How to Buy Rental #2, #3, or #4 When You’re Out of Funds (Rookie Reply)

Ashley Kehr:
Today’s rookie reply is a great one because it hits three different fears that rookie investors have when they’re ready to move on from learning into execution.

Tony Robinson:
Yeah, we’ve got someone worried about how to rinse and repeat after their first rental. Another rookie panicking mid deal because insurance blew up their numbers. And a W2 investor trying to use short-term rentals for tax savings without getting crushed by regulations.

Ashley Kehr:
This is the Real Estate Rookie podcast. And I’m Ashley Care.

Tony Robinson:
And I’m Tony j Robinson. And with that, let’s get into today’s first question. So this question comes from the BiggerPockets Forum and it says, after spending four months reading and listening, I’m close to finally taking that first step, enough talk time for execution, but I still find myself questioning what do I do after I purchase my first rental? I’m focused on long-term rentals and cosmetic burrs, but I struggle with grasping creative ways to finance and rinse and repeat. While I’m fine dropping 40, 70 K as a down payment, I feel stuck in a holding pattern wondering if I need to wait and save another 40, 70 K to do the next deal. I’m excited about Cleveland, Cincinnati, Pittsburgh, and Dayton. Any nuggets of wisdom would be appreciated. Alright, so this question is really about how to scale your portfolio beyond the capital that you currently have access to.
I think there are maybe a few approaches that you can take. The first approach is to do probably the simplest way is just to take the 40 70 K that you have right now, put that down as a down payment on a deal, and then save up under the 40 70 K and just repeat that process over and over again. It’s slower, but it’s significantly less work and requires less creativity and it’s just a really kind of tried and true approach to build a portfolio. The second path is that you find a way to recycle that initial set of capital. So you can do things like the burrs that you mentioned where you’re buying a property, you’re renovating it, you’re rehabbing it, then you’re refinancing to get back some or potentially all of the capital that you put back into that deal, right? So the burrs strategy is the second way, and then another way is then partnering with other people to help fund your deals.
So if you’ve taken down this first deal, you’ve got a bit of a track record, you’ve proven that you know how to find deals, execute, and so on and so forth, maybe then you start leveraging partners and their capital to take down more deals. And then maybe probably the more complicated path is going after something like more creative financing. If you can do seller financing where you’re finding properties that are owned free and clear and then you’re negotiating directly with the seller to have them loan you the money is another way to scale beyond your original capital. But in my mind, Astros are probably the four big buckets, but curious what your thoughts are.

Ashley Kehr:
Yeah, I think the last part of this question as to should I wait and save up more money or should I go ahead and try and find another creative way to purchase a property without waiting and saving up money? But I think the answer is really to do this simultaneously. Start saving again, but also looking for deals where you can do some creative financing. So whether that’s a bur where you’re using hard money and then you’re going to refinance out of it and pull your money back out, whether it’s going to be finding a deal where the person will do seller financing. If you go to, I think it’s called landwatch.com I think is what it is, you can literally click a toggle or a filter that is for seller finance deals that are available that people are already saying they’ll do seller financing and you can submit offers and put the offer as seller financing.
One thing that I’ve always done is when I get to go face to face with a seller or I try to have my real estate agent communicate this, if I’m going to submit an offer that’s seller financing, I always like to say, have you talked to your accountant or your CPA about the tax advantages of doing seller financing? And that usually piques a little bit of interest and it sounds more reputable to somebody having it come from their own personal CPA rather than from somebody who’s trying to buy their property. If I try and tell them like, oh, here’s all the advantages and the reasons why it’s more likely they’ll listen to their CPA than me who’s trying to haggle them for a deal.

Tony Robinson:
Just last thing I’ll say asra, I do think that there’s value in thinking about deals number two, five and 10 before deal number one, but I think it’s a bit of a fine line because oftentimes I see people get so caught up and well, how do I scale and how do I get property number two and how do I get property number five that they lose focus on the fact that they don’t even have deal number one yet. So I think the majority of your focus right now should be on how do I make deal number one work? And then from there you can start making pivots and adjustments to go on to deal number two, number five, number 10. But don’t get caught in that loop of thinking so far ahead that you forget to take that first step.

Ashley Kehr:
That’s totally a great point. So we’re going to take a quick break, but when we come back, we’re going to understand when you should walk away from a deal or stick it out. We’ll be right back. Okay. Welcome back. So this next question comes from the BiggerPockets forums and it says, hi, I am a new investor to real estate. I’m 22 and looking to do a house hack using an FHA loan with three and a half percent down. I’ve got under contract on a property in Baytown, Texas, but during underwriting we found insurance costs were 6,000 to 8,000 per year plus flood insurance. The deal no longer cash flows even long-term, and I’m past my option fee. I feel stupid backing out but don’t know what to do. Is my earnest money gone? Please help. Ouch. That does hurt. And it doesn’t say how much the earnest money was, but I will say I’ve lost earnest money.
There was a deal, it was a cabin and I found out some things, title issues and all this stuff after my due diligence period was over and I think it was $2,000 and they told the sellers, keep the money. I’m backing out of the deal. And looking back now, I would’ve rather have lost that $2,000 than be stuck in a deal where I’m losing even more money. And I think that would probably be the case in this situation. If I mean just six to 8,000 per year plus the flood insurance, I don’t think I have a single property right now that is that much an insurance per year.

Tony Robinson:
Yeah, that is wild. Six to eight grand plus flood insurance and flood insurance is not cheap. You have to go out and go out and get special flood insurance. Yeah, I agree with your point, Ashley. Whatever the EMD is, you have to weigh that cost against the ongoing cost of owning this property year after year after year after year to see if it actually makes sense to move forward with purchasing this property. I think a lot of this goes back to what Ash and I talk about a lot is that it’s easy to get emotionally attached to a deal and feel like you’ve already put so much time, effort, and in this case money into a deal. But sometime the smartest thing to do is to walk away. And if your deal does not work because of these new finances, then just go back to the settler and be honest.
Say, look, I had every intention of purchasing this property, but the flood insurance quotes that came back and the insurance quotes that came back are significantly higher than what I had originally anticipated. So I would ask that you release my EMD because this is not within my control. It’s not me trying to back out of the deal. Like here are the cold hard facts. Hey look, if you have an insurance agent that can give me a better price, I would love to talk to them, but if not, please work with me to make sure that we can walk away amicably. So I’m with you, Ash. I think I’m walking away from this deal because it’s not worth stepping into

Ashley Kehr:
Wait 100%. That should be the first step is trying to renegotiate with the seller. You might as well ask, they probably don’t want to have to start all over in the process of selling the property. So maybe they do have some wiggle room to continue to make it work. But that’s where I would start.

Tony Robinson:
And kudos to you for being 22 and locking down your first house hack, right? And then it’s a great way to start. We’re going to take a quick break, but while we’re gone, if you haven’t yet followed the podcast on Instagram at BiggerPockets rookie, then you can follow Ashley at Wealth and Rentals and me at Tony j Robinson and we’ll be right back after a quick break. Alright guys, we’re back and we’re here with our final question. This one’s about short-term rentals, taxes, and regulations. So the question is, I currently invest in long-term rentals but cannot take advantage of real estate professional status due to my W2 job using the short-term rental tax loophole to offset my W2 income with supercharge my investments. But I’m afraid of buying a property denied, but I’m afraid of buying a property and getting denied a short-term rental license.
Can anyone recommend beginner friendly STR markets, preferably within three to four hours of NYC? Alright, so a few things to unpack here. I think the first piece is that we need to break down what the short-term rental tax loophole is. I’ll try and do this in a way that’s super clear for everyone to understand. Real estate investing offers the ability to take losses, whether those are real losses like you actually lost money on that property or paper losses, things like depreciation, which is not a real expense, but it’s a paper loss. You can take those losses and apply them against other forms of income that you collect. Now, in order to take those paper losses and apply them against your W2 income, you have to be what’s called a real estate professional or qualify for what’s called the real estate professional status. For most people with a day job, it’s virtually impossible because you have to show that you put more hours into your real estate business than you do into your day job.
Most people can’t prove that. But with short term rentals, because they are classified as a business in the eyes of the IRS, not necessarily passive income like a long-term rental, you don’t have to qualify for real estate professional status. There’s something called material participation. And as long as you can show that you materially participate in your short-term rental, that then unlocks your ability to take the passive losses from your short-term rental and apply them against your W2 income. So I know that’s a mouthful, but if you just look up short-term rental tax loop, you’ll get some more insights there. So that’s this person’s motivation. And I know a lot of people who invest in short-term rentals primarily for the tax benefits associated with it, and it truly does give you the ability to largely reduce or sometimes even eliminate your tax bill altogether. Okay, so that’s the first piece.
Now, what this person is worried about is the regulatory landscape of the short-term rental industry. And while it’s shrewd that the regulations across the country have changed, shifted, evolved, some have gotten significantly more strict, it doesn’t mean that every single market is this huge regulatory risk when it comes to short-term rentals. There are really a few core things I look at to gauge the regulatory risk in a market. The first thing I look at is what is the current ordinance in that market? Can I legally rent a short-term rental? Is there a cap? Can I only do it in certain parts of town? Does it have to be a certain property? Is there a limit on occupancy? Is there a limit on usage? Just understanding what that current ordinance is to make sure that it allows me today to profitably run this property as a short-term rental because there are some markets where you can run it as a short-term rental, but you’re capped at only using it for 30 days out of the year.
Who cares if I can use it in any way, shape, or form if I only get one month from that property? It doesn’t make sense as a short-term rental. So just understanding the current ordinance. And then the second element is understanding the risk of that ordinance changing in the future. And the core thing that I focus on when I think about answering that question, Ash, is how economically dependent is that city on the revenue generated by short-term rentals? I’m going to pick on your home state of new, and in New York City, they effectively banned short-term rentals a few years ago. But if you think about why NYC was able and willing to do that, it’s because they didn’t care about the money that short-term rentals generated for that city, right? Like NYC is one of the, if not the most populous city in the United States, it generates revenues from literally every single industry.
It has no economic dependency on Ashley and Tony’s little Airbnb. But if you think about true vacation destinations, places where people only go to vacation, those are cities that are truly dependent on the money generated by short-term rentals in the form of transient occupancy taxes in the form of property taxes, in the form of people coming in saying a few nights and spending money in the local businesses where if those short-term rentals were to shut down that local economy would be severely impacted, maybe even collapse. So we want to look for cities that have that element of economic dependency and not so much the big cities that have a lot of things driving that economy. So that is my brief masterclass on the short-term rental tax food poll and regulations and how to avoid them. Ash, any questions or what do you have to add to that?

Ashley Kehr:
Any value that I can provide is I know the New York area and destination, so I can add two places that I think would be a good short-term rental areas to invest in. I did a quick Google search and tried to look real quickly if they’re short-term rental friendly. And it really depends on the specific area, but within that three to four hours of New York City is the Poconos tons of things, skiing in the Winter Lakes in the summer, and then also Lake George. It’s one of the cleanest lakes across the us I think in a great destination area. It’s close to I think Saratoga, where they have horse r ising and different things like that. But yeah, so those would be the two markets I would look into and just searching real quick, you have to get permits, things like that. And the laws vary depending on the specific area that you’re in and things like that. But those would be the two places that I would go and stay in a short-term rental.

Tony Robinson:
And I think the other thing I’d add to that question too, Ash, and this is not true for short-term rentals, but for all strategies is ask yourself what your motivation is for staying within three to four hours of New York City. Is it because there’s just this comfort factor of being able to go and check in on the property yourself and in case something happens, you’re there to kind of be present? Or is it because maybe you want to use it yourself if it’s more so the personal use, that makes sense. But if you’re leaning towards this tighter radius simply for comfort reasons, I would encourage you to understand that whether the property is four hours away or eight hours away, you’re probably not going to be the person cleaning the Airbnb. You’re probably not going to be the person fixing maintenance issues. You’re not going to be the person restocking supplies, you’re going to hire all of those things out anyway.
So if you can find a deal in a property that’s in Bozeman, Montana or Des Moines, Iowa, or name the city in the random place on the west coast, if that is a better deal for your specific situation, I wouldn’t say that you should necessarily avoid that just because it’s not as close as you want it to be. There are tons and tons of people every single day who are buying properties remotely and are successfully managing them as long as they have the right systems and processes in place and likely for you. You’re already listening to this podcast and we share a lot of the different ways you can do that remotely.

Ashley Kehr:
And one thing I would add too is if you want to use it for yourself personally, make sure you’re aware of what the rule is for that. Isn’t it a pretty gray area though, Tony, as to how many days you can actually use it if you’re writing it off as a short-term rental?

Tony Robinson:
Yeah, there was a lot of discussion on this, but yeah, I mean, usually what most lenders say is that somewhere around seven to 14 days is a good baseline of personal use. So there’s actually two different things we’re talking about here. One is a lending requirement, and then the other is how the IRS views it. So from the IRS perspective, your average state duration for the year has to be seven days or less. So as long as your average guests stay, when you look at all your reservations is seven days or less, then you’re still able to quantify this as a business. Once you get over seven days, they start to treat it more like a traditional long-term rental and you lose that ability to qualify for material participation. But if you’re seven days or less, you get that ability. So midterm rentals wouldn’t qualify for material participation because most of your saves are 30 days or more on the lending side.
The only real requirement is if you’re using a second home loan to purchase the property, and if you’re using the second home loan, there’s a personal use carve out where you have to use a property yourself in order to qualify for that specific loan. And I’ve heard different figures from different lenders, but seven to 14 days is like a usual good benchmark, but you just got to have the intention to use it yourself at some point during the year. So luckily, those two things are not connected. So I can get whatever kind of debt I want. I can get hard money, private money, conventional debt, not FHA, because you got to live there, but I can do any kind of debt that I want, and as long as I’m seven days or less, I can still qualify for material participation.

Ashley Kehr:
Yeah, I think another point I wanted to make on that too is just if their motivation is three to four hours is because they want to use it for personal use, knowing that they can’t spend, depending which way they go, they can’t spend their whole summer staying there, going every single week up there for the whole summer if they are going to use it for the short-term rental tax loophole or whatever too. So I thought I would use my A-frame all the time, the day I was so sad to rent it out the day I rented out, I was like, oh, don’t worry, kids are going to come here all the time. We haven’t stayed the night once. Maybe one time we went since we started booking it out, but it’s like, yeah, don’t make that a huge deciding factor, I would say, as to deciding on a market if you don’t know for sure if you’ll actually use it or not. Anyways, thank you guys so much for listening to this episode of Real Estate Rookie. I’m Ashley. He’s Tony, and we’ll see you guys on the next episode.