I’m Buying Land to Build Rentals…But Should I? (Rookie Reply)

Ashley:
On this rookie reply, we’re talking through three big decisions rookie investors are facing right now. How to structure a land development project, whether to invest in short-term rentals you can also enjoy and whether to cash out a retirement account to buy your first property.

Tony:
These are real questions from real investors just starting out and they hit on some of the most important things you’ll have to weigh when getting started, like risk return and how to use the money you already have.

Ashley:
This is the Real Estate Rookie podcast and I am Ashley Kehr.

Tony:
And I’m Tony j Robinson. And with that, let’s jump into question number one, which comes from AOR in the BiggerPockets form. So this question says, I have the ability to purchase a great piece of land with an abandoned home. The parcel as it sits allows for an eight unit to replace it, but we don’t have the cash for anything like that. The secondary option is to divide it into three lots, build on one sell, and then use that money to develop the other two. The three lots would only be approved for a single family. Obviously the eight unit makes the most sense for long-term money. We just don’t have the capital for a project that large yet. I also haven’t taken on that large of a multi-unit build. Would you make due with the option you have of subdividing and building? Would you build a smaller multifamily unit on the lot instead would love to get insight from others on how they would handle it.

Tony:
Interesting situation to be in, to have the lot abandoned home. It reminds me of Katie Neeson we’ve had on the podcast and that’s pretty much her entire strategy where she goes around looking for lots with abandoned homes or lots where abandoned homes used to be and then she redevelops ’em into typically larger properties, multifamily town homes that she sells off, whatever it may be. So there’s obviously a business case here that’s to be made. So ALO says in the question, I also haven’t taken on that large of a multi-unit build, but does that mean that you’ve done some sort of development in the past because kind of what I’m picking up that you’ve done some development but just not that big before. I think the question is how confident are you in your ability to execute on that eight unit deal? I get that it’s new, but is it like a sequential next step where maybe you’ve built a duplex or a triplex and eight units is just like that next move?

Tony:
Or have you only built maybe one single family home and this is an eight x bigger job than you’ve ever done before, but if this is the logical next step for you and the numbers are really, really good, which sounds like it is in the eight unit, then maybe this is an opportunity for you to go out and partner with someone. Can you raise capital from folks and say, Hey, here are the numbers on the bills I’ve done in the past, here’s what I’m projecting for this eight unit. Do you want to come in on this with me? Because if the only thing holding you back from doing the eight unit is the capital, I think if the deal is good enough, go shop it around to folks and see who might be interested in doing it with you.

Ashley:
I also want to know too the numbers on this and if the numbers actually been run for long-term because it says obviously the long-term play is better if you have the eight unit, but is that just based off the fact of like, wow, I’ll get to own eight units and hold them and that’s better than me only having one lot locked after I sell off the other two. And really then if you run the numbers, it maybe could be that the lots are better because you could take that capital, and this is a lot of Katie Neeson’s model is that she gets her lot in her building for free after selling off the other two lots and owns that property for free. So would you rather have an eight unit with a debt on it and maybe a partner so you don’t even own 100% or own a building free and clear because you sold off the other two and even though it’s one unit or it’s still a free and clear property.

Ashley:
So I think you need to know more of your why also because even if the number is slightly better on one or the other, do you want to manage an eight unit property? Do you want to have partners or vice versa? Do you want to own a single family home or do you only multifamily? But this is a unique situation you take on the single family. So I think there’s a lot more to look at than just like, oh, an eight unit is better than me ending up with one unit. So I think really take that comparison and play as to also what does it take to develop the eight unit? Do you want to put in that much work to actually do that? Do you want to learn everything that goes into developing a multifamily property? I did six patio homes before and it was completely different than doing construction of a single family home and you have to do a SW report. There’s so much more that goes into the commercial development of things, approvals, inspections, things like that. But if you already have some kind of development experience, this could just be the next step for you and maybe it’s time to level up if that’s what your goal is, to be able to do that.

Tony:
I think one other piece to include in the decision making here is what does your city prefer? And when Katie was on the podcast, she shared a story where the city gave her, I can’t remember the exact amount, but it was a good amount of money towards her project because she was helping the city execute on their plan of beautifying the streets of Bryan, Texas. And it’s like if your city maybe has some sort of incentive to say like, Hey, we would actually love an eight unit apartment building here because it helps our 10 year plan of bringing more affordable housing, whatever it may be. Maybe they give you some kind of grant or tax abatement or whatever it may be if you go and build that unit out. So I think talking to the city and saying, Hey, do you guys have a preference of three single family homes or one eight unit apartment complex and see which one they prefer.

Ashley:
Yeah, that is such a great idea. There are so many grants or especially smaller towns where you get to go and actually sit down and talk to the town employees, the building inspector, the clerk, and actually ask those types of questions. But yeah, that is a big way that Katie has made those deals work is because she is going to the town and seeing what they want instead of her telling them, this is what I’m going to do and I guess she does say sometimes this is what you’re going to give me if I’m going to take that. She’s very good at demanding and commanding if she was. Okay. Well we’re going to take a quick add break and when we come back we’re going to talk about investing in short term rentals. We’ll be right back. Okay. Welcome back from our short break. Our next question is from Sean.

Ashley:
I’m in the process of remodeling my primary residence to rent it out. I love to travel and have thought about short-term rentals in the Ozark since. I love it there and it’s close to me. My question is should I stick with some single family homes or multifamily homes first or should I use my equity to buy short-term rentals that I could stay at throughout the year? What a cool position to be in, be able to decide I got three different types of strategies I can do and each of these come with their own pros and cons. I guess one big piece to differentiate these is the financing piece. So if you’re going to buy something as your primary residence, a multifamily, you can live in one unit, rent out the other units, a single family, you could live in it and then rent out the rooms if you’re going to use that primary residence financing on it, you do have to live in the property for most loan products for at least a year. There are some circumstances where you can get out of that year criteria, but if you’re going to do your property as a short-term rental, Tony, are there any stipulations of if it is your primary home, how much you rented out where it would be mortgage fraud because you’re renting it out as a short-term rental even though you stay there x amount of year and it’s the only property you own as your primary residence?

Tony:
I actually don’t know because I’ve never done it that way where I’ve purchased it as a primary with the intention of short-term renting when I’m not there. I would assume there’s some sort of stipulation of if it’s a primary home mortgage around how often you can rent it out. So I would probably point that back to whichever loan officer or bank that you’re working with to get the debt. But if you do go the short-term rental route, there’s the 10% down second home loan, which is still an option A of lenders still offer this. So maybe you’re not getting the 3.5 or the 5% down with the primary residence, but 10% it’s not too far off. So I think there’s still some other options there to get you in for a lower down payment than a 20 or 25% type down payment.

Ashley:
And I think this one has a lot of emotional versus financial. I think as long as you run the numbers on each property and it’s a cash flowing deal or you’re living for free as a house hack, then I don’t think you can go wrong and I wouldn’t scrutinize over which one of these different strategies is going to give me the best return. Maybe if the short-term rental income potential just blows the single family out of the water, then yes do that. But since this is going to weigh a lot on how you live, this definitely has an emotional play to it. Do you have a preference if it’s a single family home and you’re going to live there and house hack the rooms or something like that, is that actually something you’d want to do or would you rather make a little bit less money each month or pay a little bit more to live in a house hack where it’s separate units?

Ashley:
So I think you definitely have to take that into consideration as much as I’d love to give you an answer of do this one. You have to look at the markets. Okay, so you said the Ozarks for short-term rental. What market would you do? The single family, the multifamily, what does the appreciation look like in those properties or in those markets? What would your cashflow be for each of those? So really run the numbers for each, run the numbers today, what they look like, run the numbers with you living in each of these properties, what it looks like for the next year, and then once that year requirement is done, what does the property look like as a long-term rental, renting out both units if it’s a duplex or converting it fully to a full on short-term rental all year round?

Tony:
Yeah, I think you hit the nail on the head ash. I think it’s hard for us to give a definitive answer about what option makes the most sense, but I think at the end of the day, Sean, the person who asked this question, it’s just like what do you want? What makes you more excited in terms of an investment? Is it a single family home that’s maybe lower maintenance and steady cash flow or is it the idea of having a vacation home in the Ozarks? You can go visit and I think if you weigh those two of like, Hey, what actually do I want more? What helps me achieve the goals that I have in mind? I think it’ll become a little bit more apparent. But the truth is that you also don’t have to choose between one or the other. Maybe the first deal is a short-term miss in the Ozarks and then maybe your next deal is a single family home or the small multifamily. So don’t feel that choosing one means that there’s no opportunity to do the other. It’s just which one’s going to first. And I think that just comes down to personal preference.

Ashley:
And Tony, is this Sean your son? Is he starting to remodel his room for one of his baby sisters to move into and he’s trying to figure out where

Tony:
He’s going? Yeah. Hey, I would be super proud if he’s got a home somewhere that I don’t know about that he’s in the middle of remodeling, so maybe one day.

Ashley:
Okay, we’re going to take our last break and we’ll be back with our last question right after this.

Tony:
Alright guys, so we’re back here with our last and final question for today. This question comes from Jared and Jared posted this in the BiggerPockets forms and he says we have $28,000 in savings and are looking to get into multifamily investing with a 20% down payment needed. I’ve thought about cashing out my 401k, which is worth around $40,000. I know the penalty will leave me with around $28,000 after taxes. I feel like there are more potential gains in real estate than leaving it in my 401k. I’m 35 and would plan to rebuild the 401k using property cashflow and savings. Should I cash up my 401k to buy my first property? So just for context here, $28,000 in cash, another $28,000 sitting in a 401k, or at least that you get after penalties and whatnot. So what is that a total of $56,000 they’d have access to go out there and get that first deal?

Tony:
I think my initial gut reaction is I would just focus on either a saving more capital. And I know that’s not like the sexy answer and it’s maybe not what Jart wants to hear, but I think that might be my first move because real estate investing does get easier if you have more capital to work with, just like point blank period. And the 40 K that’s in your 401k, I mean, I don’t know if it’s really going to move the needle a ton to go from 28 to 56 or if it’s worth, I think the 28 K to take it out of your account if you’re able to get like 200 K from your 401k. I think maybe it makes a little bit more sense, but it’s like how long would it take for you to save up that 28 K without having to tap into your 401k? So my initial gut reaction is like maybe let’s just wait and pause, but I don’t know Ash, what’s your initial take?

Ashley:
I always had this mindset of you, you don’t touch your 401k, you leave it, you let that grow, you’re diversified, you have the 401k and that was just like, I don’t know if it was just how I was brought up, even though I don’t think either of my parents had 4 0 1 Ks because they were both self-employed, but that was just always a mentality. You leave the 401k alone, you don’t touch it. The penalties and fees to withdraw from it do make me sick. Thinking about that much money gone right away. What I would first look at is doing a loan, taking a loan against your 401k. A lot of employers offer this where it’s usually, I think 50% of whatever your balance is in your 401k is what you can take out as a loan or up to $50,000. I’m not completely sure on this.

Ashley:
Ask your plan provider what it is, but I am pretty sure that’s it. So in this case, he would be able to take out $20,000 as a loan every week or whenever you get a paycheck, a small amount is paid back to your 401k. So the con of this is your money is no longer invested into the 401k. The pro is you’re paying interest but you’re paying interest back to yourself and it’s being reinvested back into your 401k. So that I think could be kind of like a compromise instead of paying those taxes and penalties is pulling your money out because you’re not going to invest it anyways in the stock market if you’re just going to cash out and put it in real estate. So I would borrow against that. The interest you’re paying is just going back to you. You’re paying interest to yourself.

Ashley:
It’s not like to a bank or anything. So I would look at that circumstance first. The next thing I would do is what I did was, and this was for an old employer though, I took the 401k from that and I moved it into a self-directed IRA. That way I can deploy the funds however I want. There are a lot of rules. I can’t go out and buy my own deal and use the funds from the self-directed IRA to actually fund that deal. It would have to be somebody else’s deal where I’m hands off from it. Maybe there was somebody else that had a deal, you were going to be passive in it, whatever. You could go ahead and partner with them, invest in a syndication as a great one that some people use their self-directed IRA funds for. And that’s just doing a rollover where you’re not paying fees.

Ashley:
I used equity trust, which is a great partner of BiggerPockets and it was the easiest thing I’ve ever done. I thought it really was going to be a lot difficult to actually roll over my 401k into self-directed IRA and then having to actually deploy my funds from the self-directed IRA into the investment was very easy too. They walked me through the whole process. So I think that there is, there’s other options for you besides just cashing out. And the third thing I would look at is what return has your 401k been getting you? What does the performance of it look like? What are the fees that you are paying? If you’re not solely invested in index funds, those fees are probably pretty large that you’re paying to have your 401k managed and for the fund fees that you’re paying. And then I would compare that to what kind of deal are you looking at and what would be the return of your money?

Ashley:
So compare what would be your return on investment in the stock market or if you put that money into a property, if you did pull it all out and run those numbers and see how they kind of play out. Obviously you can’t predict the performance of the stock market and say like, oh, but you can look back on average what’s been the performance of the portfolio and kind of use that as an average. And the same with real estate. Real estate could crash, there could be great appreciation and you sell your property and you make 50% on your money, whatever that in just one year. So you dunno, but at least you can kind of run the numbers to project which is the better return.

Tony:
Yeah, you bring up a lot of good points, Ashley and the 401k is a contentious topic, unlike Reddit. There’s some people who think the 4 0 1 Ks are like America has been scammed into this idea of the 401k and obviously there’s a lot of people who have made a tremendous amount of wealth in their life using 4 0 1 Ks. So I think the idea to participate or not participate is somewhat of a personal choice here that you’ll have to make for yourself. But I think the mistake that a lot of rookies make is they paint themselves into a corner because they have such a narrow scope on the decisions that they’re making. And what I mean by that is you said, I have 28 K and I need 20% down. That is not a factual statement because there are a ton of other ways to start investing in real estate that do not require a 20% down payment.

Tony:
You could house hack a small multifamily FHA three and a half percent down conventional 5% down something like naca, 0% down if you’re a veteran, 0% down with the VA loan. So you could house hack with significantly less than 20% down. There are investor loans. Again, we had Jeff Wogan on episode 5 88. There are 15% down investor loans you could go get that are not 20% down. We just interviewed Joe Pli on episode 5 84 and it costs him $0 out of pocket to get his first deal. He worked with the small local bank who funded the purchase and the renovation and he came out of pocket with $0 and you could do the same thing. And now your 28 K becomes your reserves for that property when you get started. So again, I think the mistake, Jared, that a lot of new investors make is that they have this idea of what real estate investing is, but the more you start to peel back those layers, you start to realize that there are so many other ways to get started.

Tony:
So if you’re dead set on investing in real estate, I would challenge you to say, okay, how can we invest with the 28 K that we have? What is the smartest move for us to make with the 28 K? And I think as you start to think through it in that way, like, Hey, if we could only tap into the 28 K, what options would we have? It’ll force you to get a little bit more creative with your solutions. So these are the kinds of big decisions every investor has to face at some point, right? Figuring out how to make your money work harder, what kind of property fits your goals, and how much risk you’re actually willing to take.

Ashley:
And remember, there’s no one size fits all answer. It’s about being honest with yourself about your financial situation, your timeline, and how much you’re willing to stretch. Thank you guys so much for joining us for this episode of Rookie Reply. I’m Ashley. He’s Tony, and we’ll see you guys next time.