TBT: Ask Marco – What Should We Pay Ourselves From Our Rentals?

Hello my friends. Welcome back to Passive Real Estate Investing where we dive into the world of real estate investing among other related topics. To help you with your real estate investing journey, today we’re doing something a little different. We’re going to take a trip down memory lane and showcase an important episode from the past on what we call our throwback Thursday episode. Now, whether you’ve been with us since the beginning, which goes back to 2015, or you’re tuning in for the first time, this episode is a must listen, we are revisiting one of our more popular episodes from the past, and believe me, what we discussed back then, whether it’s six months ago or six years ago, is just as relevant today. So sit back, relax, and let’s rewind the clock for this great episode. Enjoy.

Today’s question is an interesting one and it comes from Victor. He’s basically wondering what should we pay ourselves from our rental property? Now, this is a good question. And one that will come up at some point in time. It’s not a matter of if, but when as you start to invest or continue to invest in real estate, but Victor goes on to say, Marco, I’m an avid listener of your podcast. The content has been very helpful, influential, and actually has helped me structure my first deal.

You’re very welcome, Victor.

My sister and I are partners, and just recently closed on our first deal together.

Congratulations!

It is a seller-financed mortgage of three single-family homes. Two of which are occupied. The third will be ready in a couple of weeks. The projected net operating income is about $10,000 a year. This is only deducting principal, interest tax, and insurance, which let me correct you on that. That is not how you calculate an ROI, but I’ll get to that after I read your email here. We are managing the properties ourselves. I’m not sure if that is the standard way to calculate your NOI, because I know most successful investors like to factor vacancy reserves for repairs and other miscellaneous categories. But to us, it seems more simplistic at least in the beginning to not spend anything and keep every dollar earned from the rents after principal interest tax and insurance also known as PITI as a reserve for any repairs and also as capital to continue buying more properties. We’re thinking when we get 20 properties, we will start paying ourselves probably $150 per unit split between us. Obviously that’s $75 per unit.

Everything else, like I said, we’d keep in reserve for all expenses and capital for purchasing. So two questions. Do you think we would be underpaying ourselves or even overpaying ourselves? Question two, do you think I’m oversimplifying the expense part, but not tediously calculating every single possible expense, like vacancies, et cetera. We both have W2 jobs, so we would not be dependent on the rental income, but we do want to retire and live off income from rentals as soon as possible. We’re thinking 100 units would allow us to do that. Thanks for taking a moment to read this and I wish you all the best Victor.

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Throwback Thursday Episode (The episode originally took place in the year 2021)

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Victor. Thanks for the question.

This is a great question. And there’s actually a couple of different topics within your question that I have covered on and off over the last five-plus years on this podcast. But it also just tells me that I should probably go back and cover some of these more in-depth, such as the size of the portfolio in order to achieve a particular income goal. And I will do that. And some other things in here as well, maybe just the basics of how to calculate your net operating income and your cashflow. So maybe I need to do kind of an analysis episode, but in the meantime, let me just quickly answer that your two basic questions here. And then I will take the time to go deeper into the rest of the stuff in other episodes that are more topic-specific instead of these quick ask Marco episodes.

So let’s break this down. First of all, how much you pay yourself is a personal decision. So for some people, they’re just going to hold off, they don’t need the cash. Just like you said, you don’t need the rental income. At this point in time, you both have W2 jobs, you have income, great live off of that, and focus on building your portfolio. But if you do want to pay yourself something, you are free to do that. It’s just a matter of cutting yourself, a check, and reporting that on your tax return. That’s it. But let me, first of all, correct you on something here and for our listeners’ sake, principal, interest tax, and insurance are essentially what we also call debt service that is deducted from the net operating income or NOI for short. So very basic math is this your income from your property, less the expenses such as property taxes, insurance, property management, and you’re budgeting for vacancy and maintenance and repairs. That number is your net operating income. Basically it’s everything excluding that service. So remember NOI is all your income minus all your expenses, not including debt service, which is your mortgage payment. That’s your NOI.  So mortgage payments are synonymous to debt service. They’re one in the same, exactly the same thing. So it’s your NOI that you deduct your mortgage payment from what’s leftover is cashflow.

Now back to your question, because I want to cover that another day in another episode. So stay tuned. And if you’re not subscribed to the show, be sure to subscribe because as these come out, you’ll get notified. You really have to base your decision on two things because you don’t need the income. And you’ve said that yourself, what is your overall strategy? If you’re just getting started and you now have three properties and you need to get to that 100 unit level in your portfolio, then you should be focused on portfolio growth. So you really have two options here, focus on cash flow now, or you focus on growing your portfolio. If you want the cash now, and you want the cash flow, regardless of whether you have one property, three properties, 10 properties, you can skim some profit from that and pay yourself and then leave the rest in a savings account or the reserves of your LLC, basically your bank account and build that up, build that up to the point where you have enough of a down payment to purchase and invest in your next property and your next property. And so on.

That is a growth strategy. It’s basically saying I don’t have enough rental properties. I’m going to keep investing and buying more and then get to your number, get to your target of, you know, a hundred properties. That’s personally what I would do based on what you just described. And I’m kind of reading between the lines, but it sounds like you guys are both together. You’re wanting to grow, built a hundred units and you have income coming in from jobs. You don’t need the cash from the cash flow today. So focus on putting anything and everything you can towards building your investment portfolio. So if that’s the case, that would be your strategy. And it pretty much answers your question.

As far as cash flow, if you want to just take money away from the cashflows, there’s nothing wrong with that. That’s your right. But if you’re able to accumulate enough of a down payment from your other sources of income, like your W2 job, then you can still achieve your investment goals of reaching those hundred units. While at the same time, taking some cash flow from your rental portfolio. If you want to accelerate this, I wouldn’t do that. I would just put anything and everything you can towards your next property and your next property, and keep building it up as fast as you can, because you’re going to reap the benefits of that faster and in time where you can now apply that aggregated income or savings towards your next property. And here’s the other thing too, the faster you can get to that a hundred units, or if your goal is 10 or 20 units, whatever it is, the sooner you can get there. Then if you now shift from a portfolio growth strategy to a cashflow strategy, where now you’re focused, not on additional units in growing your portfolio size, but on increasing your cash flow.

Then one way to do that is to accelerate the paydown of your mortgages. And there’s really two strategies here. One is just don’t touch it, let your tenants pay it off over time and just maximize your 30-year amortization on your mortgage or option. Number two is you take cash flows from your most profitable property, reapply that to pay down the mortgage on that property as quickly as you possibly can on that, or maybe on two properties at the same time. And then when those are paid off free and clear, you know, there’s a pro and con to this, as well as having a bunch of equity sitting around doing nothing for you, just, I call it dead equity or dormant equity. That aside you can take the full cash flow from that one or two property that doesn’t have any debt service on it anymore because you’ve paid off the mortgage and you take that and they’ll pay down the mortgage on the next property in line that has, let’s just say the lowest balance on the mortgage or cash flows and you accelerate the pay down on that third property.

Now you take the cash flows from those three properties and you put that all towards the next property in line that makes the most sense mathematically to pay down and you pay off that mortgage rapidly. And you can see how this starts to snowball. In fact, that you could call this the snowball strategy, essentially, you now you’re taking the cash flows from all of those free and clear properties and applying it to the next property and you that down even faster. Now you take cash flow from those five free and clear properties, and you apply all that towards the next property in line. And you pay that mortgage down as rapidly as possible. All of a sudden, you’re starting to accelerate the payoff of the mortgages and these properties are now paying you more cash flow each month because there is no debt service. It’s essentially your net operating income.

Your net operating income at that point becomes your overall cash flow from your real estate portfolio. And that snowball effect starts to grow rapidly. As you start to knock these down one at a time like dominoes. So, anyway, I hope I’m not going off on a tangent here. I think I’ve answered your two questions as far as paying yourself, you know, whether it’s overpaying or underpaying, it’s really a personal decision, but ultimately you based that decision on your strategy. So ask yourself and figure out are you trying to grow your portfolio as fast as possible? Where are you trying to take as much cash flow now? And you just have a kind of a slower build-out and approach to it.

All right. I hope that answers your question, Victor, I’m going to try and cover some of these other things in another episode.

That’s it for today. Thanks for the question.

I hope you enjoyed this week’s throwback Thursday episode. If you haven’t already, remember to subscribe so you don’t miss out on a single episode. If you have a question about real estate investing or finance, simply go to passiverealestateinvesting.com and click the Ask Marco button. . I read all of them, I reply to many of them, and sometimes I cover them on the show, and I’m gonna try and do more of that. So, I am going to encourage you to go to passiverealestateinvesting.com and submit your question for Ask Marco.  Lastly, help us share the show with other like-minded people that you know who can benefit from it as well. Just visit us on your platform. Most of you are on iTunes and leave us a rating and review. I would greatly appreciate it. I read them all and I will thank you in advance. And that is it for today. Thanks for listening. I will see you on our next episode.

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