because you have some options for tax efficiency, as well as asset protection. And that whole thing, you have to look at it as a business. It’s all these entities are for your protection and to operate this like a business, cause they all have their own books.
You have to have your QuickBooks or your spreadsheets or whatever you’re using and you need to treat it as a business. All right. Well, that’s a, long-winded answer to a short question, but I guess based on what you’re asking, oh, and the last thing you mentioned, new loans, et cetera. Well, at the end of the day, it doesn’t matter whether you own them in your name or in LLCs. If you’re getting loans, any conventional financing you go for, you’re going to have to do it in your name, regardless of whether you hold title in an LLC or not. But beyond the 10 conventional loans, the portfolio loans, like what we do here with Norada real estate funding is theoretically an unlimited number of loans that you can qualify for as long as you’ve got the qualification criteria. So there’s no cap and often portfolio loans, like what we do here can be in an LLC or out of an LLC.
In fact, many portfolio lenders will actually prefer that you hold title in an LLC. So it’s not going to affect you as far as financing. So don’t even worry about that, but that’s it for today. I appreciate you all for listening. Thank you for listening. Remember to subscribe. If you haven’t subscribed already, I do my best to put out one episode per week and I will be traveling again, starting tomorrow. I seem to be traveling about every 10 days right now, a lot of good stuff going on. I will share some of that with you in the weeks and months to come, I’m working on a project that I’m looking forward to share with you, but it is not ready yet. So until then we will just keep putting out some new episodes. All right, well thank you for listening. I will see you all on our next episode.
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