Transcript Edited For Clarity

Scenario: “The pros and cons of buying rental property vs. buying primary residence.”

Enpo Tu: All right, hello viewers at home. I’m glad that we are coming out of our break from My Financial Coach – Live! Today we have a very special guest here with us, Craig Calentino, who has experience as both a mortgage lender and a landlord. What I’d like to do is to welcome back our listeners. And Craig, why don’t you introduce yourself a little bit before we get into the topic.

Craig Calentino: Okay, thanks, Enpo. My name is Craig Calentino. I’ve been in the mortgage industry for 38 years and owned my own company for 29 years. Prior to the mortgage industry, I was an auditor with Price Waterhouse in downtown Los Angeles. After three years there and earning my CPA, I decided I did not want to be an auditor for my career. Funny enough, so I joined the mortgage business with a company called World Savings, which is no longer around anymore. They got enveloped into Wachovia, which got absorbed by Wells Fargo. Blah blah blah. I’ve clearly loved what I do for a living. I help people buy one to four unit properties as well as refinance them. I’ve kept in touch with my database quite well over the years. I also started buying rental properties about 20 years ago, and that’s turned out to be one of the nicer pieces of my personal net worth with respect to the appreciation of those properties and the buying down of those loans and the increasing of the rents. It’s been one of the best decisions I think I ever made financially, starting to buy rental properties. I manage the loan myself. I don’t think there’s anything wrong with that. You do save five to ten percent of your rental income by not paying a management fee, and I’ve used a home warranty as a bit to satisfy some Property Management responsibilities.

Enpo: First of all, that’s a very impressive background, Craig. Also, I think that makes you very well suited to answer one of the questions that a lot of our listeners have been asking us, revolving around the current buying climate for Real Estate. So, thinking about how interest rates right now are at all-time well, not all-time, but recent decade highs, and there is what is considered an overvaluation of properties. I guess for our listeners, we are curious, does it still make sense to buy properties for rental or to live in?

Craig: I’ve heard that question a bit lately as rates have gone up dramatically in the last year. I mean, gosh, they’re almost triple what they were at the bottom in 2021. So, there are two parts of that question. One of them is does it make sense to buy rental real estate? The other one is does it make sense to buy primary residence, owner-occupied real estate? The latter certainly makes sense even at these current rates. The last 20 years were at a high point, but if you look at the last 40-50 years, we’re still probably under the average. We could be in a new normal of interest rates where we see rates in the low sixes to low sevens on most properties. If you were to compare most properties with someone putting a decent down payment, not say 5% down, but maybe 20-25% down on a property to live in… I bet that number, that total housing cost number including tax and insurance and possible HOA fee, might be less than rent or could be the same as rent. Rents have skyrocketed, in Southern California especially. – And nationally as well because home prices have gone up so much. Less people can afford to buy, so more people need to rent, obviously. People have to live somewhere. If we compare the housing cost of owning with renting, I think it still makes all the sense in the world to buy. Also, you’re going to enjoy, not guaranteed appreciation every year, every five years. Nearly guaranteed appreciation decade to decade. You’re going to see your loan getting paid down every month, which could be kind of fun. And you’re going to enjoy where you live; you’re going to have pride versus renting a place. So, I think 100%, it makes sense to buy properties to live in.

Now, as far as buying investment properties, it’s a little bit of a tougher equation because those are not based on emotion but on simple accounting. On “Am I going to make money every month on this property?”. Now, if we go back to the last time interest rates were in the low to mid 7’s, on investments, say rental apartments, rental 2-4 unit properties. People were buying then. People were always buying when rates were in the 6’s, 7’s and even in the 8’s. Of course people bought when the rates were in the double digits. Price points were a faction of what they were today.

Nowadays, people might need to put some more money down for the property to break even. I just ran one earlier today. It was a rental house with 25 % down, a property priced about $550,000. 25% is the normal standard minimum down payment for a rental property. The payment came out to be $3,687 a month. That same house would probably rent for about $3,200 realistically. So, on the face, it looks like that person is negative, but really it isn’t if you look at the principal that’s being bought down on their loan every month. It actually might still be under $100 negative, but you’re almost close to breaking even if you count the amortization of the principal buy-down, which effectively is the increase in the investor’s financial statement, the balance sheet. And rents are going to go up nearly every year. I don’t really remember a time when rents dropped – at least when I’ve been owning property. I’ve never dropped rents on somebody. I typically raise the rents anywhere from $95 to $125 a month every year on every property. I feel I’m still below market and the tenants expect it. So, if someone were to buy a property now, a rental property, and it was negative $100 to $500 a month, it still makes, in my opinion, great sense in the long term because the house is going to go up in value, the debt’s going to go down in value, and the rents will only go up. So, I’m a big fan of buying rental properties, even with rates where they are today, and I firmly believe that we’re going to see rates a little bit lower before the end of the first quarter of 2024.

Enpo: So, Craig, to that point then, because rates are indeed as high as they are, there is a popular idea going around, well, why don’t I just wait until rates go down before I either buy or invest in rental property or my own personal property? What would you say to that? Just a few sentences on that, kind of your thoughts.

Craig: People always want to time the market. I understand. Which I personally say “Never try to time the market”. If a house right now is priced at $500,000 with the current demand on it, with rates at seven percent, what does one think will be the future demand when interest rates are 5.5 percent? Might the demand might have to be a lot higher for that house? And we know that increased demand is going to increase the price. So we think, that when rates do drop, we are going to see even more of an increase than the standard 3-4% that we expect this year. So, short answer is: You can wait until rates drop, but the price will be higher on that same house.

Enpo: And, to that point then, I mean, no one wants to constantly refinance their mortgage. What would you say about that? There are definitely costs associated. Who bears it? Could you give us an example? Maybe a real life example?

Craig: Certainly. Me and my associates at my company, we had the best years of our career in 2020 – 2021 for obvious reasons because of the pandemic. Shutting things down. Fear in the economy and interest rates dropped. They kept dropping. Fed funds raised to keep the economy chugging along. We did most of our refinances on a no cost basis to our borrowers. The way we do that, on a zero points loan for instance, where the customer pays their own $3,500 in closing costs, how does the mortgage broker get paid? They get paid by a rebate from the lender. Say usually 1-1.5% of the loan amount. When rates have dropped dramatically, we can take a little bit of a higher rate for the customer, get say a 2.5% point rebate, and use $4,000 of that rebate money to pay for the customer’s closing costs. So, in big refi-markets, it is very possible to do a loan with no closing costs at all. Now right now, that’s not possible, because all of the lenders, the market knows that everybody is going to be refinancing certainly in the next 12 months that buys a house today. There is hardly any rebate pricing, it’s very hard to even get a zero points loan this day, let alone a no fees loan. So if someone is refinancing today, you can get in on higher interest rates for a specific purpose such as home remodel, or needed to take money out of the property to pay off a bunch of debt. Buy a luxury car, send kids to college. That person would be paying costs. I would day. It would be fair to say that person is probably going to pay 1.5 points which is 1.5% of the loan amount. Plus all of the fixed costs for escrow, title, appraisal, notary, etc. etc. messenger and all of the lender fees. Which these days with inflation, it’s affected the mortgage industry as well. Those costs are getting close to $4,000, meaning the fixed cost. So now someone would pay let’s say $4,000, where two years ago, they would have paid $0.

Enpo: I think it’s fair to say that on a “go-forward” basis, there is going to be some costs to mortgages. But in the long run, for example if we were going to go back to another 2020 scenario, that’s where it’s just a matter of working with the right mortgage broker to strike at the right time based on what the mortgage market looks like. Is that what I’m hearing?

Craig: I would say so. But, I would also state that we’ve been able to a no points no fees loan for the last 30 years on and off. Mostly on. So I would predict that in the next year or two, we will be in an environment where the rates are very stable. Where the market doesn’t think the rates are going to be dropping at times so they are comfortable paying a big rebate to attract a loan, because they are confident that the loan is not going to be paid off before they hit their break even point on that loan. So yeah, we will see these loans again.

Enpo: So to that point then, some of the things that mortgage lenders are looking at are money down. Does it make sense for there to be a certain calculation, of “we need to put a certain dollar or percentage amount down in order to get favorable rates. Or does it matter as much in a high rate environment, such as what we have?

Craig: It still matters a little bit. You are going to get very slight improvements in your interest rate and or your points which they’re interchangeable essentially with higher down payments it’s not going to be dramatic you’re not going to see a half lower in the interest rate because the guy put 50 down versus five percent down that that might be more like a say a quarter in rate. So, a little a little bit of improvement with higher down payments. Usually, when someone’s looking at buying especially a primary residence to move into (and they have a lot of cash in the bank), what I’ve seen usually is people just want to get to the 20% down point to eliminate the private mortgage insurance and not put any more money down. If you get to 25% down on a condo, the pricing is dramatically better than a 20% or less down. So that would be a reason to go to 25% down. But I don’t really see people trying to put way more than 20% down with the purpose to improve the interest rate.

Enpo: Alright. Well Craig, I want to end this not necessarily focusing completely on the mortgage. As you know, if you are a landlord it is a business. In the case of most businesses, there are fixed costs. There are variable costs and of course there’s the cost of servicing the customer. And just thinking back to my parents that own rental property, there have been times where they’ve actually had a toilet taken from them from a renter that they had to evict… so uh so kind of thinking on your experiences, you know, purely as a business owner of rental properties, do you feel that the environment is still good as a business owner? I mean just thinking of it purely as a provider of service.

Craig: I absolutely do feel still a good time to buy rental properties. I mentioned earlier, the tremendous pressure upward pressure on rents due to so many families nowadays not been able to afford to buy a property. So yeah, it definitely makes sense to buy rental properties. It always has, always will. My, obviously biased opinion: it’s probably one of the best investments somebody can make. It’s a simple business, you know. You buy a house, fix it up, you rent it out you take care of the tenant. Some businesses you can buy are very complicated, very risky. Like restaurants during COVID-19 got shut down. People have to live somewhere. You can’t outsource where somebody lives.
Enpo: Well Craig, actually that’s a good point that you just brought up. So, you know restaurants are certainly impacted by COVID-19. Some landlords in the San Francisco Bay Area such as in Oakland are actually faced with certain tenant protection laws and actions taken that have really shielded and protected tenants at the cost of landlords. I guess you know are those some of the concerns that you’re seeing? Or, is that really just location dependent? Or, I suppose in total or are you seeing more power shifting from the landlord to the tenant? What do you think is the future? Because, this is potentially a long-term business if you’re taking out a 15-30 year loan to purchase these rental properties. What’s the outlook here?
Craig: Yes, I agree with you that there has finished a little bit of a shift of power California specifically. and in other states. I’m sure it’s not nearly as dramatic, but California is a very tenant protection state. Which isn’t to say that they’re anti-landlord, they’re just very… it seems the legislature government is they’re very pro-tenant. They want to protect the person. And, yes. There’s been instances where some people haven’t paid rent for two years, and many of those people are still claiming a COVID-19 reason to not make payments. I’ve been somewhat fortunate in that I did not have one tenant of my seven rentals miss one payment during COVID-19, which I admit it was probably a bit lucky. I also have believed I wanted to deal with single family and nice townhouse type of tenants, which, again, isn’t to say that buying a larger apartment buildings is not a good idea – you actually get better leverage that way as far as “not-large downpayment” wise. But, rental income per purchase price on the building.
So, my people tended to be professionals: police officers, nurses. I always look when I’m looking at tenants for jobs that would withstand many downturns – I never predicted a pandemic, but it just seems like my people had jobs that were that were fine during the pandemic. I have friends that own commercial properties that went months and months and months and months… and it’s a terrible thing. That’s one of the risks of this business It’s the biggest risk you really can’t… well you could get some insurance for lost rent… but it’s expensive. And it only covers it for up to 12 months, I believe.

Enpo: Ok. Well Craig, I think this has been a good insight both when it comes to the financials of owning rental property but also the real business side of the equation. So, I want to thank you for joining us for My Financial Coach – Live! and we hope to have you on again in the future.

Craig: My pleasure, Enpo. Thanks for having me I really appreciate it.