10 Lessons I’ve Learned as an Airbnb Host

This is Episode 4 of The Airbnb Series. Before you read this, check out Episodes 1, 2 and 3.

Use this link to get a $25 discount on your first Airbnb guest stay. (If you use it, I’ll also get $25, a win-win for us both.)

Airbnb Host Lessons Plus Airbnb Coupon for $25 Discount

Almost one year ago, I launched a “side hustle” as an Airbnb host.

Since then, I’ve pulled back the curtain to show the good, the bad and the ugly. This includes sharing detailed spreadsheets showing my precise earnings from this hustle.
[Read more…]

The Airbnb Experiment: 42 Guests, 1 Police Visit, and $19,000

This article is Part 3 of The Airbnb Series. Before you read this, check out Part 1 and Part 2, and when you’re done, visit Part 4

Use this link to get a $25 discount on your first Airbnb guest stay. (I’ll also get a $25 credit if you use it, a win-win for both of us.)

http://affordanything.com/wp-content/uploads/2014/11/How-much-money-could-an-Airbnb-host-earn.jpg" alt="How much money could an Airbnb host earn?

Eight crazy months, 42 guests, one police incident, and $19,000 in gross income.

After three seasons as an Airbnb host, I could write a book. But instead, I’ll package the adventures, ideas and oddities into this blog post.

Brace yourself, this is an epic one.

New to this blog? Here’s the background: I own a handful of rental units. One year ago, I went on a renovation kick, morphing a 1-bed, 1-bath Atlanta apartment into a gleaming, upscale, stainless-steel-and-granite beauty.

It could fetch $1,100 per month on a traditional one-year lease. But I’m too antsy for the normal road. I strangely (and perhaps masochistically) subject my life to oddball experimentation for the sake of my personal curiosity and my readers’ amusement.

So I launched “The Airbnb Experiment,” in which I compare running a vacation rental against a traditional, one-year lease.

The vexing question: Could I earn more as an Airbnb host than I could as a “traditional” landlord?

If so, HOW much more? Is it worth a Rebel’s time?

Huh? What’s Airbnb?

Airbnb.com launched during the depths of the 2008 recession.

Its co-founders were roommates in San Francisco who couldn’t afford the rent. To scrape the rent payment together, they started inviting tourists to sleep on air mattresses (“air beds”) in their living room, and they served their guests breakfast — hence the name, “Air Bed and Breakfast,” which later shortened to Airbnb.

By 2010, the company had 15 employees working out of the roommate/founder’s shared apartment. To make room for these employees, the CEO gave up his bedroom and started couch-hopping through Airbnb. He lived out of a suitcase until the company could cough together the funds for an office space.

Their sacrifices paid off: Airbnb grew at an astronomical rate, gathering more than 800,000 listings in 192 countries over the span of six years.

I list my apartment on two vacation-rental websites, Airbnb.com and VRBO.com, although most bookings come from Airbnb. Three months into the experiment, I penned my first Airbnb update, and now … drumroll please … here’s the latest, 8 months into this project.

Shocking Adventures in the Vacation Rental Biz

Well, it’s official. When you host 42 guests over the span of 8 months — an average of 5.25 guests per month, or a turnover every 5 to 6 days — you’re bound to get at least one nut job.

That’s precisely what happened. It would be unprofessional to spill the gory details on the Internet, but let’s just say “we called the cops” and leave it at that. On a lighter note, I can now utter the phrase “we had a domestic” at cocktail parties. It’s my new favorite party trick.

(If I sound jesting or flippant, it’s because I use humor as a coping mechanism. Also, hats off to the City of Atlanta Police Department. Y’all rock.)

After what I’ll dub “The Incident,” I made a game-changing decision: I decided to stop using VRBO entirely, and I refuse to host any “new” Airbnb user. Here’s why:

In a traditional rental, landlords run extensive background checks on the applicant, which include:

  • Credit report
  • Criminal background
  • Employment history
  • References from previous landlords

By the time “tenant screening” is done, I know that the applicant holds a B.A. in Music from the University of Texas, made one late payment on their MasterCard, waited tables at TGIFriday’s for 17 months, and got an underage drinking citation when they were 19. Creepy, huh?

Obviously, we can’t go to those lengths for vacation rentals (imagine having your credit screened every time you stay at a hotel?!)

Yet most vacation-rental hosts will ask: “How do I know this guest isn’t a huge weirdo?” The answer: Read the reviews.

On Airbnb, the hosts and guests review one another. (I’m proud to have 18 reviews with a 5-out-of-5-star average.) On VRBO, the guests review the hosts — there’s no vice versa.

There’s an (inevitable) snag in both of those designs.

Airbnb’s skyrocketing popularity is a double-edged sword: Hosts get inquiries from guests without reviews. I’m often contacted by people within a few days after they’ve established a new account.

In the past, I’ve always given new guests a chance. Not anymore. After “The Incident,” I require every guest to have at least one positive review. And I won’t accept any new reservations from VRBO.com, since that website doesn’t have the functionality to evaluate the guests.

(In fairness, 41 out of 42 guests were rockstars. It’s that 1 out of 42 that hogs the spotlight.)

The drawback to my self-imposed policy? My vacancy rate will probably jump. The benefit? I hopefully won’t need to call the cops again.

Spill Your Numbers: What’s Your Airbnb and VRBO Income?

Speaking of vacancy rates — let’s cut to the chase. Time for all numbers to be revealed.

Note: This isn’t gratuitous “financial porn.” I’m sharing these numbers because I hope it will be an effective teaching tool — and I’ll expand on the lessons carried by these numbers in the rest of the post.

In the past 8 months, the gross income from Airbnb and VRBO came to $19,004.93, which is an average rate of $2,375.62 per month. Given that the unit rents for $99 per night (plus cleaning and pet fees) and I’ve had strong occupancy, this makes intuitive sense.

Here’s the spreadsheet. “HomeAway” refers to VRBO (it’s the parent company). “Withdrawals” are security deposits I’ve refunded.

How much do Airbnb hosts make

But wait! “Gross” revenue is meaningless. Let’s check out the expenses:

how much can an airbnb host earn

The results are in: Being an Airbnb host allows me to earn, on average, $605.55 per month more than being a traditional landlord.

That’s an extra $4,844.37 above the “benchmark” in the 8 months I’ve conducted this experiment.

What’s Your Hourly Rate?

I’m glad you asked.

I didn’t keep great notes on the time I spent, but I think two hours per turnover is a reasonable approximation. That represents:

  • 90 minutes of cleaning per turnover
  • 30 minutes of emails, phone calls, etc.

(I hired a housecleaner on a few occasions, but I also dealt with miscellaneous oddities, so we’ll call it even.)

That comes to 84 hours, which we’ll round up to 90 hours to err on the conservative side.

An extra $4,844.37 across 90 additional hours of work comes to a $53.82 hourly rate. That’s not as stellar as the $92/hr rate I estimated after three months, but it’s not bad.

A few notes:

  • Consumables such as soap, coffee, shampoo, detergent, etc., cost less than I expected. Yay!!
  • Utilities cost waaayyyy more than I anticipated. “When the landlord is paying, let’s crank the A/C!”
  • Cleaning I’ve handled myself, unless Will and I are both out-of-town.
  • Landscaping costs more than I’d spend on a traditional rental property, since I’m planting more flowers around the apartment entrance. (It creates a better guest experience.)
  • Standard overhead (e.g. mortgage, maintenance, etc.) are the same regardless of whether this is a vacation-rental or a traditional-rental, so they’re excluded from this spreadsheet. If you’re curious, you can scope out those numbers here.
  • Nerd Alert: The $1,100 benchmark is pre-vacancy, while the actual Airbnb/VRBO numbers reflect vacancy. I contemplated reducing the benchmark to adjust for this occupancy discrepancy, but decided to hold to an $1,100 benchmark because its a conservative estimate — the apartment may rent for anywhere from $1,000 to $1,250 depending on the time-of-year and market conditions. #GeekSpeak

Passive Income vs. Active Income: Showdown!

Travel is one of my greatest loves. These days, I’m out-of-state more than I’m home.

As a “traditional” landlord, this ain’t no thang.

Rental properties (done right) are wonderfully passive. In fact, I’ve coined a formula: “PM + PM = Passive,” which means “Preventative Maintenance + Property Manager = Passive.”

  • Preventative Maintenance means spending lavishly on “Keeping Sh** from Breaking.” Tune your HVAC, re-caulk cracks, replace that prehistoric water heater before it triggers an emergency. Prevention also means enforcing strict tenant criteria.
  • Hire the best property manager, not the cheapest.

A great-condition property with an incredible tenant and a kick-butt manager is a gloriously passive asset — on par with an index fund portfolio. Legit.

But here’s the problem with vacation rentals:  

  • Inability to properly screen tenants (as we chatted about above).
  • Insufficient margin to pay a manager and still make a profit.

In fairness, some vacation rentals may carry this margin — perhaps some gorgeous villa on an exotic beach. But my Atlanta apartment, which costs $99 per night, can’t support that type of margin.

The only way to collect a so-called “profit” (ahem) is by managing the turnover yourself. And that means one thing: It’s NOT passive. Not by a long shot.

So here’s my conclusion:

Running a vacation rental is an awesome side hustle. But it’s NOT a passive investment.

You Should Be a Host If: You want the cold, hard cash.

  • You’re looking for a side hustle.
  • You’re trying to pay down debt.
  • You’re restless and need a new project.

You Should NOT Be a Host If: You want a hands-off passive investment.

  • You want to travel the globe, living on passive income.
  • You have a crazy-hectic-busy-stressful job.
  • You’re looking for an alternative to an index fund or rental property.
  • You crave location independence.

For months, I fretted about WHY vacation-renting is so hands-on. “Is it me?? Do I suck at creating systems / checklists / automation?”

Then Will made an astute observation: “This isn’t the Real Estate industry. This is the Hospitality industry.”

Duh!! He’s right. As an Airbnb host, you’re not a landlord — you’re a hotel owner. A hotel of one.

(That should be a commercial tagline. “I’m a hotel of one!”)

What the Heck is ‘Management’? Do You Mean ‘Cleaning?’

Whoa, are you still reading? Awesomesauce.

If you’ve made it this far, you must be either bored-off-your-skull or dying to know more. I’ll assume the latter, and explain what I mean when I talk about vacation rental “management.” Here’s an example:

We set up an “air bed” (hey-oh!) anytime that:

  • A guest requests one
  • A guest makes a reservation for more than 2 people

Last month, our air mattress sprung a gigantic (un-patch-able) leak. We threw it away, figuring we’d replace it the next time we need one.

Two weeks later —

Will and I flew to San Diego (for the third time this year) for an arts and music festival. Before we left, we arranged everything:

  • A 24-hour gap between check-out and check-in, to leave “wiggle room” for any problems.
  • Clean sheets and towels stored within the unit.
  • A two-hour housecleaning, coupled with a step-by-step checklist (e.g. “wipe the inside of the microwave …”)
  • Keys stashed in a spot the guest can access without needing anyone’s physical presence.

In theory, everything is streamlined, systematized and automated.

In theory.

The guest checks into the unit and sends me a text message: “Where’s the air mattress?”

Uh-oh.

She booked a reservation for 2 adults. She arrived with 2 adults and 2 children. From her perspective, this is a minor oversight: She brought her kids, unannounced. What’s the big deal?

From our perspective — it was a very big deal. How could we set up an “extra bed” from California?

  • Plan A: We couldn’t Amazon Prime an air mattress to her — it would take two days to arrive — and FedEx Overnight wouldn’t arrive until morning.
  • Plan B: We called our roommate to ask for help. She couldn’t buy an air mattress, either, since she doesn’t have a car or bike, and the nearest Target is too far to walk. (She moved to the U.S. last month.)
  • Plan C: We asked our roommate to haul the physical mattress from our bed. “Can you please lug our mattress to the vacation-rental unit? Pretty please?” She tried, but that mattress was too heavy.
  • Plan D: Ultimately, she gave the guest our duvet, sheets, and as many pillows as she could conjure. The kids slept on the floor.

Needless to say, this was a lose-lose-lose situation:

  • It stressed us hardcore.
  • It gave our guest a sub-par experience.
  • It burdened our new roommate. (“Welcome to America! Can you haul a mattress up a flight of stairs?”)

And that, ladies and gentlemen, is what I mean by “management.”

No matter how well you plan, no matter how many checklists you create, you need an on-site manager who can deal with unplanned situations.

How much will that cost?

Unfortunately, vacation rental management typically costs between 40 to 50 percent of gross revenue. (I hear your groans! But don’t worry: That’s super-fair, considering how many turnovers, inquiries, checkout inspections, cleaners and key hand-offs they need to manage.)

Lop 50 percent from the $19,000 gross revenue, and you’re left with $9,500. Eek!!

That’s not enough to cover the rest of the expenses:

Airbnb is good money for a side job, but is not passive income

Even if it could beat a traditional lease, the net profit (after management fees) would be too small to justify the added risk and hassle.

That’s why I believe vacation-rental hosting is a great job, not a great investment.

Update 11/15/2014: There are companies like Guesty that will conduct “virtual management” — e.g. dealing with online inquiries and booking — for only a 3 percent fee. But that’s the easy part. These “virtual management” companies can’t provide boots-on-the-ground support, when guests ask, “Where’s the air mattress?” or “Can I have more towels?” or “Help! I need a plunger ASAP.” There’s a startup called AirEnvy that provides “full” boots-on-the-ground management for only a 12 percent fee, but they only offer this in San Francisco and Los Angeles, as of today.

Epilogue

My goal (personally) is to create passive investments that support a location-independent lifestyle, so this Experiment must reach an inevitable end. But it’s an awesome side job for anyone who’s not traveling (yet) and wants extra cash.

The apartment is booked through December, so you’ll be hearing another update before the end of the year — which will feature specific tips that any aspiring Airbnb host can put into practice.

An awesome host-guest experience is a two-way street, so my next post will ALSO include tips for first-time guests, including how to choose stellar listings, what level of service to expect, and how to maximize your shot at an awesome experience.

P.S. Want to be an AirBnb guest?  Use this link to get a $25 discount  on your first AirBnb booking. (I’m trusting that you’re among the 41 out of 42 people who aren’t nutty.) I believe in total transparency, so I’m sharing upfront that if you use the link to get a discount, I’ll also receive a $25 credit. Win-win!

Update 3/11/15: Check out Episode 4 of The Airbnb Experiment  — Now at nearly $30,000 in gross income, at the one-year anniversary of launching this experiment.

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How I Earned an Extra $40,800 in Two Years Without Lifting a Finger

how to earn an extra $40,800 in two years

Despite the fact that I have the best roommates in the world, I’ll occasionally remark, “I’m tired of having roommates.”

And Will replies: “Are you $1,700 per month tired of it?”

I don’t need to respond. The answer is obvious. The minor inconveniences — sharing a refrigerator, waiting to use the washing machine — pale in comparison to the additional $20,400 per year that our roommates contribute to our mortgage. It’s a total no-brainer.

In the past two years of living with roommates, we’ve collected $40,800 — enough money to buy a rental house that provides a stream of income for the rest of our lives. (More on that below).

But before I get there, I want to clarify that this isn’t a post about living with roommates. It’s a post about an ever-important concept called Opportunity Cost, critical to anyone who wants to supercharge their wealth.

Yes, we could move into a one-bedroom apartment, and perhaps someday we might. But as long as we live in our three-bedroom unit, we face a trade-off: Will and I could either live solo, like a “normal” couple, OR we could accumulate an extra $20,400 per year without needing to lift a finger.

(And as someone who types on a laptop for a living, I mean “lift a finger” literally. I get paid to lift my fingers.)

Normalcy carries a massive opportunity cost.

Normal Sucks

When we were in our early 20’s and fresh out of college, living with roommates was “normal.” But we’ve gotten older. Times have changed.

Will is almost 35, and I’m within spitting distance of my 31st birthday. We’re long past that collegiate stage of life, and over the years we’ve watched our friends escalate their lifestyles. Our friends now maintain vacant rooms — “guest rooms” — in their homes. They’ve purchased furniture, financed cars, bought diamonds.

Meanwhile, Will and I are the freaks who still live like college kids.

I can’t decide whether it’s ironic or fitting that we’re also the most financially stable. Zero debt, except the mortgages. Owners of five houses, two of which are paid-in-cash, and three of which are rapidly getting paid-off. Maxed out 401k, IRA, HSA. Huge emergency fund.

None of that grew on trees.

To illustrate the awesome power of understanding opportunity cost, let’s check out a super-simple real-life example.

Here we go:

Income: Our two roommates each pay $850 per month, for a total of $1,700 monthly. (They also cover half the utilities, but they use half, so we’ll call that even.) That means two years of living with roommates creates $40,800 in income.

Meanwhile …

Investment: A few weeks ago, we purchased a rental property for $46,000 in cash.

Coincidence? Maybe not. (Thanks for buying us a house, roommies!)

Let’s forget EVERYTHING else that Will and I do to amp-up our savings. Let’s forget about the fact that I launched my own business a few years back, growing it from $0 to six figures. Let’s forget about the fact that I drive a used Honda Civic, eschew cable TV, wear the same clothes again and again. Forget ALL of that.

Look ONLY at the fact that we have roommates. Notice that this single decision alone brought forth enough income to buy a house in cash.

Wowza.

But wait — let’s take one more step (just for the sake of over-doing it).

This rental house will command around $900 per month. Let’s say that half the rent will get gobbled up by operating expenses (taxes, insurance, vacancy, management, repairs, maintenance, bookkeeping, accounting). At this ultra-conservative estimate, this property will net $5,400 per year in passive cash flow.

Over the span of 40 years, this means we’ll earn $216,000 (in today’s dollars) — and that’s assuming we blow that money on champagne and caviar. If we re-invest that money, instead, it morphs into even more. The simple decision to have roommates for just two years could translate into $500,000+ over our lifetime. Wowza!

So let’s rephrase this question:

Imagine that a Magical Genie appeared before you, encircled by a haze of swirling mist and spicy perfume. (If it helps, picture the blue Genie from Aladdin.) After you recover from your initial shock, the Genie bequeaths you with a gift of $216,000. The only catch? You’ll need to spend two years living with two pretty cool people. You can choose these people, of course, and continue living in your own home.

Would you accept that deal?

Duh.

When You Make Decisions, Imagine the Aladdin Genie

It’s easy to focus solely on out-of-pocket costs. When you swipe your Visa, the price tag is unmistakable. But most people overlook opportunity cost — the hefty price tag that comes with each decision.

Every choice is a trade-off. And sometimes those trade-offs come at the cost of lowering our income, which shrinks our capacity to flex our investment muscle.

So whenever I make a decision, I like to imagine that a Magical Genie is offering me “a gift with a catch.”

For example:

There’s a cloud-storage system called Dropbox that can backup and sync your photos and files. The first 2 GB are free, but you can snag 1,000 GB for $99 per year. Since I’m naturally prone to frugality, I debated whether $99/year was worth the price.

Then I pictured the opportunity cost:

Imagine that I lost all my files and photos. The Magical Genie appears before me, and says “For $99, you can have it back.” Would I take that offer? Of course.

In other words, I make decisions by imagining the cost of NOT getting that item — the opportunity cost, the missed chance. Sometimes, this results in refraining from a purchase. (Imagine that I wore an old pair of earrings to a conference. A Magical Genie says, “you can wear different earrings.” Eh, boring. Still not interested.)

But other times, this makes the decision a no-brainer — like in the case of upgrading Dropbox, living with roommates for two extra years, or deciding to spend my surplus $46,000 on investments rather than crap.

(By the way, I think it’s hilarious when people imagine “investors” as Wall Street-types wearing fancy suits. My investment analysis involves daydreaming about 1990’s cartoons.)

(If you like that, tweet it.)

Objection, Your Honor!

I imagine that a few objections I’m going to hear include:

“But I can’t earn that much renting a room in my house! I only have one spare bedroom — and it would rent for $500, max.”

Work with what you’ve got. That’s $6,000 per year, enough to max out your IRA without needing to pitch a dime of your “earned income” into that retirement account. In other words, that renter can buy your retirement.

Another way to view it: That’s $12,000 in two years, which is enough to pay cash for a car.

“But I value my privacy. I don’t want to live with a roommate.”

Do you $500+ per month value it?

“Yes.”

That’s totally cool — as long as you’re deliberately deciding.

What’s the Afford Anything mantra? You can afford anything, but not everything. Every decision comes with a trade-off. You can either rent out your spare room, OR you can log extra hours on-the-job to earn the equivalent amount of money. Your life, your choice.

The key, though, is to avoid the deprivation trap: “In this economy, there’s absolutely no way to get ahead!”

Wrong-o. There are plenty of ways. Hundreds of ways. The paths you choose are up to you. Be deliberate. Be intentional. Accept the trade-offs. And don’t complain that you’ve run out of options.

“I already live in a one-bedroom.”

Awesomesauce!! If you want to live solo and frugal, downsizing is the way to go.

“I have kids.”

Will’s Dad had roommates who helped pay the mortgage, back when Will and his sister were in elementary and middle school. Why do you think Will is so enthusiastic about the idea?

By watching his Dad pay the mortgage via roommates, Will saw awesome role-modeling — frugal parenting through harnessing opportunity and working with what you’ve got. Plus, he got a chance to live with grown-ups from around the world, which broadened his horizons and turned him into the mature globetrotter he is today.

“This blog post is too long.”

Oh, fine. I’ll finish now. And as a parting thought, let me reiterate that this isn’t a post about living with roommates, per se. It’s a post about recognizing opportunity costs — and being deliberate about the trade-offs you’re willing to make. You can afford anything, but not everything, and every choice will impact your path, for better or worse.

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Five People, One Income, and Self-Made Success

bootstrapping real estate investor
Myth: If you’re supporting 5 people on 1 income (and it’s not a high income), you’re screwed. You’ll never become a business owner or an investor. You’ll be lucky just to pay the bills.

Fact: Ladies and gentlemen, meet success story: Rental Randy.

In my last blog post, I re-emphasized that the best way for two-income couples to turbocharge their savings and investments is to live on one persons’ income, and save 100 percent of the others’. Live like you’re a one-income couple.

This led to a great follow-up question: What if you’re already a one-income family? Specifically, what if you’re a family of 4 or 5, living on one income? What then? (And what if you’re single — a “family of 1″ living on one income?)

Here to answer that question is an Afford Anything reader named Randy, who supports his family of 5 on a single income … and still bootstrapped his way to becoming a successful real estate investor.

Here’s his story, in his own words, completely unchanged / unedited:

Five People, One Income, and Two Years of Savings

I have three children and did not buy my first income property until after my youngest was born. My wife does not share my drive to prepare for our future, which means she does not contribute financially to this cause. I pay the majority of the family bills and I do not have a high paying job. Still, I managed to save enough to get my first property. It took two years of saving every dime (literally) I could.

I have an unconventional life and job and work odd hours so I could be a stay-at-home Dad and primary caregiver for our children. It means I have to live off 4-6 hours of sleep a night and be a walking zombie some days, but that’s okay. I did it primarily so our kids would have a parent looking after them and not a day care employee, but I can’t lie and say the money saved wasn’t a small part of that choice.

You have to start. Just start.

One year, I decided to open a Rental House savings account at my bank. I started with about $25. Every chance I got, I deposited money in that account. Tax return? (having a mortgage and three kids helps there) Straight into the Rental House account. Xmas Gift money? Sorry kids and wife, but no big ticket gifts this year or the next. That money’s going straight into the Rental Home account. Friends want to meet at the local bar/restaurant and have fun? Sorry guys, I can’t go out until I buy an investment property. That’s $30 into the Rental House account.

I didn’t choose to buy a home that was outside my budget — say, the type of home/neighborhood you or I might choose to raise our children. That would be setting myself up for failure. Besides, it offers a sort of built-in excuse for not accomplishing my goal. I chose a price point that worked for me, went to the real estate websites, and searched for properties I could afford.

Then, after I’d saved a few thousand dollars, I went to my bank and asked how much money they would loan me. Remember, I don’t make a ton of money. I was disappointed when the bank offered $10,000 less than I wanted. No problem. I lowered my Rental House budget and kept searching. I found a property that needed a little bit of repair. Between the money I’d saved and the bank loan, I bought the property, fixed it up, and had it rented in two months.

I don’t view the rental income as “income”. It all goes to paying down the debt. The sooner I pay it down, the sooner I can buy more properties. Both my homes are owned free and clear, though I have a few thousand to pay back on a line of credit I used to help fix the second property. Also, I have a bank lined up to provide a HELOC on one of my rental houses. I will use that money (and some of my own savings) to buy my next property.

It can be done. You just have to start. Now. You don’t need a detailed plan initially. Just start saving. Now.

Savings Happens in Small Increments

Boom! Drop the mic!

That was awesome. Thank you, Randy, for sharing your story with the Afford Anything tribe. You rock.

Here are some key takeaways from Randy’s story:

#1: Savings Happens in Small Increments.

It’s tempting to get shell-shocked by a large number. “I need to save $12,000? How on earth can I come up with that?”

But savings unfolds in tiny increments. You save $10 or $20, again and again, until you reach your Mega-Number-Goal.

(It’s like burning calories — you burn an extra 50 calories here, an extra 70 calories there. And pretty soon, these tiny increments have added up to 3,000 calories, and you’ve lost 1 pound.)

(Or, conversely, you nibble on an extra 40 calories here, an extra 80 calories there, and soon you’ve gained 1 pound.)

When people say that they can’t trim their budget any further, my response is:

  • Do you buy red meat, like beef or pork? Swap it with beans/lentils or possibly chicken, and you’ve lowered your grocery bill by $20 – $60+ per month.
  • Do you pay someone to cut your hair? Start trimming your own, and you’ll save $10 – $50 per haircut, depending on the “caliber” of salon you’ve been frequenting.
  • Do you buy orange juice, cheese, and other packaged foods? I love juice, and I used to buy a ton of it. But when I was saving for my round-the-world trip, I knew I needed to cut back. Each time I shopped, before I hit the checkout aisle, I’d put back any juices in my cart and devote that money to my Travel Fund. (I literally kept an envelope with me, marked “Travel.”) That meant I saved an extra $6 each time I hit the store — about $24 per month, or $288 per year. (And these days I make my own fresh juices / smoothies at home.)

There are always ways that you can save more. Remember: there’s a difference between “I can’t” vs. “I choose not to.”

#2: Your Goal is Investing (Earning), Not Saving

Frugality is the first step — not the last.

Nobody penny-pinches their way to wealth. If that were possible, the most miserly, cheapest SOB’s would be billionaires. But they’re not.

Instead, the (self-made) millionaires in our society are the people who build valuable businesses and invest in cash-flow machines. That’s where you focus needs to stay.

Frugality is a means to an end; it’s the method by which you raise your initial investment money — your “seed” money. But you can’t stop there; you need to move to the next step.

Notice that Randy didn’t penny-pinch … and then let his money fester in a savings account. Instead, he bought an asset which will give him monthly cash flow for the rest of his life.

#3: Reinvest Your Profits

Here’s where the magic really happens:

Randy will reinvest the equity from Rental House #1 (plus his “day job” income) to buy Rental House #2. And I’m betting that he’ll use the equity/cash flow from Rental Houses #1 and #2 to purchase #3.

Do you see where this is going?

This is classic “the rich get richer.” Instead of spinning around on the time-for-money-exchange (known as a J-O-B), you create profits — and use those to create more profits.

After a few cycles of this, Randy won’t need to use his “day job” income to buy houses anymore, and he won’t need to appeal to banks. Instead, his houses will start buying more houses.

And at that point, you’ve really won the game.

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We Bought House #5. Here’s a Behind-the-Scenes Look — Including the Numbers.

Moderation is not my strong suit.

I don’t just eat one chocolate-chip cookie — I either eat zero, or I eat the whole batch. I don’t just travel for a weekend — I either stay at home, or I hit the road for weeks/months/years.

And apparently, I can’t just buy one or two houses. Afford Anything Tribe, I’d like to introduce you to House #5, which is Rental Unit #7 in my ever-growing passive income portfolio.

In this article, I’ll share the no-holds-barred, behind-the-scenes story:

  • How I found this house.
  • Why I choose this area.
  • The NUMBERS! Yes, you nosy people — all $$ will be revealed. :-)

But first … check out the pictures.

Click Display Images in your email program to see this picture - rental unit #7 in Atlanta

The outside of the house … not too shabby!

atlanta rental property

Selfie! Because the first thing you do when you buy a new house is take a selfie, right?

cage your air conditioner - real estate investing lesson

Ah, now that’s home security …

rental property investing in atlanta - house 5 - the kitchen

The stainless steel stove is a nice touch, and the cabinets in are decent shape. Planning to add a dishwasher, though.

rental property investing in atlanta - house 5 - the bathroom

Thank goodness the tile and sink top are a neutral white color. Might swap the faucet for a modern chrome color.

rental property investing in atlanta - house 5 - the master bath

The so-called “master” half-bathroom is small but in good condition.

Can you read this? If so, click Display Images in your email program

Another selfie!! Will takes a pic in the bathroom mirror.

rental property investing in atlanta - house 5 - the living room

Ah, good ol’ windows on two adjacent walls. Add some curtains and you’ll have a pretty nice room.

rental property investing in atlanta - house 5 - the bedroom

How on earth do you snap an interesting picture of an empty bedroom?

totally irrelvant cat photo

Completely irrelevant cat photo. Because the Internet needs more cat photos.

It started with this blog.

People who blog about money tend to know each other. We hang out and swap stories about our websites, usually over strong margaritas.

So about two years ago, I had dinner with a blogger named Lauren Bowling, who (at the time) had just launched a site called L Bee and the Money Tree.

(When we met, she immediately blurted out: “I thought you’d be taller!”)

Lauren was getting started in real estate investing. She and her fiancé purchased a fixer-upper in an “improving” neighborhood. Their plan: Remodel the home, live there for 5+ years, and enjoy equity gains as the rest of their neighborhood slowly beautified.

At least, that was the theory.

Instead, they broke up. Ouch.

But Lauren is a strong lady. She kept the house, oversaw a major renovation by herself, and — about a year ago — invited me to her “housewarming” party to celebrate its official unveiling.

As I drove past the ramshackle buildings that dotted the road to her first investment house, I’ll admit: My knee-jerk reaction was, “OMG Lauren, are you f***ing crazy?!”

Her neighborhood — at first blush — doesn’t seem like a place where you’d want to invest.

You can tell a lot about a neighborhood by the types of businesses located there. In cushy middle-class neighborhoods, you’ll see Starbucks, CostCo and Panera Bread.

In respectable working-class communities, you’ll see little “bodega”-style food marts, beauty salons, thrift stores, and the occasional used tire yard or emissions-testing station.

But Lauren’s neighborhood? Several storefronts were boarded up; vacant. Uh-oh. That’s not a good sign.

But any good investor looks at a neighborhood not for what it currently is, but for what it’s on track to becoming. Formerly-vacant buildings are beginning to fill. The area is turning around.

Lauren saw its potential — and urged me to develop my vision, as well.

I was dubious — (all investors should nurture healthy skepticism) — but I started digging for information. And the more I dug, the more I began to conclude that she was right.

How to Evaluate a Neighborhood

Lauren’s neighborhood is still a tad outside my comfort zone (she’s a very early adopter), but a nearby section of Atlanta, called West End / Adair Park, definitely suited my style.

This neighborhood used to be thriving, I discovered, but it fell during the 1970’s and 80’s and experienced ensuing blight. Here’s a crime map: “Red” indicates high-crime-risk; “Green” shows low-crime-risk. As you can see, I’m looking for houses in the “Yellow” zone.

atlanta crime map - real estate investing

Image courtesy Trulia.com/local

This area is now seeing a slow-but-steady revitalization.

Jobs and Business - It’s close to the airport and features easy public transit access, meaning that many airport workers (TSA officials, baggage handlers, etc.) live here. The surrounding area also holds other service jobs (manufacturing, delivery, etc.) which also keep this neighborhood alive. One strong vote of confidence: Ace Hardware opened a location here. (Hardware stores are an especially strong sign of neighborhood development — by definition, they’re the first type of business than a re-developing area needs.)

Transit - The Atlanta Beltline is a planned 33-mile loop of multi-use cycling/walking/jogging trails alongside 22-miles of light-rail tracks. Once complete, the Beltline will link the city’s neighborhoods together, improving accessibility and reducing Atlanta’s car-dependence. Fortunately, the Beltline runs directly through this neighborhood. In fact, a 2.4-mile section of the Beltline has already opened here. That’s a huge +1 for this neighborhood.

Greenspace – This neighborhood opened a new park in 2008, alongside the Beltline. Why does this matter? It’s good for home-price stability, quality of life, and it’s a symptom of smart urban planning.

Infrastructure – The local authorities recently invested $2 million in new sidewalks, streetlights, trees, and other neighborhood improvements. Awesomesauce.

Artists - Atlanta’s “what’s happening” magazine, Creative Loafing, called this area the “Best Neighborhood for Artists” — another strong sign that the area is improving. (Tip: Follow the artists.)

What Are Other Investors Doing?

Signs point to neighborhood improvement, so Step Two is to start chatting with other local investors.

I met one person who purchased a home in this neighborhood for $25,000 in spring 2013. He invested about $100,000 into renovating it, listed it for $192,000 in spring 2014 — and received multiple offers. :-)

This tells me two things:

  • The underlying land is cheap …
  • … yet people want to live here.

That’s a perfect combination.

Why? Land is overhead. I don’t make money from the land; I make money from the building. The less I need to spend on the underlying lot, the more I can put into updating the cabinets / countertops / appliances. Cheap Land + Consumer Demand = Happy Investor.

Meanwhile, on the corporate builder/developer scene, this neighborhood just opened its first condo — “SkyLofts” — in a former abandoned Sears parking lot, and the units are selling quickly. Another +1 for the neighborhood, as it reflects growing demand.

Three Crucial Concepts About Real Estate Investing

Okay, so I’ve identified a neighborhood that’s (potentially) improving, and I’ve met other investors who are profiting nicely in this area. But why should I buy a house there? How does “Theory A” lead to “Conclusion B”?

Let me take a step back for a second, and quickly explain three critical concepts:

1) Risk is Tied to Reward

If you buy stocks, you carry more risk than someone who buys bonds. You also enjoy the potential for bigger rewards.

That’s simple enough, right? But it doesn’t end there. WITHIN the niche category of “U.S. stocks,” some investments are riskier/reward-ier than others.

A large company like Coca-Cola or Nike probably won’t collapse — but it also probably won’t experience double-digit growth. It’s low-risk, low-reward. Likewise, a tiny startup company might flop. Or it might become the next Tesla Motors. More risk, more (potential) reward.

Risk is tied to reward, both across categories as well as within categories.

Are you still with me? Okay, let’s apply this to rental properties:

An established neighborhood features:

  • Low turnover
  • Low vacancies
  • Stable values
  • Low-risk, low-reward.

An emerging neighborhood features:

  • High-turnover
  • High-vacancies
  • Volatile values
  • High-risk, high-reward.

And that leads us to the next point —

2) Judge Your “Risk-Adjusted Return”

Occasionally, I’ll get an email from a reader saying: “You’re only getting X percent returns? Ha! I get Y percent returns!”

But that information alone is meaningless. Investors need to judge reward in the context of risk.

The stock/bond market is an obvious example: Getting 10 percent returns from your Enron stock is different than getting 10 percent from a U.S. government bond — it’s not “the same” 10 percent. If you’re comparing two investments with different risk profiles, X does NOT equal X.

That’s why you need to understand investments within their risk framework.

In traditional stock-investing, this is referred to as “risk-adjusted return,” and analysts have devised all kinds of fancy algorithms to try to understand it.

You don’t need a finance degree, though — you just need to understand this broad concept, and apply it to your own personal choices.

And that brings us to our last point —

3) Diversify Your Holdings

If you have a 401k or IRA, you should split your money between some combination of U.S. stocks, international stocks, bonds, and cash.

I mean, duh. That’s basic.

The same applies to real estate investing. If you’re going to own a handful of rental properties, you should diversify enough so that you’ve spread your bets, but not so much that you lose track of what you’re doing.

For example: I specialize in residential rental properties in metro Atlanta. That’s niche.

  • I don’t flip houses.
  • I don’t own retail space, offices, warehouses or mobile home parks.
  • I don’t invest outside of metro Atlanta.

Am I missing out on plenty of great opportunities? Of course. But I can’t become an expert at everything, so I’ve narrowed my niche to a very specific property type and location.

I can’t do everything. I do ONE thing, and I do it well.

However, WITHIN that niche, I diversify. My properties are located in across the city, in neighborhoods that range from “trendy” to “suburban,” from “established” to “emerging.”

Here’s a map of my property locations:

atlanta real estate investing map - click Display Images in your email to see this

Why This House?

Back to my original question: Why did I buy this house?

To diversify my holdings.

Most of my rental properties fall towards the conservative side of the risk-reward spectrum. I own properties in stable, well-established neighborhoods.

As a result, most of my properties (only) meet the One Percent Rule. They rarely exceed it. And they almost never double or triple it (with the exception of House #2).

But in the same way that an investor might put a small fraction of their portfolio in “frontier markets” like Ghana or Albania, I decided to put a small fraction of my portfolio into a “frontier neighborhood.”

And that leads us to House #5 / Rental Unit #7 —

  • Stats: 4-Bedroom, 1.5-Bath
  • Size: 1,625 square feet
  • Style: Suburban Ranch House
  • Condition: Good
  • Built: 1972

Last Sold: $140,000 in October 2009

Foreclosure or Short Sale?: Of course! Everything I buy is a foreclosure, short sale or distressed sale. (That’s where you snag the best deals, y’all!) This house was a short sale, just like House #1 (my first investment). Houses #2 and #4 were foreclosures, and House #3 was a distressed sale / motivated seller.

UPDATE JAN 13, 2015: I’ve updated these numbers to reflect the actual (ballpark) repair costs. We replaced the kitchen cabinets and countertops, bath vanities, carpet/padding, installed gutters and added a new A/C. We theoretically could have deferred the kitchen/bath upgrade for a few more years, but we decided not to procrastinate. Better property = better tenants. :-)

What did I pay for this?

  • Purchase Price: $46,000
  • Repairs Needed: $15,000
  • “Total” Acquisition Cost: $61,000

What does that gross?

  • Rental Income: $800 – $1,000 per month
  • Does it Meet the One Percent Rule? Obviously.

What does that net?

  • Mortgage: — (Paid-in-Cash)
  • Taxes: $67.41 per month ($809/year) based on 2013 tax records
  • Insurance: $58.33 per month ($700/year) estimated
  • Vacancy: $75 per month ($900/year) at 92 percent occupancy, $900/mo rent
  • Management: $90 per month ($1,080/year) at 10 percent fee, $900/mo rent
  • Repairs/Maintenance: $50 per month ($600/year) based on “one percent of purchase price” rule-of-thumb
  • Total Expenses: $340.74 per month

Cash Flow: $459.26 — $659.26 per month, or $5,511.12 — $7,911.12 per year

Cap Rate:

  • $5,511.12 / $61,000 = 9.03 percent
  • $7,911.12 / $61,000 = 12.96 percent

WTF does that mean?

In a nutshell:

  • The “cap rate” (the “return on investment”) is between 9 to 13 percent. WAHOO!!!!!!!
  • The “cash flow” (the $$ in my bank account) is $5,500 – $8,000 per year.

Another victory for the Financial Independence // Passive Income Brigade. This house offers uber-strong cash flow, a ridiculously awesome return, PLUS the potential for long-term equity gains (which is pure icing on the cake.)

Happy dance!!!!!

And with that …

FAQ’s:

Q: Is that literally the exact amount you’ll earn?

A: No, I’m not going to have precisely $600.00 in repairs annually, nor will I have exactly 92.00 percent occupancy. This is an educated estimate based on prior years’ tax records, current insurance rates, the maintenance history of my other properties, and an analysis of other rentals in the same neighborhood. In reality, real estate earnings will fluctuate every year — that’s why you should be prepared for a range. (Also, note that vacancy/management estimates are based on $900/mo rent.)

Q: How in the $%#&(&!@ did you pay cash for a house??

A: Will and I live on one person’s income, and save the other’s.

In 2012, we earned roughly the same amount, so we saved about 50 percent of our income. In 2013, my earnings outpaced his, which meant that we saved 77 percent of our income. My business continues to boom in 2014, and again, all of my income goes into savings (and taxes).

This goes back to the mantra I keep repeating on this blog: Mind the Gap between your income and spending. The more you earn, the easier it is to save.

Q: That’s all well-and-good that you can live on one person’s income (and therefore buy a house in cash), but that’s not realistic for most of us. Most of us NEED two incomes to survive.

A: First of all, that’s false. The median U.S. household has 2.5 people and 1.3 incomes, according to the Census Bureau. In other words: The median American lives on one income per two people.

If millions of people can do it, why can’t you? Don’t take that as an affront; embrace it as a challenge. :-)

Second of all, are you really “minding the gap?” Be honest with yourself. Are you really optimizing? Here’s what Will and I do:

  • We live with roommates.
  • We drive used cars.
  • We don’t buy fancy clothes / jewelry / furniture.
  • We don’t have cable TV.
  • We choose to live in cities that have a reasonable cost-of-living.
  • We either work-from-home (me) or live-close-to-work (him).
  • We “self-insure” (buy cheap insurance with a high deductible; keep a huge emergency fund).
  • We save tens of thousands on taxes by maxing out our 401k, IRA and HSA accounts.
  • We’ve both always, always, always had a side hustle. We’ve never had “just” one job.

So … lather, rinse, repeat, and you’ll eventually amass $50,000 in cash. Invest it, then re-invest the profits, and you’ll create a self-sustaining cycle.

Q: But I don’t want to buy a used car / cut my cable / live with roommates.

A: That’s a choice. You can afford anything, but not everything. You can choose to spend thousands buying a new car or keeping your guest room vacant — but that choice demands trade-offs.

Be deliberate about those trade-offs. Never confuse “I can’t” with “I choose not to.”

.

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Showdown! Keep Your Mortgage vs. Crush Your Mortgage -– Who Wins The Championship?

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Ready to rumble?

There’s a fight brewing. Two contenders have climbed into the ring.

Both are clawing for victory. Only one will survive.

It’s a showdown.

In one corner: Crush Your Mortgage, and his team of anti-debt advocates.

In the other corner: Keep Your Mortgage, and his cheering crowd of leveraged investors.

Who will take home the title?

Pay Off Your Mortgage vs. Invest

In all seriousness: “Should I pay down the mortgage? Or should I invest?” is a hot question.

And it’s been consuming my thoughts recently.

At the risk of sounding obsessive, I’ll admit: I think about this everyday. I ponder this while I’m cooking. While I’m gardening. While I’m running gnawing chocolate-chip ice cream straight from the pint.

Why deliberate so much?

  1. It’s complex.
  2. It’s not theoretical. It demands a decision (and it needs one now).
  3. It influences the path of hundreds of thousands of dollars. Yikes! (And I thought being an adult would be easy.)

And since I have three mortgages, that’s three times the fun. ☺

So let’s take a look at some of the factors at play.

The Reigning Champ: The “Keep the Mortgage” Fighter

The reigning champion in the ring, returning to keep his heavyweight title, is the “Keep the Mortgage” fighter.

He’s the champ because most of America supports him. Most people spend 30 years paying off a 30-year mortgage. (Not that most people are investing that money, but …) Keeping the mortgage is the norm.

But Afford Anything Rebels don’t blindly side with the majority. We’re radical free-thinkers. So let’s think.

Here are the benefits to Keeping the Mortgage:

1) Investment Gains > APR on Loan

The top reason why Rebels keep the mortgage? They believe their investment gains could outpace their loan APR.

This is a simple concept: You borrow money at a low interest rate. You invest it for a higher return. You pocket the spread.

• Banks borrow from the Fed at a low rate; lend to the general public at a higher rate.
• Travelers earn in dollars or euros; spend in Thai bhat or Colombian pesos.

And whether or not you’re consciously aware of it, every person who holds a mortgage and invests also plays this game.

So – Could your investments really outpace your mortgage APR? Probably. From 1990 to 2010, the S&P 500 returned 9.14 percent as a long-term annualized average.

“WTF does that mean?”

If you dumped a bunch of cash into an S&P 500 index fund in 1990 and didn’t touch it for 20 years, you would have earned 9 percent annual returns over the long-haul.

“But those were unusually great years. Right?”

Nope. Those two decades include the dot-com burst of 2001, plus the Great Recession of 2008. (Notice that the timespan ends mid-recession, before the recovery.)

“Oh, so I could earn 9 percent. Then why are we having this conversation? Isn’t keeping your mortgage a no-brainer?”

Nope. In finance, there’s a concept called “risk-adjusted return.” It’s a fancy way of saying that you can’t just stare at your returns in a vacuum – you have to look at returns within the context of risk.

• Earning 10 percent on Facebook stock isn’t the same as earning 10 percent in a savings account.

• Earning 12 percent on a dingy rental property in a high-crime area isn’t the same as earning 12 percent on a sparkling rental property in a high-end, luxury resort.

• Borrowing money to invest in the stock market isn’t the same as paying off a loan.

“But I’m not borrowing to invest!”

Yes, you are – in the form of opportunity cost.

But we’re getting off-track. In this section, we focus on arguments in favor of Keeping the Mortgage. So let’s look at the second reason:

2) Compound Interest > Simple Interest

Alright, this one gets a little more complex. Hang with me:

When you invest, you earn compounding interest.

• Year 1: $100 * 10 percent = $110
• Year 2: $110 * 10 percent = $121
• Year 3: $121 * 10 percent = $133

By the end of Year 3, your original $100 has grown by 33% of its value. Wowza.

Mortgage interest … well, if Facebook had a relationship category for mortgage interest, it would be “It’s Complicated.”

Mortgage interest is calculated as simple interest, meaning that it’s a straight-line rather than a compounding figure.

• Year 1: $100,000 * 5 percent = $5,000
• Year 2: $100,000 * 5 percent = $5,000
• Year 3: $100,000 * 5 percent = $5,000

Seems “simple” by definition, right?

But there’s a curveball: Mortgage interest is “amortized,” which means that during Year 1 of a 30-year mortgage, the vast majority of your payments are applied to the interest, rather than the principal. In other words, you barely make any equity gains as a result of mortgage pay-down.

In Year 29, the tables are turned: You’ve repaid almost all the interest, and the bulk of your payments are now used for equity paydown.

This gets complicated quickly, so let’s use charts and a calculator to illustrate it:

pay off the mortgage or invest

Here’s the situation illustrated in the chart:

  • Loan: $200,000
  • Term: 30 Years
  • Interest: 5.375%
  • Tax and Insurance: $250/mo

This tracks the first 8 months of the mortgage. Notice how the bulk of the payments are applied to interest, with only a tiny sliver going to the principal?

Okay, now climb into our Time Machine, speed ahead to the year 2044, and look at our payments.

should i pay off my mortgage early

Notice how the majority of payments are applied towards principal, with only $5 on interest at the end?

(Yeah, this is how I spend my Saturdays. #NerdAlert)

Let’s recap:

  • If you invest, you earn compound interest, which is sexy.
  • If you pay mortgage interest, you’ll only pay simple interest (yay!!), but you’ll pay on an amortized schedule (boo!!).

If your head hasn’t exploded yet, check out the next “Keep the Mortgage” argument:

“‘Cuz We Are Living in an Inflationary World”

(Sung to the tune of Madonna’s Material Girl)

If you have a fixed-rate loan, inflation is your best friend.

Thanks to inflation, you’ll repay your loan in cheaper-and-cheaper dollars over time. Today, your monthly mortgage payment is $1,400. That same $1,400 could buy you roundtrip airfare from New York City to Christchurch, New Zealand.

In 2044, your mortgage payment will still be $1,400, but thanks to inflation, that money will only cover a quick hop from New York to Chicago.

Major point in favor of keeping the mortgage intact, and investing instead.

(P.S. Actually, your future mortgage payment will be a little higher due to taxes and insurance. But since those expenses will burden you regardless of whether you carry a mortgage or not, we’ll leave them out of the equation. Death and taxes, right?)

Speaking of taxes …

Mortgage Interest Deduction on Taxes

First, an important Public Service Announcement: Never spend money for the sole purpose of a tax deduction. You’d literally spend $1 for the sake of saving 33 cents.

That said, I’d be remiss if I didn’t at least mention that your mortgage interest is tax-deductible, which lowers the “effective” interest rate on your loan.

For the sake of a simple example, let’s say you paid $10,000 in mortgage interest this year, and your overall tax rate is 25 percent. (Not your top marginal bracket, but your overall rate.) You’d save $2,500 in taxes.

(This is a rough number — there are more complex factors that come into play.)

You’ll get the biggest tax-deduction impact when your mortgage is fresh and new. Your tax deduction will shrink as you progress along the amortization clock.

The Contender in the Ring: Crush Your Mortgage ASAP

The dark-horse contender fighting in the ring, eager to claim championship victory for himself, is the “Crush Your Mortgage” contender.

This fighter has fervent supporters among a minority niche. If you fight for the Anti-Debt Army, mortgage freedom is the penultimate victory.

Mortgage freedom is rare. When most people say “I’m debt-free,” they mean: “I’m debt-free except for my mortgage.” In America, it’s assumed that every homeowner carries a mortgage until age 55-65+. Breaking free is a defiant act of rebellion.

But should you crush your mortgage? Let’s look at the arguments in favor:

#1: Lower Debt-to-Income Ratio

Let’s assume you’re a rental property investor. You have a mortgage at 5 percent. New 15-year mortgages are being offered at 3 percent, and you’re hungry for a slice.

You have two choices:

a) Refinance your current mortgage.
b) Decimate your mortgage so that you can qualify for a new mortgage (on a new house) at 3 percent.

Both are solid options. If you can wipe out your current mortgage in a short timespan (before rates will rise), you might be better off clearing the slate so that you can qualify for another mortgage.

“Um, Paula, WTF?”

I know, I know. It sounds ridiculous to crush debt in order to take out more debt. So let’s move to Reason #2 —

#2: Better Cash Flow

Crush your mortgage, and your cash flow will skyrocket. (Wheeee!)

If you’re an owner-occupant, you’ll keep a huge chunk of your paycheck. If you’re an investor, you’ll keep a massive chunk of your rental income. You win, either way.

You can then invest every dime of the money that would have gone to mortgage payments. In an S&P 500 Index Fund, you may make long-term 9 percent returns without the added risk. (Or you can buy your next rental property in cash.)

This is one of the most compelling arguments I’ve ever heard for crushing your mortgage. And so is the next one —

#3: Humans are Imperfect.

It’s grand to ask, in theory, “Should you pay off your mortgage or invest?”

In reality, though, how many people will actually invest that money? How many will spend the cash on steak dinners, pedicures, brand-new cars, handbags, and trips to Aruba?

Furthermore — (and this is the argument that really gets me) — will you then feel guilty while you’re enjoying those activities? Will you surf the waves in Costa Rica while thinking, “I’m borrowing for this trip, via opportunity cost?”

(BTW: You can’t think this way. You’ll drive yourself nuts. #AskMeHowIKnow. Ironically, the only way to stay sane is by embracing a little economic irrationality.)

Speaking of economic irrationality …

#4: Would You Invest a HELOC?

Ready for some cognitive dissonance? (Am I ever!!)

Would you borrow a home-equity line of credit and put that money in the stock market?

“Heck no!”

Really? Why not? What’s the difference between borrowing a HELOC and putting your money in the market, rather than using that cash to build home equity?

“Um … a HELOC has closing costs.”

Fine. I’ll give you the $2,000 to cover closing costs, if you take a massive loan against your house and shove all that money into the stock market.

“Uh, I still don’t want to.”

Why not?

“It’s uncomfortable.”

Again, what’s the difference? Aren’t you borrowing against your house, either way?

“Uh …”

Boo-yah!

This is another one of the most compelling “Crush Your Mortgage” arguments I’ve ever heard.

Actually, it’s a great litmus test. Would I be willing to borrow a HELOC and use that money to buy more rental properties? You betcha. Absolutely. In fact, that’s how we bought House #4.

But would I be willing to borrow a HELOC and give it to Wall Street? Hahahaha … No.

No-no-no-no-no.

****

Championship Victor

Which fighter wins the round? “Crush Your Mortgage” vs. “Keep Your Mortgage”?

There’s no clear victor. As you can see, there are rock-solid arguments for both.

But in my next blog post, I’ll explain which choice I’ve made — and why. Stay tuned!

(UPDATE, 4/22/2014: Here’s my decision.)

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P.S. If you want to read even more about this topic — (Man, you just can’t get enough, can you?) — here are two of the best blog posts I’ve read on this subject:

  • Former hedge fund manager and self-made millionaire Todd Tresidder wrote the article-to-end-all-articles on the “mortgage paydown vs. invest” controversy. I contemplated his article for days. #Obsessed.
  • Financial independence striver Johnny Moneyseed took a stand on the issue, writing a compelling argument for the “invest” side. His stance is well-researched, and the debate that erupted in his comments section (almost) restores my faith in Internet debates.

Enjoy!

The AirBnb Experiment: How I Impulsively Started a Vacation Rental Business

This article is Part 1 of The Airbnb Series. When you’re done, check out Part 2 and Part 3.

Use this link to get a $25 discount on your first Airbnb guest stay. (I’ll also get a $25 credit if you use it, a win-win for us both.)

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“I wonder if …”

The greatest adventures of my life usually begin with that phrase.

When I say “greatest,” I don’t necessarily mean “best.” Sometimes I mean “weirdest-smelling” or “insanely-profitable” or “almost-gave-me-malaria.”

  •  “I wonder if I could start my own business …”
  •  “I wonder if I can really resist ever working for someone else …”
  •  “I wonder if I can eat this??”

(I say that last line way too often, usually accompanied by: “Hey, smell this. It hasn’t spoiled yet … right? Riiight?“)

The latest “I wonder,” however, is relatively mild — all things considered. It won’t involve cross-country trips or cross-contamination or even cross-dressing. It won’t land me on the nightly news. And it won’t hold the potential for massive profits, but it also offers limited downside.

You see, I recently finished renovating one of my apartment units. Pre-renovation, it rented for $700 per month. Post-renovation, I think I can rent it for about $1,100/month.

But then I started thinking, “I wonder if …”

“… I could boost my profits by renting the apartment as a short-term vacation rental?”

And that’s how The AirBnb Experiment began.

How I ‘Accidentally’ Started a Vacation Rental Business

(Brief background for new readers: My partner and I own six rental units, which produce a combined $35,000/year in net passive income (after all expenses, including management). You can read about them here, here, here and here.)

As soon as “I wonder if …” popped into my mind, my knee-jerk reaction was to focus on the drawbacks of managing a vacation rental business.

  • More turnover.
  • Higher vacancy.
  • Extra management.
  • Upfront costs of furnishing.
  • Higher guest expectations (full-service).

I observed those objections arising. And then I asked myself, “How can I battle these?”

#1: Separate “Investor Paula” from “Manager Paula.” I’ll track my hours and ‘pay myself’ the free-market rate for this position ($20/hr). Then I’ll see whether or not Investor Paula still makes a profit, even after paying Manager Paula for her time.

This is crucial. Many business owners think they own an investment, when they really just own a job. The only way to successfully invest in real estate is to make a profit after paying yourself (or paying someone else).

#2: Commit. I’ll commit to this experiment for at least 6 months, if not a year. That way, I can measure vacancy and turnover across the span of several seasons.

#3: Budget. I’ll furnish the apartment on a $2,000 budget – including paying myself for my labor. (I’m not giving my time away for free!)

Here’s what happened next:

Step 1: Shopping Spree!

I’m shocked at how much stuff – lots and lots of stuff – is needed to furnish an apartment.

Yeah, there’s the obvious furniture:

  • Mattress/boxspring
  • Bed frame / headboard
  • Sheets, comforter, pillows, duvet
  • Dresser
  • Couch, slipcover
  • Window treatments
  • Coffee table
  • Bedside end table
  • Reading lamp
  • Kitchen table and dining-room chairs
  • Plates, bowls, spoons, forks, knifes
  • Pots, pans
  • Mugs, glasses
  • Coffeemaker

But after I began furnishing the space, I realized there was another LONG list of things that I hadn’t even considered –

  • Trash cans for kitchen/bath
  • Hangers
  • Dish towels
  • Baking trays
  • Placemats, potholders, can opener. (Who buys a can opener? Isn’t that something everyone just has?)
  • Bath mats,  towels
  • Cable TV! *Forehead slap!* I forgot that most people expect a TV …
  • … along with a TV stand (that’s a furnishing category?), cable box, remote control …
  • Oh yeah, and wireless internet!! Doh!

I set up the apartment with all of the “Consumer Disposables” that create a good customer experience in a vacation rental, such as:

  • Toilet paper
  • Hand soap for kitchen/bath
  • Shampoo, conditioner, body soap
  • Coffee, tea
  • Dishwashing detergent
  • Sponges and paper towels
  • Laundry detergent and fabric softener
  • Salt, pepper, cooking oil
  • Iron / Ironing board
  • Hairdryer

And even after all of this, after 5 solid days of carefully thinking through every possibility, my first few guests began requesting items that I still hadn’t considered, such as a plunger and toilet brush.

Bottom line: It takes a TON of stuff — especially small stuff — to create a home-away-from-home experience.

Step #2: Photograph the Space.

I have a new appreciation for interior photographers. After lots of trial-and-error, here’s what I came up with:

The AirBnb Experiment

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Is it better to rent something as a vacation rental or a long term rental?

custom cut glass shelves

Pro tip: Close the toilet lid before taking a photo of the bathroom. It gives the image a more pulled-together look.

Pro tip: Close the toilet lid before taking a photo of the bathroom. It gives the image a more pulled-together look.

Step #3: List the Space.

Although I’m referring to this as the “AirBnb Experiment,” I’m actually offering the apartment on two websites – AirBnb.com and VRBO.com. The vast majority of my bookings have come through AirBnb, although just this morning I got my first VRBO booking.

Because I’m OCD and slightly a perfectionist, I scanned the neighborhood competition and wrote a listing that could compete head-to-head with the best of them. I also added a map with pinpoints at all major restaurants, bars, shops, salons, gyms, etc., within easy walking distance. (Which are a LOT.)

Step 4: Develop Procedures

Next, I developed a checklist of check-in, check-out and turnover/vacancy procedures. This way, I don’t have to rely on my (unreliable) memory. I can just follow my checklist.

The checklists are too long to reprint in full here, but they include:

• Walking through the unit after check-out to make sure nothing is damaged/stolen. (My checklist features an inventory of all the stuff within the apartment.)

• Refilling any “consumer disposables” that are low. (Coffee? Sponges? Soap?)

• Washing the linens, vacuuming, mopping, emptying the trash, and overall cleaning up the unit after check-out. (I’m thinking of hiring a company that will handle this step.)

Step 5: Create a Standard Guest Greeting

Finally, I created a page that welcomes guests and highlights the amenities of the apartment. I tried to anticipate any FAQ’s, and answer all of these on a pre-written page.

(Here’s where you’ll find the remote. Here’s the wireless internet password. Here’s how the ceiling fan works.)

This step is more for my benefit than the guests. You see, I want to run a business – not have a business than runs me. And the best way to execute that is to automate, by creating checklists and procedures that I can give to anyone who steps in to fill my shoes while I’m traveling.

When I create an FAQ page, and post it to the refrigerator, I’m automatically giving my guests one fewer reason to call me. And that makes the business more hands-off.

6 Lessons I Learned as an AirBnb Host

After all this, what lessons or conclusions have I learned?

#1: Holy moly, humans need a lot of crap.

Like seriously, when/why/how did we as a society get to the point in which we need so much CRAP to maintain our existence? I’m not finger-pointing, as I’m as equally guilty of this as anyone. I maintain a spatula and dish towels and sponges and dishwashing detergent in my own home.

But can we just take a moment to reflect on the sheer volume of possessions that we need in order to have a functioning home? It’s kinda astounding, when you step back and think about it. I’m not moralizing; I’m just … shocked, really. It’s not something you think about, until you have to buy all of this junk at the same time, in one HUGE Target/Ikea run.

#2: Know the difference between a commodity business vs. a service business.

Running a vacation rental business is waaayyyyyy different than simply offering a rental property. I had long suspected this to be true, but the experience of going through the motions really brought that lesson home.

When you invest in rental properties, you’re offering a commodity. In my case, I renovate old fixer-upper homes (manufacturing) and sell it in bulk, one-year time increments (wholesale).

When you run a vacation rental, you’re offering a service. If someone wants more towels, they’ll call you. It’s a completely different beast from renting a vacant space to a long-term tenant.

#3: Competitive pressures skew the market.

When you’re offering a rental property, you’re competing against other investors.

But many of the other hosts on AirBnb aren’t investors. They’re owner-occupants (or renter-occupants) who list their personal home, and spend the night at a friend or family members’ house, just to make some extra cash.

Because they’re not concerned with their ROI, they can under-price the competition. This exerts downward pressure on the prices. It’s great for guests, but it limits the upside for hosts – especially those of us who are full-time investors.

#4: Taxes suck.

When you offer a short-term rental, you need to pay the city 8 percent sales tax and an additional 8 percent occupancy tax (the same types of taxes that hotels charge.) That’s a 16 percent additional bite from your profits, which you wouldn’t need to pay if you were offering a long-term lease. Wowza!

(Tax rates vary from city-to-city, but suffice to say that it’s a LOT.)

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I hope those conclusions don’t sound too negative. There’s a huge upside to vacation-rental hosting, as well:

#5: It’s super-fun.

Most of my money-making efforts happen in front of a laptop, and sometimes, I just want to tear myself away from a computer screen.

Managing a vacation rental (and rental properties in general) give me awesome variety. I can interact with flesh-and-blood people, rather than stare at pixels. It’s a great change-of-pace.

And it’s not like I’m in traditional “customer service,” interacting with grumpy people. I’m hanging out with people while they’re on vacation. They’re relaxed, they’re in a great mood, and there’s here to have fun.

#6: It’s the best of global travel … under my own roof.

One of my favorite aspects of traveling is meeting people from around the world. By running a vacation rental, I can capture that same experience – in my own building.

My first guest, for example, was born in Jamaica and shares my love for exploring the Caribbean islands. She and I chatted at length about our travels in that region, swapping notes about our favorite off-the-beaten-path coves and beaches.

It’s the same type of conversation that I’d have with a random traveler at a hostel or a cafe … the type of international human connection that I love most about travel. And I dig that it happens under my own roof, and that I get paid for doing it.

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But that said, a business is a business, and it needs to turn a profit. So how lucrative has this been so far?

First, let’s set an income goal:

Price on a One-Year Lease: $1,100/mo
(Less vacancy projection for long-term rental: $100/mo)

Benchmark for Comparison: $1,000/month

Vacation Rental Additional Expenses:

$100/mo utilities (including electricity, gas, cable, internet)
$40/mo consumer disposables (refilling the sponges, soap, shampoo, etc.)
$160/mo management (8 hrs/month at $20/hr)
$250/mo sales and occupancy tax (rough ballpark)

Projected minimum revenue needed to break-even: $1,550/mo.

In other words – unless we hit that base rate, it’s more sensible to rent this unit to a long-term tenant on a one-year lease.
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In the month of March, I’ve earned $1,619. That’s a total “profit” of $69 for the first month (after paying myself for my time).

Screen Shot 2014-03-20 at 2.24.43 PM

But as you can see, these are all estimated numbers. The REAL data will come over the span of the next few months, as I:

• Track REAL hours
• Track REAL receipts
• Pay REAL utility bills

So – Is a vacation rental more (or less) lucrative than a long-term lease?

Stay tuned. ☺

Update: Check out Part 2 of The Airbnb Series here, followed by Part 3 here.

P.S. Do you want to stay in an AirBnb spot when you travel? Use this link to get a $25 discount on your first AirBnb booking. I believe in total transparency, so I’m sharing upfront that if you use the link to get a discount, I’ll also receive a $25 credit. Win-win!

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Reader Question: Should I Buy a House With Cash?

should a grad student buy a house with cash
One Afford Anything reader asks:

In my area, I can buy a quality house/duplex for $45,000 – $100,000.

My partner and I want to get a house with great rentability. We’ll live in it for 4 years while I finish graduate school, at which point we’ll move.

We hope to keep the place – as a rental property — indefinitely.

My question is: Are we better off buying a 100% cash purchase that will give us less rental income? Or are we better off financing a property that is more expensive, and will give us higher rental income?

Sincerely,
Confused with Cash

Here’s my reply:

Dear Confused:

You can’t look at investments in a vacuum. You need to frame the invest within the context of your life.

You’re about to enter a 4-year graduate school program. That means you won’t be earning much income, and you’ll be spending a lot of your time on non-income-producing work.

Given your grad-student status, I’d make an all-cash purchase right now.

After you graduate and you and your partner are both working full-time, you can think about increasing your leverage. But while you’re in school, stick with the option that will free your mental space and maximize your flexibility.

That said, let me add two more points:

#1: Cash Reserves

I don’t know how much money you have set aside for emergencies – such as car repairs, home repairs, and covering your cost-of-living if you can’t find work. I’m assuming that you already have decent reserves built.

Building a cash reserve comes first, before everything else.

If you have to take out a very small mortgage (e.g. plunk down an 80 percent down payment and finance a small piece of the house) for the sake of preserving your emergency fund, go ahead and do it. It’s more important to have a strong emergency fund than it is to be mortgage-free but have $0 in cash reserves.

Why? Let’s say that you’re mortgage-free, but you have zero savings. Suddenly, your heater breaks. In the middle of winter. In Minnesota.

Suddenly, you’re on-the-hook for paying for a very expensive (and urgent) repair. If you don’t have cash reserves, you’ll be forced to charge it on a credit card — with a double-digit interest rate. Yikes!

Feel free to take out a mortgage in order to protect your cash reserves. Think of your mortgage as a “cheap insurance” policy that will protect you from sliding into credit card debt.

Speaking of which …

#2: High-Interest Debt

Since we’re chatting about buying a house in cash, I’m assuming that you don’t have any high-interest debt, such as a credit card. If you have a dime of debt, I’m assuming it’s ultra-low-interest (e.g. lower than a typical mortgage).

If that assumption is wrong … friggin’ pay off your debt. That’s Priority Number One. Build a teeny-tiny cash reserve (about $1,000) and then devote every dime to paying off your high-interest debt.

Assuming you’re debt-free and you have solid cash reserves, shoot for the all-cash rental property purchase. And enjoy grad school!

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