This article is presented by Steadily. Read our editorial guidelines for more information.

Running a rental business comes with its fair share of headaches, but one upside is that just about every rental activity associated with buying, maintaining, and operating a rental property is tax-deductible. We’ll walk through a checklist so you remember to keep track of your actual expenses and get the maximum tax benefit. 

At the end of the day, the logic is that you should only have to pay taxes on your profits, which is your rental income minus all of your expenses. That’s the number that will be entered on Schedule E when you file your taxes. 

Common Tax Breaks for Real Estate Investors 

For many real estate investors, mortgages play a crucial role in turning that dream into reality. When it comes to seeking tax deductions, mortgage interest emerges as a valuable tax incentive. Mortgage interest becomes deductible when secured by the home, distinguishing it from cases involving personal loans. This secured debt allows the home to serve as collateral for repayment. 

To qualify for tax deductions, your property can be a primary or secondary residence or even a rental property with a mortgage. However, there are exceptions, such as the limitation of the interest deduction to $750,000 for married individuals filing jointly and $375,000 for those filing separately. Meeting specific conditions, including filing the appropriate forms, itemizing deductions, and ensuring the mortgage is a secured debt tied to the home, is crucial for claiming the deduction. Consult your mortgage company, which typically provides IRS Form 1098 detailing the interest paid in a given year. 

Property taxes 

Property taxes, often a significant expense, can be offset through deductions on personal income tax returns. The Tax Cuts and Jobs Act of 2017 capped state and local tax deductions at $10,000 ($5,000 for married couples filing separately). This deduction extends to various property-related expenses, including city-imposed hospitality or occupancy taxes on short-term rental properties like those listed on platforms such as Airbnb or VRBO. 

Identifying deductible property taxes involves distinguishing between eligible properties, including primary and vacation homes, and nondeductible payments, such as unpaid taxes, those on rental or commercial properties, transfer sales taxes, costs related to home renovations, and utility bills. Choosing between standard and itemized deductions depends on personal circumstances, and it’s advisable to select the option that provides the greatest tax benefit. 

Asset depreciation 

Business expenses are typically deductible in the year incurred, but for long-term assets, a depreciation schedule is followed. Categories and useful life periods are outlined in IRS Publication 946 and 527. 

Depreciation applies to items like appliances, furniture, vehicles, buildings, and more. While landlords may find depreciation rules inconvenient, understanding these rules can prevent surprises when claiming deductions. 

Insurance premiums 

Insurance premiums, including mortgage insurance, are often overlooked deductions. Landlords can deduct the entire insurance premium for rental properties, whether held personally or in an LLC. This deduction extends to umbrella insurance policies, flood insurance, and even a proportional amount of homeowners insurance for primary residences with tenants. 

Repairs 

Unlike long-term assets subject to depreciation, repairs are fully tax-deductible. The distinction lies in whether the expense constitutes an improvement to the property. Routine repairs, like painting, basic landscaping, or replacing fixtures, do not trigger depreciation concerns. Major renovations aimed at increasing property value, however, fall into the “improvement” category. 

Cleaning and maintenance 

Operating expenses related to employee and contractor wages, as well as materials for cleaning and maintenance, are fully deductible for landlords. 

Utilities 

Utilities are deductible if not reimbursed by tenants. While landlords may cover some utilities, deductions are limited to the actual expenses incurred, excluding amounts reimbursed by tenants.

Property managers 

Fees paid to property managers, whether full-time professionals or part-time assistants are tax-deductible. Outsourcing property management tasks offers both convenience and financial benefits. 

Legal and professional fees 

Fees paid for tax professionals, legal services related to contract reviews, and memberships in professional organizations are deductible when used for legitimate business purposes. 

Advertising 

Fees associated with advertising, such as posting on platforms like Craigslist and Zillow, are deductible. 

Commissions and referrals 

Business-related expenses, including referral fees for finding tenants and commissions paid to current tenants, can be deducted. 

Travel and transportation 

Landlords can deduct travel expenses using either the standard mileage rate or actual expenses. Keeping accurate records of distances traveled and associated costs is crucial to maximizing deductions. Deductible expenses may include meals, taxis, airfare, and hotels. 

Office expenses 

For those claiming a home office deduction, maintaining proper documentation and justifying business use is essential. Renting an external office space simplifies this deduction process. 

Reporting rental income and expenses 

Landlords can use Form 1040 or 1040-SR Schedule E, Part 1 to report rental income and expenses. For more than three rental properties, separate Schedules E should be included for each property.

Final Thoughts

Rental property owners can benefit from various tax deductions, but attention to documentation and timing is crucial. You should be sure to validate any tax strategies and documents with an accountant and ensure you are adhering to tax law. 

Accurate recordkeeping, including receipts, bills, and checks, is vital for substantiating rental income and expense claims. Filing on time ensures alignment with current legal frameworks, and choosing between standard and itemized deductions depends on individual circumstances. By understanding and utilizing these tax advantages, property owners can maximize their financial benefits within the bounds of applicable regulations.

This article is presented by Steadily

Steadily is America’s best-rated rental property insurance provider. Get coverage online in minutes for all property types and all policy durations, including short-term rentals. Visit Steadily.com to get a free quote today.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

Mindy:
Hello, my dear listeners and welcome to the BiggerPockets Money podcast. My name is Mindy Jensen, and with me as always is my weird in his own way co-host, Scott Trench.

Scott:
Thanks, Mindy, I guess. I certainly am interested in creative finance. Hi, Mindy. We are here to make financial independence less scary, less just for somebody else to introduce you to every money story, because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting. Today, we talk to Paco de Leon, author of Finance for the People and host of the podcast, Weird Finance. Paco’s work centers on artists, creatives, and freelancers. And on today’s episode, she’s going to share with us her insight and tips on how artists and creatives of all types can shed the belief systems that have kept them behind and build new practices and work a system to get them financial success.

Mindy:
Paco really gives insight into the mindset shift it takes for creatives to make in order to be able to reach financial success. And this episode is not just for people who view themselves as creatives, but also for anyone who is a freelancer, anyone who does not want the 9:00 to 5:00 work model, or really anyone who has limiting beliefs around money that have kept them behind.

Scott:
Yeah, and a lot of these creatives, it seems, struggle with two fundamental problems. One is the belief that pursuing wealth is a worthwhile goal. There’s often an aversion to some of the capitalist constructs that we take for granted here on the BiggerPockets Money Podcast. And then second, once we’ve overcome that limiting belief or aversion to building wealth, there’s a playbook that creatives need to follow that’s different than the playbook that W2 employees might follow, because they’re not receiving a steady paycheck. They might have project-based work. And so, you’re going to really get a lot of value out of this if you’re in any one of those camps. If you know anyone in any of those camps, I think you’re get a really good perspective on how challenging it can be for some folks to accept value of building wealth, and then to actually master the playbook.

Mindy:
Let’s bring in Paco de Leon. Paco de Leon, from the Weird Finance podcast. Welcome to the BiggerPockets Money podcast. I’m so excited to talk to you today.

Paco:
Thank you so much for having me on. I’m excited to chat with you folks as well.

Mindy:
So Paco, you studied finance, and work in finance, but you identify as an artist and a creative, which are two very, very separate things. How do you reconcile these two different parts of yourself?

Paco:
Well, philosophically, I sometimes think that not everything reconciles. So I’ll start with that. Sometimes, things just feel like they don’t fit. But, I will also say that I don’t think that being an artist or a creative person, and also understanding the abstract world of money, and finance, and accounting, I don’t think that those are mutually exclusive things. I think you need to have a wild, and robust, and vivid imagination to try to understand financial concepts, because they are quite abstract. If you think about the concept of interest, inflation, inflation is a good one, that one, we can all feel it. You can’t really touch it, but we all understand how it’s impacting our lives. And, those are the same brain activity that is required for imagining a story, or imagining a drawing in your mind’s eye. It’s the same activity going on. So, I don’t think that they conflict, but I will say that I know that I have a high tolerance for boring things in life. I have a high tolerance for tedium, and that is what I think accounting is ultimately.

Scott:
I think you’re an exception here where… At least there’s a stereotype of creatives not being good with money. I love your framework of saying, “No, they’re actually using the same brain and the same thought processes, both for storytelling, art, and finance.” But, in your experience, is that stereotype often true, that creatives are not good with finance? And if so, why?

Paco:
So, I think, a lot of creatives might buy into this idea that they’ve been sold and that they’ve been told that this world is not for you, that there’s complicated math, or just if you think about the images that are reflected back to us from the world of finance up until very recently, you go to a financial planner’s website and it’s a closeup picture of a super nice watch and a sailboat. And, the images alone, I think, project a world that a lot of creative people feel like, “That’s just not for me.” It’s very serious and it’s very stuffy. I think there’s a lot of jargon that happens. And, I’ve been in those rooms. I worked in a wealth management firm. And I have before thought like, “Oh, what the world wants of me when I’m playing this role is to seem super smart and to say big words, so that I prove to the client that I’m smart.”
And, creative people, at least in my experience, they’re scared of that. It feels intimidating. Even if you have issues with authority, then there’s another layer of intimidation because that person sitting across from you is authoritative. They’re using words that scare you. So I think the world just feels like it’s not built for them. And, yeah, they’ve been sold this idea that, “I don’t know if you’re good at drawing. You’re bad at math.” But, again, my partner is an interior designer and she tells herself, “I’m not good at this stuff.” But, she can understand space and scale. She can understand the depth of something. She can understand the world in meters. Or, yeah, she understands math. I think, it’s just not applied in a way that is palatable for creative professionals.

Mindy:
With so much confusion over money just with everybody. This is not just for creatives, this is for everybody, I wonder if it’s sometimes easier for people to just say, “Oh, that’s not for me.” Than it is to dive into it. I mean, I’ve certainly done that.

Paco:
I definitely think that we’re experiencing a moment in the world where it feels a lot easier to blame a lot of externalities than to find where you have agency. Of course, there’s things outside of our control that are always going to have an impact on our lives. I’m not saying that that doesn’t exist. But, in every moment, we can figure out how are we going to reframe this? How are we going to think about this? How are we going to find those little slivers of agency where we can exercise our power? And, yeah, I feel like, I definitely have encountered a lot of folks where they just think they can’t do it. And, sometimes part of my job is to just say, “Hey, let’s take a deep breath and figure out why you think you can’t do it. What stories are there. And, can we rewrite the stories if you really believe that? Where can we find examples where you have done something that feels outside of your wheelhouse in the math finance area and you’ve done well? And let’s try to follow that trend.”

Mindy:
So, you studied finance. What does your childhood look like that led you to studying finance? Did you guys talk about money growing up?

Paco:
No. I am a lazy person. Around when my time was starting to run out in college and I needed to pick something, it was 2006, right, so we’re right in the peak housing bubble. And so, what I started to observe was there’s these salespeople and these sales positions in the world of finance and they don’t seem to have to work hard like a lawyer, or a doctor, or a professor, and they make a lot of money. And I thought, “Well, I’m probably smart enough to do that job where you sit down, and it’s air-conditioned, and you look at the computer, and talk to people, and do math stuff.”

Scott:
No blood.

Paco:
Exactly, exactly. It seems easy, sell somebody something, this idea of, “I’ll take your money and make more money. And then, I could go home at a reasonable hour, and still play in my band, and be an artist, and do all this stuff.” So, I was really assessing where can I be the laziest with the maximum return? And also, what is a good fallback or what is practical? I didn’t want my parents to be worried if I got a liberal arts degree, or went to study music, or something. I felt like, “Yeah, they’re probably going to worry about me, so let me do something that’s going to not let them worry and feels practical.” So, that’s the lens. It was not a real strategy, frankly. But, I’m glad I chose the path. I think it’s unfolded in a beautiful way for me.

Scott:
Wonderful answer. Thank you for sharing that. Can you give us a little bit about your career, and what you started out doing, and how you got to what you currently do?

Paco:
Yeah, it’s a funny beginning, because I was the first person in my family to go to college. So there’s so many unknown unknowns. And I thought, “I’m just going to lock in this degree and everything’s going to work out.” And so, I’m getting my degree. And then, I’m like, “Oh, I should probably not have Jamba Juice as my only job on my resume. I should probably, I don’t know, try to get some finance job.” So, I stumble upon a job from a big bank and it’s called credit manager. And I’m like, “Okay. Well, I don’t know what that is. Sounds fancy. Let’s apply for it.” It’s a big cattle call. And, there’s a big line at a call center. I’m like, “Hmm, I don’t know what this is.”
Next thing I know, I’m doing a role playing exercise with one of the managers and I’m interviewing for a debt collector job. I didn’t think I would get it. Got the job, was there for two years, collected on auto loans for two years of the last years of college. Everybody, whenever I say that, they look at me like, “Oh, you poor thing. That must’ve been horrible.” It was truly one of the best jobs I’ve ever had, because I was not a hardcore collector, and I was working for a bank, so I was only collecting on the debt that the bank owned. I wasn’t at some agency where the debt had been sold off. So it wasn’t hardcore collections in that sense, one.
And then, two, I sat on the phone for four hours a day, five days a week for two years asking strangers to pay the bank money back. And after that, I was like, “I could talk to anyone, anywhere, any place about money, because I have done the most awkward thing you can do.” Call somebody at dinner and say, “Hey man, sorry, you’re 35 days past due on your Honda Civic. Could you make a payment?”
So that was my first job. And then, I left truly right as the infrastructure was starting to crumble during the housing crash, I didn’t know that was what was happening. But in retrospect, as soon as that started to fall apart, I graduated, jumped ship. I tricked this small boutique business consulting and management firm here in Los Angeles into hiring me, the summer of 2008 with a finance degree. Can’t believe it. Just can’t believe it.

Scott:
Is that your version of saying you successfully interviewed, and applied for, and got a job?

Paco:
Yeah, yeah. I absolutely somehow still got a job in the summer of 2008.

Scott:
That’s because you’re saying, “I love calling people at eight o’clock at night to collect them their auto loans.” And, I bet you, everyone was like, “You’re hired. 2008, this is it.”

Paco:
Okay. I didn’t love it at the time. It, for sure, was just a job. It’s one of those things, like hindsight is 2020, where I’m like, oh, my job now, as a financial planner, running a bookkeeping agency, just trying to help people with their money, that job was so, so, so integral, because all of the awkwardness was just washed away those first two years. I didn’t even have a degree yet, and I was like, “I’m pretty sure I could talk to anyone about money after this.” So, 2008… Sorry, this is such a long story, this is probably not what you bargained for.

Scott:
This is great. No, you take your time. This is wonderful.

Paco:
2008, I’m working for this boutique small business management firm. It’s basically bookkeeping and accounting for a book of clients. And then, the boss does some consulting. It is all creative businesses. So, in this job I am learning QuickBooks, I’m learning bookkeeping. My boss sends me to do another accounting 101 class at UCLA extension. I’m like, “This is great.” So, I’m running the books for a bunch of creative firms. And then, I’m interacting with creative people. So, the big lesson here I learned, creative people are just scared to death of doing the wrong thing. And I’ll give you one example where I had one owner of this interior design firm. She was writing a check to pay herself from the business account or something like that. And she was paralyzed. She was scared about writing the wrong thing on the check. So, 22-year-old me is sitting there with this 45-year-old woman who owns this company and helping her write this check, right?
So that’s where I was like, “Okay, creative people, I love them. These are my people. But, they’re scared. Something’s going on here. This woman’s freaked out about writing a check.” After that, I got laid off from that job. I’ll tell you, my career has been a bunch of times getting laid off and almost getting fired. And it’s because I have an entrepreneurial spirit, I’ll tell you that much. But then, after that, I go into financial planning and wealth management. It’s a boutique firm again in Los Angeles, they’re managing just north of a billion dollars. And that’s where I’m working with a lot of Hollywood people. I’m sitting at the table across from two Harvard graduates. One is a VP of Paramount, the other one is a VP of some other studio. And I’m just getting schooled. I’m learning how deals are made. I’m learning how people are negotiating contracts. I’m learning how you save $50,000 on a tax bill.
And then, first I’m like, “Oh, this is shiny.” My ego is like, “Hey, kid, look at you. You’re smart. You made it. You’re legit.” And then, after time, I was like, “Man, what about the artists? We never get to help the people that actually need help, right? We’re only helping people with millions of dollars. We’re only helping artists after they’ve made the money.” And around that time, my friends start asking me things like, “Hey, what’s a bond?” Or like, “Hey, dude, my grandma gave me 10 grand. What should I do with it?” Or like, “Oh crap, it’s April 15th at 9:00 PM, can you come over and help me with my tax return?” And I’m like, “Bro, not an accountant, but I’ll sit down with you.” So, it was this parallel thing happening, where I’m getting all this professional experience, again, just showing up. And then, my artist community is starting to recognize, “I think you know stuff about money kid.” And those eventually start to converge.
One day, I find myself unemployed and I don’t know what to do. I think I’m going to go to law school. I know that’s not the right path. And, it’s a very LA story. I’m meditating every day and I’m asking my intuition, I’m asking the universe, “What should I do? What should I do? What should I do?” And, the thing that keeps bubbling up is, “Oh, maybe try to help creatives with their finances.” And so, I formed this company, The Hell Yeah Group, and the great hypothesis that I had, right, the question I was trying to answer is, “Is there a way to serve the creative community in a way that makes sense? They don’t have to already be rich and feels good for me?” Right?
And so, I started a bookkeeping agency. And so far, that has been the service-based business that makes money, that helps people. And then, that allows me to then do weird stuff, like write a book called Finance for the People, do a podcast called Weird Finance, make a bunch of free content online, and hang out with Mindy and Scott on a Tuesday afternoon just shooting the shit.

Scott:
You, I think, said you were broke around this time. So, was there a paradox here where you were getting better and better at learning the ins and outs of finance in general, but your personal finances were not growing at the same time congruently with it?

Paco:
Yeah, Scott, I was a broke financial planner. The people who I’d be sitting across the table from, right, they’re Harvard graduates, $5 million net worth. And, that morning I had ridden my bike seven and a half miles to get to work. Did a bird bath in the lobby of the office building. And, I was growing lettuce in a garden to save $2 at Trader Joe’s, which I’m going to tell you what, not a great budgeting strategy. Not a great strategy for cutting down your expenses. But yeah, I was not making a lot of money in those jobs and I didn’t recognize that maybe I could talk to my boss and negotiate higher pay. I just accepted the default. And, I think one of the things that was holding me back, outside of things that were systemic, like the wage gap internally, I just felt like, “This is what I’m worth. And, I can’t possibly ask for more, and I ought to just be grateful for what I have.”
So there was a lot of internal work that I needed to do to figure out, “Why do I have these ideas about my own self-worth?” Or, “Why do I feel like I’m not valuable compared to other people when I am helping move the needle, I am helping increase revenue?” So, that’s where I started to learn, “Oh, you could know everything about why you should put 10, 20, 30% into a 401k. You could know about the 50, 30, 20 budgeting rule. You could know the academics with finances, but there’s so much internally sometimes that your…” There’s internal discoveries, I think, that you can make that can help you propel or reach your financial goals. And sometimes, you got to be in a tough spot, I think, before you could recognize that there’s even something holding you back.

Scott:
So what was this pivot point? How did you go from Produce Inc to producing?

Paco:
Ooh.

Scott:
Yes, I knew that you were going to love that one. But, what was the catalyst that changed your mindset around this and got you going?

Paco:
This is a little controversial, but I’ll tell the story. So, remember how I told you I had the bookkeeping experience. When I went to go work for the financial planning firm, my boss was like, “Hey, kid, you are bookkeeping. So why don’t you do my books?” So I was doing my boss’s books. And, we had a deal where he was like, “Okay, if I make over half a million dollars, then you’re going to get 10% of everything.” Right? So, we had a profit sharing. And that was really what saved me was the bonus at the end of the year. But it was 11 months of struggling. And then, that one month I got the bonus. But one day, I was doing his bookkeeping. And, I knew how much he paid himself the whole time. But, a couple years in, I was like, “But how much does he pay himself relative to me?” And so, I did the math, because he was paying himself $23,000 a month and I was getting 36,000 a year. And so, I did the math and it was 13 cents for every dollar or something stark like that.
I’m not saying I deserved a dollar for every dollar, he’s taking a risk, it’s his business. But that I felt punched in the gut when I did that math and made it relative. And so, for me, and I know it’s not black and white anymore, but in that moment I thought, “Oh, this is a game. And you will either be exploited or you exploit.” Right? You’re either employer or employee. And in that moment I thought, “I think I can probably get people to pay me more if I go off on my own.” And so, that’s when I went to the dark side, and was like, “I’m going to figure out how to start my own business, and leverage my skills, and maybe reach an audience that I know I can inherently reach.” So that’s when the seed was planted, but it was a lot of time, months after, maybe even a year after that, I think, when I finally did something about it.

Scott:
So I’m going to ask a biased question here, and you check that bias and throw it out here, but you’ve used the words now exploit, dark side, leverage in the context of starting a business, is that mindset common in the creative world? And, is there a defense mechanism that you’re employing there with some of those clients to help them get money? Is that just a part of the interaction you have on a regular basis with your clients in having to couch some of these things in those terms?

Paco:
Yeah. I use that language as well to show that I’m cognizant of the fact that the system that I am participating in, it is inherently exploitative. There’s things I could do, Scott, I could set up a co-op, but I’m actively choosing not to. Right? There’s a lot of things that I could do. So, yeah, I think a lot of people reckon with this. And earlier, Mindy, when you’re like, “How do you reconcile things?” This is a beautiful example of sometimes things, you don’t reconcile them, you recognize that they’re… Can I say a bad word on here? I know I already said one bad word. Okay. You recognize that things are fucked up and you maybe participate in that way.
But, what you do is maybe you find other ways to offset your participation. And I’ve done that, right? I put out a lot of free stuff and I help people who can never afford to pay me. I feel like writing finance for the people is a community service. Yes, I was paid for it. But, my God, it takes years to write a book and it’s truly a labor of love, because it’s really not that much money at the end of the day when you think about everything that goes into it. And I really felt like I needed to put this out there. So, am I dodging your question or am I answering it?

Scott:
Well, you certainly answered the question for you, which I think is awesome. I guess, the other part of my question was, is this something that you find common among creatives that you work with? Is almost an aversion like, “Hey, accumulating wealth is unpleasant, because of what it represents about our society”? Is that something that you contend with your clients regularly?

Paco:
One of the things that I see with the mindset thing when it comes to entrepreneurship is that a lot of creative people are much more willing to be a freelancer when it’s just them selling their time, not having to leverage another person’s time, and energy, and care, and effort, and labor. They’re much more comfortable with that. But, oftentimes, what happens is you start to see the limits of freelancing, where it’s just you, right? You can only trade your time for money, or you can only take on so many projects. So, if you’re trying to accomplish a certain level of wealth, you’re going to be bound by constraints as a freelancer, that’s the reality. You could sell a product that’s one way to scale. Or, oftentimes, what I see a lot of people do is create an agency. Then we start to see some of these layers of, “How do I not be evil?” Is the question.
Then, we see that on the investment side, and certainly we see that on the real estate side for sure. The investment side, I have a great example. The most common thing people ask me when it comes to reconciling these feelings in the investment world is, “What is your recommendation for investing in companies or in funds that they’re not evil, they’re not doing bad things to the planet, and funds that are not holding bad companies?” And the answer is always, this is very complicated. Sure, there are funds that exist that are “socially responsible.” I’m not going to get into the weeds about green-washing and all that stuff. Sure, that exists.
But, the thing that we need to understand is that the mechanism for extracting profits from companies where the people who are creating the labor, they create the value and they don’t get to extract the profits, right, that trickles up to the shareholders. That is inherently exploitative. But, I still don’t think that conscientious objection is the way to go. I think that this is the system that we’re in, that if you want to have power and make a difference, then you must get the money, that is part of it. You must have money in order to direct change, to have power, and that is an unfortunate… Not an unfortunate, it’s just that this is the game that we’re playing. This is the game that we’re continuously choosing to opt into every single day.

Mindy:
Switching gears slightly, you have an agency that does bookkeeping for creatives. What are some of the common problems around money that you’ve found that creatives run into?

Paco:
Different businesses at different levels are going to have different problems. So I would say, when you’re first starting out, the first problem is figuring out if people are going to pay you for the thing you think they’re going to pay you for. Right? Are you solving an actual problem, one? And then, if you are, will people solve that problem for you? So, one funny example I like to throw out there is, on the one hand, it might be hard to get people to pay you to do something. But on the other hand, there are companies out there where the service is a guy will drive to your house in a van, and then he will clean up all of your dog’s poop in the backyard because you don’t want to. That’s bizarre that that’s a service, because I would rather keep the money in my pocket and go pick up the dog poop. But, things like that exist, right?
So, I think it’s all about finding the right solution for the people who are willing to pay. And I think once you understand that framework, it will be a lot easier to make money. And the other framework I like people to think about is, yeah, when people have pain, they will pay you to take the pain away. That’s the world that we live in. I have a tooth right now that’s bothering me, and I’m going to wait until it bothers me a little bit more frequently. I’m going to wait until the pain is too much, because I don’t know, maybe I’m a bad person, and I should pay attention sooner. But, that’s just how I am. It’s like, when the pain gets to me enough, that’s when I’m like, “Fine, here’s my money.” When you think about business in that context, I think it makes it a lot easier to find out like, “Okay, whose problems can I solve?”
I will say some timely things that a lot of people deal with is waiting until the very last minute to file their taxes, and then recognizing, “Oh no, I did nothing. I didn’t do any bookkeeping at all for the prior year.” And so, right around this time, I get emails from people and the panic is palpable through the words on the screen about how worried they are. Everybody thinks they’re going to go to jail. So yeah, not really understanding their place in the market and who’s going to pay for the solutions that they provide.
Another big thing that I see a lot of freelancers deal with is making money for the first time and not saving for taxes, getting sticker shock with the tax bill. Yeah. So that’s a tough one. There’s a really easy remedy for that. And, all you have to do is open up a sales tax savings account, and then for every dollar that you earn, you save between 10 and 30%. Check with your accountant, whatever they recommend. 10% is probably going to be okay, 20% is better, 30%, maybe you’ll end up with too much, but then you’ll have cash come tax time, and you can put that into a IRA or you can reinvest it into the business. It’s not a bad thing to have extra cash on hand. I would say, those are some of the most common issues that creative entrepreneurs and freelancers deal with.

Mindy:
Paco, I’ve heard you say assets are either bought or created. Can you explain what you mean by this?

Paco:
Yeah, I use that in the context to help people understand how to build wealth, right? Because building wealth at the end of the day is having assets. So the way that you get assets is you either make them, like creating a business is a really great example. I guess, you could build a house from the ground up and that would be an asset, not my cup of tea, but if it’s yours, go for it, or buying them, right? So, we go to work, and we get a paycheck, and we use a portion of our paycheck to scoop up assets. And the way that the great majority of us are going to do that is through a tool, like your 401k account, your IRA, or if you have a brokerage account. So you’re buying assets, right? You’re buying stocks, or oftentimes funds that hold stocks, and that is how you are buying assets every time you get paid. And, it’s really boring, but that’s the path to wealth, folks.

Scott:
We talk to a lot of W2 earners on this podcast. Right? And, there’s a lot of different ways to get to financial independence and to build wealth. The one that I think is heavily weighted and discussed here is, “Hey, you save up a percentage of your paycheck. Get those raises. Keep your lifestyle static and let the wealth build up here.” There are themes that go along with that, like, “You don’t need to have that big of an emergency reserve if you’re going to be employed for 20 years.” Right? “You don’t need to have a lot of cash. You can invest in long-term assets that aren’t really liquid there.” I imagine with artists and creatives, there’s more irregular cash flow for many folks there and a different overall financial strategy is needed to build wealth, and be sustainable, be safe, be conservative. What do you typically see as a pattern for these folks?

Paco:
It is really hard as a creative to manage your finances when you have lumpy cashflow. That’s definitely one of the biggest issues that a lot of project-based creative people deal with. And so, that’s why I am such a champion when it comes to… You really need to think about your freelance practice as a business. What are the processes that you have happening and how can you repeat them on a regular basis, so that you can always have options? And, for what that looks like really is options for different clients and different projects to be working on. So I think that’s definitely something that if I had the answer to figuring out how to help creatives manage the most volatile piece, I think I could be president, right? Then, I would have a crystal ball, I would know everything. But, that’s the name of the game. That is the hardest part. And I don’t have it figured out yet.
And even myself, the way my business is set up is, I run this boring, straightforward fee for service business, and then that allows me the latitude to then do project-based work. That’s really not lucrative at the end of the day, but it’s fun, and it goes back into the business in a good way, like having a book, having a podcast, those are forms of content marketing and advertisements. But, yeah, that’s something I’ve been thinking about a lot lately is because we’re no longer in this zero interest rate environment, right, there’s no longer the TikTok creator fund. There seems to be a lot less money being thrown at creative projects than there were 3, 5, 7 years ago. And then, anecdotally, some of the creators that I’ve spoken to lately said 2023 was a tough year for them. Brand deals have dried up. They’re not making as much money. I’ve heard podcasting was a rough year for a lot of my fellow podcasters.
So yeah, one of the things I’m thinking about as we’re out of this 0% interest rate environment is things that were super un-sexy 3, 5, 7 years ago, which is a pretty classic, boring, straightforward service based business or a boring business. They’re getting sexy again. And, that’s where I’m wanting to orient people’s gaze like, “Hey guys, maybe do this steady thing that you can rely on and count on. And let that be the thing that funds your creative projects.”

Scott:
There’ll always be a lot of people who want Scooby-Doo. What was the other one you came up with? Full credit to Mindy for that one.

Mindy:
That’s an actual company Carl and I dabbled in. We considered doing this and we were going to call our company the Rocky Mountain Turd Wranglers.

Scott:
Nice. Yeah, I love that advice, and I think we’ve talked to Cody Sanchez here on the BiggerPockets Money podcast. I know Alex Hormoze has been on the BiggerPockets podcast. And that’s just such a great place to go exploring if you are interested in building wealth at this point in time and you are willing and able to put in those hours to free up the time for these creative outlets. And that brings me to a question I have for you is you started off our discussion by talking about how you’re innately lazy and that’s your goal. What would you be doing if you didn’t need to work at all? You’ve mentioned a band several… What is the goal for you? How would you love to spend your day if you become financially free?

Paco:
Honestly, it would look a lot like how I spend it already, and I feel very grateful and very lucky that I have been working on this business for nearly 10 years, and it’s grown, and it’s freed up my time, and I have opportunities to work on projects that I find interesting. I do have a running joke with my partner, and it’s always like, “Yeah, I just can’t wait until I don’t have to work anymore.” This is a very LA thing. “I’ll go DJ a yoga class or something silly like that.” I’m not really going to DJ a yoga class. But, I think what I would do is I would just make weirder and weirder art with my friends, because I wouldn’t have to be concerned about the market constraints. So, I’d probably make a lot more music. And, probably, I don’t know, make a cartoon. I’d probably dabble in various art forms with my friends. That’s what I’d do.

Scott:
I love it. So your thesis is, start a services based business, because there’s lots of good opportunity there, and then use that to fund your creative outlets in weirder and weirder art, and you drink your own Kool-Aid, and do exactly that with your day-to-day and love it.

Paco:
Exactly. You’ll get to DJ every yoga class and it’ll be great.

Scott:
All right. So, you mentioned yoga. I know you have a closely related meditation practice that you work on. Can you tell us a little bit about that, and if there’s any linkage to your money story?

Paco:
Yeah, I’ve been meditating for a decade now. I have a pretty regular practice. I fall off when I go on vacation every time. I just don’t meditate on vacation. But whenever I get home, I always begin again. And, the thing that meditation has given me is it’s allowed me to work on my attachment to things, which I think is really important when you’re running a business. And I think that’s really important when you do public facing things, because we’re all at the hands of what the market is doing, and what the market will do, and what the audience wants, and what the algorithm wants. And, I think the more that you can exercise letting go of outcomes and just falling deeply and profoundly in love with the everyday process of showing up and doing the thing, whatever it is, then you’ll feel freer, one. And two, I think that is what is required for success ultimately.
So, in a weird way, I do feel like meditation has played a gigantic role in any of the success I’ve seen. But, a huge part of that is ultimately letting go of it. And, I think once you let go of it, the pressure is gone, you just love showing up every day. There’s a Buddhist phrase that’s like, before enlightenment, you have to chop wood and carry water. After enlightenment, you have to chop wood and carry water. Which basically means, your life is going to be the same and you’re just going to just fall in love with the process because that’s all we ever have, this moment right now.

Mindy:
I like that a lot. That’s so true. Once you do something, you’re still going to have… I think that applies to financial independence too, Scott. Before you reach financial independence, you’re still going to have to chop wood and carry water. After you reach financial independence, you’re still going to have to chop wood and carry water. Paco, I love this. I love you. I have had such a good time with you today. Can you please share with our listeners where they can find you?

Paco:
Yeah. If you want to listen to my podcast, it’s called Weird Finance, and it is available wherever you’re listening to this podcast. Also, you should sign up for my weekly email newsletter called The Nerd Letter, and that’s the best way that we can stay in touch and I’ll send you an email every week. You just go to thehellyeahgroup.com, and you sign on up, and I’ll see you in your inbox.

Scott:
Thank you so much for sharing such a wonderful breadth of thoughts today, and really giving us an insight into the world of creatives and finance. Really appreciate it and your perspective was really unique and powerful for us.

Paco:
Thank you guys for having me on and just letting me be my full weird self. I appreciate it.

Mindy:
This was so much fun, Paco. Thank you so much, and we will talk to you soon.

Paco:
Take care.

Mindy:
Scott, that was Paco de Leon and that was a fantastic episode. What did you think?

Scott:
I thought she was fantastic. I am really walking away with new perspective that in the creative community there is likely a significant amount of the population that’s averse to the concept of building wealth and perhaps even capitalism from a moral standpoint, because I just take it for granted that that’s the system we live in and that we’re here to help people build wealth. I haven’t empathized with that enough, and I think that Paco is so perfectly equipped to understand those challenges and that mindset in that community, and I think she’s doing really good work in there. So, there’s a two-part problem. It’s one, alignment with the concept of building wealth and getting over or past that roadblock for a lot of creatives. And then, two, the playbook that they need in order to build wealth, which is going to be different and need to have different tools at their disposal than the folks that are pursuing financial freedom through a traditional W2 corporate ladder path.

Mindy:
You’re right, Scott, they’re going to have to get, pardon my pun, creative with their financial freedom and their financial mindset, because they don’t typically have the tools that are available to a W2 employee, but that doesn’t mean that they can’t build wealth and provide for their future. Again, I feel like you, Scott, they need to get creative. All right, Scott, should we get out of here?

Scott:
Let’s do it.

Mindy:
That wraps up this episode of the BiggerPockets Money podcast. He is Scott Trench and I am Mindy Jensen saying, see you later, excavator. Shout out to listener Scott for that one.

Scott:
If you enjoyed today’s episode, please give us a five star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at youtube.com/biggerpocketsmoney.

Mindy:
BiggerPockets Money was created by Mindy Jensen and Scott Trench, produced by Kaylin Bennett, editing by Exodus Media, copywriting by Nate Weintraub. Lastly, a big thank you to the BiggerPockets team for making this show possible.

In a recent CNBC article, it was revealed that more than half of Americans earning over $100,000 a year live paycheck to paycheck. This eye-opening statistic highlights a fundamental truth: The road to wealth isn’t solely about income but depends significantly on transforming financial habits. 

In this guide, we’ll debunk the oppressive notion of budgeting, offering a transformative process to fix money leaks, cultivate strategic spending habits, and execute consistently for financial improvement.

Budgeting Is Dead—What to Do Instead

If the word “budget” sends a shiver down your spine, you’re not alone. According to a recent Lending Club report dated September 2023, over 60% of Americans steer clear of financial planning because, well, the “B-word” is just too daunting. 

But fear not because I want to introduce you to the revolutionary concept of “budgeting is dead.” Here are the steps to follow instead.

Step 1: Tracking your income and expenses

So, you want financial mastery without the stifling confines of a traditional budget? Well, it’s all about tracking, not budgeting. As the wise ones say, “What gets measured, gets done.” Committing to regular income and expense tracking is the foundational step for the “budgeting is dead” process—a process that will help you master your financial landscape without feeling like you’re straitjacketed by an old-school budget.

Step 2: Getting leverage

If you’re not a spreadsheet wizard or time is your most precious commodity, let technology do the heavy lifting. Platforms like Simplifi.com, Empower.com, or You Need a Budget (YNAB.com) turn financial tracking into a breeze. Say goodbye to complexity that could kill your momentum.

Step 3: Uncover where your money is really going

Picture your finances as a boat sailing toward your goals. Now that you are regularly tracking your income and expenses, you now know how your boat is constructed. Maybe it’s made of the finest metal and is impenetrable. Maybe it’s more like a leaking life raft that is quickly taking on water. 

No matter which boat you think you have, commit to doing this step at least once a year to eliminate any “holes” that could cause your boat to leak. In this step, you need to categorize each expense as Destructive, Lifestyle, Protective, and Productive. 

• Destructive expenses lead to debt and poverty: think of addictive habits, compulsive spending (eating out, shopping, etc.), and unnecessary fees (credit card fees, late fees).
• Lifestyle expenses don’t contribute to building assets: think of nonessential spending that doesn’t enhance your life, like subscriptions (magazines, wine club, razor club, movies) and other excessive spending.
• Protective expenses help maintain wealth: think of expenses that help you optimize and/or protect your wealth.
• Productive expenses enhance both current and future life: think of career building, business building, and investment activities that yield more income than you spend.

Step 4: Taking decisive action

With a clear understanding of your spending habits, now it’s time to take a proactive approach to wealth creation. Here’s how:

• Eliminate destructive expenses like a bad habit (because they are). Get professional help if needed.
• Reduce lifestyle expenses by identifying low-hanging fruit and eliminating nonessential spending.
• Negotiate/renegotiate protective expenses to get the most value for your money.
• Monitor productive expenses, ensuring spending aligns with income during different wealth creation phases.

Final Thoughts

Even big earners can find themselves doing the paycheck hustle. So, let’s ditch the one-size-fits-all budget and embrace a more strategic spending approach.

Sure, it might seem like a deep dive into your financial soul, but remember, this isn’t a one-off thing; it’s a habit to cultivate regularly. Consistent, persistent action will be your ticket to financial success.

Ready to break up with budgeting and make financial mastery your new BFF? You got this!

Protect your wealth legacy with an ironclad generational wealth plan

Taxes, insurance, interest, fees, bills…how can you acquire wealth, let alone pass it down, when there are major pitfalls at every turn? In Money for Tomorrow, Whitney will help you build an ironclad wealth plan so you can safeguard your hard-earned wealth and pass it on for generations to come.  

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

Commercial real estate has had a few rough years, and it seems like things won’t be getting better anytime soon. The sector is set for a potential rise in defaults, as higher interest rates have increased the costs of refinancing. 

And with $2.8 trillion due between now and 2028, more landlords could be feeling the crunch. According to data firm Trepp, commercial debt maturities are expected to balloon in the next few years. While many loans were extended or refinanced, the clock is slowly ticking for the CRE sector as those extensions are coming due. 

Worst Commercial Slump in the Last 50 Years

The CRE market has been struggling to regain its footing since the start of the pandemic, especially in office space. When the pandemic hit, many office spaces emptied, forcing landlords to make deals to delay payments until things recovered.

Unfortunately for those invested in the office arena, remote and hybrid working is now becoming the norm, with many businesses downsizing their office space or even becoming fully remote.

Now that the CRE debt is coming due, landlords are starting to squirm. Because of how commercial mortgages are structured, when the debt matures, the principal must be paid off in full or refinanced.

This has led to one of the steepest commercial real estate price declines in the last 50 years, a group of economists at the International Monetary Fund (IMF) found. This can largely be attributed to higher interest rates, steep monetary policy tightening, and stricter bank lending standards, according to the IMF.

While the office sector has been the hardest hit, the entire market has felt the sting over the last few years thanks to a souring CRE market. Vacancy rates in multifamily homes have increased, and rent growth is expected to decline in the coming year, according to CBRE. Industrial spaces are also showing signs of weakening. 

The only potential bright spot in CRE is the retail sector, as robust consumer spending and suburban migration has driven demand for outdoor shopping centers. 

Interest Rates Aren’t Going Down Fast Enough 

While interest rates have gone down a bit, it might not be enough. According to The Wall Street Journal, many borrowers are refinancing at rates higher than when they first took out loans. 

The Federal Reserve is under pressure to cut rates, with some economists expecting a cut by the end of the year to 3.75%-4% and continued cuts by the first half of 2026 until the rate hits 1.75%-2%. However, that might not be fast enough for the CRE sector. Fitch Ratings expects delinquency rates in commercial real estate to increase to 4.5% this year, while regulators are worried about the spillover effects.

In its 2023 annual report, the Financial Stability Oversight Council (FSOC) cited exposure to commercial real estate as a concern for financial institutions and said that they need to better understand the risk. Nearly 50% of CRE’s outstanding debt is held by banks.

“As losses from a CRE loan portfolio accumulate, they can spill over into the broader financial system. Sales of financially distressed properties can… lead to a broader downward CRE valuation spiral,” FSOC said in its report. 

The Bottom Line for Real Estate Investors

Commercial real estate investors should buckle in and get ready for a bumpy ride over the next few years. That said, although the CRE space is under pressure, there’s still some time for landlords to negotiate. Still, with CRE sales also under pressure, that’s devalued properties, making it hard for lenders and borrowers to agree on how much the property should be worth.

With banks becoming more risk averse around CRE and under more regulatory scrutiny, that could open opportunities for non-bank lenders such as private credit to step in. And for some savvy investors, the stress in the CRE market could provide opportunities.

In other words, there could be opportunities for investors to find distressed properties for a great value, provided they’re prepared to weather some uncertainty in the next few years. However, uncovering these bargains will require a lot of due diligence to avoid falling for value traps.

Real estate investors should make sure to heavily scrutinize every opportunity that presents itself. While there will certainly be some opportunities to revitalize properties, not all cheap properties will be worth the long-term price.

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Dave:
Hey, everyone. Welcome to the BiggerPockets Podcast. I’m your host today, Dave Meyer, joined by one of the OG original BiggerPockets members, podcast hosts, all sorts of things. Mr. J Scott, himself. J, thank you for joining us today.

J:
Thanks for having me back. I feel like it’s been a minute since I’ve talked to you guys.

Dave:
I know it’s been way too long. How far back do you go with BiggerPockets?

J:
2008. Six months before I flipped my first house, I found BiggerPockets ’cause I did a Google search for how to flip houses. So yeah, I think it was something like March or April of 2008.

Dave:
That’s incredible. I bet half of our listeners right now didn’t even know that BiggerPockets was around in 2008. Not to date you, J-

J:
Oh, I’m old.

Dave:
… but just to explain that we have a lot of experience at BiggerPockets. We’ve actually been around for about 20 years, which is incredible, and J has been one of the most influential investors and participants in our community. So we do have a great show that I’m very excited to have J on for because we’re going to be answering questions, some of our audience and some of the Internet’s biggest questions about the economy, about the real estate market-

J:
Hold on. Hold on, I thought we were talking about Taylor Swift and the football game that’s coming up. I’m not prepared for an economic discussion.

Dave:
Well, we could sneak one of those questions in there. Do you have strong opinions on what’s going to happen there?

J:
I don’t. I don’t. It just seems like that’s all anybody’s talking about these days. It doesn’t feel like anybody’s talking about economics or real estate anymore. All I hear about is football and Taylor Swift.

Dave:
Well, there’s some escapism going on where everyone’s just tired of talking about the economy or what’s going on, but it is so important, we have to be talking about what’s going on with the news and the housing market if we’re going to make good at investing decisions. So unfortunately, J, actually, I’m going to stick to the script and make you answer some real questions that are going to be useful to our audience. So let’s just jump right into our first question here: housing crash. This is the number one thing being searched right now on Google about housing, about the economy, and we want to know what you think, J. Are you on the housing crash side of things? When I say housing crash, let’s talk specifically about residential ’cause I know you invest both in residential and commercial real estate.

J:
So here’s the thing. First of all, when we talk about housing crash, too many people, I think, conflate this idea of the economy and the housing market, and they’re two very different things. So when I hear the question, “Are we going to have a housing crash?” Sometimes people actually are asking, “Are we going to see an economic market crash?” Because they assume it’s the same thing, but historically, they’re two very different things. Let me ask you a question, Dave. Going back to let’s say, 1900, how many housing crashes have we seen in this country?

Dave:
Crashes? I want to say just one, but maybe two, ’cause most of the data I look at is from the ’40s on. So I don’t know if there was one during the Depression, but I’m pretty confident since then there’s only been one.

J:
Yeah, there wasn’t one during the Depression, and the only housing crash we’ve seen in this country was in 2008. We saw a little blip in the late ’80s with this thing called the savings and loan crisis, which was another recession that was tied to real estate. But for the most part, every recession we’ve had in this country, and we’ve had 35 recessions over the last 160 years, every recession we’ve had has been non-real estate caused. Typically speaking, when you have a recession that’s not caused by some foundational issue with real estate, real estate’s not affected. Now, 2008 was obviously a big exception. 2008 was a real estate crisis, and it was a real estate-caused recession, and we saw a housing crash.
But the problem there is that I think there’s something called recency bias that where a lot of us are falling prey to. It’s the last big recession we remember, and so we assume that the next recession and the one after that and the one after that are going to be similar to the one we remember the best, which was the last one. But the reality is 2008 was very out of the ordinary. It was the only time we’ve seen housing crash in the last 120 years. So I think the likelihood of a housing crash anytime soon, and it’s not just because of historical reasons, and we can talk about other reasons, I think it’s very unlikely that regardless of what the economy does over the next couple of years, I think it’s very unlikely we see a housing crash or even a major housing softening.

Dave:
Well, see, J, this is why we bring you on here. You have so many good stats and an excellent opinion on this, and I completely agree with you about this. I was calling it a year or two ago this housing market trauma that I think my generation, I’m a millennial, had and a lot of people around my age grew up during this era when the housing market was a disaster for most people, and they feel like that that might happen again. Of course, there’s always a chance. But as J has provided us with some really helpful context, that is not the normal situation in a broader economic downturn. I am curious what you think about this, ’cause part of me thinks there’s this recency bias, but there’s also this desire for the housing market to crash by a lot of people. For people who might not be investors are own property currently, I think a lot of people look at prices now and the relative unaffordability and are hoping or rooting for a housing market crash, even though it sounds like you think that might not be likely.

J:
Yeah. There are a lot of people in this country that are really unhappy with the direction of the economy and their personal finances. I think inflation at 9% a year-and-a-half ago really threw people and put people in a pretty bad situation. We talk a lot about the wealth gap in this country. There’s a big gap between those who have money, those who have hard assets, real estate and stocks. 10% of this country are millionaires, but the other 90% are struggling, and there’s a big gap between the two. Those who are struggling, they don’t want to be struggling. They remember 10 years ago when there was a crash after 2008, and all the people that had lots of money started buying up houses and buying up stocks and buying up all the hard assets, and they want to go back to that time.
They want to have a chance to participate in that. Unfortunately, I don’t think we’re going to see that type of opportunity again anytime soon. Yeah, there’s a lot of frustration out there. It’s also, I’ve talked a lot about this over the last couple of weeks, there’s a big disconnect between economic data. The economy is looking really good purely from a data standpoint, but economic sentiment or public sentiment is just the opposite. There are a lot of people who don’t feel like things are good. People don’t feel like the economy’s moving in the right direction. They don’t feel like their personal finances are moving in the right direction. So there’s this big disconnect between what the data’s telling us and how people are feeling. So yeah, it’s a tough time out there right now.

Dave:
Okay, so I do want to dig into that disconnect that you just mentioned a second ago, and we’re going to get right into that after the break, along with some of the other hottest questions in real estate like, when will mortgage rates come down? Will affordability ever improve, and what is the single biggest economic risk right now? Stay tuned. Welcome back to BiggerNews. I’m here with J Scott hashing out some of the most debated economic questions in real estate right now. If you remember, right before the break, J pointed out that there’s a big disconnect between what the economic data is telling us versus how people, the American people actually feel. So let’s dig into that. That’s a great topic. Let’s jump into that a little bit because I see the same thing.
When you look at traditional measures of the economy, things like GDP, it grew in Q4, and it actually started to accelerate at the end of Q4. We also see labor market has been up and down a little bit the last few months, but generally, it’s just unemployment rate is very low in a historical context. There are many different ways to measure the labor market, but many of them point to strength. So when you look at these old school or traditional ways of looking at the economy, it looks great, but you see people are frustrated. They have a lot of pessimism about the economy. I’m curious, do you think it’s because that gap in wealth that you mentioned? Because when you look at GDP, that’s basically a measurement of how big the pie is growing, but it doesn’t really tell you anything about how that pie is being divided up between people in the United States.

J:
Well, this is a weird thing because yes, we have really poor public sentiment right now. People feeling stressed and strapped and not happy with their personal finances, but at the same time, they’re spending money. You look at holiday shopping, we were up 14% year-over-year for holiday shopping this year. People are spending money. Despite the fact that college loan repayments restarted, so people you would think would be more strapped there. The cost to rent right now, 52% more expensive to rent than own right now, so you would think people are feeling strapped paying their rent. Food costs have obviously gone through the roof. Even though inflation has come down, we’re still seeing higher than typical food inflation. So that thing, when people go to the grocery store once or twice a week, they’re getting hit pretty hard.
So you would think it would impact people’s spending habits, but the fact that we saw GDP grow at 3.9%, the fact that we saw year-over-year holiday spending up 14%, that tells me that people aren’t really feeling it. I’m thinking that part of the issue, or part of the reason for that is number one, we are seeing that credit cards are getting maxed out. Savings is at the lowest rate in history right now, so people are running out of money. But at the same time, the average homeowner has $200,000 worth of equity in their home that they can tap, not even including that 20% that the lender requires them to keep in. So people can tap home equity if they need to.
The stock market is at all time highs. So anybody that owns stock has the ability to cash out some of their stock holdings, and they have access to cash. Anybody that holds Bitcoin or gold or other hard assets, those things are going through the roof, so people can sell their assets. They have access to cash and they can just keep this gravy train rolling. So I think as long as the economy is moving along and asset prices are going up, people are going to find access to cash one way or the other, and they’re going to keep spending. So it’s just a question of is this musical chairs as the music going to stop at some point, and we’re going to see everything come crashing down?

Dave:
I’ve been surprised personally, J, with some of the things that you mentioned. Back in September when student loans resumed, I was like, “Okay, things have to start slowing down,” or you periodically get these reports from the Fed or other sources that say that all the excess savings from the pandemic from stimulus checks, that has all been depleted, but it keeps going. Obviously the credit card stuff is concerning, but I personally felt like the writing was on the wall six months ago. But it continues to go on, and I continue to be surprised.
So I think that is one of the things I’m going to keep a close eye on throughout this year is just what is going on with consumer spending, because that makes up 70% of the U.S. economy. So as long as people keep spending, as J said, that bodes well, at least for the traditional ways of measuring the economy like GDP. Now, I do want to get back to the housing market a little bit. You mentioned that you don’t think the housing market is going to crash. Can you just talk to us a little bit about some of the fundamentals of the housing market and why you think the housing market is poised to at least remain relatively stable in the coming years?

J:
Yeah. So it all boils down to supply and demand. Just like everything else in the economy, if you look at supply and demand trends and supply and demand pressures, you get an idea of where prices are likely to head. It shouldn’t surprise anybody that we in the single-family world are seeing high demand and low supply right now. Anytime you have high demand and low supply, prices tend to go up or at least they stabilize. So historically, we generally see about 1.6 million properties on the market at any given time in this country. We’re at about half that right now, so there aren’t a lot of properties out there to buy. Supply is low. At the same time, heading out of the Great Recession, 10 years ago we were at about 5 million units underserved. There was demand for about 5 million more housing units than we had.
Well, we’ve been building units at about the same rate as demand has been increasing for units. So based on that, we can assume that we’re still about 5 million units short in this country on housing. New homes, we completed what, 700,000 last year I think it was, or maybe we sold 700,000? So that’s still like seven years worth of inventory that we need to sell to catch up to the demand in new housing. So long story short, low supply, high demand, not enough building basically means that prices are going to be propped up. Case-Shiller data for November just came out a couple of days ago, and that data is always a few months behind. But data for November basically indicated that we saw a 5% year-over-year increase in housing prices, and housing prices are once again at all time highs. So things aren’t slowing down yet.
I suspect they will at some point, but again, I don’t think there’s going to be a crash because I think that this low supply and what’s driving low supply, people might ask. Well, it’s the fact that millions of homeowners, 85% of homeowners or something like that, maybe it was 87% have fixed-rate mortgages at under 5%. Something like seventy-something percent have under 4%. So homeowners aren’t going to sell their houses right now and get rid of these great mortgages just to go out and buy something else that’s overpriced and have to get a mortgage at 6 or 7%. So I think this low supply is likely to persist. I think the demand both from people who are paying 50% more to rent and now want to buy, investors who want to buy more property, large institutions like BlackRock and others, hedge funds that want to buy, there’s going to be a lot of demand out there. So I don’t see prices coming down anytime soon, even if we do see a softening economy.

Dave:
That’s a great way of framing it. I think for our listeners, it’s really important to remember that housing crashes don’t happen in a bubble. It really does come down to supply and demand, and you can analyze each side of those. As J said, when you talk about supply, it’s very, very low right now. So if you think that there’s going to be a housing crash or you want to know if there’s going to be a housing crash, you have to ask yourself where would supply come from? Where is it going to materialize from? And I don’t see it. Construction is actually doing decently right now, but it would take years at this decent clip to eliminate the shortage you talked about.
You mentioned the lock-in effect, and that’s constraining supply. It’s also worth mentioning that inventory was already going down even before the pandemic because people have been staying in their homes longer. Lastly, I know a lot of people, especially on YouTube, talk about foreclosures coming in and starting to add supply, but there’s just no evidence of that. You might see a headline that it’s up double from where it was in 2021, great. It’s still about 1/3 of where it was before the pandemic and it’s at 1/9 of what it was during the great financial crisis. So I don’t see it. I hope I’m wrong because I do think it would help the housing market if there was more inventory, but I just don’t see where it’s coming from.

J:
At this point, it looks like there’s only one thing that’s going to drive more supply, more inventory, and that’s mortgage rates coming down, interest rates coming down, because at that point, people feel more comfortable selling their houses and buying something else because they know they can trade their 4% mortgage for a 5% mortgage or a 5 1/2% or a 4 1/2% mortgage. So people are going to be more comfortable doing that. But what’s the other thing that happens, if interest rates come down?

Dave:
Demand goes up.

J:
Demand’s going to go up. So even if we fix the supply problem, the way we fix it is likely going to create more demand. So I’m not saying that nothing could impact the market, but I think it would take some major economic shock. It would take a black swan event or it would take some major economic softening, the labor market imploding and unemployment spiking, something like that before we really saw any major increase in supply. There’s no indication that we’re anywhere near that. So I think we’re going to see prices about where they are for the next several years.

Dave:
That’s really important to note that there’s always a possibility of what’s, quote, unquote called, “black swan events.” Basically, it’s something J and I and no one out there can really predict. These are things like the Russian invasion of Ukraine or COVID, things that just come out of nowhere and no pundits or people who are informed about the economy can really forecast those types of things, so of course, those are always there. But just reading the data on the supply side, I totally agree with you. Just to play devil’s advocate for a minute here, even if you couldn’t increase supply, you could change supply and dynamics in the market if demand really fell, if people just didn’t want to buy homes in the same way. I do feel like you hear these things that if housing affordability is at 40-year lows, and so do you have any fear or thoughts that maybe we see a real drop-off in the number of people who want to buy homes, and maybe that would change the dynamics of the market a bit?

J:
I suspect that we will see that trend, but I think that’s a 5, 10, 15-year trend. I don’t think that’s something that’s going to hit us in the next year or two or three because, again, really, it’s pretty simple. Right now, it costs 50% more to rent than to own, and nobody in their right mind is going to trade their 3% mortgage to pay rent at 50% more. So I do see this becoming a, quote, unquote, “renter nation” over the next 10 years, but again, I don’t see that being a short-term thing. I think that’s going to be a consequence of the market fixing itself. I don’t think that’s going to be a driver of the market fixing itself.

Dave:
So the one thing you mentioned that could change the market, and I think it’s really important to mention that when we say, quote, unquote, “the market,” most people think we’re only talking about prices, and that is a very important part of any market. But when you look at an economic market, there’s also quantity, the amount of homes that are sold. That’s super low right now, just so everyone knows, we’re at, I think, 40, 50% below where we were during the peak during COVID, so that’s come down a lot. One of the things that you mentioned could potentially change, in my mind at least, both sides of the market, both the number of sales and where prices go is if mortgage rates come down. So J, I can’t let you get out of here without a forecast or at least some prognosticating on what is going to happen with mortgage rates in the next year. So what are your thoughts?

J:
So I think they’ll come down. It doesn’t take a genius to make that prediction. I think most people are predicting that. The reason for that is as of December, the Federal Reserve, the Fed basically reverse course said, “We are done, our hiking cycle for interest rates for the federal funds rate.” At this point, the next move will probably be down. When the government starts to lower that federal funds rate, that core short-term interest rate, that’s going to have an impact on other markets like the mortgage market and mortgage interest rates. So the market is pricing in that core federal funds rate could likely drop from where is it? It’s at like 5 to 5 1/4 right now to somewhere between 3.75 and 4% by December.
So 40% of investors are betting their money that the federal fund rate’s going to be down around 4% by the end of this year. So that’s about a point-and-a-half less than where it is now. Does that mean we’re going to see a point-and-a-half less in mortgage rates? Probably not, because that’s spread between the federal funds rate and mortgage rates right now is smaller than normal, so that spread will probably expand a little bit. But I think a point-and-a quarter drop in federal funds rate will likely translate to about 3/4 of a point in a drop in mortgage rates. So if we’re right now at about 6.6, 6.7, 6.8%, 3/4 of a point puts us around 6%.
So if I had to bet, I would guess that by the end of this year we’re somewhere between 5 3/4 and 6% mortgage rates, which is a decent drop, but it still doesn’t put us anywhere close to that 2, 3, 4% that we were seeing a couple of years ago. It will open up the market a little bit. There will be some people selling. You mentioned foreclosures increasing. It turns out that the bulk of the foreclosures that we’re seeing are houses that were bought in the last two years. So there’ll be an opportunity for people that bought in the last couple of years who are struggling to get out. So yeah, I do see mortgage rates coming down, but if I had to bet, I would say 5 3/4 to 6% by the end of the year.

Dave:
I hope you’re right, and I do think that’s general consensus. I think for most of the year, it will probably be in the sixes, and it will trend to downwards over time. I do think personally that it’s not going to be a linear thing. You see that it’s relatively volatile right now. It went down in December, it’s back up in January, but I think the long-term trend is going to be downward, and that is beneficial. You mentioned it’s going to open things up a little bit. How do you see this playing out in the residential housing market throughout 2024, just given your belief that rates will come down relatively slowly?

J:
I think it’s going to have probably pretty close to the same effect on demand as it does on supply. So I think rates coming down is going to encourage some people to sell, and it’s going to encourage some people to buy, and I think those forces will pretty much even each other out. In some markets, we may see prices continue to rise a little bit. In some markets we may see prices start to fall a little bit. But I think across the country we’re going to see that same average, what’s 3% per year is the average of home price appreciation over the last 100 and something years. So I think we’ll be in that 3 to 5% appreciation range for much of the country if I had to guess. Here’s the other thing to keep in mind. You mentioned that this isn’t going to be linear. This is going to be an interesting year.
We have an election coming up in November, and historically the Fed does not like to make moves right around the election. They don’t want to be perceived as being partisan and trying to help one candidate or another, and so I think it’s very unlikely. In fact, I think there’s only two times in modern history where the Fed has moved interest rates within a couple of months of the election. So I think it’s very unlikely that we’ll see any interest rate movement between July and November, which is a significant portion of the year when you consider that we’re unlikely to see any movement between now and March. So that basically gives us March, April, May, June, and then December. So we have about half the year where we could see interest rate movements. So if we do see any movements, it’ll probably be big movements in that small period of time as opposed to linearly over the entire year.

Dave:
That’s really interesting. I had not heard that before. It makes sense that the Fed doesn’t want to be perceived as partisan, so that’s definitely something to keep an eye out for. It makes you wonder if there’s going to be a frenzy of… it’s already the busy time for home buying, what did you say, April through June, basically? So that’s the busiest peak of home buying activity and might be the most significant movement in interest rates. So we might see a frenzy in Q2 then.

J:
Yeah, and we can take that one step further. While the Fed doesn’t like to seem partisan leading up to an election, there is evidence that they tend to be in favor of supporting the incumbent, regardless of whether it’s a Democrat or a Republican. They like to see that the economy is doing well in an election year. So what we’ve seen historically, again, not right before the election, but typically, the few months prior to an election or the few months prior to prior to the election, we see the Fed make moves that tend to favor the economy and to favor the incumbent.
So I wouldn’t be surprised if we see a drop in rates in the March, April, May timeframe, even if the economy isn’t necessarily indicating that’s necessary. I think that’s something that Jerome Powell was preparing us for in December when he came out and said, “Hey, we’re open to dropping interest rates if we need to.” After two years of basically saying, “We’re going to keep rates higher for longer,” he suddenly reversed course and prepared everybody for us to start considering dropping rates. So I think that that just could be just a signal that they’re going to be a little bit more dovish in the first half of this year than they otherwise would be.

Dave:
Okay. So we are getting into some of the good stuff here, and we are about to cover a recent economic change that will impact lending and the biggest economic risk to investors right after the break. Welcome back, everyone. J Scott and I are in the thick of it talking about the most pressing issues in real estate right now. Before the break, we got J’s predictions on interest rates and what we can expect from the Fed in 2024. While we’re on the topic of the Fed, and man, I pray for the day we don’t follow the Fed as closely as we’ve had to the last couple of years, but they recently made an announcement in a different part of their directive here and announced that the Bank Term Funding Program is ending on March 11th. J, can you just tell us a little bit about what this program is and what this means for the financial system?

J:
Yeah, so last March, there was this big regional bank called Silicon Valley Bank. Anybody that wasn’t paying attention, basically-

Dave:
It feels so long ago-

J:
Right.

Dave:
… there’s so much has happened since then. I can’t believe that was only a year ago.

J:
It was less than a year ago. Crazy.

Dave:
Yeah.

J:
But basically, this bank, they bought a whole lot of Treasury bonds and based on the movement of those Treasury bonds, the value of those bonds fell considerably. The bank was in a bad financial situation or it was looking like they could be. So a lot of, not investors, but depositors in that bank started to take their money out. A lot of those depositors were venture capitalists and startup tech firms that had literally millions of dollars in the bank. So some ridiculous amount of money closer to $50 billion was at risk of flowing out of that bank over a couple of days, and the bank essentially became insolvent.
The state of California basically took the bank into receivership, and the federal government said, “We need to make sure that this isn’t a broader issue that contaminates other parts of the banking sector.” So they set up this thing called the Bank Term Funding Program, where they told banks, “If you’re in this situation where you bought too many Treasury bonds and movement in bonds has caused you to lose a lot of money, come to us and we’ll give you a loan against those bonds to ensure that you have lots of cash on hand, and you’re not facing this crisis.” They set up this thing called the Bank Term Funding Program, which was a way of loaning money to these banks that said they needed it. Between March of last year and June of last year, banks basically went to the fund and said, “We need a $100 billion.”

Dave:
Oh, just that?

J:
Yep, 100 billion. A lot of it was in the first couple weeks, but over the first three months, 100 billion was borrowed from this fund. For the next six months through November, December, essentially nothing was borrowed. Basically, banks indicated that they were in a pretty good position, they didn’t need to borrow money from the government, and they were very favorable loan terms, by the way. But banks basically indicated, “We don’t need to borrow.” Then in December, the Fed started talking about, or the Treasury started talking about getting rid of this program. It was supposed to be a one-year term, which means the program would end in March. Right around the time they started talking about getting rid of the program, suddenly banks started borrowing again. Banks went back to the program and said, “I need money. I need money, I need money,” and it went from 100 billion borrowed to 170 billion over the course of about a month.
The most likely scenario here was that banks realized that they were getting near the end of having the ability to borrow cheap money from the government, and so not because they needed the money. If they needed the money, they probably would’ve gone and gotten it sooner, but because they saw an opportunity to get this cheap money, they went and they took another 70 billion. So a lot of people are looking and saying, “Well, obviously this program is still needed because another 70 billion was borrowed over the last two months. Banks are still in need.” But the more likely scenario is that banks were just taking advantage of this cheap money, and that’s the reason they borrowed, and there haven’t really been any banks that have needed the money since last June.
So I don’t see them phasing out this program as of March to be a big deal. The Fed has also said that anybody that’s borrowed money doesn’t need to pay it back right away, they can pay it back over years, so there’s no risk to the banks that have already borrowed. More importantly, even if they were to get rid of this program on March 11th, I think the date is, if on March 12th there was a bank that was in trouble, I have a feeling the Fed would step in and say, “Okay, we’re going to bail you out.” So I don’t think there’s a lot of risk here. I think it’s something that’s going to be talked about over the next two months a good bit. But I think at the end of the day, it’s going to be a non-event. The government’s already indicated they’re going to bail out anybody that’s in trouble, so anybody big enough that’s in trouble. So I don’t see this being any real issue anywhere.

Dave:
In a way, you can see it as a sign of strength. If the Fed is feeling confident enough, as you said, they’ll bail out people who need it. If they’re saying basically people don’t need it, hopefully, that means that the acute issues with the financial system last year with Silicon Valley Bank and a couple of the follow-ons after that is alleviated, and now there’s a little bit more confidence in the banking system. So that’s great news.

J:
Yeah, and those banks that had trouble last year, they were in a very specific sector. They were in the tech sector. Their profile of borrower and depositor was very different than the typical bank, and that led to a lot of the issues, not so much an issue with the underlying banking system.

Dave:
All right, J, last question before we let you get out of here. Is there one economic issue or risk that’s keeping you up at night, or what are you most worried about are going to be following the most closely this year?

J:
I’ve been saying this for a good six or nine months now, but I think the biggest risk to our economy is the cost of debt for small and medium-sized businesses. There are a lot of businesses out there that need debt to run. They rely on bank loans or SBA loans, or maybe they need equity. They get money from venture capitalists if they’re in the tech space, and a lot of businesses are running negative. They don’t make a profit. They rely on this debt to grow and get them to the point where they become profitable, but they aren’t profitable yet. A few years ago, they were able to borrow this money at 3%, 4%. In the case of venture capital, they were able to get investment money whenever they needed it. Typically, these loans or these investments are on a two to three year runway, meaning that in two to three years, they either need to be refinanced or recapitalized or companies need to go out and get new investment because they’re going to run out of money.
Here we are two to three years after interest rates started to go up, and a lot of these small and medium-sized businesses are now facing a situation where they need to refinance their debt or they need to get new debt, or they need to get new investment. It turns out the cost of capital right now, for obvious reasons, because interest rates have gone up 5%, the cost of that debt has gone up tremendously. So small businesses that were borrowing at 3 or 4% three years ago now need to borrow at 6 or 7%, and business owners can’t afford this. So to borrow at those rates, they need to cut costs, they need to lay people off, they need to scale down their operations. What we’ve seen is that bankruptcies have gone through the roof over the last year, and on the horizon, there are a whole lot more bankruptcies looming. So I think this risk to small businesses is probably the biggest risk to the economy over the next 12 to 24 months until interest rates start to come down.

Dave:
This is a really under reported issue it feels like, ’cause you hear these huge things where it’s like, “Oh, tech, UPS yesterday laid off 12,000 people.” That’s a huge deal. But when you look at who is employed and where, most people work for small businesses, you see these high-profile things. But the American economy in so many ways is based off of small business. So if as you say, a lot of these companies are facing bankruptcy or challenges that is maybe going to keep me up more at night than it has been over the last couple of months.

J:
Yeah, and it’s not just the small and medium-sized businesses, I think they’re the ones that are most at risk. But even companies like Target and Walmart, they finance their operations by issuing bonds. They raise money by issuing bonds. A couple of years ago, they could raise a billion dollars by issuing bonds at 3%. Well, nobody’s going to buy bonds at 3% anymore because you can get U.S. bonds at four and 5% these days. So if Walmart or Target wanted to go out and raise a bunch of money to finance their operations and to continue to grow, they’re going to have to issue bonds at 6 or 7%. That’s a huge difference in their bottom line how much they’re paying an interest.
So if they can’t expand operations as quickly as they were, as much as they were, that’s going to impact their business. That’s going to impact GDP. That’s going to impact their hiring. That’s going to impact how much they can pay in additional wages, and that’s going to reverberate through the economy. So it’s not just small and medium-sized businesses that are going to struggle. I think they’re the ones at biggest risk, but I think even big businesses, we’re going to start to see wage growth slowing. I think we’re going to start to see more layoffs. I think we’re going to see less growth over the next year or two, again, until interest rates start to come down.

Dave:
Well, J, thank you so much for being here. I really appreciate your time. If you guys didn’t know this, J and I actually wrote a book together. It’s called Real Estate By the Numbers. It teaches you how to be an expert at deal analysis. If you want to learn more from J and myself, you can check that out on the BiggerPockets website. Otherwise, J, where can people connect with you?

J:
Yeah, jscott.com. So go there and that links out to everything you might want to know about me.

Dave:
All right. Well, thank you all so much for listening to this episode of BiggerNews. We hope this discussion and insight into what’s going on in the housing market and the economy helps you make informed decisions about your real estate investing portfolio and really what you do with your money generally speaking. If this is helpful to you, we appreciate your feedback and a positive review. We always love knowing what types of episodes you like most here on the BiggerPockets Podcast. Thanks again for listening, and we will see you very soon for the next episode of the podcast.