Hello my friends. Welcome back to Passive Real Estate Investing where we dive into the world of real estate investing among other related topics. To help you with your real estate investing journey, today we’re doing something a little different. We’re going to take a trip down memory lane and showcase an important episode from the past on what we call our throwback Thursday episode. Now, whether you’ve been with us since the beginning, which goes back to 2015, or you’re tuning in for the first time, this episode is a must listen, we are revisiting one of our more popular episodes from the past, and believe me, what we discussed back then, whether it’s six months ago or six years ago, is just as relevant today. So sit back, relax, and let’s rewind the clock for this great episode. Enjoy.
Today’s question comes from Carlos and, you know, I love these questions. It just tells me that you guys are listening and thinking and really interested in real estate and real estate investing and what it could possibly do for you and your family and your future generations. The power is there. When you get started, it just feels a little bit slow, but as you grow your portfolio and start to gain momentum, it’s very interesting to see how it starts to build and stack, especially when you’re looking back after about three or four years, and you’ve been adding at least one property to your portfolio. And if you’re in a good growing market, it really starts to pan out, but it gets really exciting when you start to get to 10 properties or more, but you just build up.
And for some people, they can do that in a year or two. And for other people, it takes them literally 10 years or more, but don’t compare yourself to other people, just focus on your own personal investment goals and what it is your trying to achieve, because that’s going to be different for everybody. And I actually talked about goal setting to some degree on yesterday’s Ask Marco episode about Smart Goals. So maybe go back to that and just check that out.
Today’s question comes from Carlos and he writes and he says, hi Marco. I am trying to build a real estate portfolio and I have some questions. So what’s interesting here is he’s got four questions. So I’m just going to call these common questions about real estate investing. His first question is, is it better to get a 15 year or a 30-year loan with a 20% down payment in order to get better returns and overall financial deal?
——————————————————————————————————————————————
Throwback Thursday Episode (The episode originally took place in the year 2020)
This episode is part of our Throwback Series and may include references to older content such as web classes, events, promotions, or links that are no longer active or available. While the conversation and insights still hold value, please note that some information may be outdated.
Download your FREE copy of The Ultimate Guide to Passive Real Estate Investing.
If you missed our last episode, be sure to listen to Teaching My Kids About Wealth-What I Wish School Had Taught Me
See our available Turnkey Cash-Flow Rental Properties.
Our team of Investment Counselors has much more inventory available than what you see on our website. Contact us today for more deals.
SUBSCRIBE on iTunes
I think I understand what you’re saying here. The basic question is really, is it better to get a 15 year 30 year fixed rate mortgage, fully amortized? And that’s what the traditional and standard 20% down on conventional financing. Uh, so is it better to get 15 or 30 years? Well, the answer is, it depends. The reality is, is that we all know that a 15-year mortgage can be paid off in 15 years or less. A 30-year mortgage will be paid off in 30 years or less. The 30-year mortgage, in my opinion, gives you far more flexibility. Your monthly payment is going to be lower, but of course, over time, you’re going to pay more in interest over the life of that loan. But the question is, is does that really matter with inflation? You have to remember that your monthly payment is fixed. It doesn’t change. So the purchasing power of the dollar each and every year becomes lower and lower. So what is essentially, let’s say a $500 mortgage payment today in 10 years or in 20 years is going to be somewhat laughable, but it’s just not going to have the same impact as what the purchasing power of that same amount of dollars today will be in 10 or 20 years. So you have inflation as your friend. And that is really kind of an interesting thing about debt financing is that it becomes worthless as time goes on. The other thing I like about 30 year fixed rate mortgages versus the 15, is that you can still pay more principal each and every month or every quarter and amortize it just like a 15 year mortgage. So you can still pay off that 30-year mortgage in 15 years or more or less, you can pay it on whatever schedule you like.
You have complete flexibility from zero to 30 years. With the 15, you don’t have that flexibility. You can pay it off sooner. You could pay it off in 12 years, but your minimum monthly mortgage payment, the principal, and interest payment is going to be fixed. So to give you kind of a real example here, if you look at a hundred thousand dollar mortgage at a 5% mortgage rate, the 15-year mortgage monthly payment, the principal and interest is $791. But if you go with a 30 year fixed-rate mortgage, it’s 537, it’s a difference of $254. So does that make a difference? Well, it might, it depends on the property. If your true net cash flow on a property is $300 a month, that real spend cash at the end of the month. That’s your cash flow? Well, it will make a significant impact on that, but that might not make a difference to you.
You may not care about the cash flow on one or a few of your properties, at least not right now, because you’re building your portfolio. You’re still looking to add and grow the size of that portfolio. So the cash flow is important, and of course, you want positive, not negative cash flow, but it may not be as important to you today, as it will be, let’s say in five, 10, 20 years or when you retire. So if that difference, does it make a difference and you really want to pay down those mortgages on your properties sooner. Then you can opt for the 15 year. I honestly don’t really see any advantage of going with a 15 year over 30 because the thirties still gives you the ability to pay it off in 15 years, if, and when you choose it, if your property is vacant for a month and you have that turnover, then you know, you have the ability to pay a lesser amount in principle and interest for a month or two until you have that tenant in there, the property is stabilized. And now you just pick up where you left off with the higher monthly payment to amortize that loan quicker.
Just as a side note here, you know, comparing the total interest paid on a 15 versus a 30-year mortgage, it’s basically this, that same a hundred thousand dollar mortgage 5% interest. The total interest you’d pay on a 30-year fixed-rate mortgage, assuming that you make no extra payments would be 93,200 and just under $56. Compare that to a 15 year fully amortized loan with no extra payments. It’s a little less than half it’s $42,343 in total interest. The difference between those two with that extra 15-year amortization is just under $51,000. It’s $50,912. So yes, you can save quite a bit on the interest paid on that mortgage over the 30 years. But again, keep in mind that this is over a long period of time. It’s over 30 years. Your tenant is paying off that mortgage for you, not yourself, but still, it’s taking away from the potential net worth or equity gain that you would have in a shorter period of time. And don’t forget, your friend is inflation. So it’s helping to erode that over time. So I think given a choice between the two I’d go with the 30-year loan paid off faster when my investment strategy calls for that, because I want to increase my equity, my net worth, and increase my cash flow. But that’s just a shift in your strategy, going from acquisition or growth mode to a more of an income strategy where you are essentially lowering the debt on your properties one or two at a time to increase your monthly cash flow. Alright, well, that’s a long answer to your first question. So let me hit up your other three.
Your second question here is, is there a benefit to buy pre-construction versus already built houses? And I assume what you mean by already built is newly renovated or what we offer, what we sell to our investor clients here at Norada Real Estate, which are turnkey cashflow rental properties. So if you’re comparing those two, I’ve talked about this on other episodes. Here’s the basics of it, new construction I have a bias for, but it doesn’t mean that is what I’m investing in. In fact, I’m actually not. I’m buying newly renovated properties, essentially what we’re selling here as turnkey rentals, the preconstruction homes are certainly all new. There is nothing used or consumed, so everything should be new and there shouldn’t be any issues. Now they do come up from time to time, you know, there’s some complexity to properties and there’s mechanicals and whatnot, but they also come with a warranty, a builder’s warranty, which could be anywhere from two to 10 years and they cover different things.
So you often have to check what is actually covered, but you shouldn’t have any issues with that with newly renovated properties. I will say that you shouldn’t have property problems with those properties. Does it happen? Sure. From time to time it does. And if it happens pretty quick, like right after you purchase the property sometimes, and I’ll actually say often the, uh, partners that we have in each market, the property providers, these large full-scale property renovators will actually step in and address the issue or check it or fix it. A lot of times, they actually carry a short term warranty that they just offer as part of the sale. So you do have some coverage, but at the end of the day, if the property is in good condition, you have a thorough inspection. You review it thoroughly yourself, or with your investment counselor here. And everything checks out the likelihood of having a problem is pretty minimal.
So there is a difference between new construction and newly renovated, but it’s not that large, especially if you have had a fairly extensive scope of work done to that property. So that’s one of the differences between preconstruction and newly renovated homes. Another thing that you will find often, but not always are pre-construction homes are typically far out in the suburbs of a Metro area or market. Not always, but often they’re often in what I call the path of progress. It’s basically just where the city is growing out or in that suburb or location or market where the city is just naturally growing out because they just need more housing, more household formation. And that’s where they’re putting it often not always, but often that leads to some forced price appreciation because the builders running out of land, they’re building more homes as they sell more, they raise the price. And that just gives you a forced appreciation just because that’s typically what happens when developments build-out and more homes are sold in each progressive phase.
However, with newly renovated homes, you’re going to find them in mature well established stable neighborhoods. There’s a lot of predictability. There’s already a lot of interest from home buyers and prospective tenants. There are established good school systems there, crime in schools and everything else is measurable because there’s history and you don’t always have that or see that, or find that in new construction areas, if the new construction area is just a pocket within, within the city, and it’s already surrounded for miles with housing all around it, then you can also make some predictions about, you know, what that neighborhood will be like, just because of the surrounding. And the third thing about this is, and maybe this is the most important thing for you or other people listening. And that is the cap rate and the cash on cash return. So we’re talking about the immediate returns, not the future returns measured in terms of equity or appreciation, but often, and again, not always, but often what you will find is because pre-construction homes tend to have a higher cost relative to a comparable property that’s newly renovated, but more importantly, a higher cost relative to what they will rent for basically what we call the rent to value ratio or the rent to price ratio because that is typically lower.
All else being equal. You will have a lower cap rate or capitalization rate, therefore, lower cash on cash return, which is your immediate rate of return on the property when you buy it. And so that probably will playout for the initial few years. That could be one to two to three years, maybe a little longer that will ultimately stabilize and become more comparable to a newly renovated home in an established neighborhood. Or, but generally speaking, new construction will have lower cap rates and lower cash on cash return. So if you’re measuring your returns in the beginning in percentage terms, based on cap rates or cash on cash returns, like what you’re getting right now on your money this year, and next year, it’ll be typically lower. You’ll do better with newly renovated homes. However, if you have more of a growth play, an appreciation play, you’re looking for that equity growth, and that is the strategy you’re.
So you’re picking your markets and properties based on that. Well, then the lower cap rate and the cash on cash return really won’t be that important to you at all because you’re not measuring your gain short term from that immediate return on your cash. You’re looking at your gains in the next three to five-plus years as that property grows in terms of price appreciation and equity growth. Alright enough about number two, number three, your question here is, is it better to manage your own properties or give them to a property management company? Quick, simple answer, 99% of the time, you’re better off having a professional full-service property management company looking over and controlling your properties for you in your market, especially if you have, well, I guess it doesn’t matter whether you have one property or five or 10, the thing is, is unless property management is something you know how to do you’re good at, and you really want to do you probably shouldn’t be managing your own properties.
That is my personal opinion, but I would say that a lot of investors will tell you the same thing. That would probably be most people’s professional opinion. But again, the choice is yours. It’s doable, but especially if you’re beginning or starting out and you are just starting to build your portfolio and you’re cutting your teeth, or you’re relatively green, definitely have a property management company. Do it learn as much as you can over time. And then if you want to venture out and manage your own properties, you could start by doing that on one or two or three at a time and gain that experience and then continue. And your fourth question here, how much should I save in reserves for maintenance repairs and missing rents? I assume you mean vacancy? Well, that’s pretty simple. Again, it depends on the type of neighborhood that you’re in because that’s going affect your, uh, what you save now, really this could be one or two questions that you’re asking.
You might be asking me, what do you budget for maintenance and repairs? And for vacancy, if that’s the question, then I would say, start off with five and 5%, 5% for vacancy allowance, 5% for maintenance and repairs, and then adjust that up or down, depending on the type of neighborhood you’re in the condition of the property, the types of tenants you’re dealing with. And if you have history on that property, you can adjust based on the history of that property in that neighborhood. But I like to start with five and five. So that’s 10% of your gross collected income or gross scheduled income. And then just adjust it up or down. As you see fit. Some investors like to go with three or 4% on each. Some of them are very conservative and they will budget six to 8% on one or both of these.
So that’s basically the range. Now, if you’re talking about reserves, as in, how much should I hold in? My operating account, the general rule of thumb is to try to stick in the beginning to three months of gross rent. So a thousand dollars a month in rent on your property, a budget $3,000, just to have that in your operating account. And you can adjust that upward down. It could be two months worth or four months worth depends on how conservative you want to be, but as time goes on and you build a larger portfolio, especially if you know, this is in the same company, your same LLC holding LLC, but it doesn’t matter if you’re using a holding company, you can move funds as needed to just make sure you account for that properly with your accounting, but you would have a, roughly three months worth of gross rent for that first and second property.
And then as you start to build your portfolio, you can scale that back because you’re not going to have a vacancy in two or more of your properties at the same time necessarily, but especially if you have a larger portfolio, it’s pretty rare that you’re going to have a vacancy and all of your units at the same time, and same for repairs, maintenance and repairs just happen as they happen here and there, it’s not a scheduled thing. So you don’t need to have the same amount of dollars in reserve for all of your properties because the turnovers and the repairs happen in staggered months throughout the year and not necessarily year after year. So you could pull it back and scale it back. So, anyway, I’ve answered your fourth question in two different ways, cause I wasn’t sure what you’re asking here, but that’s about it.
So Carlos, you basically end this email saying thank you. I really appreciate what you do all the best. All right, well, you’re very welcome. And I appreciate the question.
I hope you enjoyed this week’s throwback Thursday episode. If you haven’t already, remember to subscribe so you don’t miss out on a single episode. If you have a question about real estate investing or finance, simply go to passiverealestateinvesting.com and click the Ask Marco button. I read all of them, I reply to many of them, and sometimes I cover them on the show, and I’m gonna try and do more of that. So, I am going to encourage you to go to passiverealestateinvesting.com and submit your question for Ask Marco. Lastly, help us share the show with other like-minded people that you know who can benefit from it as well. Just visit us on your platform. Most of you are on iTunes and leave us a rating and review. I would greatly appreciate it. I read them all and I will thank you in advance. And that is it for today. Thanks for listening. I will see you on our next episode.
—————————————————————————————————
Download your FREE copy of: The Ultimate Guide to Passive Real Estate Investing.
See our available Turnkey Cash-Flow Rental Properties.
SUBSCRIBE on iTunes