December 2022

Do You NEED an LLC for Rental Property?

Do You NEED an LLC for Rental Property?


Do you need an LLC for rental property investing? Ask some investors, and they’ll hit back with a resounding “of course!” But ask another group of investors, and they’ll tell you “not at all!” This duality causes many rookie investors to become confused, not knowing when to protect their property with the limits that come with an LLC. So how are millionaire investors setting up their properties and partnerships? Or, more specifically, what are Ashley and Tony doing to protect themselves?

Welcome back to this week’s Rookie Reply! We’ve got some great questions queued up for our cabin and campground co-hosts, Ashley and Tony, to answer! First, we take a question about what to ask a seller during a final walkthrough, and how talking to tenants may be worth the extra time. Then, we hint at when to ask a listing agent for financials on a commercial property, the great LLC vs. umbrella insurance debate, and finally how to buy an investment property when you’re strapped for cash!

If you want Ashley and Tony to answer a real estate question, you can post in the Real Estate Rookie Facebook Group! Or, call us at the Rookie Request Line (1-888-5-ROOKIE).

Ashley:
This is Real Estate Rookie, episode 248.

Tony:
But you have to weigh the pros and cons of the risks associated with keeping it in your personal name versus the cost of doing it under the LLC.

Ashley:
And what you just said, I think is one of the most missed expenses on a line item, when people are analyzing a deal, especially it’s your first deal, you are putting it into an LLC. I don’t see a lot of people accounting for those fees that you just said of setting up an LLC, that’s going to enter your cash flow. Maintaining the LLC, it’s only $25 in New York City.

Tony:
25?

Ashley:
Every year for the annual filing fee.
My name is Ashley Kehr and I am on live with my co-host Tony Robinson.

Tony:
And welcome to the Real Estate Rookie Podcast, where every week, twice a week, we’re bringing you the inspiration, motivation, and stories you need to hear to kickstart your investing journey. And I want to start today’s episode by shouting out milkman2333.
Milkman left us a 5-star review on Apple Podcast and said, “I owe everything to this podcast. What an amazing show, easy to listen to, and I love when they give updates on themselves. Started listening in May 2020 and because of them, I had the courage to buy in November 2020, January 21 and September 2021. Trust me and listen. Next up for me, is partnership with the silent partner. Thanks, Tony and Ashley, I owe it all to you guys.”
Well, milkman, we appreciate that. And honestly, that’s why we do what we do. We love hearing stories just like that. So if you haven’t yet left us a 5-star or honest, I should say, I’m waiting and review on whatever platform it is you’re listening to. Do yourself a favor, do us a favor and leave them for us.

Ashley:
And that’s why me and Tony, are geeking out because tonight and we are going to a meet up, we are going to get to hear so many inspiring stories from rookie investors and just experienced investors or the motivation and excitement of somebody who’s trying to get started in real estate and attends this networking event.

Tony:
Yeah. It’s so crazy. As much joy as I get from buying that next property and getting that listing live and seeing the returns come in. It’s a different level of fulfillment when I read stories like that and hear people in the rookie audience who say, “I was afraid, I was confused, I was lost. I didn’t know where to start. And I started listening to the podcast and now I have one deal, two deals, five deals.” And we hear these same stories over and over and over again. And it’s just such a crazy and humbling kind of position for us to be in.

Ashley:
Well, tell everyone about that text that you were telling us about this morning that you got about the person who bought the short-term rental.

Tony:
So Olivia Tati, she sent me a text over the weekend and she said, “Tony, thank you so much for your inspiration, for your guidance.” She’s just taken her first listing live and she was like, “Within the first couple of weeks, our mortgage is covered for the next couple of months and they just took the listing live.” So hearing stories like that, it’s crazy. It makes it all worth it.

Ashley:
Okay. Well, today we’re going to go over four Rookie Reply questions. We are going to talk about LLCs, putting properties into your personal name and what are some of those differences and what you should consider when deciding to do that. Then we’re also going to talk about financing options.
We have Lisa who gives us a scenario of what her current financial situation is, and we give her some ideas as to how she can tap into some money to buy her first investment property.

Tony:
Yeah. And then we also kind of finish off by talking about what to do at that final stage of your escrow period? What are those things you should be looking for to make sure you’re not stepping into a bad deal? So overall, lots of good questions.

Ashley:
Yeah.

Tony:
All right, so let’s get into our first question, which comes from Evan Yen, and Evan’s question is, “What are the best questions to ask a seller during the final walkthrough?” So I can kind of share my experience, first.
I don’t think I’ve even really seen most of the sellers that I bought my properties from. I’m typically not there during the inspections. If it’s a rehab, I typically will walk with my crew. But if it’s just a typical property that we’re buying, short-term rental, I’m almost never there during the property inspection. So I don’t really ask the seller any questions.
What I do use is information from the property inspection report to kind of inform my decisions around, not even what I need to ask the seller, but what are the things I need to follow up on. So for example, we have a property center contract right now and we had our first inspection come back and there were a lot of question marks.
Some of the things that came out of that are, “Do we need to replace the septic?” The property inspector couldn’t get access to the septic tank, it’s an older property. We want to know what the condition of that is. We need to follow up with that. There’s no working HVAC system. So now we need to go and look out, “Okay, what are we doing to quote out new HVAC?”
There’s a pool in the backyard, that’s been filled with dirt. What is it going to cost for us to go out and get that pool brought back to life? So I think the property inspection honestly is going to give you a lot of the questions that you need to ask yourself when it comes to purchasing this property. What do you think, Ash?

Ashley:
Yeah, and to get technical, when I hear the word final walkthrough, I think about you’re ready to close the next day and you’re doing one final walkthrough of the property. So I don’t know if that’s what they mean or just any kind of walkthrough of the property, after you’ve gotten it under contract, but I typically don’t see a lot of the sellers either doing those processes even if I am going to the property myself, a lot of times the sellers aren’t there.
So if it’s an off-market deal, it most likely is the seller taking you through the property, again, but I would say you can get a lot of information just from listening and not even asking questions from the seller, but everything they say anyways, make sure you’re verifying that information too.
So just some typical things that you can ask about the property, if you did do an inspection, ask them about these issues, these problems that came up. If they have any more information about it, are there any things, any kind of routine maintenance that they currently do on the property that you should be aware of? And then just maybe the history of the property too. Finding out things like that.
But as far as if it’s the final walkthrough, it’s the day before closing, I don’t see a lot of questions that you could ask because you’re already forced to close the property, anyways.

Tony:
You’re pretty close. One thing I will add is sometimes you do give value by talking to the tenants. There’s a property that we did walk yesterday, the owner wasn’t there, but the tenant was there and she gave up some information around, some deferred maintenance and things she had noticed about the property. So sometimes if you talk to the tenant at the property, they can give you maybe more information than even the actual owners can.

Ashley:
Yeah. I love when tenants are home and I see your property. I feel very uncomfortable-

Tony:
Ashley, this is dollars sounds.

Ashley:
… that I’m walking through because I do feel a lot of tenants, it’s a hard situation for them not knowing who’s going to buy it, what’s going to happen, are they going to have to move? And that can be very uncomfortable coming in as a potential buyer and just being in that situation. But I do think you can get tons of information from the tenant.
And what I do too is I ask the seller once I have it under contract, if I can send an estoppel agreement to the tenants. And this basically is a form that the tenants are going to fill out with their contact information and then what the terms of their lease agreement are. If they own any of the appliances, what utilities they pay, do they have any pets, just all the information about them that would typically be on a rental application or be in their lease agreement. And then I also compare that to either what the owner, the seller had said, or what is in the lease agreement.
Another thing I ask too is, what are repairs and maintenance that need to be done to the property? And you usually hear an earful of repairs that actually need to be made or just improvements that they would like seen done to the property too.

Tony:
So Evan, hopefully that helps answer the question for you, but again, everything we shared I think is what you want to lean on. But to me, tenants inspection reports as we were going to get a lot of golden information.

Ashley:
Okay, next up. Oh you know what? Actually, before we go to the next one, I’m going to say one more thing about that information on the property. The last thing I’ll say, is Google the address of the property.

Tony:
That’s a great idea.

Ashley:
Because I had a wholesaler try to sell me a property and you know what? I just knew that I had seen that property somewhere and the address of it looked so familiar. So I googled it and it had been a meth lab.
I remember it being in the news that they had busted this house and when you cook meth in a property, you have to do some kind of remediation to make it safe from all the chemicals in there. So just Googling a properties address can give you information on the property too.

Tony:
Just imagine going to list that property for rent and you thought, 123 main street and then potential tenants type in, 123 main street and the first thing that pops up is meth house.

Ashley:
Yeah.

Tony:
You’d want to, A, know about that before the tenants. And B, be able to say, “I know, we took care of it, here’s what we did. It’s brand new XYZ.”

Ashley:
Right. And it was a wholesaler trying to sell it. So the fact the wholesaler hadn’t even Googled the address and was trying to sell the property into somebody else, he did not know anything about that. And I don’t think he was ever able to get rid of that property-

Tony:
Sell that property.

Ashley:
… and probably fell out of contract. Yeah. Okay. The next question is from Caitlyn Lauture. “Question for anyone with experience with mid-size multi-commercial. Is it appropriate to ask the listing agent for financials upfront before even seeing the property? Or is that information only disclosed during due diligence period? In other words, how much information can I ask for upfront? I’d love to base analysis on actuals, trying to determine what is customary so I can ask the best questions and make the best impression with the seller. Thanks all.”
So I actually did this today. Someone sent me a campground for sale and immediately I emailed requesting the financials on the property and then said I would like to review those before I go and see the property, because I think there’s so much more information you gather from the numbers on the property that you can see kind of an idea of, “Okay, this is where it makes sense. Is it even worth me going to the property to look at it and kind of doing some due diligence beforehand?”

Tony:
Yeah. I think in the commercial space, most brokers almost expect potential buyers to request financial information. Usually, you will have to submit or sign some kind of non-disclosure agreement or NDA, but as soon as you sign that, most brokers will send you a trailing 12 for like, “Hey, here’s a property over the last 12 months.” They might send you tax returns, just anything they have. P&Ls, regarding the property and the owner’s financials.
Because for a commercial property, you almost do need that information to be able to even make an informed offer around what you’re willing to pay for, because if you think it’s doing X, but in reality it’s doing Y, when you go to purchase that property, get debt, whatever it is, it’s going to be far more difficult for you. So I think that is common for commercial.

Ashley:
And especially if there’s leases on the property too. You want to get copies of the leases and know what the rent is now on the property and how long of a term you’re going to be stuck with that rental income, because you could know projections that the market rent for this size unit is X amount, but it could be way undervalued, and there you still have 12 more months left on their lease and you’re going to have to carry that property along those 12 months at that lower rental income, which would vastly decrease your cash flow over that time. So completely appropriate and I highly recommend asking for the financials upfront.
I have had times where the agent has said they don’t really have financials. It’s a mom-and-pop self storage facility, where they go there the first Sunday of the month, collect the rent and cash, but that gives you actually more leverage.

Tony:
Leverage.

Ashley:
So that’s where you go to the realtor. Well are they going to be accepting seller financing offers since this would be a hard property for a bank to finance with no financials and a track record.

Tony:
And just break down what Ashley’s saying, most commercial lenders when they’re lending on self-storage, large partner complexes, whatever it is, they’re not looking at Ashley and Tony as the borrower to say, “Well, we give you this debt.” What they’re looking at is, “What is the current and historical performance of that property, and can the performance support the debt that we’re going to give you guys?”
So we ran into this issue a lot as we were looking for hotels this past year to try and purchase, is that a lot of them were small mom-and-pops that had terrible books or no books whatsoever. And because of that, most banks weren’t willing to lend on those properties. Banks want to see stabilized assets.
But to your point, it did give us leverage because we got multiple seller financed offers, that sellers willing to entertain because they knew that that was the only way they were going to sell that property.

Ashley:
Yeah, and that out is to, it’s completely appropriate to ask for those kind of things, as much as information as you want before you’re even under contract if that’s what you need to run your numbers, because you don’t want to be stuck estimating something that you could verify before you make that offer.

Tony:
All right, well let’s jump into the next question. This one comes from Cade Bigelow. Cade says, “I’m super new to this. I just found out about BiggerPockets a few weeks ago, but what is the importance of putting your home under an LLC instead of your personal name? Is that something you should do, that everyone should do or only in certain situations?”
So Ash and I both kind of come from different ends of the spectrum where almost none of my long-term holds are under my personal or are under my LLC and Ashley’s on the opposite and we’re almost all of yours are in LLCs, right?

Ashley:
Yeah.

Tony:
So I’ll kind of talk about it from my perspective of why I didn’t, and then Ashley can talk about maybe why you did go that way.
For us, a lot of the debts that we were using didn’t allow us to purchase it using an LLC. We got personal debt, which meant we had to hold those titles in our personal names. Now, we could have gone back and updated those loans, I’m sorry, updated the titles on those properties after we closed to change ownership from our personal names to our LLC and then kept the debt on our personal names. We just haven’t done that.
Instead, what we opted to do was to get an umbrella policy. So we have debt titles on our personal names, then we have this umbrella policy that gives us that additional layer of protection in addition to our home insurance. So for us, what was more important was getting the most favorable debt terms, and in order to get that, we had to, under our personal names.

Ashley:
For my properties, when I first started out investing, I wanted that nice 30-year fix, low interest rate. So I did a lot of the rentals that I owned myself in my personal name. Then every time I have a partner, I put that partner into an LLC. So any properties we buy together go into that LLC with partner A. Anything I buy with partner B goes into that LLC together. And then we typically get commercial financing on those properties.
I have found one bank that would lend me on the residential side for putting a property into an LLC. It was not a 30-year fix, but it was a 25-year fix, but at the time, interest rates were around four and a half percent if I would’ve done it in my personal name. And they charge us 7.375%. So it almost would’ve been better off going to the commercial side and getting it fixed for five years to have that lower interest rate, but once again, the mistakes you make is a rookie investor.
So typically mine are in an LLC for the liability protection, especially with having partners. I never recommend that you go on title in your personal name with somebody else in their personal name too. So I like having that liability protection is the biggest thing why my properties are in an LLC and then I’m mostly doing commercial lending at this point.

Tony:
I think the other thing to consider too, Cade, is the additional cost comes along with LLCs because in California, I don’t know, I think our attorney charge is 1200 bucks. So just file all the paperwork, set everything up, and then every year it’s $800, just to maintain the LLC.
You have your additional tax returns, you have to file every year for your LLC, your QuickBooks subscriptions for each LLC, the bookkeeping becomes a little bit more expensive because there’s multiple files that your bookkeepers are working with. So there definitely is an additional cost to having multiple LLCs. So you have to kind of weigh the pros and cons of the risks associated with keeping it in your personal name versus the cost of doing it under the LLC.

Ashley:
And you can also get umbrella insurance if you do have in your personal name, and that’s what I did, was get an umbrella insurance policy that basically on top of your landlord policy that covers the rental, you have another higher coverage so that if you are sued, there’s more money that the insurance company would pay out to protect you in a lawsuit.
And what you just said, I think is one of the most missed expenses on a line item, when people are analyzing a deal, especially it’s your first deal, you are putting it into an LLC. I don’t see a lot of people accounting for those fees that you just said of setting up an LLC that’s going to enter your cash flow. Maintaining the LLC, it’s only $25 in New York City.

Tony:
25?

Ashley:
Every year for the annual filing fee.

Tony:
800 in California.

Ashley:
It’s about $800 to start it, the LLC with total fees, but to do the every year it’s only $25 per an LLC. But if you have that $800, that’s a huge chunk of your cash flow potentially to have that. And I don’t think a lot of people run the cost of that business. And then of course, as you grow your portfolio, you can spread that number out among your units if they’re all in that same LLC, but definitely something to think about too, for sure.

Tony:
Cade, I think my last piece of advice would be if having this LLC set up is the only thing that’s preventing you from submitting offers, just put the offers in.
You can always go back and adjust title later down the road. If you find a lender that says, “Hey, you need an LLC set up to get this kind of debt.” Then handle that during your escrow period, but I think what’s more important for you Cade, is getting those offers in finding that first deal and just getting started.

Ashley:
Okay. So our next question is from Lisa Ann. “What is the best way to determine lending when you have no cash down? All my money is invested in stocks right now. I have equity in my home and decent credit. Do you borrow from your own home, get private lending, then refinance? Is there anything that prohibits you from buying more properties afterwards? Do you apply in your own name or create an LC? What is the best resource to research options in your state? Thank you.”
So the first thing that I think of when I see this, is that she has money invested in stocks. So if those are not in a retirement account, and they’re just in a brokerage account, then you are able to go and get a line of credit against those stocks. So instead of having your home as collateral, if you went and put a line of credit on that or a mortgage on that, your stocks are actually going to be the collateral.
So there are limits. You have to have at least over a hundred thousand dollars in value, I believe. And it probably differs on what bank you go with to do this, but there are limitations on it, but it’s usually a very low interest rate because your collateral is so liquid, where if you do not repay your debt, the bank isn’t foreclosing on a property and then having to resell it, they’re basically just cashing out your stocks and taking that money and running. So there’s a lot less risk for them. And that way you’re getting a better interest rate. So I would say that would be your first option is getting a line of credit against your stocks.
People, you may have heard people do this with their 401(k) where they take a loan from their 401(k). The difference is when you’re doing the line of credit against your stocks, is your stocks are still invested, you’re not touching them. So you still have that kind of separate income accumulating over there and you’re not pulling it out. Where when you take a loan from your 401(k), you’re actually drawing the money out of the stock market to borrow from it, and then you’re repaying it back.
Good side, you’re paying yourself back the interest and putting it back into your 401(k), but you’re losing that investment strategy, and I always love to diversify.

Tony:
Yeah. It’s two really great point, Ashley. On the line of credit side, you’re exactly right. I have a line of credit with E*TRADE and we use that to fund some of our real estate stuff. And literally, even as the market fluctuates, if they see that your stock portfolio starts to decrease to a certain level, they won’t even ask you, they’ll just sell your stocks and they’ll recoup whatever funds they need.
So that is one of the, not risks, but it’s really how the bank mitigates their risk when they’re lending this money to you, but like you said, the interest rates are so incredibly low on that stuff, it’s almost like free money. And we use that to fund, I think two of our initial deals when we were out in Louisiana.
And the 401(k) piece, it sucks that you’re pulling your money out and you’re not getting on that, but it is also better than taking those penalties and just pulling that cash out. So a lot of times when people ask me like, “Hey, should I cash out my 401(k)?” I was like, “I mean, it’s an option, but if you can get a loan, even if you can’t access all of that capital, maybe if it’s some of that capital, at least you’re not paying those penalties on pulling that money out and you’re paying yourself back, so it’s still going to grow.”

Ashley:
And then the next question is, “Is there anything that prohibits you from buying more properties afterwards?” So she had talked about, she did this line of credit, so the only thing that would happen is depending what path she chooses, whether it’s free financing or primary, is that your debt-to-income would be affected because you have now taken out a loan on the property and you now have that debt repayment. So that would affect your debt-to-income.
So you would just have to look at what would that repayment amount be, what is your income, and would you stay under the bank’s requirement, the threshold? Do you know, off the top of your head what the requirement is right now for a DTI, for most banks?

Tony:
No. I haven’t applied for a loan in a little while. So, no.

Ashley:
Yeah. Me either.

Tony:
I’m not even sure.

Ashley:
It’s just on the commercial side, but they don’t ask.

Tony:
Yeah. The only other thing that I’d add there too, when we’re thinking about kind of how to set this up, talking about lines of credit, Lisa, and in my mind, I think the best way to leverage a line of credit is if you’re doing some kind of BRRRR.
So if you’re buying a distressed property, you’re rehabbing it and then you’re refinancing and put some kind of long-term fixed debt because say that you do this with just a traditional line of credit and you go out and you buy a turnkey property. Now, your capital that you invest into that turnkey deals essentially stuck in that property for who knows how long. And most lines of credit aren’t infinitely open, right? So at some point you have to pay them back and it could just get into your cost’s way.
So in my mind, the ideal way to do it is you take your line of credit or whatever it is you’re doing, use that, buy a distressed asset, rehab it, fix it up, put in some long-term fixed step, repay yourself, and then pay down that line of credit, and now you can recycle that line over and over again.

Ashley:
Yeah. I just looked it up. According to Google, an average lenders like to see a 43% debt income or less.

Tony:
Yeah. So that means say you make a thousand bucks a month, your debt obligation should be $430 or less. So if you’re at 431 or higher, that’s where banks start to have some concern.

Ashley:
Okay. And then we kind of already touched on this, “Do you apply in your home name or create an LLC?” On the last question. So I’d refer back to that one and see which one kind of fits for you, and then what is the best resource to research options in your state?
So I think all of the questions that were asked can kind of be general over every state, that there’s not really state specific on types of ways or which strategy you should go to pull money out of your brokerage or your investments.

Tony:
I think the last thing, and Lisa didn’t even really ask this, but if you find a killer deal, Lisa, and say you don’t have the capital to take it down and maybe some of these more creative options aren’t working for you, then find a partner.

Ashley:
Mm-hmm.

Tony:
Right? And that’s what Ashley I did when we found these amazing deals at the beginning of our real estate deals. We didn’t have the capital to take it down. We found a partner. So look for someone in your network that maybe has an interest in investing in real estate, but doesn’t have the time desirability to do it themselves, but they have the capital.

Ashley:
Okay. Well you guys, thank you so much for listening to this week’s Rookie Reply. I’m Ashley at Wealth Firm Rentals, and he’s Tony, @tonyjrobinson. Make sure guys check us on YouTube and subscribe to the Real Estate Rookie and leave us a review on your favorite podcast platform. We’ll be back on Wednesday with a guest.

 

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Tips to Build a House Hack STACK in Your 20s

Tips to Build a House Hack STACK in Your 20s


Couch flipping may be the best side hustle you’ve never heard of. It’s so lucrative that today’s guest Parker used couch flipping to save up his down payment for his first house hack! Of course, who could have assumed otherwise from someone like Parker? He’s a financial analyst who made an intelligent move from expensive Boston to sunny Tampa to house hack for the first time with one of his best friends. He’s making some impressive moves at a young age, but he still has questions about what to do next.

Although Parker is thankful for buying the house hack, he doesn’t know what he should do after he moves out. Does he sell the property, keep it as a rental, transfer it into an LLC, or go back to renting as he saves up enough money for the next house hack? He also has some very pressing capital expenditures on his mind, like a new roof, HVAC, and other large system replacements that could cost him and his house-hacking partner tens of thousands out of pocket. These replacements won’t be cheap, but they could help improve the property before he potentially sells.

And like most FIRE-minded twenty-something-year-olds, Parker needs to know where the highest ROI for him is. Does he continue to save up to buy another house hack, or should he be contributing to his tax-advantaged Roth, HSA, and 401(k) accounts? Plus, with such an unbelievably lucrative side hustle like couch flipping, how much time should he put into building this income-replacing revenue stream? Parker is on a great path, but with guidance from Mindy and Scott, he could reach financial independence even faster!

Mindy:
Welcome to the Bigger Pockets Money Podcast Finance Friday edition, where we interview Parker and talk about house hacking and couch flipping.

Parker:
A little bit of both, it really depends. That’s why I bought the truck I own because when we moved here I bought the truck for $3,500, put some money into it, it’s probably worth five grand now. So when we were renting a house we would just buy a couch, stage it, maybe clean it up, re-list it, offered delivery on the couch. But I think between September, 2021 and May, 2022, we made $36,000.

Mindy:
Hello, hello, hello, my name is Mindy Jensen. And with me as always is my can definitely bench press at least 10 pounds more than me co-host Scott Trench.

Scott:
Maybe, but no one can lift our listener’s spirits like Mindy Jensen.

Mindy:
Aw, Scott that’s so sweet, you’re going to make me cry. Scott and I 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.

Scott:
That’s right, whether you want to retire early and travel the world, take a break for a year and travel the world. Go on to make big time investments and assets like real estate or start your own business, we’ll help you reach your financial goals and get money out of the way, so you can launch yourself towards those dreams.

Mindy:
Scott, I’m excited to talk to Parker today because he has a fun set of circumstances and also a really amazing side hustle, that we don’t get into until the very last minute, where you will find me a little bit shocked at how much he can make.

Scott:
Yeah, Parker’s crushing it, has a lot of good options. And he needs to focus in on a couple of key areas and make some allocation decisions. He can do anything but he can’t do everything.

Mindy:
Ooh, taking a page from our friend Paula Pant. All right, before we bring in Parker I must tell you that the contents of this podcast are informational in nature and are not legal or tax advice. And neither Scott nor I, nor Bigger Pockets is engaged in the provision of legal tax or any other advice. You should seek your own advice from professional advisors including lawyers and accountants regarding the legal tax and financial implications of any financial decision you contemplate.
Before we bring in Parker let’s take a quick break. And we’re back. Quick note, if you are interested in being a guest on the finance Friday, and having Scott and me review your financial situation to see what we would do if we were in your circumstances, please apply at biggerpockets.com/financereview. All right, today’s guest is Parker. He is 26 years old. He has a rental property that he co-owns with a friend and he’s busy fixing up the rental, and would like to take a year off in the next few years to travel. Parker, welcome to the Bigger Pockets Money Podcast. I’m so excited to talk to you.

Parker:
Pumped to be here. Love the podcast. Let’s do it.

Mindy:
Yay, thank you. Well, let’s do it. Let’s jump right on in. “We have a salary of approximately $4,200 a month after taxes and 401K contributions, with additional income of $475 a month from a tenant and two to $400 a month from side hustles.” We’re going to jump into those in a minute. Your debts total or I’m sorry $346,000 balance on a 30 year fixed interest mortgage at 4.125%. So since you own half the house, I’m assuming half of that is your mortgage?

Parker:
That’s correct.

Mindy:
There’s no other debt, so yay, off to a great start. At 26 that’s a really, really, really great start. Monthly expenses total approximately $3,000. I really don’t see anything in these monthly expenses that stand out. You’ve got $1,100 in housing, 200 in utilities. The food is something that I would like you to reconsider. “I’ve got a $1,000 for food,” which is approximately a third of your budget. Health and wellness a 100, car insurance 90, gas 125, travel a 100, gifts 100, Amazon 50, gym 50, clothing 50. Again, nothing really crazy. Maybe you’re eating organic or something super healthy.

Scott:
Well, we found out at the beginning of the show that Parker benches 225 pounds, so he probably needs a lot of extra food to maintain that [inaudible 00:04:19].

Mindy:
Yeah, I’m thinking he’s eating protein.

Parker:
Yeah, food’s my big thing. I eat a lot, I work out a lot. Thankfully it’s Costco, so maybe some that includes some toiletries and stuff like that as well. I figured you were going to point it out.

Mindy:
Moving right along to your investment accounts. We have a mostly pretext 401k of $28,000, that’s great for being 26 years old. $12,000 in a Roth IRA, 2,400 in an HSA, 19 in cash, 10 in-house equity, 1,000 in alternative investments of crypto and silver, and 5,000 in truck equity, which we will talk about later. So can you give us a very brief overview of your money story Parker?

Parker:
Yeah, let’s do it. So I grew up in a mixed financial household. So my parents were solidly middle class and my grandparents were somewhat better off. So I was really fortunate to be able to graduate completely debt free, paid for by my grandparents. But I also got to see how my parents struggled with money at the same time, and I didn’t want to make the same financial mistakes they did. So when I went to college and knew that it was going to be I paid for, I knew I wanted to set myself up for success knowing that once I got out of college it wasn’t you’re going to rely on family money or whatever. You have to set yourself up for your own success and be able to support yourself. I’ve always been interested in finance and I studied business, that’s the main part. I guess I’ve always been really independent, so I don’t like the idea of having to rely on other people. So being able to financially support myself and set myself up for success is important to me.

Scott:
Awesome. Well, can you tell us a little bit about your career and how that’s progressed over the last couple of years?

Parker:
Yeah, so I work as a financial analyst make about 70, 75K a year. Started off in accounting. So I graduated in 2019 with a degree in international business and finance and moved to Boston, going into the office, everything like that. And then COVID happened, went fully remote. Was kind of like, “Why am I paying all this rent in Boston?” I was paying $1,500 a month for rent. Everything was closed, couldn’t really do anything, that allowed me to save a lot of money, but I wasn’t very happy. So I was living with my buddy there from college, we were like, “Let’s go check out Tampa for a weekend.” Came down and really liked it and we ended up moving here about a year and a half ago in 2021. Rented for a year and ended up doing a house hack together, which I don’t think I’ve heard anybody on the podcast who’s bought a property with a friend. I think it’s a unique thing. People think we might be in a relationship or it’s like a different thing. But no, we’re just friends from college who bought a property together.

Scott:
I’ve done that.

Parker:
Yeah, it’s awesome. We have different strengths and weaknesses. I’m kind of the numbers guy, the design guy, and he’s an engineer, so he is great at fixing stuff up, so it actually works really well.

Mindy:
Oh, okay. I’m going to highlight this for a second. If you have money and maybe not super awesome at fixing things, finding somebody else to partner with who has money is not the best choice. It’s good that you’ve got two financial powerhouses that are putting money into a problem, and there’s no problem in real estate that is too big that you can’t solve it by throwing enough money at it. However, that’s not what we are here for at the money show.
So partnering with somebody whose strengths are your… not strengths, I hate the word weaknesses, but whose strengths cover what yours do not is a great way to partner. I think that’s an awesome partnership. We don’t see a lot of friends getting together and buying a house together, because there can be some issues that happen. You’re all friendly when you start off, but then something happens and you want to do it one way and he wants to do it the other way, and then the friendship can kind of fracture. But you’re still stuck together with this legal document that is called home ownership. So did you guys go into a partnership agreement? Did you write out everything in advance?

Parker:
We didn’t get a lawyer and write everything down basically, but we basically came to an agreement verbally which I know is not the best thing. We should probably get something in writing, but we have an understanding of when we’re going to move out, what are we going to do with the property. We veto each other on decisions, stuff like that. This isn’t a guy I’ve been living with a year, we’ve been living together since my sophomore year in college, it’s been about six years. He’s a good friend, he’s as financially stable or even more so than I am. So we both feel very comfortable in being able to make the mortgage payments and we both have a similar vision for the property.

Scott:
I think this is perfect. I’ve done something very similar to this in my past and I think it’s great. At some point you should put it in writing. And you’ll approach your friend with saying, “We’re not going to have a problem here.” You’ve known this guy for a long time, sounds really reasonable. “But one day you are going to get married and I don’t even know this person, you’re not even dating them yet. And if you were to pass away, I might be dealing with that person, they might be terrible.” Or use yourself as a reverse with that. Or if you already have significant others and you say, “I’ll have a kid and that kid will be a pain in the rear, you’re going to have to deal with when this thing is over. So we’re not negotiating against each other, we’re negotiating against these future people in our estate and we want to get those things buttoned up.”
And a very simple tool, you don’t have to spend a lot of money on this. A very simple tool that I think is very powerful is this shotgun clause in the agreement. Because really if things get bad you want to exit the deal. There’s a whole bunch of other things you can and should cover in the agreement who has final say, but a shotgun clause if you’re not familiar with it essentially says if you want to exit the deal, you say, “I’d like to buy you out at this price.” And they have one opportunity to say, “Yes,” or, “no, I’m going to buy you out at that price.” They can reject and go the other way, very simple and effective tool for dissolving partnerships in that situation.

Parker:
That’s a great idea, I like that.

Scott:
Probably cost you 500 bucks to get an attorney to draw something up like that and it’ll just be there.

Mindy:
So Parker, what is your greatest money pain point and how can Scott and I best help you today?

Parker:
I think it’s really figuring this house out. Trying to treat it more as an investment as opposed to a forever home, because it’s definitely not a forever home. We could put a $100,000 dollars into this house if we wanted to, but that wouldn’t really make financial sense in terms of a rental property. At the end of the day it’s a two bed, one bath, a 1,000 foot main house and a 380 square foot mother-in-law suite. So you could put a million dollars into it at the end of the day, it’s not going to rent for more than 2,500 a month. As it stands right now it’ll probably rent for about 2,000 to 2,200 in the main house. And then the mother-in-law suite we did a full renovation on, so it’d be probably more like 1,200.
So there’s more that needs to be done. The roof is going to have to be replaced because it’s 18 years old and I live in Florida, and there’s this whole homeowner’s insurance crisis going on. And they won’t insure the house within the next year or two unless we get the roof replaced as far as I know, so that’s a big expense. The HVAC might need to be replaced in the next couple years as well, so that’s maybe 20 grand right there. And then the rest of the house it’s all been renovated within the past 15 to 20 years, so it’s not bad but it’s just things need to be updated. So my main question is how do you view putting in improvements into a house hack? Because I think the main goal of this property is to live here for two years. So then we’d sell it within the next five years we’d not pay income tax on that gain.

Scott:
Be careful with that assumption because if part of it is a rental… So let’s suppose hypothetically that the… is the property purchased in both your names or just one?

Parker:
It’s in both our names.

Scott:
Okay. And is any part of the property a rental without you living in it?

Parker:
So right now we’re living in it and we’re renting out the in-law suite.

Scott:
Okay, that portion… so this is the pain in the rear. From a tax perspective the portion that you live in you can’t depreciate and is your primary residence, and the portion that you rent does depreciate and is not your primary residence. So filing your taxes on a house hack is a real pain, and is even more complicated than filing taxes on a true rental property or someone with a primary residence, even if it’s a bigger property with that. Yet the house hacker by definition is always a frugal, you know what? And so they’re not going to spend hundreds of dollars on tax preparation for the most part each year. If you fit that mold, you’ll have a DIY tax project to learn at and think about when that comes up. But I’d encourage you to think of it more like a rental and less like a primary. Well, it depends. If you’re living in the big part of the house then it’s more like a primary than it is a rental.

Parker:
Okay. What do you guys see as the highest ROI in terms of sprucing a place up.

Mindy:
Kitchen, number one, hands down, but also the roof because you live in Florida where they have hurricanes.

Scott:
The roof doesn’t change your rent, right?

Mindy:
No, the roof doesn’t change it.

Parker:
That’s the thing. I think it might have been replaced without a permit in the past because it doesn’t look 18 years old. But we have state subsidized insurance because in Florida that’s the only insurer that would insure the house, Citizens, I don’t know if you’re aware. So the appraiser said it had three to four years of useful life left, which was lucky because they won’t insure if it’s one to two years useful life left.

Scott:
The way you win with the roof is if you stay on it for as long as possible, and do nothing to it and then replace it at the last possible minute without having an emergency forced upon you. So that’s the game I think that you have to play as a real estate investor is how do you time that perfectly. I don’t know if you can, so that roof is going to add no value to the property other than you saving money.

Parker:
Exactly.

Scott:
It may.

Mindy:
Well, then you can insure it.

Scott:
Once you get to that point you have to.

Mindy:
Okay, well let’s run through the numbers on this property.

Parker:
Yeah, we purchased it for 375. It appraised at 367, so we had to pay an appraisal gap of 8,000, but they gave us 9,000 at closing, so it basically evened out. They gave us that money because there was a lot of issues with the house, which we can go into, but we put 5% down, so only two and a half percent each. Out of pocket it was like 15K each at closing. And then we’ve put in an additional $30,000 into renovations so far, so another 15,000 each. Total mortgage payments 2200, which is 1100 each. And then we rent out the in-law suite for 950 a month, utilities included to a friend of ours. So total out-of-pocket cost about $630 a month for living expenses with utilities at another 200 each. About $830 a month is my current living expense right now, which is pretty crazy when you can’t really find a one bedroom in Tampa under 1500 or 2000, so it’s pretty awesome.

Scott:
What would the property rent for fast forward a year or two, it’s all stabilized. What do you think of the cash flow analysis, you gave me some of those numbers, but what do you think you’d net from a cash flow perspective?

Parker:
Yeah, so the in-law suite, I don’t know, it’s tough to value an in-law suite because the laundry room is disconnected from the house. So there’d be shared laundry between the main house and the in-law suite, that’s how we do it now. But there’s a lot of these in Tampa, a lot of multi-generational households and stuff, and I’ve seen them similar ones go for as much as 1,400. But conservatively I’d say 1,100 to 1,200 on the in-law suite, and then the main house 2,000 to 2,200 as it sits right now. Maybe 3,200 for both and our mortgage payments 2,200.

Scott:
Walk me through what you would estimate for vacancy, CapEx and repairs, property management, those types of things.

Parker:
Our plan is to stay in Tampa, so we’d manage the property ourselves at least for the time being 5% for vacancy. It’s a pretty hot area. Maintenance and repairs, we’ve put a lot into it already. I don’t know how you budget that on a 5% annual basis or something like that, but I haven’t really thought about that as much.

Scott:
Okay. So we got $150 a month in vacancy. We got $150 a month in maintenance and CapEx on the low end with those, and then I assume that tenants would pay utilities.

Parker:
Yeah.

Scott:
Okay.

Mindy:
Okay, I have a comment. I want you to bump up your vacancy to 8% because one month is 8%, not 5%.

Parker:
Okay, that sounds good.

Mindy:
And if you can get it rented faster, that’s great, then you just have extra built in. But if it takes longer to get it rented, then your numbers are all out of whack. CapEx is something that I like to personalize for each property based on the actual age of the things in the property. Like your roof needs to be replaced in the next couple of years. A roof, I don’t know what it is in Florida, but where I’m at a roof is 10 to $15,000 and it lasts 25 years. So over the course of 25 years you should be saving up 10 or $15,000 and that’s just a couple of hundred dollars a month. But if your roof is 20 years old and you need to replace it in five years, you now need to save up $10,000 in five years. So that’s $2,000 a month or you need to save up 10 to $15,000 in one year to replace it, so that’s a whole lot more. Did you get any concessions for the roof?

Parker:
Just the 9,000 they gave us at closing.

Mindy:
Just covered everything. And that’s fine, you bought it in April of 2022, which was the hottest market that the real estate scene has ever seen in the-

Parker:
It was tough.

Mindy:
… history of the world. It was tough. So that’s why somebody’s like, “Oh, why did you pay more than it appraised for?” Because that’s what you did in April of 2022, that’s just how it went. So with CapEx you’ve also got your furnace, you said the HVAC will need to be replaced soon. I don’t know how much an AC is there. I think it’s like eight to $12,000 where I’m at. You have time to start getting quotes and start asking people, “Who do you use? Who’s reliable?” Start getting quotes and find somebody. Don’t wait for the next hurricane to come through because then it’s impossible to find anybody to work on your house. I don’t know where you are. Or when was the last time there was a hurricane in Tampa? It’s been a while hasn’t it?

Parker:
100 years.

Mindy:
Okay, well, then you’re due, so-

Parker:
We’re due.

Mindy:
… make the quotes now. But you don’t want to wait until, “Oh, I’m going to do it in June.” And then the end of May something comes through and now you can’t get a new roof. And then you don’t have homeowner’s insurance and then there’s a lot of-

Parker:
That’s also my concern with Citizens, which their customer base is doubling every year because of the homeowner’s insurance crisis. If there was a hurricane even if it was in Miami, putting in a claim it could take years and could be a big financial risk. That’s my other concern in terms of getting the roof replaced and maybe going through a private insurer. But I don’t know if it’s worth paying double compared to a state subsidized policy.

Scott:
I think these numbers should make you a little uncomfortable, it will make everyone uncomfortable with this. But I think in your case a good exercise would be to go through and do the work of customizing your CapEx allocation and saying, “I think my roof’s going to last me three more years.” Give it a guess, that’s your best one. Okay, great, that’s $10,000 over three years. That’s what $3,300 a year that I need to save, that’s 400 bucks am I doing that right a month.

Mindy:
Let’s call it 400 a month.

Scott:
Yeah, 400 a month I need to save. Then on top of that I’m going to need to replace the AC, that’s going to be five grand making that up, that’s going to be in five years. So that’s 1000 a year, about a $100, 80 bucks a month. And you add those up, one by one, and if there are any other things around the property. Maybe the kitchen’s fine and you’re good to go for 15 more years before you need to really update that and that’ll be 10 grand. So 10 grand divided by 15 years divided by 12 or whatever it is. I don’t know how bad his kitchen is. Maybe it’s good, maybe it’s bad, I don’t know. But if you do that exercise you can stare at a number and say, “Okay, that’s really what my cash flow is going to look like in this particular property over the next 10 years or five years.”
And that will help you make decisions based on that. So my belief is that once you do those numbers, and I would encourage you to keep property management here, you’ve got a okay property. It might break even a little bit and if it’s in a good spot and you hold onto it for a long time, it might appreciate. But this is not going to be a cash cow property once you move out, even when you do move into market rents. So something to noodle on there and that may be exactly what you want, that’s fine, it’s a great way to build wealth. Or it may be not what you want, you want to sell it and see if you can harvest service some gains if you can add value to the property.

Parker:
Yeah, I think the goal is to keep it as a rental. Tampa rents are growing 20% year over year, so those numbers could even be outdated. But it is an old house. I do have to budget more in maintenance than probably the average house, it’s a 1950s house. Another thing I wanted to ask was when we move out should we transfer it into an LLC or just… is that even possible or is that something I should just ask my lender about?

Mindy:
I was going to say your lender is probably going to tell you not to do this because if you transfer the ownership out of your own name, which is where the mortgage is currently in this will trigger a due on sale clause where all of a sudden the lender will say, “Okay, now you owe us the entire remainder of the balance of the mortgage.”

Parker:
So they make you refinance basically.

Mindy:
You will lose-

Scott:
They could.

Mindy:
… all of your… it could, it could.

Scott:
This is a huge debate we’ll get into this for a good five minutes here. This is a great one. Go ahead Mindy.

Mindy:
My lender that I go to all the time said when rates were 2% and you could refinance at 2%, nobody really cared. Lenders were like, “Look, if the payments are continuing to be made, we’re not going to make a big deal of it.” But now that you have a 4% mortgage and for an investor rates are like 9%, 7%, 8%, they might make you refinance. They’re losing money on their 4% mortgages, they’re losing money on their 2% mortgages. So if they can get you to refinance, they will.

Scott:
I think that there is a lot of people who… we’re asking about a major policy change here. So first of all the question is can I put it into an LLC? The answer is yes, you can put it into an LLC. The question is what are the pros and cons of doing that? The pros are potentially some protection once you’ve moved out of the property from legal liability. If you self-manage the property, guess what? They can still go after you for those types of things. And you really in my opinion and I’m not a lawyer, you should ask a lawyer about this. But my opinion it’s like why the heck would you self-manage the property and put it in an LLC, when you’re exposing yourself to the risk of this due on sale clause that Mindy just pointed out in order to do that.
Second, if I’m going to protect the property by putting it an LLC and going into the trouble of setting up an LLC, running the LLC, filing taxes for the LLC, all those different types of things, I need to be protecting something that’s worth protecting. And you guys have maybe 30K in equity in this property and if you sold it you probably have transaction costs, you probably have very close to zero equity in the property right now. So am I really going to go through all this trouble to protect nothing is another question that I’d ask here.
So obviously I have a strong opinion but I’m not allowed to go all the way there because it’s a legal topic with this. Next up is the due on sale clause. I actually think that the due on sale risk is not that large because most of these lenders they don’t keep the loan on their balance sheet, they sell it to a large institution like JP Morgan or one of these big banks, Wells Fargo, whatever that’s going to service the loan. And they can always sell the loan again to Fannie Mae, a government backed corporation. So I don’t understand why a performing note, whatever get called due. The due on sale clause is an option, not an obligation of the lender to call the note due and force you to refinance. It is possible, it could happen. It hasn’t really been a factor in the last 20 years for any investors.
I don’t know a single person who has had a note called for this and I’m not anticipating it. But if move all the properties to LLC, you might get some protection peace of mind on the liability side if you set everything upright and higher a property manager. But you might assume this keep you up at night risk of the lender calling the note due. So I don’t think there’s a good answer to this question. And I think if you post this to the Bigger Pockets forums, you’re going to find people with very strong opinions either way on this based on what they’ve done.
For example, you probably should post it there and see what people say. But my guess is that I would maybe keep it in your name for a while here and consider shifting it over, if and when you have a much lower debt to equity balance and have something worth protecting here and are maybe not self-managing.

Mindy:
I would say if you are going to do the LLC for protection purposes get an umbrella policy instead. It’s an umbrella that covers all of your assets and interests so that you don’t… You’re not going to be sued, your insurance company has more money than you do, so they’re going to cover you. I’m doing a terrible job explaining what an umbrella policy is. Let’s look that up on Google, so I can actually say what is umbrella policy? An umbrella insurance is extra insurance that provides protection beyond existing limits and coverages of other policies. Umbrella insurance can provide coverage for injuries, property damage, certain lawsuits and personal liability situations. So something that I just discovered is I re-quoted my homeowners and car insurance policies, and got an umbrella coverage for all of this for less than what I was paying for a lower amount of car insurance at a lower amount of homeowners insurance. It’s not that expensive to get a very simple umbrella policy. And that I think is a better choice than going into an LLC, and potentially losing your 4% interest rate just to save some liability.

Parker:
That makes sense.

Scott:
Also I would not put the property into an… we can talk about lawyers about this one, but I would not put the property into an LLC while you live in it. You want protection, you living in the property, how is there going to be a corporate veil there if you’re an inhabitant on inhabitant of property.

Parker:
Not going to sue myself.

Mindy:
Okay, I have a couple of other questions about your property.

Parker:
Yeah.

Mindy:
How did you take title with your friend? Did you take it as joint tenants or did you take it as tenants in common?

Parker:
I think whichever one, if one of us dies the equity goes to my beneficiary not the other person.

Scott:
So you used tenants in common.

Mindy:
That’s tenants in common. Okay, that’s good. That’s good because that makes it easier for you to separate yourselves if you decide, “Hey, I don’t want to live here anymore.” He’s like, “Ooh, I would really like to live here.” And you’re like, “Hey, why don’t I just sell my half to somebody else,” if he can’t afford to buy you out or he doesn’t want to buy you out. That makes it a lot easier to do so. If you are considering buying in a partnership, talk to your attorney, talk to your real estate agent about the different types of ways to take title. And one last question is why do you rent your mother-in-law suite out for less than it could be rented for?

Parker:
We’re helping out a friend so that’s a main thing, and then he allowed us to continue doing renovations while he was basically living in it. So it’s a very flexible situation where if we need to enter the property and fix something or do anything like that, it’s also less liability because he’s our friend, he’s going to pay on time and he is reliable.

Mindy:
I am so glad that this friend is paying on time, however, lots of friendships have been broken up over this. So I will say because I am older than you are, I will say that I hope you have a lease and if you don’t you need to get one. And is there an end date for him living there because you are essentially subsidizing his rent by $250 a month every month that he lives there, which is very generous. And him allowing you to do work on the house while he’s still paying you rent allows you to collect some money while you’re fixing it up, but eventually that has to end. He’s listening to the show now and he is like, “Mindy shut up.”

Parker:
It’s a month to month lease.

Mindy:
So I would have a conversation with your co-owner and say, “How long do we want to let Bob Jones live in the mother-in-law suite before telling him, ‘We’re going to raise the rent to 1200, which is the going rate, would you like to continue to live here or would you like to find a new place?’”

Parker:
I have a question about that in terms of the backyard is pretty much shared and the entrance way to the in-law suite, you basically have to walk past the whole house. So how would you structure that in a lease where the laundry area is shared and the backyard is pretty much shared? Would you put up a fence to make a private area for the in-law suite, or would you write in a lease that the laundry room is shared between buildings or something like that?

Scott:
I think I’d write it in the lease that the laundry room is shared, and I would just say that there’s common area in there, and I’d make it clear who is responsible for common area maintenance. So for example, in some of my properties like a duplex, I’ll just say unit A is responsible for shoveling the sidewalk and maintaining the front lawn. And that’s just part of the deal with living in unit A, unit B does not have to worry about it or whatever.

Mindy:
Yeah, definitely be specific. When there is an opportunity for confusion the tenants will take that opportunity to be confused. Now describe again the laundry situation, can you close off the laundry room?

Parker:
Yeah, it’s an outdoor closet almost.

Mindy:
Okay. So the tenant in the mother-in-law suite wouldn’t necessarily be bothering the other tenants? I would absolutely post specific laundry hours. You can’t do laundry at two o’clock in the morning. Laundry can’t be done after eight o’clock or nine o’clock or whatever, because that could disturb the tenants in unit A. And the laundry is common area and the yard is common area. And if somebody is going to be responsible for mowing the lawn that’s great, and if they’re not responsible then they have to pay for lawn service.

Parker:
Yeah, that all makes sense.

Scott:
Well, from the property standpoint I think you have a decision to make about whether you want to sell it or keep it after a couple years. You will have tax complications advantages relative to other folks when you make that decision. But you’ve got a property that is likely not to lose money for you over the next couple of years, but is also you need rents to go up for it to continue to produce a good cash flow.

Parker:
I have another question if that’s all right. So right now I’m basically paying $800 a month to live, if you subtract the equity towards the house, the cost of my net worth’s is 600 bucks a month including utilities. So if we want to move out of this place it’s fine right now but I’m 26, I don’t know, I might want to live alone at some point in my life. How do you justify going from paying $800 a month to living alone and paying $1,500 a month or more? I don’t even know if that makes sense. So I need to grow my income by a certain amount or is it I need to just buy another property or sell this property? Because I think the goal is to turn this into a rental, but then it’s like where do I live because I don’t have the capital to buy another property. So does it make sense to turn this into a rental just to turn around and pay rent to somebody else?

Scott:
I think it’s a philosophical question and one around your values. So what I did is I house hacked in dumpy duplexes for seven years. I came on the other side of that with a moderately sized real estate portfolio, lots of savings, more cash invested in stocks and a position of at least a baseline for sure well beyond that level of financial independence around the age of 30. I just went to New York City last weekend, had a blast, visited a friend. To rent a one bedroom in an okay part of town is 4,500 or $5,000 a month, it’s an incomprehensible amount of money to me. But you live in New York City, you have all these different fun things you can do, it’s a blast. Whatever you want to do is there, it’s a life choice.
What you do you want is that worth not pursuing financial independence for 10 years and going and having a ball in this city and then figuring it out in 10 years? For lots of people the answer is yes, for you it might be yes. You can’t have it all. You probably can’t go there and come out with five properties in the next seven to 10 years and do that, but you can do that. I don’t know if there’s a right answer to your question, is that even a helpful initial response in framing that?

Parker:
Yeah, no I totally get what you’re saying. I think it’s more so we know we don’t want to be here forever just because it’s two guys and sharing a bathroom, a 1,000 square foot house. Obviously, like you said house hacking you have to take on some amount of risk and discomfort and everything like that. I think the main thing is I want to have a plan one to two years from now on what I’m going to do. I think the plan, like I said, is to turn into a rental. So I’m trying to mentally justify, okay, my out-of-pocket living expenses could go from 800 to $1,500 a month if I go that route. So in that sense it’s just part of budgeting for that expense to come, or trying to grow my income to match that housing increase.

Mindy:
Well, let’s look at your income and expenses. You have $4,200 a month salary and you spend $3,000 a month. Where does that $1,200 a month go?

Parker:
Right now it’s just going to cash. I’m about to max out my Roth, so my cash is going to go down to about 13K. That’s my other thing am I over contributing to retirement? I feel like that’s hindering my cash flow. Maybe if I want to buy another property or invest in other side hustles I’m not really keeping that much cash after contributing to retirement. And I contribute 12%, 8% pre-tax, 4% Roth, then I’m maxing out my Roth and I’m also maxing out my HSA this year. So that’s about 19,000 towards retirement. And then I’m only cash flowing about 12,000 a year plus my side hustles, maybe a little bit more. What’s your thoughts on that if I want to…

Mindy:
What does invest in side hustles mean? What side hustle do you have?

Parker:
Right now I’m not really doing much. We used to be really into flipping furniture and stuff like that, that’s basically how I was able to afford the down payment on the house. I have some other side hustles. But in terms of investing, buying another property or buying another income producing asset would be my goal.

Scott:
Okay, so let’s zoom out even further here. I think there’s a fundamental question of what do you want in one year, three year, five year, seven years? What is that trajectory? If you said, “I want to have five cash flowing properties and be reasonably set up there, and I’m willing to sacrifice most other things to get to that point.” We’d say, “Okay, continue house hacking.” Maybe even move into the mother-in-law suite or whatever with that, figure that out. Keep your expenses ridiculously low, grind and side hustle. Let’s talk about this job, all that other kind of stuff. If you’re saying, “I’d like to have one, maybe two more properties over that time period and live a really nice life in the meantime.” Okay, now we’ve got a different thing there. The goal is not to be retired in five years if that’s the case and we can do that. So what’s your hunch there? What do you want?

Parker:
I think I’d like to buy another property. I don’t think I will have enough cash to do that before I move out of this property. So this is probably going to be some type of place to rent while I transition, but I think I want to buy another property.

Scott:
So you want to house hack another property as soon as possible.

Parker:
Exactly. There’s a lot of what ifs with the economy and interest rates and everything like that. But I think I’d like to buy another property maybe two to three years from now.

Scott:
Well, you could buy another property next year if you stop the contributions to a lot of these things. You have $19,000 in cash, we save five by not contributing to the Roth, and we have another 12 by the end of the year in order to do that. And guess what, I think that’s perfectly reasonable. If you think a house hack has a good ROI, I did that. I did not contribute to a Roth and instead purchased a house hack, because it’s a better return in many cases. Now, not always, there’s always market risks and those types of things. But on average in a 3% inflationary environment and you’re advertising alone, you’re spending less to live, the house hack’s almost always going to be better than one of these retirement account contributions if you buy reasonably well. So that’d be one place to think about it if that’s really your goal. You got 30 years to max out those retirement accounts, maybe 40.

Parker:
That’s true.

Scott:
You have only probably five more years to house hack quite as reasonably. Mindy’s not liking this.

Mindy:
I am not liking this. I’m bit my tongue while you say this.

Parker:
Yeah, but then it’s me saying the money I contribute now is going to be worth the most when I retire because I’m never going to be younger, especially, the Roth and HSA contributions.

Mindy:
The Mad Fientist says, “The HSA is the best retirement account on the planet, in the whole world, in the universe,” yada, yada, that’s direct quote. So I would say continue to contribute to the HSA because I love it so much, it has a lowered limit too like 3,500 or something for you because you’re single.

Parker:
Yeah, 36 something.

Mindy:
I would love to see you continue to contribute to the Roth IRA, but if you choose to buy a house that’s fine too. I will give you some homework assignments. I would like you to look at what other remote job opportunities pay. So perhaps you could find a new job that pays a lot more, that allows you to continue to save for your retirement, and save for a house hack at the same time. I would like to know how much time you were spending on your couch flipping side hustle. Was this just seriously pick up a couch and then list it and give it to somebody else? Or were you doing work to fix up the couches?

Parker:
A little bit of both, it really depends. That’s why I bought the truck I own because when we moved here I bought the truck for $3,500, put some money into it, it’s probably worth five grand now. So when we were renting a house we would just buy a couch, stage it, maybe clean it up, re-list it, offered delivery on the couch. So I think between September, 2021 and May, 2022 we made $36,000 after expenses.

Mindy:
$36,000, that’s a job. That’s a whole job and this was like part-time work.

Parker:
Yeah, pretty much.

Mindy:
Okay. Research opportunity get back on Craigslist and Facebook Marketplace and start finding these couches and if it needs a lot of work, skip it. But if it doesn’t need a lot of work you’re just picking it up, storing it in your garage while you wait for somebody to come buy it, do that. That’s my new favorite thing, we should have talked about this the whole time. $36,000, good God.

Parker:
Well, 18,000 each over nine months. We were probably each clearing 2K a month after expenses in profit.

Mindy:
Why did you stop?

Scott:
So your next property needs to have a big garage.

Parker:
It was kind of the COVID craze with furniture being hard to find. I don’t know if I could continue making that and the house has taken up more time as well, but it’s been a great side hustle.

Mindy:
Do you make $36,000 on your house right now? No, you don’t. So there you go, flip couches.

Scott:
I agree with that. I think that income is a major factor here. You’re early in your career. Financial analyst is a great way to start your career. I’m biased, that was my first job. But I think it’s fantastic, a lot of options open up to you after that because you understand financial… You’re literate with financial statements, what good looks like. You can tell what’s what’s going bad. You can make basic economic analysis, it’s a really good trading ground for a lot of things. So you have a lot of options there. It’s a slower career path if you stick with it for 15 years, I think there are other options. So I would encourage you to think about jumping around in the next couple of years. And I think this side hustle is really exciting. Run your numbers, do your spreadsheet on that one as well.
And then do your spreadsheet on your house hack. Last spreadsheet you should run is on Roth IRA, HSA, 401k and compare them to a house hack under moderate conditions. Your ROI on the house hack if you put down 5% in any normal environment, and who knows next year could be a bad year for real estate, I don’t know with those things. It could be a bad year for stocks. But in any normal environment the house hack ROI is going to be 50 to 100% with a low down payment on that, if you’re reasonably able to assume 3% appreciation on that. And so while I get that first year of Roth is going to be worth the most in 30 years, the first year of the house hack is going to be worth the most in 30 years.
I bought my first place for 240 in 2014, now that place is worth 550. My Roth contribution in 2014 ain’t worth 300 grand. Proportionally as much as that investment is, it’s maybe be doubled in that time period. So I think it’s a really powerful tool there. And look, the reality of your situation right now is you have ways to make more money, you’ve got a good property, but you cannot have your cake and eat it too. You can’t have spend $1,500 a month on rent and max out your Roth, contribute to your 401K and your HSA and buy a property. You got to choose. And so use your skillset as a financial analyst and rationalize it based on the highest returns there. And I think there’s no way you’ll run those analyses and come out with another house hack as the clear winner, unless you believe prices are going to go down substantially for a prolonged period.

Parker:
Regardless of what I think it’s hard to predict. I kind of have these differing opinions. My finance background has me thinking, “Oh-” And I think that’s what most people say you should get your 401K to the match, then max out your Roth and go back to your 401K and completely max it, and then after that go into a taxable brokerage or investing in real estate. But if I did that I have no cash left, so I think that’s a good point.

Scott:
Run the analysis, ask yourself what do I believe and then do the thing with the highest return that you believe.

Mindy:
Do you have a match at your company?

Parker:
Yeah, 4%, I’d have to contribute 8%, but right now I’m contributing 12.

Mindy:
I would contribute enough to get the entire match.

Parker:
Yeah, I am, I am.

Mindy:
What do they say that’s free money. So then you could pull back on that if you choose and take that extra 4% and put that into cash. Or take that extra 4% and put that into your HSA, and then stop the HSA and the Roth and just think about it.

Scott:
I agree with Mindy that you should take the match, but I do want to also just continue to push the seed of doubt in there that you are 26 years old, you’ve already started two or three different businesses at this point, some of which have been very lucrative and opportunistic. Getting cash in your bank account that you’re willing to use to advance your position is going to be way more powerful for you than almost anybody else in different life positions.
Because you will use it to change that job, join the startup, start your own business, try the next rental property investment, those types of things. And the ROI on that is going to be higher than the 10% that you’re going to get on an annualized basis in an index fund in the stock market. Everything on top of that, that you don’t need to pursue those opportunities I think that you dump that into the tax advantage retirement stack as far as you can go. But I have a heavy bias towards cash for folks like you in your situation that are learning lessons, working, living literally in their business, all that kind of good stuff.

Parker:
Right now’s the time I’ve got no dependents, no girlfriend, no anything. That’s the thing I like about real estate is I can have an active role in creating my success. Not that contributing to retirement is not a good thing, but it’s just buying ETFs and just letting it sit there doesn’t really feel like I’m being as proactive towards being successful.

Scott:
I think 10 years down the road Parker with $30,000 in cash is going to be way richer than Parker with $50,000 in his investment accounts and less in cash.

Mindy:
That’s hard to argue with.

Scott:
I can compute that in a spreadsheet though, the formula would work out. Hopefully, the argument at least makes you think about things.

Mindy:
Parker this was a lot of fun and I’m really jealous of your $36,000 couch flipping side hustle. That should be a main job, that’s not even a side when it pays $36,000 a year. So get back into that, that’s really awesome… Even if you can only do half of that $18,000, there’s your down payment. So I encourage you to start combing the ads again to find the stuff that sold really, really well.

Scott:
IF you make that much money also, that’s a good one to set up the LLC for, so you were asking about LLCs.

Mindy:
Yes, it’s a great LLC and a self-directed solo 401k and oh my goodness, so many fun things. I really appreciate your time today Parker. Thank you so much for joining us and we’ll talk to you soon.

Parker:
Thank you guys. Love the show, so great to be on. Thank you.

Mindy:
Aw, thank you.

Scott:
Thank you.

Mindy:
That was Parker, and I cannot believe he makes $36,000 flipping couches. I’m going to go buy a truck and flip couches too Scott.

Scott:
I think it’s a great side hustle and I think that… Well, we didn’t really touch on this nearly enough. The big story here is how Parker sets himself up for income growth over the next couple of years. At 26 financial analysts making $75,000 a year, the world is his oyster. He needs to go and figure out how he can apply that skillset to a variety of opportunities. Either continuation of his track in the finance world, starting a new business, buying more real estate, expanding the site hustles, all those things are really the major lever in his financial position on a go forward basis. And I think that’s exactly where he should be focusing his time.

Mindy:
I agree. I think he’s got a lot of different opportunities and just what does he want, what are his goals and how does he want to accomplish them, and how many different ways does he want to make money? It seems like there’s a lot of passive and semi passive ways that he can generate income.

Scott:
Yeah, he’s got a lot of good options just needs to focus in on them.

Mindy:
Yep. All right, Scott, should we get out of here?

Scott:
Let’s do it. And that wraps up this episode at the Bigger Pockets Money Podcast. She’s Mindy Jensen and I am Scott Trench saying give me a hug, ladybug.

 

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The Dominoes are About to Fall

The Dominoes are About to Fall


Deleveraging is a term you probably haven’t heard. And don’t be surprised; most news networks will never cover what deleveraging is or what it means for the real estate market. But, this capital constriction could implode the housing market, causing numerous investors and funds to go under, leaving the rest to pick up the scraps. This massive change is about to happen, but don’t get too scared; if you bought right, you could be one of the lucky few with a buffet of cash-flowing deals to choose from.

So, who’s better to ask about this impending crisis than Ben Miller, co-founder and CEO of Fundrise? He’s been on both ends of lending, not only buying significant assets with credit but also supplying the funding to others who need it. Ben is predicting a massive change in the real estate market that will shock investors to the core and could leave the economy worse for wear. This deleveraging crisis Ben talks about is not a simple concept, but once you understand how and why it’s happening, you unlock a piece of knowledge that 99% of other investors miss.

Ben speaks on how bridge loans and floating financing have put thousands of investors (and lenders) in a bind, why banks will be strapped for cash in 2023, and the scenarios that could play out over the next year if everything goes wrong. Make no mistake, this is NOT a doomsday forecast or some hypothetical hype meant to worry investors. Deleveraging is a real scenario that could have cascading effects for decades. If you’re investing, this is a CRUCIAL episode to tune into.

Dave:
Hey everyone. Welcome to On the Market. I’m Dave Meyer, your host joined with James Dainard up in Seattle today. James, ready for the game?

James:
I am ready. I got my cough drops. I’m ready to scream as… The 12th Man is a real thing so I will be screaming with him.

Dave:
I’ve always wanted to go to a game there. Is it really something different?

James:
Oh, when you are back here I will take you. Yeah, I’ve been seasoned ticket holder for a long time. It is loud. When Beast Mode did the beast quake, it was the most intense thing I’ve ever heard in my life, it was absolutely crazy.

Dave:
Yeah, that sounds fun. Well I’m going to be in Seattle in two weeks but you’re not going to be there unfortunately. But next year we’ll do it.

James:
If there’s a game I might be able to give you tickets, let me check the schedule.

Dave:
I’m definitely in. Well let’s get to real estate. So today we have Ben Miller who is the CEO of Fundrise who just full disclosure is the sponsor of our show. But Ben is the single most knowledgeable people about real estate I’ve met in my life. And this is a fantastic episode and interview that we just had. Can you give a brief summary to everyone listening about what they can expect to hear here?

James:
I think this is such a great episode. This is actually one of my favorite ones that we’ve done and the reason being is everyone’s looking for this opportunity and they’re frozen right now. They’re like, I’m not going to buy anything until I figure out what to buy. Ben talks about what’s coming down our pipeline and as an investor to prepare of where the major opportunities are. And the hints he drops are… everyone wants to know where to make the wealth, it is what we’re going to talk about in this episode.

Dave:
And I do want to just give a little bit of a disclosure here because some of what Ben talks about is a little more advanced. We get into the details of the banking system and how loans are generated in real estate, specifically commercial real estate. But it is crucially important to what Ben’s thoughts are about what’s happening in real estate right now. And he provides really good concrete examples of how some of the shifting dynamics in the debt markets and this big deleveraging as he calls it, that we’re going to see over the next couple years could impact commercial real estate assets. So it’s a fascinating episode, I personally learned a ton, but just be before warned that there is some nerdy wonkery in here. But I know for people like James and I, we loved it.

James:
I love shooting this sh*t with Ben, I think I sent you an email before the show, I was like, I had to listen to this podcast twice to digest it, but it is fascinating and it probably changed my whole strategy for what I’m going to do in 2023.

Dave:
Wow. All right. Well those are bold words so if James has taken it that seriously, you definitely want to listen to this. So we’re going to take a quick break but then we’ll be right back with the CEO of Fundrise, Ben Miller.
Ben Miller, the CEO of Fundrise. Welcome back to On the Market. Thanks so much for being here.

Ben:
Thanks for having me guys.

Dave:
Well we’re excited because last time we had a great conversation talking a lot about Build to Rent, but James and I have both listened to a podcast you were on recently. James admitted he listened to it twice because he liked it so much. That was talking about de-leveraging, I think it was called the Great De-Leveraging on that podcast episode and it was fascinating. So we were hoping to start there and just learn a little bit about your thoughts on this topic. So can you just start by telling us a little bit about what de-leveraging is?

Ben:
Yeah. So it means to reduce the amount of debt you have, less leverage, de-lever and that’s basically I think going to be a ratchet on the economy and on all assets this coming year or two.

Dave:
And so when you’re talking about that de-leveraging in terms of real estate, are you saying existing property owners are going to reduce the amount of leverage they have on properties or are purchases on a go forward basis going to use less of debt or how would you describe the phenomenon of de-leveraging as it pertains to real estate investing?

Ben:
So the argument I’m making right is that virtually the entire financial system, not just real estate, has to reduce the amount of debt it has, it has to de-lever. And that is because we were in a low interest rate environment, basically zero interest rate environment, for 15 years and before that we’d been in a falling interest rate environment for 40 years. So that’s a long time. And we move to a high and rising interest rate environment, so you’re basically, it’s like you’re a fish and now you’re in the air. It’s a sea change, completely different environment. And in that rising interest rate or high interest rate environment, the amount of debt a asset can support is less. So to put the math on it rather, you have a business, you have a apartment building and you have a certain amount of income from it, let’s just say a million dollars a year. When your debt service doubles, which everybody’s debt service in the new interest rate environment has gone up at least 2x, maybe 3x, you can’t support the same amount of debt service as you could before. So you have to have less debt on the asset.

Dave:
And are you seeing this already starting to happen in your portfolio or how are you noticing this manifesting itself?

Ben:
Well I can talk about us and then I can talk about what I’m seeing firsthand. So we’re a little bit different than most borrowers. We have essentially what’s like a public REIT, there are publicly registered REITs and so our leverage is much lower. Our average leverage in our funds is 45%, 43%. So that’s a lot lower than most companies or businesses lever their assets. A typical private borrower probably wants to lever 75%, 65%, maybe 80%. So for us, basically we don’t really have this higher leverage problem, but we do have a couple of assets where I have it, because it’s the average leverage, so some are higher. And when I look at a… I’ll give you an example asset and how it’s playing out and what it means and you can then extrapolate that to a lot of other borrowers. So we have a $300 million warehouse line that holds a lot of rental residential with a big investment bank and we’ve got that line of credit or warehouse line, it’s a revolver so you can buy, you can pay it down, you can borrow it again. About 18 months ago.
And so when we got it, we bought a interest rate cap and I think talking about interest rate derivative is a really interesting subset underneath this topic. And basically what the investment banks like to do is lend their balance sheet to you and then you take that and you buy real estate or anything and then they go and they securitize it. Basically their business is really by generating fees and they use their balance sheet to basically enable themselves to get more capital management fees, capital market fees. So that’s really what they’re doing. So they’re not really lending to you, they’re really just bridging you to the securitization markets. And securitization markets, last year, 12 months ago you could borrow… that portfolio we built, you could borrow a 2.25% fixed for five years and now that securitization market is 6%.
So we have to pay down that line with that investment bank, we have to pay it down, we’ll do that and we have to bring it down from what it was probably 73% leverage to 55% leverage. And that’s basically a pay down of about 15, 20%. But it’s illustrative of when interest rates have gone up so much, you basically have to pay down. And we don’t have to pay down until the cap expires, interest rate cap, basically the size of the loan we got is too big for an interest rate that’s 6, 7, 8%. So we have the liquidity, we have a lot of liquidity so it’s not going to be a problem for us. But for a lot of borrowers, if your lender turns around and says I need you to write a check for 20% of the loan and I need that in every single loan that comes due or any loan that basically you’re going to get for a new property, that’s basically the problem for a lot of borrowers.

James:
Yeah this is really interesting because with the sudden increase in rates, this is the fastest we’ve ever seen rates increase this quickly, we’re seeing this in all segments and I think everybody is seeing these interest rates rise and they’re all thinking that the housing market’s going to crash and that there is some sort of crash coming. And for a while I’ve been thinking that there’s going to be this investment graveyard because of exactly what you’re talking about where the loan out values do not work with the current money and there’s going to be this massive liquidity demand to pay down these loans right now. And I know a lot of apartment guys for the last four or five years or the last two years, I know we staggered out our portfolio to be at 5, 7 and 9 years on fixed rates because… Or in 10 years, because we didn’t want to get into that liquidity crunch. But I feel like I’m seeing this now everywhere on any kind of leverage where it’s hard money, it could be banking, it could be commercial loans where the asset now can no longer pay for itself and there’s going to be this huge shortfall of money. And I think that’s where we’re going to see the biggest opportunity coming up, is this demand for liquidity.

Dave:
So it sounds like generally… I mean across the commercial real estate spectrum, we’re seeing people who have adjustable rates or commercial loans are reaching maturity. They’re basically facing the prospect of either having their current loan going up or they’re going to have to pay off their loan or refinance at a much higher rate. And this is going to cause a lot of liquidity issues across commercial real estate. So first and foremost, is this mostly with residential commercial or are you seeing this across the asset classes?

Ben:
Residential is probably the best.

Dave:
Oh really? Yikes.

Ben:
And office is probably the worst. I don’t know, on my podcast I had Larry Silverstein, the owner developer of the World Trade Center and he and I… It was just an insane interview and he’s talking about, he’s like, I’ve been… He’s 91 years old and he’s talking about one building that he’s developing that’s 5 billion dollars.

Dave:
You only need one if it’s 5 billion, then you’re pretty good.

James:
That’s working smart.

Dave:
There you go.

Ben:
I’m a piker compared to him. But anyways, you have office buildings throughout all these big downtowns that are just like, oh my god, they’re just… they’re unfinanceable. Literally, you couldn’t get a bank in the country to give you a loan at any price, period. Done. It’s zero liquidity. Liquidity means ability to get money. No money, so office is the worst. But if you’re a small business, forget about it, it’s everything. So I talked to another bunch of banks this week, this week? This week, yeah, yesterday and the day before, one of the banks we are a borrower, big relationship with them. And they were telling me, so this is a top 15 largest bank in the country, hundreds of billions of dollars of assets, hundreds of billions of dollars. And they said to me, so the way… where do banks get money, right? That’s a question, right? I love to understand how my counterparties work. Because if you understand how they work, you understand how they will behave. So banks, 90 some percent of their money comes from runoff.

Dave:
Never heard that term.

Ben:
Banking and insurance or asset management, you have deals that pay off and as they pay off you have money to redeploy or relend. So it’s called runoff.

Dave:
Oh okay.

Ben:
So yeah, that’s actually where most lending… When you go to a bank and you borrow money, it’s actually from somebody else paid off their loan and that’s why they can lend you more money because they’re usually pretty heavily levered up, banks are levered nine times or something. Of all the people levered banks are the most levered. And so nine times is like 90% leveraged and I think they’re actually like 92-3% levered technically. So anyways, so this bank basically probably lent 30 billion dollars in 2022. I said to them, what’s going on with you and how’s it going on with this liquidity crunch? And he says to me, for 2023 our forecast to the amount of lending we can do based on the amount of runoff we’ll have is by next December we’ll be able to lend a hundred million dollars.

Dave:
This is a bank with hundreds of millions of dollars of assets.

Ben:
Hundreds of billions.

Dave:
Billions.

Ben:
They would’ve normally lent, I don’t know, 30, 40, 50 billion in a single year. And they only have a hundred million to lend next year.

Dave:
What! Is it just…

Ben:
Yes.

Dave:
Okay. So you’re saying that none of these deals are going to pay off because they think they’re going to default or just no one’s going to sell or where does the lack of runoff come from?

Ben:
The essence is, for a deal to pay off it either has to sell and nobody’s going to sell or the borrower has to write you a check which they probably got from refinancing with someone else. But since nobody will finance you, nobody will pay off their loans. That’s whats happening, it’s a fact. Leading up to the last podcast in the last two weeks, I’ve met with probably 7 of the top 15 banks in the country. 7 of the 15, all the exact same.

Dave:
Really?

Ben:
They’re all exactly the same situation, yes.

James:
This is why I listened to that episode twice.

Ben:
People didn’t believe me. I was on Reddit and they were like, no way, this can’t be true.

James:
You were talking about the turtles, right? Will you go over the turtle concepts? Because this is a very complex topic and it made it very tangible and it’s like this never ending…. Go ahead Ben, go ahead and explain it.

Ben:
Okay. If I can do it justice here, because I’m not normally good at being succinct. So the point of the story about the banks is you don’t often think about where the banks are getting their money. And there’s a saying in politics, which is always follow the money. You to got to follow the money, so you’re going to borrow from the bank, but where did the bank get the money? The bank got it from depositors, they got it from a payoff and then the bank levered that, the banks are levered, they borrow, anybody in the market who’s lending to you borrowed against their asset. Just to try to make that simpler, if you go to a bank and give them your house as collateral, you get money from them and they have your collateral. A collateral is an asset and they take those assets and they borrow against them.
So now your lender is a borrower from someone else, your lender is also a borrower and who do they borrow that money from? Another institution who also borrowed money. So there’s this infinite chain of everybody is a borrower and a lender in the system and it stacks up. In a hard money world, you have a property with a hard money lender, the hard money lender may have borrowed against that portfolio of hard money loans from a bank. And the bank has that collateral and that bank has borrowed against that portfolio of loans. So the bank is levered and where did they borrow the money from? They borrow the money from different parts of the securitization market. For example, who levered that up with repo loans. And so there’s just so much more debt in the system than you can see. And because basically we went from a low interest rate environment to a high interest rate environment, everybody in that chain of borrowing to lender, the lender to borrower, everybody’s over levered. 90 some percent of the market, some huge part of the market’s over levered.
And so as the defaults happen or as the pay downs happen, it’s just a cascading effect. And I’ll give you an example. I know a big, big private equity fund, everybody’s probably heard of them, let’s say, I don’t know, top three or four and country, every private equity fund started credit funds over the last 10 years, debt funds. And they went out and became lenders. So if you have an apartment building or an office building and you borrowed from them, let’s say 75% of the money, they turned around and borrowed that money from a bank. And so they have a hundred million dollar property, they lend you 75 million, they turn around and borrowed 55 million from Wells Fargo who is actually pretty active in this part of the market, they call it an A note. And then the private equity fund, we keep it B note and then the borrower basically just thinks that the money was borrowed from this fund, but it’s actually really more complicated than that.
So what happens is, let’s say you have a loan with this credit fund and your loan’s coming due on December 1st and you go over to the credit fund and say, hey I need an extension, the market’s horrible, I’m not going to sell this today, let’s just extend this loan by 12 months. Well that credit fund’s going to say no because they have a loan from a bank and they turn around to the bank and say hey bank, we need to extend this loan. And the bank’s like no, pay me. Because certain banks are saying, F-you pay me. And so the credit fund is turning around and saying, no, pay me. And you’re with the borrower saying no, no, look its fine, the property’s doing fine, just give me an extension. I mean what are we talking about? Just give me extension.
How many times have you gone to a bank and it’s just expected to extend the loan. It’s like nothing, fine I’ll pay a small fee, let’s just extend this thing. No, you can’t extend it, pay me. Well how much do you want? 10%, 20%, they need to turn around pay down their lender because they have to de-lever the loan, they actually used this collateral to get the money to pay you. So there’s this chain of nobody cannot pay down because everybody’s borrowed from someone else. And so if you have a loan, you think you’re going to extend it in the next 12 months just because the property’s doing fine and you go to the bank, you might be surprised to them say, no.

Dave:
So what happens then? I just think the whole system is obviously so dependent on this chain continuing to operate, what happens when… Like you said, at any point any one of the lenders could just be like, no pay me. So what happens to, let’s just say an operator of a multi-family property, what happens when they can’t get liquidity or they can’t refinance? How does this all play out?

Ben:
So there’s a few possibilities, so let’s do the easy to the hard. So the easy way is that multifamily operator says fine, I’m going to go sell all of my freaking stocks and bonds I own, they probably have money outside and they sell it all and pay down, they’re not going to lose their apartment buildings. So they can turn around and sell all their assets and pay down the lender. That’s a luxury situation to be. I just want to point out the second order consequences of that is a lot of people are going to have to be selling their liquid assets like stocks and bonds to pay down their loans. And I’m talking about even massive institutions are going to have to do this. They’re going to have to pay down their loans and so the amount of liquidity is going to go away.
And when you have forced sellers, prices fall. So that was exactly what happened in England. If you guys remember UK two months ago, the gilt or the UK treasury spiked and all these pension funds had to go turn around and sell other assets to basically cover their margin on their treasuries, on their gilts. So the liquidity crisis happened not in gilt but actually in CLOs. So that’s why the cascading effects are much more sneaky because it will hit the liquid markets because that’s where you get money, that’s where you get liquidity. Somebody along the line is going to have to get liquidity. So let’s just say the borrower says I can pay down.
Scenario two they can’t pay down, they go to the lender and the lender says… Depends on the lender, so now if you’re talking about credit fund, they’re going to foreclose, they have to, they don’t have a choice, the extend and pretend that was the playbook for all of banking for the last 15 years, they can’t do, they can’t extend and pretend because the loan no longer covers. Who’s going to pay the interest rate that it doesn’t cover, it just literally fails their FDIC regulations that say you have to have capital ratios, so it just fails it, so they don’t have a choice. The regulator is going to make them default that loan. So credit funds are going to foreclose.
The private equity fund I was thinking about foreclosed on two deals last month from huge famous borrowers. And all this is happening, nobody’s talking about it, its not hitting the news. But you would’ve heard of the borrower and you would’ve heard of the private equity fund. The residential deal they foreclosed on, they’re happy to own it. But even though they are the lender, they still have to pay down the senior. Because if they foreclose, they have a big apartment building and they’ll say 80%… And I know of a deal where this happened in a major city, the deal basically… Even at 80% that credit fund has to pay down their senior lender, it’s not enough. Even if they foreclosed, the senior lender who that has that asset now they foreclosed on, it’s still over levered with their senior lender. Do you follow?

James:
Yeah, it’s just leveraged to the till, it’s a complete mess.

Ben:
Yeah, so it’s confusing. So I almost wish I could say names but it’ll get me in too much trouble. So I’m just going to name like, you went to ABC lender and you borrowed 80%, ABC lender, now foreclosed on your 200 unit apartment building, great, they have a 200 unit apartment building, but they borrowed from XYZ lender and XYZ lender is still saying pay me down, pay me off, pay me down. So even that ABC lender has to sell some… They have to do a capital call, they have to get liquidity, pay down. And so there’s again liquidity getting sucked out of the system. As liquidity gets sucked out of the system, prices fall. It’s the opposite of quantitative easing, opposite of what happened in 2021 where there was all this money everywhere and prices went up everywhere, money is being withdrawn from the system.
If you’re familiar with money supply, the M2 is going to fall because of this deleveraging dynamic and also quantitative tightening. So you actually are going to see, I think a liquidity shock next year as all this money leaves the system. So that’s a second scenario. They also foreclosed on an office building and they’re like F this, what am I going to do with this office building? The office building’s probably worth less than their loan, way less, maybe actually less than the senior lenders loan. They may give that whole office building to the actual bank XYZ bank, bank of America or something. Offices just defaults left and right. It’s going to be a blood bath and everybody talks about office to residential conversion, they don’t know what they’re talking about.

Dave:
Yeah, we’ve had a few people on this show come on and be like, yeah that doesn’t work.

Ben:
It’s just some academic or somebody talking about it, government policy, it’s like, you’re dreaming.

Dave:
It sounds like maybe 5% of offices could realistically be converted, if that.

Ben:
One obvious point, how often is an office building a hundred percent vacant?

Dave:
Yeah, right.

Ben:
Never, there’s always some five tenants in there and this building’s 20% leased, how do you renovate a building when there’s 20% leased with five tenants, you can’t.

Dave:
Yeah, it doesn’t make sense.

Ben:
Anyways, the question [inaudible 00:26:43] interesting is basically does the regulator… Right now the regulator has the hurt on the banks that really… Just absolute [inaudible 00:26:50] to them. So the question is, does the regulator start looking the other way and saying, okay, I know that you have all these assets that are basically in default and not covering, I’m going to look the other way. That’s a question that is… I don’t know, I suspect the regulator is not going to do that, for a bunch of reasons. I say this a lot in my little world, but this is more 1992 than it is any other period in our lifetimes.

James:
In 1992 the investment companies got… Everyone thinks of the crash as 2008. But in 1988 to 1992 the investment banks got rocked and it was the same type of liquidity crunch because the Fed did not step in at all. They did not look the other way in these investment… I was reading up on that and wasn’t like 90% of investment companies just got hammered during that time? It was some astronomical amount that it kind of shocked me and they couldn’t recover for a good two, three years, I want to say.

Ben:
Yeah. So I say that that was the worst real estate crisis in American history, way worse than 2008. Most people our age, it’s way before us… So basically the policy approach back then was let them all burn and they foreclosed on I think 8,000 banks and every developer had their loans called, so every developer you can possibly name either lost all their assets or basically was nearly about to lose all their assets, nobody was spared. And so a lot of times you see with policy and actually generally with human behavior is, if something happened that was bad, people don’t repeat that mistake until enough’s times passed that people forgot and then they do it again.

Dave:
Seems like it’s about time. Yeah, it’s been 30 years.

James:
We’re overdue really.

Ben:
Yeah, so we’re like the full circle. If it doesn’t happen in this cycle, it’s definitely happening next time we have a down cycle. Because it just seems like all these lenders who got over levered, all these borrowers who got over levered, they seem like the bad guy and we should just let them all burn. And it feels very politically satisfying, so we might end up there again this time.

Dave:
You just don’t think there’s political appetite to bail out banks again after what happened 15 years ago?

Ben:
And bail out private equity funds and bail out the rich, that doesn’t… I think there’s probably not going to be any more stimulus this decade. Bailouts and stimulus, forget about it.

James:
Yeah, stop the stimulus. But sometimes you have to let things burn a little bit, right? I mean that’s capitalism.

Dave:
That’s capitalism. Yeah, that’s the basic…

Ben:
Okay.

James:
And what Ben’s talking about is a big deal, it’s in all different spaces of this… People were just middle manning money everywhere for the last two years and making good returns. And it’s not just in the multi-family space and these office buildings, the hard money space was really bad as well. These lenders would come in, they would sell the notes off at 7%, 8% and now these lenders are paying to their senior bank, they’re paying 10, 11% and what’s happening is these fix and flip or burn investors, they’re coming in and they’re going, hey my projects are taking too long, I’m over budget, the value kind of fell, I need that extension and their rates are getting jacked up five, six points or they’re having to come in with money or they’re just not getting extended at all. We’re actually a hard money lender up in Washington and we’ve had so many requests for refinancing other lenders because they have no choice, the lender will not extend right now and it’s causing a big, big deal. And then we’re looking at the loan to values and that’s our answer, yeah we can do this loan but you need to bring in another 15% down and these people do not have it.
And that’s what’s so terrifying, in 2008 we saw a lot of REOs and bank owns through the residential space. But this is like, if you don’t have the money, you can’t pay your bills. And these investment banks and lenders, they’re going to have to take this… There’s going to be a lot of REOs and deed in lieus going back to these banks and banks are going to become… we’re all freaked out that the hedge funds were going to be the biggest residential owner with all this acquisition of housing and they might be just based on bad loans coming back to them.

Ben:
And so again, all the interesting things are the second/third order consequences. So the second order consequence is everything you just said James, is that appraisals are going to start coming down because you’re going to have all these bad REO marks and people are going to be forced to sell and that’s going to really hurt your LTVs. So then you’re going to go to borrow money or refinance and then the LTVs are going to be even worse and then they’re going to be more foreclosures. So we’re going into this cycle that just starts to tear apart… it’s this vicious cycle down and that’s one of the other consequences across the board. And in every [inaudible 00:32:19] we’re a FinTech, buy now pay later. Guess what? Super levered.

Dave:
Yeah. You said appraisals are going to come down, so I presume that you think there’s going to be a significant decline in property values across commercial real estate assets? It has to, right?

Ben:
Yeah, there’s no question. It’s a great opportunity essentially because we’re not talking about organic pricing, the price that banks sell things at, there’s no relationship to what you think is actually worth after the next, I think, probably 24 months of real downturn and distress. And so there’s an opportunity to buy or opportunity to lend to and if you have low amount of debt, this is literally what Larry Silverstein was saying, you go through horrible crises, you come out of it, you still own the building and now he’s worth 10 billion dollars or something. It is part of the game, don’t get caught in the part of the game where you basically lose your asset.

Dave:
So you mentioned Ben, that there’s a lot of opportunity, for people listening to this how would you recommend they take advantage of some of the upcoming opportunity you see?

Ben:
You can go talk to the banks, approach the banks, the banks are going to have… They don’t have it yet and they’re really slow. The brokers that were doing all of the lending will move to become the brokers for this middle capital, this bridge capital, I call it gap funding, rescue funding. All the brokers that were previously doing the work to find you senior loans will now do this work. So the brokers are probably the biggest source of flow. Its funny, the stock market, I still think they’re another leg down, and then overall markets, the recession hits earnings. So you want to be in credit, you want to be in credit this part of the cycle because the real value, the real opportunistic value I think is still a ways off. But the lenders they’re really the headwaters. But the deal flow is going to percolate everywhere else.

James:
I know we’ve reached out and we’re definitely getting a lot of response. The different types of lenders are a little bit, I think seeing it first. These local hard money guys are definitely seeing it first right now because the notes are shorter term, they’re usually 6 to 12 month notes where some of these other ones, they’re 2, 3, 5 years. And there is a lot of inventory starting to show up. I have been getting quite a bit of calls from lenders saying, hey, we just took this back deed in lieu or we’re going to foreclose this, what can you pay for this? And they don’t typically like my number, but the number is the number. But you can do it right now with the local smaller lenders, they’re not big deals but there is volume coming through for the smaller investors or the mid grade investors right now. And it is coming to market as we speak.

Dave:
And it sounds like Ben, you’re putting together a credit fund at Fundrise to take advantage of some of this.

Ben:
Yeah, we’ve had a credit strategy for a long time, but we had sort of sized it back over the last two couple years because it just was… We were deploying mostly elsewhere because it wasn’t attractive. And now all of a sudden its like… I feel like what’s happening now or in the next couple years will happen to us or for us five times in our life, the kind of deals we’ll see, the kind of lending we can make. I went through 2008, I have all these scars from 2008 and so 85% of the time it’s business as usual. And then there’s a few times where it’s just the entire ballgame’s made or lost. And so yeah we’re going to do credit first and then we’ll do equity second. Because you could almost see the other side of this, you could feel confident that it’s not permanent. It’s a couple years of transition to essentially a new borrowing environment.
And some people are unlucky, they had maturities come due in the middle of this, basically this period where there’s high rates and no liquidity and that sucks. It’s unfortunate for them but it’s an opportunity for someone else, problem is an opportunity. I’ll give you another example, this is outside real estate, but we have a tech fund we launched and we’re debating this, I don’t know if we’re going to do this because it’s so controversial, but I have sales coverage, I was buying all this… I came in and started lending to all these big… Investment banks, they get these deals and they securitize them and the problem is all these deals they intended to lay off or syndicate they say, they got stuck with, it’s called hung loans. So they have tens of billions of all these hung loans. And an example of one that’s well known is they have 12 billion dollars of Twitter’s debt. And I know exactly who has it and I’m talking to them and I’m like, at some point they’re going to just dump this debt for nothing. They’re just going to be like get me away from this thing. And we’re debating internally, is this a good opportunity or is this just too messy?

Dave:
Wow.

Ben:
It’s so messy.

Dave:
It’s the brand new debt.

Ben:
Yeah, yeah, the new debt. So I don’t know if it’s a good idea or not. This is an interesting question, but that kind of thing is insane. Twitter was worth 44 billion a year ago and you’re like, do I like it at 5 billion? I don’t know, maybe.

Dave:
That must be a fun debate to have.

Ben:
Well also it’s just like, I don’t really want the noise. That’s the problem with it, it’s not just evaluation question, I’m only making an economic decision here, but I’m not sure that’s allowed. But it’s just illustrative, it’s just totally illustrative of that it’s a special time to have that kind of investment opportunity.

Dave:
All right. Well Ben, thank you so much. This has been very, very insightful, I’ve learned a tremendous amount. And honestly it’s really surprising people aren’t talking about this. So I guess maybe that’s my last question to you, is why is this not being talked about more broadly?

Ben:
Yeah, it was so fun to be here. Everybody talks about this, but back in early February, I was obsessed with the pandemic, February, 2020. And we were going to California, my kids and my wife and I, we were going to be in California for Valentine’s Day. And I was like, we can’t go and made the kids wear masks on the plane and my wife’s like, you’re f*cking losing it, she was so annoyed with me and at some point everybody woke up to it. There’s something where information has to leak out to the public and it adds up, it requires a preponderance of data before people will shift. And it then happens all at once.

Dave:
People don’t want to believe inconvenient news.

Ben:
And it’s just like people are busy, it’s not what they’re focused on. And so it just takes enough pings before people will start to pay attention. So that’s why… at least I think that’s like… And of course everybody, in this case its all the participants in the financial system, they’re not talking about it, this is the last thing they want to talk about. They want to say everything’s great. And same thing with China, they’re like, everything is great, pay no attention to the the doors we’re welding shut in Wuhan. So again, there’s active participants trying to stop this from becoming a story and that’s confusing for the media and it takes a while for it to just to graduate.

Dave:
All right, well we’ll have to follow up with you soon as this unfolds, we would love to get your opinion because you’re obviously a bit of a canary in the coal mine right now, warning us ahead of time. So we really appreciate your time Ben, this is always a lot of fun when you come, so thanks so much for joining us.

Ben:
Yeah, thanks for having me.

James:
Thanks Ben.

Dave:
I don’t know whether I should be excited or scared right now.

James:
I’m actually extremely excited because I feel like we’re all looking for that massive opportunity and this is going to be a big deal. For a while I’ve always thought about this investor graveyard and I think it could be a banker graveyard, not an investor graveyard.

Dave:
Yeah. You’ve been saying this for a while that, specifically, and just for everyone to understand, we’re talking about mostly commercial, this could bleed into residential as Ben was saying, there’s all these secondary and tertiary impacts, but it could be really interesting for people who have… Syndicators, people who can raise money to start going and trying to buy these assets really cheap right now or in the next six months, whatever.

James:
And especially because banks don’t want to own assets. A lot of times they don’t want them, they want to get rid of them. And if you have liquidity, it’s going to make a big, big difference in… I’ve been saying that for a while because the weird thing is I’ve saw people make a lot of money over two years and then six months ago they’d be like, oh, I’m strapped on cash. And I’m like, well, you’ve just made this much money over the last two years, why are you strapped on cash? And that could come to a fruition in 2023, there’s going to be a call for some liquidity and it might all be on the street.

Dave:
You’re a perfect person to answer this question because you do a little bit of everything, you lend, you flip, you buy distressed assets. If all of what Ben thinks is going to come to fruition does, and we start to see liquidity crunch, declining prices in commercial real estate, how would you look to best take advantage of it?

James:
For us, I think we’re trying to gear up with more private equity and equity partners to where we’re trying to bring in some bigger dollars on this. A good example is we’ve done more syndicating deals in the last 120 to 150 days than we did the previous two years because the liquidity is on a crunch. But partnering up with investors that have cash right now is key to everything. And whether it’s fix and flip apartments, it could be burr properties or cash flow properties, for us, you want to attach to where the liquidity is. For us, we’re raising some money right now because we do see the opportunity with these buying notes, buying defaulted buildings, and then just really start building the relationship with these people with paper.
And like what Ben talked about, it’s hard to get ahold of the big banks. You can’t get ahold of them, I don’t know anybody there. But these small local lenders, you could be reaching out to them and saying, hey, I have liquidity, I’m looking for projects, let me know what you have. And I can tell you we’ve gotten some fairly good buys recently where I’m like, I just throw a low number out and they do the deal. They’re like, can you close it in five days? And we’re able to kind of click that out. So just talking to the people that have been in that space, all these hard money guys that have been harassing you for two years to lend you money, talk to them, see what opportunities are and then keep your liquidity on hand, don’t rush into that deal, make sure it’s the right one.

Dave:
That’s very good advice. All right, well thanks James, this was a lot of fun. I really do enjoy having conversation with you and Ben. It’s always a high level conversation, pretty nerdy and wonky stuff, but I think for those of us who really like the economy and the nuts and bolts of how this all works, this is a really fun episode.

James:
Oh, I love having Ben on. I start geeking out and we go down rabbit holes, they’re all fun to go down.

Dave:
Oh yeah, absolutely. When the cameras turned off, we were trying to convince Ben to let us come out to DC and hang out with him in person, so maybe we’ll do that next time.

James:
Oh, I’m a hundred percent in.

Dave:
All right, well thanks a lot James, have fun at the game.

James:
Yeah, go Hawks.

Dave:
I don’t really have any dog in this fight, but I’ll root for the Hawks for you, so hopefully you don’t have to… I guess, can I say that on the air?

James:
Yeah, I got a big bet on the line right now.

Dave:
Do you want to tell everyone what your bet is on this Seahawks game?

James:
Yeah, I think my mouth got me into trouble because we’re playing the 49ers, they have a better talented team. And I made a bet with one of my good buddies who’s also a 49er fan that the loser has to wear the other team’s logo Speedo to the pool for a whole day. So I’m really hoping it’s not me.

Dave:
Yeah. Well I’ll root for the Seahawks for your sake, but that is a pretty funny bet, and hopefully you didn’t just tell too many people, this is the tail end of the episode, so maybe no one’s listening anymore.

James:
Yeah, everyone should be rooting that the Seahawks win, no one wants to see me in a Speedo.

Dave:
All right. Well thanks a lot man, this was a lot of fun. Thank you all for listening, this is our last episode of the year, so happy New Year to everyone, we really appreciate you helping us and supporting us through our first year for On The Market, we’ll see you in 2023.
On The Market is Created by me, Dave Meyer and Kaylin Bennett. Produced by Kaylin Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jinda, and a big thanks to the entire BiggerPockets team.
The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.

 

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



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Homebuilder sentiment falls again, but bottom may be near

Homebuilder sentiment falls again, but bottom may be near


A worker walks on the roof of a new home under construction in Carlsbad, California.

Mike Blake | Reuters

Homebuilders were less confident about their business in December, but they are starting to see potential green shoots.

Builder sentiment in the single-family housing market dropped 2 points to 31 in December on the National Association of Home Builders/Wells Fargo Housing Market Index. Anything below 50 is considered negative.

This is the 12th straight month of declines and the lowest reading since mid-2012, with the exception of a very brief drop at the start of the Covid pandemic. The index stood at 84 in December of last year.

“The silver lining in this HMI report is that it is the smallest drop in the index in the past six months, indicating that we are possibly nearing the bottom of the cycle for builder sentiment,” said the NAHB’s chief economist, Robert Dietz. “Mortgage rates are down from above 7% in recent weeks to about 6.3% today, and for the first time since April, builders registered an increase in future sales expectations.”

Mortgage applications rose last week on lower rates

Of the index’s three components, current sales conditions fell 3 points to 36, buyer traffic was unchanged at 20, but sales expectations in the next six months increased 4 points to 35.

Regionally, sentiment was strongest in the Northeast and weakest in the West, where prices are highest.

The NAHB continues to blame high mortgage rates, which despite the recent drop are still about twice what they were a year ago. That has caused affordability to plummet.

“In this high inflation, high mortgage rate environment, builders are struggling to keep housing affordable for home buyers,” said NAHB Chairman Jerry Konter, a builder and developer from Savannah, Georgia. “Our latest survey shows 62% of builders are using incentives to bolster sales, including providing mortgage rate buy-downs, paying points for buyers and offering price reductions.”

But Konter noted that with construction costs up more than 30% since the beginning of this year, builders are still having a hard time cutting prices. Roughly 35% of builders reduced homes prices in December, down from 36% in November. The average price reduction was 8%, up from 5% to 6% earlier in the year.

“NAHB is expecting weaker housing conditions to persist in 2023, and we forecast a recovery coming in 2024, given the existing nationwide housing deficit of 1.5 million units and future, lower mortgage rates anticipated with the Fed easing monetary policy in 2024,” said Dietz.



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1031 Exchange Deep Dive: Mistakes You MUST Avoid

1031 Exchange Deep Dive: Mistakes You MUST Avoid


The 1031 exchange is a strategy that helps investors build more passive income, with fewer properties, all while avoiding the tax man. While many real estate investors know about this strategy, only a few of them know it well enough to pull it off. The rules are simple; sell a property, buy another property with the proceeds, and pay no capital gains tax. But, this is far easier said than done, and it’s much easier to make mistakes than most people think. Even our real estate hero, David Greene, had a 1031 exchange go awry.

To clear up the misconceptions, highlight the common mistakes, and guide us to tax-advantaged freedom, we’ve brought on 1031 exchange expert, Ryan Finch, to the show to share everything he knows about this misunderstood, often misused strategy. Ryan is a real estate investor at heart, house hacking as a sophomore in college to live for free. After working at multiple commercial real estate and development companies, he got the itch to start investing heavier himself and help others propel their wealth.

Now, Ryan works to help real estate investors and everyday homeowners make the most out of their equity. Ryan has unlocked the tools that have allowed those with home equity to build passive income streams, buy bigger, better properties, and reduce much of their landlord burden, all in a single transaction. If you’ve been sitting on some post-2020 equity, this episode will teach you how to use it as fuel for your financial freedom fire, all while ditching the tax bill that comes with selling!

David:
This is the BiggerPockets Podcast show 707.

Ryan:
One of the most common phrases we get is, “Ah, I wish I talked to you three months ago. I wish I talked to you six months ago. I wish I would’ve sent my mom to you last year when she was in the middle of this.” So we really like to talk with people early so they’re aware of their options so that no one needs to be paying taxes unnecessarily.

David:
What’s going on, everyone? This is David Greene, your host of the BiggerPockets Real Estate Podcast here today with a very, very, very good episode for you. Today, I interview Ryan Fitch, who is a 1031 expert, runs a company that helps people with 1031s and does consulting to help people build wealth through real estate. And we get all into the 1031 exchange. In this episode, you’re going to hear things that you didn’t know existed. You’re going to hear about common faux pas that you can avoid. You’re going to hear about strategies that you probably didn’t know were open to you and how you can go from being an active investor into a passive investor. This is an amazing episode. I’m very happy to bring it to you today.
So I don’t want to take too long before we get to Ryan. But before I do, today’s quick tip is don’t delete all the knowledge you have as an investor. We often make decisions based on our emotions, and if you get in a bad emotional state, you don’t like your portfolio, you’re in pain from what’s going on, you just want to get rid of the whole thing, you can easily make bad choices.
In fact, buyers look for sellers that are in a position where they’re in pain and they just want out, and that’s how they get the best deals. Use the BiggerPockets community to help you. There’s people out there that can give you advice that you didn’t even know was a possibility. An example of that is a podcast that we have today. So if you’re ever in a situation where you’re in a problem with your portfolio, don’t just sell it. Don’t just despair. Don’t get too negative. Don’t forget everything that you’ve learned. Reach out to somebody from BiggerPockets. Let them know what’s going on and see what options you have available to you.
With that being said, let’s bring in Ryan. Ryan Finch, welcome to the BiggerPockets Real Estate Podcast. How are you today?

Ryan:
Very good. How are you, David?

David:
I am doing wonderful. Thank you for asking. All right. Let’s hear about your business, your life, your investing portfolio. Tell me who is Ryan Finch and how did he get involved in real estate?

Ryan:
Great. So my name is Ryan Finch, president and founder of Tangible Wealth Solutions. We’re a wealth management firm that specializes solely in investment real estate. I got really interested in real estate at a young age and actually bought my first home, my sophomore year of college. I read a book on invest in real estate, got really interested, went to my parents, asked for my second year room and board in cash up front, ran my own painting business and that was my down payment. So I found I could rent the bedrooms out and live for free and was able to get my parents to co-sign on the loan. It took several months to convince them, but that was my first foray into real estate and trying to get started in building my own portfolio.

David:
So what were those initial stages? Did you have thoughts in your head like, “I’m going to be a real estate investor, I’m going to work in real estate”? Was it sort of just, “Well, they’re into it, so I’m going to be into it”? At what point did you get passionate about being able to help people build wealth through real estate?

Ryan:
Sure. So going back before that, my mom was a paralegal in commercial real estate and I did not understand how she worked at a law firm without going to court and was just like, “How are you actually in law?” Not like the attorneys and paralegals I see on TV. So she brought home the plans for what at the time was Elitch Gardens, was a large amusement park that was in Northwest Denver. It was being moved down to these railroad tracks just outside of downtown Denver. So it was a massive redevelopment.
She brought home the plans and said, “Why work on this? This developer is going to build this?” And then I stopped her and said, “Well, who’s that guy? What do they call it?” So that’s a real estate developer and they redo these things. And so show me that. Another big project in downtown Denver and I just was like, “That is what I want to do. I want to look at land property and I want to change it to something better.” And it was just as downtown Denver, the urban core was starting to change.
They were starting to bring fun stuff to do downtown. ‘Cause up until that point everyone just… After they got off work, left downtown Denver. So I got to see that right at the very beginning. And then to see Elitch get built and know like I remember now it was just a piece of paper. So that was the initial spark that really got me going down the fascination with real estate.

David:
I’m glad to hear you say that. I just realized as we were talking, there’s quite a few people that have an answer similar to yours where they’ll say, “I love the idea of driving down a street and seeing dilapidated homes and making them nice. Or, I love the idea of seeing a boring interior and fixing it up and making it pop.” Sometimes they love to do it on a budget. And then there’s other people I’ll talk to and say, “I just love seeing how the math works out. Or I love chasing the deal. Once I get the property, it’s boring. I don’t want it anymore, but then I want the next deal.”
And I’ll bet you that there’s a limited number of avatars of why we’re motivated by real estate, why we like it that we never ask. I think we just always assume real estate is all the same thing. But that’s fascinating. I hear you saying that you like this idea of the creativity and the improvement. You’re pushing the ball forward, you’re taking something ugly, making it pretty. You’re taking something less valuable, making it more valuable. How did that drive manifest itself in the way that your career ended up going?

Ryan:
Yeah. I always professionally would take the next job that I could learn more. So I was not trying to climb the corporate ladder because in my head, my initial goal was, “I’m going to just build a real estate portfolio. I’m going to learn finance. I’m going to learn everything from these jobs I take, but eventually I’m going to go on my own and I’m just going to have my own real estate investments.” And then founded Tangible Wealth Solutions with that sole purpose back in 2016 to really advise people on how to invest in real estate, base it on their goals and really try to help them avoid a lot of the pitfalls I saw over my career in banking development, special assets, and then also try and promote those qualities and values that I saw the people that were really successful.

David:
And then once you were there, that’s where you actually started consulting with people and you took this passion for real estate, developing it, helping other people understand how to manage their assets, how to grow them. And it all sort of culminated in this 1031 approach where you were taking people that had some form of equity or money they’d built up in real estate and reinvesting it into an asset or a situation that worked better for their life. Is that a fair summary?

Ryan:
Yeah, absolutely. And the 1031 exchange is an incredible tool and we started helping clients with strategizing how to use the 1031 exchange to benefit. One of the biggest ones we started working with or type of client was clients selling in California, particularly the San Jose area where we could sell one home, 1031 exchange and buy three or four homes in Denver. We were able to increase their cash flow significantly and help them get closer to those goals.
So the 1031 exchange started with helping clients move from one property type to another property in a different location that got closer to their goals, especially the ones that were more cash flow oriented.

David:
Yeah, I love that. I wish more people thought along those terms. I think when someone says I want cash flow for instance, they often go to the areas where they get the properties that cash flow the most and just try to buy a lot of them and it’s very slow versus if you say I want cash flow, how do I get there? Well, it’s very difficult to increase cash flow. You’re held hostage by market conditions. You can’t make rents go up, but you can create equity by buying in the right areas, by improving properties, by buying them below market value. You have a lot more influence and control over creating equity.
And then once you have it, vehicles like this let you take this massive amount of equity like somebody in the South Bay and build and move it into a cash flow market and they get there in 10% of the time as it would be if someone was repeatedly buying in Denver. Are these the type of solutions that you’re often offering to your clients?

Ryan:
Yeah, absolutely. It’s doing that upfront analysis to see if selling the property. One, understanding the performance of your property. One of the biggest mistakes or parts that we see people missing is they look at their total amount of cash like, “Oh, I love this property. It pays me X amount a month.” And then we run the math and divide it by the equity and show their return on equity and be like, “Well, relative of the large amount of equity in your property, that’s actually a really low cash flow.”
So when we start talking about percentages, it’s much more adaptable to look at other markets than using whole dollar amounts. think people get stuck on that whole dollar amount. And they don’t realize sometimes, “Well, you could be getting this same cash flow in a CD or now that interest rates have gone up, you could get this in a high interest savings account.” And a lot of people aren’t doing the math to look at the percentage and they just look at that whole dollar amount not realizing they were in a market that properties have taken off in value and that’s actually a low cash flow relative to your equity.

David:
So in my world, we often refer to this as return on equity And investors, like you said, they notice, “Well, when I bought it was cash flowing a thousand a month and now it’s cash flowing 1,800. So I’m doing good. I’m up 80% from where I was.” But if you look at the actual equity in the portfolio, they’re often getting a 1% return, 2%. It’s very, very common for me to see in the last eight years that we’ve had just prices going up. Sub 3% return on equity, which no one would go buy a property at a 3% return on their money. They’re always going to want more.
But they’ll look at the stuff that they already have and they’ll never think twice about it. They’ll just accept it. It’s one of the first things that when someone comes to me for consultation, they say, “David, can you look at my portfolio? I want you to tell me what to do. You pull that open and it’s staring you in the face.” They’re vastly underperforming.
Money is so lazy. You would never let an employee that comes in and you get paid for eight hours but you work for 30 minutes. But that’s what your properties are doing. Is that similar to what you see in your space?

Ryan:
Yeah, it’s dead on. That’s exactly what we’re seeing when we’re running the math and trying to understand. Also, add that with someone wanting to pay down debt early and there’s the thought of getting a property free and clear, but not having that leverage work to you, especially if you’re in growth mode and you’re trying to really build wealth. We see that often as the case too where they’re the stigma with debt or they’ve got their own beliefs against debt. But when you do the math and you see the power of debt, when you use it as a tool, a lot of that time that return on equity with the power of debt is really, in my opinion, a math solution. And it’s a math problem that you’ve, you’ve got to figure out.

David:
Now, I understand that you have a funny motto that your company operates by when it comes to helping your clients find their next deal. Can you share what that is?

Ryan:
Sure. So we look at DSTs for clients, other 1031 properties, direct real estate, other real estate syndications. When we’re looking at these different deals, we like to say we kiss a lot of frogs. So we kiss a lot of frogs trying to find what makes sense for clients. And then sometimes we have to remind them when we’re making recommendations of we’re highlighting these three or four. To them, it can look easy like, “Oh, here’s three or four good strong option.” It’s like, “Well, we probably kiss 20 frogs to find those three or four deals that do make sense.”
And some people, because they don’t see the legwork going into it, they sometimes get a biased opinion of, “Oh, it must be easy to find four good deals.” It’s like, “Man, you got to really sort through to find those.”

David:
I can so relate to that. We’ll have buyers come to work with the David Green team. When I was an agent or my agents now, all pour through every house on the MLS and there’s 300 of them and I’ll narrow it down to the four that are the absolute best opportunities. I’ll show them those four and they’re like, “Yeah, but that’s only four. I want to see some more.” I’m like, “Oh, I didn’t let you see that there was 296 other ones that don’t work. So that’s definitely something in our position we need to make sure we communicate to people like the work that was done to get to the point where you’re showing them that opportunity. Because kissing frogs is not fun and it’s why a lot of people don’t actually go do the 1031 is, “I don’t want to have to analyze a bazillion properties, but having the right people can help.”

Ryan:
Yeah, absolutely.

David:
All right. Now we talk about this all the time, but let’s take a walk back in time. So tell me where does your background on 1031s come from?

Ryan:
So background, 1031 exchanges, always research it to know it for myself. And then we help clients doing 1031 exchanges. And then just through the process of doing exchanges, understanding the nuances, we really started then finding the other avenue. So within a 1031 exchange, there’s multiple options. There’s direct real estate. So selling one property, buying another property, they’re what are called DSTs, which stands for a Delaware statutory trust. And that’s where you can sell property and exchange and be a partial owner of institutional real estate and get rid of the management component. And then one of the lesser known is actually oil and gas mineral rights.
So just from helping people with their 1031 exchanges and establishing ourselves as an expert in the field, we’ve figured out these different options for clients and even the nuances between them to really help people come up with solutions based on their goals where clients would come in and they’d say, “I want exchange from this to this.” And then we’d listen to their goals and we’d say, “Well, did you know that this might work a little bit better. Or maybe we need to take this into account.”

David:
Now, can you explain or clarify why we even have this rule in the first place?

Ryan:
Sure. So the first legislative action in 1921 that really made the 1031 exchange legal or put some parameters around it to allow… It was done to really guide or drive people into reinvesting in more properties and investing capital, building capital. One of the bigger reasons people were doing this was for farmland is so they wanted farmers who owned small farms to grow into bigger farms. And instead of every time they went from one property to a larger property and growing and ding them with taxes, they felt that everyone in the investors would benefit better if that money was kept working for them.
So it started more with farmland and then years later there was a big lawsuit between a timber company and the IRS because when they first started out, you had to exchange on the same day and this timber company fought and said, “Well, nothing really states that it has to be the same day and can we have some more parameters because it’s almost impossible to exchange one property for the same property on another day?”
They ended up winning. And so from that point on, the IRS then went back and added these dates and deadlines and made it much more functional and put the exact parameters around the 1031 exchange. So it started out very loose, encouraging reinvestment in property and then there’s been several iterations since, but then they had to add the timing parameters. And those time parameters, at first they sound like, “Oh, 45 days, that’s plenty of time. 180 days to close plenty of time.” And then as you’re in that window, it’s like time speeds way up.
That 45 days goes by much, much faster than you would expect. And so that’s the history of the 1031 exchange. So even though they did give you this timing parameter, it’s not the same day. 45 days in my opinion is a lot shorter than a lot of people realize.

David:
Oh, a hundred percent. And then there’s also rules about what has to happen in the 45 days that I ran into that were not something that was explained to me and I ended up with less than 24 hours. I know a lot of people that have these issues that come up with 1031s. There’s a lot of nuance that goes into doing them.

Ryan:
From the government standpoint, the best reasons to have the 1031 exchange and the 1031 exchange has come up several times in the last several years about changing it. But the big argument is it really allows for more fluidity in the real estate market. It allows for more transactions to happen. It allows for the trade and improving because typically someone sells ability to someone else or sells a private to someone else and they’re going to come in and improve that building. And so not only is it help real estate and areas in real estate continually improve, it creates a lot of jobs as well.
You have the real estate brokers. You have the mortgage lenders, title insurance companies, then you have the construction and trades and there’s just so many people in the economy that benefit from the continued transacting of real estate that there’s a lot of economic drivers.
So even though they’re deferring these taxes, the benefits of deferring those taxes to the overall population, workforce, demographics, all that stuff benefits so much from the 1031 exchange. I’m also very biased because I work in the 1031 exchange, but I do see all these moving parts and people who are involved and professional partners that everyone is earning a living doing this, that it’s really a big benefit. And then when you look at it from the investor standpoint, one of Warren Buffett’s quotes is one of the most powerful things in the world is compound interest.
If I can do a 1031 exchange and I can go from one property and then I think this other one is better, I can keep all of my equity working for me. So say an easy 10%. Okay. Well, I have 100 grand. I go from one property to the other. Well, now I’m going to have my 100 grand still working for me in the other property. But if I had to pay 15, 20% capital gains, now I have 80% or 85% working for me. I had to get a much bigger return just to get back to a hundred.
Investing in real estate allows me to continue to invest but keep all of my equity growing at that higher rate. And so the fact that when you trade from one asset, one property to the other property that you’re able to keep all of that invested for you, take that over a 20, 30-year career and that difference than if you did a different type of trading and another type of asset that got dinged with taxes every trade, yeah, it’s a massive gap.

David:
It’s the velocity of money. It increases how… And that’s just something, I’ll take a brief break to explain to everyone how powerful real estate is with wealth building, not just for the people that own it, for everyone involved. I loved you pointed out how many people are involved in the transaction. Every time a property changes hands, there’s money that is exchanged, which means someone actually created wealth for themself and the government got a piece of it through all the different taxes.
It’s hard to get into now, but just when money changes hands frequently, the wealth of a nation increases rapidly. And not just the wealth of the people of the nation, but the government itself is also creating more. So if a dollar goes from me to you to seven other people, everybody made a dollar, everyone spends a dollar, everyone got the good that they exchanged for the dollar. When we all just hoard our money and no one spends it, everyone gets more poor.
This is one of the Keynesian economic factors why they support that type of an economic approach. And from that element, it’s true. If you get rid of the 1031, the thought would be, well, the government will collect more taxes because you can’t defer it. But all that happens is none of us would sell properties. We would all hold onto them a lot longer. And that’s why at BiggerPockets we are hammering this because it’s okay to sell something and reinvest the money, especially if you’re going bigger and better and you’re more experienced and you get to do good by helping all the people that are involved in that.
So from that perspective, let’s say that someone’s listening to this and they’re like, “Yeah, I got some equity in my portfolio. I bought it six years ago. I didn’t expect to have the run-up I did. But man, it’s amazing. I bought in Denver, Colorado at 400 and now it’s worth $600,000.” That’s life changing money for a lot of people, especially because it hasn’t been taxed yet. You have an opportunity to avoid the taxes. What are some things that they should be asking themselves? What kind of goals would you be digging into to figure out that they have? What are some options that they have? Tell me if they were coming to you to say, “What do I do with this property?” How would you handle that consultation?

Ryan:
Absolutely. So at first I would just talk to them, get to understand the property itself. What goals is this property satisfying and which ones is it falling short? Like, “I’d really like more cash flow or the cash flow is fine, but I’ve got a lot of equity I might want to unlock.” So really understanding what the property is doing for them. And then just in an ideal world, what would you rather this money doing? What could we be doing? I’d rather it growing at a more rate. I don’t need as much cash flow. I’d rather in maybe in urban core that’s really changing or I really want to try and hit some home runs. But really identifying what they’d rather the money do and then pick the strategy or the property type that’s going to work best for them and then decide, “Okay, I really believe that what you need exists and we could get there. We have a high confidence level and now let’s look at doing a 1031 exchange.”
I think sometimes people are so excited to maybe recognize the big gains they had and are like, “All right. I want to do a 1031 exchange.” And then they list it for sale or even go to sale and they’re under their 45 days and you’re like, “These properties that we’re looking at were not taking a step in the right direction or were not moving yourself forward or it’s a lateral move and why did we take that risk to move laterally?”
So really understanding what the property is doing for them today and in an ideal world, what they need it to do for them. And does it make sense to do that? If someone said, “Oh, I’m getting 10% cash flow but boy I’d rather have 40% cash flow.” Well, unlikely we’re going to be able to exchange and find you something for 40% cash flows.

David:
Yeah. Increasing the return on your equity, basically if you got a return on equity of two or 3%, that you can get a return on investment of eight or nine or 10% if you reinvest, that’s a very easy metric to tell. It makes sense to do it. But there’s other ones as well, right? You’ve got the opportunity where, “Okay, this property is appreciated. I fixed it up. I bought it for 400. It’s worth 650.” But the market is kind of stalled where you’ve got $250,000 in equity and there’s opportunity to sell it and buy a new fixer upper.”
And add another $200,000 to that property through forced appreciation and what I call buying equity, which is where you buy it under market value. Are there situations where you see that investors that are a little more active and they enjoy you fixing a property up, making it better, they’re not afraid of the elbow grease where they can grow their wealth that way too?

Ryan:
Yeah, absolutely. If they have the ability to create value themselves, then that makes it even more attractive to move forward for those types of properties. And then when you’re looking at the 1031 exchange, the other component that we like to run side by side is does it make sense to keep the property and borrow against it and use that for the next property?
We just want to make sure that, one, it fits their goals, they’re okay with that, but instead of a 1031 exchange, sometimes leveraging into the next property can make sense. And then other times the cash flows really tight on this property and maybe it’s not high enough on the next property. And cash flow is really what can protect you in a downturn. And then they can kind of be in a tight where you don’t want to take that risk.

David:
I like the opportunities where you can get a little bit of both. Maybe you’ve got a single family home in San Jose or some area that’s had a recent explosion, Seattle, but the projections aren’t going to be that it’s going to grow as much as maybe South Florida, Texas, one of these other opportunities. And you sell a single family home that you’ve already maxed out the value and you go buy a triplex in a growing area that has value opportunity also.
So you get some extra value or equity in the property. And because that area is growing, you start combining all of these factors that build wealth through real estate. Sometimes people think buying and holding is just the only thing to do and they buy a 90,000 place. I’m going to own it for 30 years and pay it off. And they stop thinking about, it’s not about owning a property, it’s about owning the energy that property contains. And if you go roll that energy into something more and grow it like the snowball, real estate starts working for you.
I’m only saying this because I assume in your position you frequently come across people with a locked fixed mindset that they just think, “This is my portfolio. This is what I have.” Maybe they’re emotionally attached to the property and you can see possibility that they might be missing.

Ryan:
Yes, absolutely. Or they want to go. I want to go from here to here. And you’re sometimes like, “Well, that is a path, but there might be another way to get there.” I think some people come in with one focus and we talk through it with them and we help go in another direction. So I do think it’s real important to listening to where they’re headed and then pointing out some other options that sometimes this direct path be open to that changing.

David:
Yes. So on that note, common sense is not always common practice. You might hear this, but you might agree with it in principle, but that doesn’t mean you’re going to take action to do something different. So what are the top things that Ryan Finch wishes that people asked or knew before trying to do a 1031?

Ryan:
Sure. So one misconception we constantly see as you only need to exchange your equity. And so people think, “I have a million dollar property, I have half a million debt. I just have to exchange my half a million and I’m good.” You need to exchange the equity and the debt. So your net sales price is the total amount you need to exchange. So I’d say that’s one of the most common misconceptions we have.

David:
Let me jump in real quick. So what you’re saying is if someone has 250,000 in equity, they think they can sell it and pay cash for a $250,000 property. Right?

Ryan:
Exactly. That’s exactly it. Yes. You need to replace the debt. You could replace the debt with more cash. So I just have to make sure that my total properties I bought in my exchange equal my net sales price of the relinquished property. So that’s one. The like-kind test, like-kind exchange. People hear that term and they think like-kind means industrial for industrial, single family rental for single family rental. It’s very broad. You can sell a single family rental and buy an office building.
An office building can buy investment farmland. You could sell farmland and buy an industrial complex. It’s very broad and in oil and gas, mineral rights qualify because that’s the real estate below the ground. So there are 1031 misconceptions they have in their head, “I’m going to sell this condo and I got to buy a condo.” So like-kind is very broad.

David:
Can I dive into that a little bit? Like-kind does sound like if I sell a duplex, I have to buy a duplex, right?

Ryan:
Yeah.

David:
How does the government define what like-kind means?

Ryan:
Great. So it is a real estate property held for investment purposes. So when you paint that brush or use that umbrella over the top of everything, that’s what it really needs to be. So just to help the client currently that was wanting to me to help her with a 1031 exchange, she bought a property 10 years ago. It’s appreciated significantly, put her parents in the home 10 years ago, but she’s never filed that in her tax return as a rental property. And so the advice from the CPAs, everyone we talked to was it’s really never been held as a true investment property.
And so it’s really going to be shown as a single family home… I’m sorry, a second home, so you can’t 1031 exchange that. So in that case, that like-kind exchange is what we were trying to help them with but weren’t able to because it’s not a property held for investment purposes. We were trying to show, well it was investment purposes, but because it was never on the tax return, or we didn’t deduct, there’s no way or story to back that up. But really any property held for investment purposes falls under a like-kind exchange.

David:
Now, can I sell a property and buy Bitcoin?

Ryan:
Not without paying taxes.

David:
Okay. Right. That’s not eligible for a 1031. I can’t go buy a piece of art. I can’t go buy a baseball card or some form of NFT. It has to be real estate, right?

Ryan:
Correct.

David:
That’s so good to know because there’s so many misconceptions in our space. You’d be amazed or maybe you wouldn’t be amazed maybe you know about it, but I was amazed how many human beings still think you have to put 20% down to buy a house.

Ryan:
Yes.

David:
Right? It’s amazing in the era of social media where I forget that there’s people that still think that, and I’ll say it and you’ll get this record scratch like what? So there’s so many things like this where listening to these podcasts or talking to somebody at your firm about what options you have explode with possibilities. I can’t tell you how many time people book a time to speak with me and then when I say you could do this, you hear this like, “You mean this entire time I could have done that?” And I’m like, “It popped out to me in 1.2 seconds.” That’s an obvious answer and they had no idea.

Ryan:
The one I point out is the three property rule for 1031 exchange. There’s actually three different rules that you can choose which one you want to use for naming replacement properties. So the most commonly known one is three replacement properties. Any value, you got to name them during that 45-day window. The nice thing is you don’t have to commit to the rule until the day you name.
So I may be having a strategy based on the three property rule, but on my 44th day it makes more sense to switch to one of the other two rules. I could do it on that day. So I’m not locked in at the beginning of my 45-day to using one.

David:
What are the other two rules?

Ryan:
Yeah. The second rule is the 200% rule. So I can name as many properties as I want as long as when I add them up. They’re not more than 200% of the net sales price of what I sold. And so a lot of times when we’re breaking people into smaller ones, the 200% rule is the one we tend to use.

David:
That was not explained to me when I did mine and it was mostly… Most of my portfolio was paid off. So I sold about $4 million worth of real estate and I only had a note of 500,000. Long story short, there was actually another note of 500,000 that escrow missed that I now have to just pay cash for because I bought more. That was a little frustrating. But for the purposes of this, I had to reinvest right around 3.5 million out of the 4 million I sold for. And they did not explain to me the 200% that never came up.
So what ended up happening is I submitted a list of a lot of real estate that I was during my 45-day period that I was then going to go pursue over 180 days. They said, “Oh no, you can only pick $8 million worth of it.” I’m like, I have to invest 3.5 Million. How could I only identify 8 million of real estate? I had about 24 hours to do it. So had I listened to a podcast like this ahead of time or known about these three rules, that would’ve helped me a ton. Even with someone who’s been investing as long as me and who teaches this stuff, it just never came up and no one explained to me that there was a limit on how much you can identify.

Ryan:
Exactly. Those are the two most common rules. The third rule, which I’d say is the least common, the least used, and not a lot of reasons or situations I would see it being used, but it’s called the 95% rule. And that’s where now I can name as many properties as I want for as much as I want, but now I have to buy 95% of what I named. So that is in my opinion, a pretty scary spot to put yourself in, especially with real estate is you lose a little bit of that ability or that the hammer to hit you if you walk away from that deal gets much bigger. And so I feel like that 95% rule is one where, “Man, I have to have a really good reason for using it.”
But the three property rule and the 200% rule, the two most common rules, but I’d say a lot of people that come to see us the first meeting have in their head the three property rule only and not realizing that we can do this 200% rule.

David:
Well, and sum up for me what the three property rule is.

Ryan:
So three property rule means I can name any three properties for any value so they can all add up to… If I sold a million dollar property, I could name three $1 million properties. I could name a $4 million property, a $2 million property. So the total amount that I named dollar amount doesn’t matter as long as I only named three properties.

David:
That would’ve been nice had that come up. I did not know.

Ryan:
Yeah.

David:
What ended up happening was I ended up putting more in contract than the 200% because I had too much money that I had to invest and I couldn’t make the numbers work, so now I had to close on 95% of them, which meant anything I put in contract I had to close on. Trying to negotiate with a seller no one in the back of your head if they say, “No, there’s nothing I can do,” is a terrible feeling to be in. It feels like you’re in a standoff and you got no bullets in your gun and you’re just like, “Ah, I hope this person doesn’t figure out it’s a terrible movie scene type of situation.” This would’ve been very good to know before I was in that point where I had literally one day to try to make all these decisions. It was terrible.

Ryan:
We typically recommend clients start… If they’re doing direct real estate, start putting properties under contract 30, 45 days before they’re closing. And the real estate market we had six months ago that that was very tough to do. You’re getting outbid and someone is like, “I got to wait. Your property hasn’t closed yet.” In this market now, it’s easier to do. It’s a little more acceptable. But if you could tie a property up before your 45-day, what you’re doing is basically just stretching that 45-day window, giving yourself more time.

David:
All right. Now, what about some of the tax benefits that you get when you invest in real estate and then you go do a 1031 exchange. So you gain from depreciation on a property and now you sell it. Do you get to start over a whole new clock and get new depreciation again?

Ryan:
Your basis will be the new basis that it’s been depreciated down to and then you’ll get to continue to depreciate that basis down. You don’t get any additional basis to depreciate.

David:
Which is good to know because people may be expecting, “Oh, I’m going to start all over again with a new $5 million property.” That’s not the case.

Ryan:
Yes. One caveat to that is you could 1031 into a property and if you do what’s called cost segregation analysis, which for a higher price property or for a multi-family property, what you can do with that is they can go in and look at the furnace, the cabinets, all the stuff that could be depreciated on a much shorter window and then depreciate that.
So in a way you could grab all that depreciation that was going to be depreciated over 29 and a half years and some of that could be done in the first several years. So you could move up your tax benefit. And then as long as you 1031 exchange, that depreciation doesn’t get recaptured, it continues to get deferred. The other misconception that people have is, “Oh, well, my depreciation recapture comes out. That’s fine because I’m in a low tax bracket.”
Depreciation recaptures that 25% regardless of your income tax bracket and that is oftentimes… We’re calculating what someone’s taxes are going to be or helping them with their CPA, that’s a part like, “Oh, I’m in the 10%, 12%, 15.” It’s like now it’s 25 regardless of your income. And that can really make a big difference in someone saying, “Yeah, it makes sense to continue to 1031 because the pain from taxes is just way too high.”

David:
Absolutely. Now what about if you buy a property through a 1031. You exchange one for another. You know that you have to reinvest all the equity, but what happens if you do a cash out refinance after the sale?

Ryan:
Sure. So after the sale would be okay. Doing a cash out refi before your sale can get some scrutiny. But once you’ve completed that 1031 exchange, pulling cash out will not affect your exchange.

David:
A lot of people don’t realize that either, that you can get equity out of the property, but it’s not through the sale. It has to be through the refinance. A lot of people’s minds are blown. So what I ended up doing with mine because I ended up in this terrible situation, is I bought some properties just pure cash and then after it was done, I refinanced those properties and now that cash that I could pull out was not taxed. I didn’t have to worry about waiting for the cash flow to build it up because I was investing, I think it was around $4 million.
A lot of them I bought with 80% down. Or sorry, 20% down, 80% loan. And then three, four, five of them I just paid cash for and then it was done. I refinanced and now I have that capital restocked back in my account where I have reserves. I have money I can put into the properties to fix them up. It was actually incredibly easy to do and I thought there’d be some rule that said, “You can’t do that because it was like a loophole.” But not at all. They don’t look at a refinance as a capital event where you owe taxes.

Ryan:
Yeah, because it is after the 1031 exchange, right? You’ve followed all the rules, you’ve checked all the boxes, and once you’ve done that and your exchange from one property to the next property is completed, that’s really all they’re looking at that you’ve completed all those stages and now you’re in a different part of the life cycle of that property, but it’s no longer having to be done within the rules of the 1031 exchange because it’s been completed.

David:
Now, the last line of questions I have for you have to do with common faux pas that you come across with helping people do this. What are some of the most common mistakes or misconceptions people have?

Ryan:
So one would be choosing the wrong 1031 exchange rule. The other would be letting the tax tail wag the dog where people are so focused on not paying taxes that they go into a subpar investment. And so we’ve seen that where they’re getting close to their 45 day and they’re like, “All right, I’ll do this property.” And they pick the property and you’re looking at it like, “Man…” Types of properties that we try to avoid is when I make someone else’s problems mine. Sometimes you’ll make their problems yours because there’s a value add component. But a lot of times people will… They’ll like the property so much, they’ll look past.
Maybe there’s some foundation issues. Maybe there’s some of these other issues. But all that person’s problems are going to become yours once you own their property.

David:
The tenant is a big one.

Ryan:
Yes.

David:
No one sells their rental property even if it’s not performing well. Most people don’t if everything is smooth.

Ryan:
Yes.

David:
You think about selling your property when you have headaches, you don’t want to deal with it. And it’s almost always, “Oh, I’m buying it with the tenant inside of it.” And you’re like, “I love that.| Thinking about the tax benefits and not the headache that you’re buying into is a big problem.

Ryan:
Yeah. So I think that’s a big one. One is a lot of people don’t realize they need the qualified intermediary. So we’ll have people set up and my closing, I’m like, “Who’s your qualified intermediary?” And they’re like, “The who?” And so having that qualified intermediary set up, we oftentimes recommend getting the qualified intermediary set up when your property to sell goes under contract. Why wait until two days before you’re closing. It doesn’t cost you anything usually to get it set up and have them ready. And they know that deals fall through all the time and they’ll work with you to get it set back up when you go back under contract. But getting that QI set up beforehand makes a lot of sense, so you’re not having to rush the last second or, “Oh, it’s deposited in my account.”
That’s okay. I’ll just send it to the QI. Well as soon as you deposit in your account, that’s the taxable event. So people not realizing they need the qualified intermediary set up beforehand is another problem.

David:
And it’s heartbreaking too. That’s one of those things where our people will message me and say, “Hey, I just sold my house and my CPA said I’m going to have this much in taxes. I want to do a 1031 exchange. I sold it five days ago, so I saw 40 days. What should I do?” And I’m like, “Oh, if you have that money, you can’t. You have constructive receipt. It needed to go to an escrow, a qualified intermediary.”

Ryan:
That’s exactly it. We see that with people. The other part is with the naming. I’ve had someone say, “I named mineral rights and so now you can help me.” And I’m like, “Wait, what did you…” Or I named DST? And they literally put DST on the 45-day naming. It has to be the actual mineral rights, the exhibit with all the wells, the legal description. So that actually… Another point. You can submit your 45-day naming deadline paperwork in on day 35 and have it as your placeholder. And then something changes six days later and you’ve got a better property. You want to place one. Name your paper again and say, “This is the updated one. Most current dated.” But it’s not a, “Once you’ve named it, you can’t change it,” until the 45-day.

David:
So coming back to long-term goals, what’s another step to think about as an end component to this whole process?

Ryan:
So when you’re thinking of your 1031 exchanges and you’re thinking of buying real estate, building a real estate portfolio, one component of that is the mental side of why. What do I want this money to do? And so sometimes we see people get so focused in a big balance sheet and then, “Well, how do you want that balance sheet to help you in your life?” So that’s where our planning comes in where it’s not just about building the wealth, but how are we going to use this wealth? How is this going to benefit you, benefit the people around you?
And then think about what type of real estate and at what stage of your life do you want to own that real estate? So a lot of our clients who’ve put in the work, they bought a rental, bought another rental, bought an apartment building, and have built significant real estate portfolios. They’re still very active in managing or managing the property manager.
And so there’s a certain time where they may want to take their foot off the gas on the growth and just start getting cash flow and not be so involved. A lot of times that will be where we see the DSTs, the Delaware statutory trust and the oil and gas mineral rights as a great 1031 component because it can allow them to be a more passive investor. What you are giving up is that ability to improve the real estate drive value, doing these things that are really growth-minded where you’re active in it, but if you’ve really hit your goals of equity and the cashflow is what you need now to live the way you want, those can be really good options.
And then when you’re thinking of passing your real estate to the next generation or you’re helping your parents understand how best to pass to you, really thinking through the assets that are going to be inherited or transferred and how that person receiving it, if they’re all about owning rental properties and a multi-family property, industrial property that can work great.
Person passes away. There’s a step-up in basis. You inherit it. You can go and grow those assets. And then these more passive tools can be great for someone who their heirs are all over the country and maybe the one brother wants to keep it and the other brother wants to sell it, but the brother that wants to keep it can’t afford to buy the other one out. And so inheriting real estate can be really challenging. And so there are steps you can take ahead of time and other 1031 options that people may not know about to position that portfolio for a wealth transfer.

David:
Yeah, it’s good to know that you don’t have to stay locked into owning real estate. You don’t want to own anymore or the headaches that come from it. There’s actually options to avoid taxes and get out of active ownership or the multitude of properties that you might have and you want to decrease that. Or like you said, sometimes inheriting real estate is a form of a partnership. You’re forced into a partnership with someone that you didn’t really choose and you have different goals.

Ryan:
Yeah, absolutely. What I find fascinating too is every one of the clients that have built these large portfolios and are at that point in time where we’re helping them 1031 exchange and it’s about estate planning. I’ve never ever heard the word easy. And so building a portfolio of real estate is work and you’re creating value and you’ve got to be ready for those things that go wrong, don’t go your way. And it’s really having that long-term focus.
But just knowing that investing in real estate is not easy. Things go wrong, tenants, and there’s so many people that you have to rely on to move your property forward. It’s challenging and you’re really earning those returns. So we just encourage people when we’re helping them, especially when they’re early on buying their first couple properties or just getting started is reminding them that there’s going to be bumps along the road and we need to keep our eyes on the long-term goal of where we’re trying to get to.
But what I often see is somebody who’s bought a property, it’s worked great for six years, they’ve got that terrible tenant. They’ve got the insurance claim. They’ve got all this in a three-month period and they’re like, “I just want out.” They want the pain to stop so bad that they take these huge losses. And if they could just take a breather, take a step back and think, “Hey, we had six good years. This is a short period of time.”
But that knee jerk reaction to get out of your real estate is one part where we try to get in front of the client, work them through it, and then yeah, the common sense isn’t always common practice that of course people know to buy low and sell high, but how often when you’re in pain or you’re really uncomfortable, your mind just wants to end the pain and you just sell.

David:
Which is what we teach buyers to go look for in a motivated seller as you have motivation. So here now we’re teaching people who own real estate, “Don’t be the motivated seller. Go talk to the professional and find a better way out.”

Ryan:
Yeah. Don’t be forced to sell. I’d say that’s one of the number one ways you lose money in real estate is putting yourself in a position where you’re forced to sell that quality real estate that you own.

David:
All right. Last question for you. Sometimes CPAs repeat misconceptions or misinformation. Either they don’t know or they’re not pursuing excellence in their craft and they’re just ignorant of this. So what are some good resources for people to look some of this stuff up if they don’t want to just rely on a CPA?

Ryan:
Sure. So a lot of times getting second opinion from another CPA can be really good. Some CPAs don’t deal with 1031s very often or it’s been a while since they re-looked at it. So they may not have all the information they need to give the advice. But a lot of the large qualified intermediary companies will have really good resources on their websites. So three large ones that we work with, we work with quite a few, but three large ones. One would be IPX. Another one would be Asset Preservation Inc and First American Exchange.
Those three have very detailed websites that have a lot of information about 1031 exchanges. They break it down. That’s oftentimes where we’ll direct clients who have technical 1031 exchange questions and CPAs where they’re getting information on a website that is typically has been prepared by their in-house legal counselor, their in-house CPAs where it’s not somebody giving it their best shot and throwing it up on website.
So I’d say those are three areas that you can have a high level of confidence if you’re reading it there for 1031 exchange advice. And they’re also very… Those three and several other [inaudible 00:45:18] we work with are very open to answering questions. They do not mind. They would much rather. From the ones I’ve talked to, they would much rather you call and get the right information so that if you do choose to work with them, things go the way they’re supposed to.
Then you didn’t call, you didn’t get the information and now you’re yelling at them because something’s not working and they’re like, “Well, that’s not how these work.”

David:
All right. Well, thank you for that, Ryan. We just might have to have you back to dive deeper into some of these topics in the future, because this is fascinating. You’re a wealth of information and we don’t want to keep people here for a four-hour podcast. But before I let you out of here for today, if people want to reach out after hearing this, where’s the best place for them to find you?

Ryan:
So our website is www.tangiblewealthsolutions.com. That has a lot of information. There’s a contact us website or you call our office number, which is 720-4396540 and we are here to answer questions, help people with their planning and offer solutions based on what people are trying to do or definitely want to be out there helping people. One of the most common phrases we get is, “Ah, I wish I talked to you three months ago. I wish I talked to you six months ago. I wish I would’ve sent my mom to you last year when she was in the middle of this.” So we really like to talk with people early so they’re aware of their options so that no one needs to be paying taxes unnecessarily.

David:
That’s right. So everybody reach out to Ryan, reach out to his company. If you’ve got questions about this, if you got a portfolio you’re not happy with, this is the best case. Don’t just assume you got to figure it all out yourself. There’s people out there that’ll help you and I’m one of them. You can reach out to me and I can see what I can do in the same way, because if you’ve already done the hard work of building up a portfolio, it shouldn’t suck. You shouldn’t hate it. You shouldn’t be sitting here like I wish I wouldn’t have done this. There’s a way to reallocate these assets that you can start to love real estate against. So thank you, Ryan. I appreciate everything that you’ve shared with us today. Keep doing the good work out there and we’ll have you back again.

Ryan:
Perfect. Thank you. No, I really appreciate your time, David, and in allowing me to be on here.

David:
General disclosure, not an offer to buy nor a solicitation to sell securities. Information herein is provided for the information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss or some or all principle invested. Past performance is not indicative of future results. Speak to your finance and or tax professional prior to investing. Securities offered through Emerson Equity, LLC member, FINRA/SPIC. Only available in states where Emerson Equity, LLC is registered. Emerson Equity, LLC is not affiliated with any other entities identified in this communication.
1031 risk disclosure. There’s no guarantee that any strategy will be successful or achieve investment objectives. Potential for property value loss. All real estate in investments have potential to lose value during the life of the investment. Change in tax status.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or the tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. Potential for foreclosures. All finance real estate investments have potential for foreclosure. Illiquidity. ‘Cause 1031 exchanges are commonly offered through private placement offerings and are illiquid securities, there is no secondary market for these investments.
Reduction or elimination of monthly cash flow distributions. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Impact of fees and expenses. Cost associated with this transaction may impact investors’ returns and may outweigh tax benefits.

 

 

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



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Housing market in the throws of a winter freeze, says Realtor.com Sr. Economist George Ratiu

Housing market in the throws of a winter freeze, says Realtor.com Sr. Economist George Ratiu


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George Ratiu, Realtor.com senior economist, joins ‘Power Lunch’ to discuss the state of the housing market, how future rate hikes could impact home buying and how the housing market could look in two years.



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A Tale Of Two Halves

A Tale Of Two Halves


It’s finally over! The crazy, unpredictable, and just plain weird housing market of 2022 has ended. Though analysts like me will likely be studying the 2022 housing market for years to come, we can finally take a quick look back at what happened this year and infer what might be in store for the year to come.

2022 was a tale of two halves. January through May/June was one type of market, and July through December was a very different market. It’s not possible to determine the shift’s exact date, but it was within this timeframe.

The First Half

Through the first half of 2022, we saw a continuation of the wild appreciation that defined 2021. Every major variable that influences housing prices was putting upward pressure on the market. There was strong demographic demand fueled by millennials reaching their peak home-buying years. A decade of underbuilding contributed to a nationwide housing shortage. Inventory was almost non-existent. And, of course, mortgage rates were historically low. 

But then, things changed. In March of 2022, the Federal Reserve started raising the federal funds rate, pushing up bond yields and mortgage rates. The change of policy actually spiked demand as homebuyers and sellers rushed to transact before the full impact of higher mortgage rates were felt. This, combined with normal seasonality, allowed the party to continue and for prices to continue going up for a few extra months.

The Second Half

Eventually, the impact of skyrocketing mortgage rates took hold. Already facing ultra-high home prices, higher mortgage rates priced many homebuyers out of the market, and demand fell. When demand falls, inventory tends to rise, which is exactly what happened.

Screen Shot 2022 12 28 at 3.22.52 PM
Months of Supply (2016-2022) – Redfin

As inventory rose, sellers who were drunk on power over the last several years started to lose their leverage. Slowly, buyers started to have more options, and a bit of balance returned to the market, pushing down prices.

Screen Shot 2022 12 28 at 3.23.02 PM
Median Sales Price (2016-2022) – Redfin

Some of the decline since June is seasonal, but as of December 2022, prices are down almost 10% off their May peak, and a typical seasonal decline is 5%-7%. The descent from the summer peak was deeper in 2022. 

It’s worth noting that although prices are declining, they are not in free fall. Prices remain up year-over-year, and inventory has started to moderate. Mortgage rates have come down from October to December, and there are signs that the drop-off is becoming less steep. At this point, we remain in a correction, but not a crash. 

What Will Happen In 2023?

Will we see a continuation of the downward trend we’re in now? Will things get worse? Or could the market reverse? 

To me, it will again be a tale of two halves. I believe in the first half of 2023, we’ll see a continuation of the market we’re in now: sellers don’t want to sell, and buyers don’t want to buy. Of course, deals are still underway, but I expect sales volume to remain well below what we’ve seen for the last 7-10 years. Even though inflation is moderating, there remains too much uncertainty in the economy for the market to stabilize fully.

Hopefully, during the first half of 2023, we will see inflation come down and get more clarity about what is happening with the global economy. But what really matters for housing volume and home prices is about one thing: affordability. If housing stays as unaffordable as it is now, sales volume and appreciation will stay low. If affordability recovers, I expect the housing market to stabilize and perhaps even see a modest recovery in the second half of 2023. 

It sounds overly simplistic, but housing is just too unaffordable in current market conditions. Some estimates say that housing is the least affordable it’s been in over 40 years. Until this changes, the housing correction is here to stay. The housing shortage and demographic demand haven’t gone anywhere. As soon as affordability improves, I think housing market activity will resume.

Will Affordability Improve? 

Affordability is made up of three factors: 

  • Real wages
  • Home prices
  • Mortgage rates

Affordability can improve if wages go up or home prices and/or mortgage rates decline. Let’s take a quick look at if any of these things can happen. 

Real wages

According to the Bureau of Labor Statistics, real (inflation-adjusted) wages are down about 2% year-over-year but have ticked up about 0.5% since September. Nominal (not inflation-adjusted wages) is actually up a lot, but inflation is too high and wipes out all of those gains.

Real EarningsNovember 2021September 2022October 2022November 2022
Real average hourly earnings$11.21$10.95$10.95$11.00
Real average weekly earnings$390.20$377.71$377.80$378.42

Although it’s a positive sign that real wages have ticked up a bit, it’s very modest. It is possible that, as inflation moderates, real wages will go up—but I find it unlikely that that will happen in a meaningful way. To me, concerns about a slowing economy will slow the pace of wage growth alongside inflation. Therefore, no real progress on real wages will be made. 

Housing prices

One area where affordability is likely to improve is home prices. Residential real estate prices will likely see year-over-year declines nationally, making homes more affordable. For affordability to really improve, we’d probably have to see prices drop more than 10%, and it’s very unclear if that will happen. If prices drop at all, and by how much, it will depend very much on mortgage rates.

Mortgage rates

Mortgage rates can be confusing, especially recently. The Fed continues to raise the federal funds rate and has signaled they intend to keep doing so into 2023. Yet, mortgage rates are falling. What’s going on here? 

Mortgage rates are not directly tied to the federal funds rate. Instead, it is very closely tied to the yield on 10-year treasuries. So, in a way, mortgage rates are more influenced by bond investors than by the Fed (although bond investors are highly influenced by the Fed. It’s confusing, I know).

Over the last several weeks, bond yields have fallen for two reasons. First, inflation is moderating faster than expected, which tends to cause a rally in bonds, sending bond yields down. 

Secondly, there are fears of a global recession. These fears tend to prompt global investors to seek the safety of U.S. Treasury bonds, which pushes bond prices up and bond yields down. When bond yields fall, mortgage rates also tend to fall, which is exactly what we’re seeing. So, mortgage rates may fall next year and end the year somewhere between 5.5% and 6.5%, down from the most recent peak of 7.23% in October 2022. 

Conclusion

If my premise that the 2023 housing market hinges on affordability is correct, then there are two plausible outcomes for the second half of 2023. 

First, mortgage rates fall, along with modest price declines (less than 10%), combining to increase affordability during the second half of 2023. This would likely cause a bottoming of the housing market in Q1 2024, and we’d start to see growth in the market again come early 2024. 

The other option is affordability doesn’t improve in 2023, probably due to persistently high inflation and mortgage rates. If that happens, the second half of 2023 will look like the first half of 2023, and we’re likely in for a longer correction. In this scenario, we will probably see housing prices drop 10-20% over the next two years, and we won’t see a bottoming of the market until late 2024/early 2025. 

It’s tough to know what will happen, given the amount of economic uncertainty. As of this writing, I think the first scenario is more likely given the recent trends in inflation and bond yields. But both options are reasonably likely at this point. Unfortunately, the next twelve months are cloudy at best. 

What do you think will happen in 2023? Let me know in the comments below. 

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



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Inside the largest home for sale in Malibu:  million

Inside the largest home for sale in Malibu: $58 million


This $58,808,000 mansion overlooking the Pacific Ocean is one of the largest homes for sale in Malibu. At 16,600 sq ft the single-structure residence is the grandest of its kind and a whopping 4,100 sq ft bigger than the next largest single-family home on the market.

The Bali-inspired residence at 11870 Ellice St is perched above the Pacific Coast Highway in Malibu is on the market for $58,808,000.  The modern glass-and-concrete architecture, called the Kaizen House, is built around an open-air courtyard with lush palms and a koi-filled pond at its center. CNBC’s Ray Parisi tours the six-bedroom-ten-bath mansion with co-listing agent Branden Williams president and co-founder of the Beverly Hills Estates.



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From K in Debt to 4 Properties and How to Snag a Low Mortgage Rate in 2023

From $40K in Debt to 4 Properties and How to Snag a Low Mortgage Rate in 2023


Low mortgage rates, sneaky homebuying strategies, and getting into (and out of) debt, Lindsey Iskierka‘s story has it all. As the lead real estate agent on the SoCal David Greene team, Lindsey is in the thick of real estate day in and day out. But she’s not just helping others buy and sell homes, she also boasts a respectable rental property portfolio, with four units sprawled out across the states in three completely different markets. And even though Lindsey is in the real estate game now, it wasn’t always this way.

Back in 2015, Lindsey wasn’t making much after getting her grad degree. With her husband interested in real estate, they decided to go to a seminar, which later turned into a $40K debt they had to climb their way out of. Lindsey decided to get her real estate license to not only help pay off this debt but save enough to buy their first home—a house hack in Long Beach. It didn’t take long for the home to appreciate, leaving Lindsey and her husband with a hard choice—sell or refi the property.

We won’t spoil the story, but her choice allowed her to buy multiple other units across the country, which has now become a portfolio of short-term and medium-term rentals. Lindsey also gives some killer advice on how first-time homebuyers and investors can snag rock-bottom mortgage rates in 2023. We’re talking two percent lower than today’s rate! If you want to hear how you can lock in a rate below five percent, we suggest you stick around!

Ashley:
This is Real Estate Rookie, episode 247.

Lindsey:
And there’s a program that was recently released called the 2-1 buydown. It’s not an adjustable rate mortgage. Basically, it’s saying, “Hey, rates today are 6%,” which do 6% for easy math. For the first year that you own the property, you’re going to have 4% interest rate. The second year you own the property, you’re at a 5% interest rate. Year three, you go to 6%. There’s no pre-payment penalty and it’s not an adjustable rate where you’re subject to the market rate at that time. So in three years, if rates are 10%, 11%, 12%, we can’t even fathom that, right? But rates have been there.

Ashley:
My name is Ashley Kehr and I’m here with my co-host Tony Robinson.

Tony:
And welcome to the Real Estate Rookie Podcast, where every week, twice a week, we’ll bring you the inspiration, motivation, and stories you need to hear to kickstart your investing journey. And I want to start off today’s episode by shouting out Nick Halden 5621, who left us a five-star review on Apple Podcasts. Nick said, “I recently started listening to podcasts and I really like the way both of you conduct the show, the way you ask questions, the way you share your experiences, it really gives a lot of insight and knowledge to someone like me who is planning to buy his first investment property. Keep up the good work.” Nick Halden, we appreciate you, brother.
And if you’re listening to the show and you have not yet left us an honest rating and review, please do on Apple, Spotify, whatever platform news you’re listening to. The more reviews we get, the more folks we can help. And helping folks is what we do around Isn’t that right, Ashley?

Ashley:
Yes, it is. And speaking of all of our wonderful listeners, especially the ones that leave us five-star reviews, we are going to be in Denver on February 23rd, with almost all of the podcast host from every bigger pockets podcasts, and we’re going to be having a meetup in Denver. So make sure you guys go to bigger pockets.com/events to check out what we have in store for you in Denver. And if you guys want us to come to your city, send a DM to the Bigger Pockets Instagram account, or to myself or Tony at Wealth Firm Rentals or at TonyJRobinson and let us know where you guys want us to come.

Tony:
Well today we’ve got an amazing episode. We have someone who’s somewhat connected to the Bigger Pockets ecosystem. We got Lindsey Iskierka and she works with David Greene. Some of you guys may know that name from the other Bigger Pockets Real Estate podcast. But Lindsey comes on, and she’s just a wealth of knowledge, both as an investor and as an agent. And we talk about both sides of that equation as we go through the episode.

Ashley:
Some of my favorite lessons and takeaway from this episode are talking about different markets, 1031 exchanges, and then also the current market, which we had this drastic change from high housing pricing, low interest rates, and now it has shifted to high interest rates and lower prices. And Lindsey, I think explains why this actually can be an advantage to you as an investor and just a buyer in this market today.
Lindsey, welcome to the show. Thank you so much for joining us. Can you start off telling us a little bit about yourself and how you got started in real estate?

Lindsey:
Yeah, happy to. First off, thank you for having me. It’s a pleasure to finally talk to you guys and connect here. So my name is Lindsey Iskierka and I’ve been in real estate since 2015, got my real estate license, bought my first investment property in 2016 and since about May 2021, I have served as David’s partner and lead real estate agent for the Southern California real estate sales team. So, help investors buy, sell, invest, house hack, short-term rentals, mid-term rentals, long-term rentals, we do it all. And real estate’s my life and I love what I do.

Ashley:
And that is the David, David Greene that you are talking about.

Lindsey:
Absolutely right. For clarification

Ashley:
You probably don’t need to say his last name, but just to clarify. So Lindsey, when you got your license, this was before you actually started investing then,. That came first?

Lindsey:
Fully after I knew I wanted to invest in real estate, but we just didn’t get started quite yet. But I have an interesting story as to how I even got into it and I’ll probably go into that, but-

Ashley:
Let’s hear that right now. I would love to hear it.

Lindsey:
So I don’t recommend my start to real estate to anybody, but it is my story and here we go. So after grad school, I met my now husband and he had an interest in real estate investing. Real estate was not on my radar. No one in my family invest in real estate, owns properties. I have one memory of my parents buying a house when I was seven and they still live in that house today. Real estate just really wasn’t even on my radar or a wealth building strategy I had heard of. After grad school, I was making 14 bucks an hour, thinking there’s got to be a better way here. And I met my husband. And at the time, he had an interest in real estate investing but hadn’t gotten storage yet. [inaudible 00:05:02] of course. And then we went to one of those free seminars that’s supposed to teach you everything you need to know about real estate investing.
One thing led to another. Next thing we know, we were $40,000 in debt. We had bought one of those guru programs. And while I’m grateful for that experience and what it made me do, it was, they promise you the world, they promise you they’re going to teach you everything you need to know. And in reality, it wasn’t. We were just so far back in terms of our goal. So we had to get real and paid this debt off. And a way that we decided to do that, moved in with my grandmother. We rented a room from her for a year and a half. And so we got married during that time. So newlyweds going back to grandma’s house, you can imagine.
But we had a goal in mind, and I got my real estate license at that time. So, then within a year we were able to pay off that $40,000 in debt and save up reserves to buy our first house hack. And so, while I don’t recommend those programs to anyone, it served its purpose for our story and I’m actually really grateful for that experience. I don’t know if I would be where I am today if we didn’t endure that. So that’s how I got started. And so getting my license was a way to help pay off debt. But I had grinded, I worked really, really hard, built my business over five years before meeting David Greene. And so that was how we got started.

Tony:
So Lindsey, first thank you for sharing the hard part of your journey in terms of getting started. And a similar thing in my journey as well where my partner and I, we spent not quite $40,000, we spent $20,000 on a program like that. The program was more so focused on teaching you how to become an apartment syndicator, do commercial real estate. And after we, joined, we did zero commercial deals. And I always think, man, was it a waste of $20,000? But through that program, I became really good friends with the guy who introduced me to short term rentals. And it’s like, had I not done that program, would I have found this asset class? Would our portfolio people we’re at today? Would I even be on this podcast?
Even though it’s always super crappy to have to go through those situations, it’s like if you can find that silver lining and use that as your motivation to keep going forth, and there’s maybe still some value in that. So I just want to know, how did you not get discouraged? You invested all this money, you had these big dreams of everything that was going to happen, didn’t turn out the way you wanted to, you moved back in with your grandparents, it’s almost like a worst case scenario. So how did you, even with all that happened, stay motivated to continue moving forward and really still take your start in real estate investing?

Lindsey:
Really good question. I think we had a powerful why. We were already planning our feature together and I thought, “Okay, what I’m exposed to, it makes sense.” I know this can work and this wasn’t it, but here’s what we’re going to do. And when we lived in southern California, so it’s very difficult, very expensive market to start investing. And we thought, “Okay, if we’re going to own a home, we have to house hack.” There’s really no other way to get started. And we just had a strong enough conviction that he and I can do it together. This program wasn’t what we hoped it would be, but like you said, I did end up having some relationships with people that I don’t know if I would have if I didn’t go through that program. And opportunities came from there and it gave me hope that there’s a better way and I knew this could work and I just hadn’t found it yet.
So put my head down, I realized, and I fell in love with real estate. That was another thing too. I loved it. And that level only grew stronger as I saw the potential for it. So I knew the path that we were going on before was not the right path, and we hit a speed bump here, but what can I learn from this? I would argue that also is what makes a successful investor. Because you’re going to make bad choices, you’re going to make bad decisions or you’re going to have to pivot and say, That didn’t work. Now what.” But you can always find the lesson and the blessing in everything. So we are blessed that we also were put in a position as a newer couple to have conversations about money. We had to have real talks about how we’re going to pay off this debt, what are we going to do? How are we going to come together and do it?
So talks about money weren’t taboo to us, it wasn’t a fighting point, it wasn’t a difficult point for us. And I’m grateful for that very early on. So, several combinations and just his support. He was so supportive of me and he believed in me that I could do this. Because he was in law enforcement, and so he was really the steady, W2, not many flexible hours. I had more flexible hours and I was set off to go into this real estate thing. And he had such belief in me that I thought, I have no other choice. I have to make this work. So how am I going to make this work? And ultimately, we knew house hacking would be the best way to get started. And in paying off that debt, I built a pretty good real estate business for my first year being an agent. So it just all started to come together with consistent action.

Tony:
I love your story so far, Lindsey, and I can just see the motivation coming off your face, but I want to, before we go too far, I just want to, if you can let the listeners know what does your portfolio look like today? How many units do you have? Where are those units spread out? Because a lot of real estate agents, even though they might do a ton of transactions a year as a real estate agent, they might own zero real estate themselves.

Lindsey:
Yes. But they’re investor friendly, right?

Tony:
But they’re investor friendly. So what does your portfolio look like today?

Lindsey:
Sure. So we have sold a few of our houses this year. We’re in the middle of our second 1031 exchange right now. But as it stands today, we own four properties. Two of those are short-term rentals. One is a long-term rental that we’re actually going to start renovating and turning it into a midterm rental for better cash flow. And then we have a primary. So that’s where it is right now. But we’re actively buying, looking for more deals and really wanted to, probably more than double that next year.

Ashley:
Lindsey, can you explain real quick what a 1031 exchange is?

Lindsey:
Absolutely. So 1031 exchange, it’s a tax deferring strategy for real estate investors. So anytime you sell a property, it’s an investment property, meaning non-owner occupied, you don’t live in it, you’re a subject to capital gains tax. So what investors do, and it’s a great way to scale a portfolio, is you take the income from selling that property, you immediately roll all those proceeds into the purchase of another property. And so you avoid the capital gains tax.
And it’s a great way to scale. It’s a great way to buy a bigger asset or get into a new asset class and it’s used by investors to scale a portfolio more quicker and you avoid taxes. So, it’s our second one that we’re doing. First one worked out well too. That was from our house hack that we did. And if you want to do a 1031 exchange or thinking about doing it, you need to make sure you have a QI, qualified intermediary, to help you with that transaction. Really important piece of the puzzle. And then an agent that knows what that is and knows what is needed when you get into escrow to make sure that it actually goes through. And you can save tens of thousands of dollars in taxes if you do this correctly.

Ashley:
Lindsey, I want to talk about and start getting into some of your deals. So what markets are you currently investing in for those properties that you have?

Lindsey:
So personally, our first house hack was in Long Beach, California. So coastal town in southern LA County. Right on the border of LA Orange and County right there. That’s where I started. And then we thought it was a good idea to 1031 exchange that property into three houses in the Midwest. And those cities that we invested in were Kansas City, Missouri, Birmingham, Alabama. And so we were in those two markets for a little bit. We also now own a short-term rental in Kalispell, Montana. It’s right near Glacier National Park. I personally love national parks for short term rentals. I just think it’s always going to be a market or a key component of the market that I want to choose for my own investments. So we have that, but we still own one property in Kansas City, Missouri. And then we’ve sold the other ones. And I own again in Joshua Tree, is my other short-term rental.

Ashley:
With the 1031 exchange, so when you sold that one property, you bought those three with the funds from that first property. So what made you decide to, how did you even begin to find those three other markets? Can you walk us through that process?

Lindsey:
I can, definitely. So it was an interesting time in our life. So I would’ve house hacked longer. And that’s something that maybe we’ll get into in a little bit as well. Our family was growing, we were expecting [inaudible 00:13:45] and I thought we are out of space where we currently are at. And so we moved out of our first house hack, rented it out. It was cash flowing, but it needed some major repairs. We didn’t have the capital at the time to replace both roofs and redo the plumbing. It needed a lot of work. But we had equity and we thought, okay, we want to scale. How can we make this property work for us? A cash-out refinance did not work. We did a VA zero-down loan on it, so just a [inaudible 00:14:13] and cash out refinance. Ultimately, just really didn’t leave us with enough equity to really do much with. The only option was to sell it.
And I wanted to keep that property, but just at the time we had to make a decision. Made sense to sell it. When you do a 1031 exchange, you have a very quick timeline in terms of when you have to identify the properties that you’re going to buy. At the time that we were doing this, I had a newborn and an 18-month-old and did not really have a ton of energy or knowledge about other markets where I could manage renovations, I could do all of the different facets of buying several properties. So we turned to turnkey. We’ve been Bigger Pockets listeners for many years already. I’ve been listening to Bigger Pockets since 2015. So we had heard about turnkey investments, the pros and cons. At that time, turnkey properties made the most sense for us in that life stage. We were able to see the properties on a spreadsheet and say, okay, where’s the best ROI? What are the best neighborhoods that are available that we can identify within that 45-day period to meet the goal that we had to have for the 1031 exchange to go through?
So not to get too complicated with 1031 exchanges, you have to meet a certain property value limit and you also have to breach your proper loan amount limit. So all the pieces of the puzzle made it so that we were looking at turnkey properties and what available inventory they had for us to meet those requirements. We chose Kansas City, Missouri because my husband’s sister actually was in medical school in Kansas City, Missouri. And she was able to tell us in those suburbs of Kansas City where the better areas were. She said, “Oh, you want to go over here, go over here, avoid this area.” Thought great. And then Birmingham, Alabama actually had some really great ROIs according to the spreadsheet we’re looking at it. It was right next to downtown Birmingham. That was the best performing property that we had. So it was on a whim. We knew we wanted Kansas City out of the choices that we had based on the boots on the ground knowledge that we had access to. But other than that, it was just, “This’ll work, this’ll work.” We have to choose the markets.

Tony:
Lindsey, I just want to circle back really quickly on that decision you made about refinancing versus selling the property. You said that doing a refinance, you wouldn’t be able to tap into all of the equity. Can you just elaborate on what you mean by that? Why can’t you access all of the equity in a cash-out refinance?

Lindsey:
So we were going to do a cash-out refinance, we could only pull out 70% of the LTV. At the time, we had about, or that’s loaned to value. So we had bought the property for 750 in 2016. By the time it hit 2018, early 2019, it was worth 950. So we had 200,000 inequity. And if we’re going to do a cash-out refinance after doing all the math, we were only left with $65,000, $70,000 that we could actually put towards a purchase of another property because we put zero down.
So when you have equity, you have to also think about how much did I put into the deal? And with this one, since we didn’t have any, it really ate away at that plus. So we were doing the math, it didn’t make sense for us to let this property go and we really couldn’t do much more to it. And we had some hard tenants that gave us the idea that, let’s just get rid of this one. It’s served as purpose, let’s move on. So if we were refinance, we had wonderful tenants, it might have been a different story, but still, the money that we had access to after the refinance, was not enough for us to feel like we could fix up the property to hold onto it long term and to scale.

Ashley:
I think that was a great explanation because I think we get a lot of questions like that and we see people post in the Real Estate Rookie Facebook group as to here are my two options, which one should I do? And I think you did, the thing that everybody should take away from this is, you ran the numbers on both, what’s going to, the outcome, if you go either path, what are you going to be left with?
So, if you are going, say you have this amount of capital available, are you going to put it all into one house? Are you going to spread it out over several houses? We’ll use those scenarios and run the numbers, and what’s it going to look like in a year? What’s it going to look like in five years? And that’s what you did with either refinancing or selling and you looked, what capital do you have left and what can you do with it? So I think that was a perfect example of how running the numbers and just doing that analysis on those scenarios instead of just like, eeny, meeny, miny, moe, catch tiger by the toe, I’m going to go refinance.

Lindsey:
We had to. Funny thing too is, this is something to note is that at that time we wondered if we were at the top of the market. We had $200,000 in equity as new investors. That was pretty attractive. And we thought, gosh, what if the values do go down? This is in 2018, early 2019, pre pandemic. We thought we were at the top of the market or there was chatter about that. So I had to take that into consideration. If we don’t sell it and I refinance, can we make these repairs on the property, have it still cash flow? Because we had a great interest rate, and rates were up at that point. So can we make this work? And ultimately, it just didn’t. And we thought, “Hey, we have to make a move here. Here are the options that we have.”
So we at least made a move. And I think that’s something I really want the rookies on here to pay attention to is, taking action, even though it’s not the absolute best action, it’s better than not taking any action at all. I think people are so afraid of making a mistake and that’s inevitable. You’re going to make some mistakes and that’s okay. But the important point is to take consistent action with the available information that you have at hand with your trusted team, your advisors, and move the needle forward, however that may look in that situation.

Ashley:
You hit it right on Lindsey, that, so focused on making the right decision. But sometimes either decision can work out for you. Don’t get so focused on maximizing the cash flow. That’s why there’s more deals to be done, especially your first deal. Don’t waste time actually taking action by getting into that analysis paralysis of what’s the best way to do this? I want to maximize and pinch every single penny, but just getting started, that’s going to give you the momentum to go and give more deals. And that’s going to end up giving you a better return starting now than waiting until you’ve finally decided this is the route you’re going to take.

Lindsey:
Now you can no longer afford that property.

Ashley:
Yeah, that’s a great point

Lindsey:
Because you waited to long.

Ashley:
And how you were talking about the market, how you were thinking maybe it’s the top of the market, we should sell it now too, is something if, you went and refinanced and you pulled out that equity and then all of a sudden values did drop, but something comes up where now you do have to exit the property and now it’s not worth what you had drawn out in equity too. So there’s always that risk and that’s something, you know guys did a great job of foreseeing if those things were to happen along with running the numbers too.

Lindsey:
Thank you for that.

Tony:
Lindsey, you also mentioned that part of the reason you sold was because of the, not issues, but maybe the tenants weren’t your ideal tenant. Were you self-managing this property or what did that relationship look like with those tenants?

Lindsey:
Ooh, really good question. So partly yes, we did a property management for the back house. So just to give you a quick layout, it was a front house, a little craftsman house in the front that we lived in. There was a duplex in the back, the duplex in the back had sets of tenants and we had property management for that. Part of it was because, like I said, my husband was in law enforcement, he wanted safety, he wanted people to not bother us if they had concerns, they want us to see us as the bad guys. We wanted to act like, “Hey, we’re tenants too. You go talk to the property manager and not think that we’re the ones raising rent.”

Tony:
They didn’t even know that you guys were the owners. No.

Lindsey:
Oh wow. The first set of tenants did, because they saw us moving.

Tony:
So they’re moving in, you’re like, man, those landlords, they kind of suck guys, watch out for them.

Lindsey:
I know. [inaudible 00:22:18].
We had to play it up and it worked. Because we were the same age group, roughly, and they believed it. And it wasn’t until we had a main waterline backup that one of my tenants saw me walking the property with a contractor and she’s like, ‘Wait, are you paying for all this?” I was like, “Okay, fine. We own the property.” They caught me at that waterline to take care of. So that part was property management. We cut that as property management.
When we moved out of the front house and we bought another primary residence, when we moved out of that front house, we decided to do section 8 and we used a VA program actually called the VA VASH program. And essentially, a section 8 for veterans. So we wanted to do good with our housing. We had this wonderful house in a great part of Long Beach and we thought, “Okay, we may not get maximum rent here, but how can we use this house for good?” So we put a military family in there where they were trying to go through school, they couldn’t really afford rent in the area. And so that made us feel good by putting military housing, providing housing for veterans, which is very close to us. My husband’s a veteran too, obviously we used the VA loan, so we wanted to do good with the house that we had. So we did that. But things just turned a little sideways with some of our tenants, and it’s okay, we learned lessons, but they were not that ideal.

Ashley:
I think this is the first time anybody’s ever talked about this program. Can you maybe explain it a little more?

Lindsey:
It’s a wonderful program. I’m so glad we found it. Basically it’s sponsored by the VA and they work right alongside HUD. And essentially, it works just like section 8. Your unit is valued by the zip code and number of bedrooms, just like section 8 is. And it’s given a market value for that area. And it goes up little by little every year. So you get the benefits of section 8, where you do have guaranteed income coming in, which is really nice. Is that during COVID, should any tenants not be able to pay their part of the rent, HUD stepped in and paid the full rent amount, which was nice. So we didn’t run into that issue, but it was just another perk of that program.
So you have guaranteed income and you get to choose the background that you’re comfortable with. We really wanted a family in there because we had two bedrooms. We brought our daughter home in that unit. We really wanted to help out a military family. So we did that. So you can choose if you want a single person, a family, if you want no history of substance abuse or evictions and things like that. So you can set your criteria as to what kind of tenant you would accept and then they get the application process. You have a rep from the VA that works with the family or the tenant works with you and it’s very, very similar to section 8, but it’s only for veterans. So it was a great program.

Tony:
What was it like for you as the landlord to get added into that VA VASH program? Was it a long process? Was it pretty quick and easy? What was the vetting process for you to get onboarded?

Lindsey:
Probably depends on your perception of easy and quick versus difficult. It wasn’t bad. It wasn’t bad. The property had to meet certain criteria for inspections, but we took great care of that property. We had renovated it during the time that we lived there. And it wasn’t that long. Maybe it took six to eight weeks I want to say, for our application and inspections to be done. So it did sit vacant for a little bit and that was okay, but it felt good to know that we were going to do, like I said, we really wanted to do good with the property that we had. Six to eight weeks I want to say, with inspections and everything. And then we got tenants in there pretty quickly after that. So it wasn’t very quick. It wasn’t super easy. There were a lot of trips back and forth to the HUD office. So if things like that stress you out, just be prepared for that. But in hindsight, it really wasn’t that bad.

Tony:
And the quality of tenants that you got, you said that maybe you wouldn’t do it again, if I heard you correctly? what were some of the lessons there?

Lindsey:
I would do it again, just these, I would do it again. I think part of it too, and this is a dynamic that house hackers have when they move out of a home that was an investment property, but also primary residence. You put your blood, sweat, tears into those properties. So when you go back and you see tenants not taking great care of the home, smoking in it, grease stains all over your kitchen, they were damaging our doors and our brand new windows. So it’s rough to watch someone not beat up your house a little bit, when you’re like, “I brought my daughter home in that house, can you not?” So that was just a more emotional thing. But they were complaining quite a bit. They were not supposed to be smoking in the house. They would blame everybody for certain problems and they called us certain names when things didn’t go their way. So I would do the program again. Just at that time, the tenants were stressing us

Ashley:
Lindsey, when you did that program, did they pre-screen these people for you? And then did you do any additional screening on top of that too?

Lindsey:
They did pre-screen the tenants to make sure it fit the criteria that we wanted and then they presented their application to us and we can approve it or deny it. If I recall, we weren’t able to meet them in person, but we could deny their application if we wanted to at that time. It may change since then, but at that time we were able to approve or deny them as tenants as they came through.

Tony:
Well, thank you for introducing us to VASH, Lindsey. I’ve never heard of that. Ashley had never heard of that. And part of the reason this show is so cool is because Ashley and I can learn new things and selfishly take them into our own business. But obviously so many folks in the Rookie audience are going to be benefit from hearing about this program as well.
I want to transition just a little bit because you are in a unique, I think, viewpoint or vantage point as opposed to most of our guests, because not only are you a real estate investor, but you also see a ton of volume as a real estate agent. And there’s been so much uncertainty this year around whether or not people should get started in real estate investing. If I’m someone that’s sitting on the sidelines that has zero deals, is now the right time to buy? There is a bunch of price competition earlier in the year and then as that slowed down you saw interest rates climb super, super fast. So from your perspective as both an investor and as an agent, what are your thoughts on whether or not right now is a good time for new investors to get started?

Lindsey:
Really good question. Of course, this is a common conversation that we’re having and it goes back to what’s more important to you. So we had people, like you said, there was prices getting bit up through the roof. It was so hard to get an offer accepted. People held off. Okay, once interest rates started going up, prices came down, competition ceased, but people are holding off because now interest rates are too high. The fact of the matter is, we’re never going to have the perfect storm of a market where interest rates are low or good, prices are stable, there’s less competition, you have negotiating power. Something has to give. So the wonderful thing about real estate investing is that it comes back down to the fundamentals. Does a deal work today? Yes or no? What’s great, an advantage about people who do want to get started or continue their portfolio in today’s market, they are forced to underwrite the deal better.
People could get away with buying not such great deals earlier this year and in 2020 because they were saved by low interest rates and by prices going up. They’re just grateful they got a deal, because it’s so hard to lock one in. Today, you really have to make sure that the underwriting is solid, that the monthly payment, that the cash flow, that whatever metric you’re tracking makes sense with today’s interest rates. If rates go down, fantastic, you’ll refinance. You won’t then be having to jump into the market when everyone else is now going to jump back into the market. Because then if rates drop, I ask clients to sell the time. If rates drop, what do you think is going to happen? Oh, maybe prices will go back up. Yeah, exactly. And then we’re going to be right back to you complaining that prices are too high, it’s too competitive and you want to wait till it cools off. It’s cooled off.
So you have to decide what makes more sense for you. And what I think is great is that if you lock in a property at today’s interest rates, it can only get better. Because if rates drop, you’ll refinance. If you bought when rates were 3%, two and a half percent, if you need to refinance right now for whatever reason, you probably can’t afford that mortgage payment. And you’re stuck with that. And maybe the property is lost value right now already. And now you can’t sell that in scale. So I think you’re actually more at a better advantage right now than people were eight months ago, nine months ago, because that market is gone. You’re back to the fundamentals of real estate in this market. So there’s me buying opportunities no matter what market we’re in. If you’re an investor, you’re investing, no matter what the market’s doing. You’re finding opportunities in that current climate and taking advantage of it.

Ashley:
I saw someone post that on Instagram a couple weeks ago, maybe a month ago. And probably was you if you posted, but it was a real estate agent. And it seriously hit me, like, oh my gosh, that is so true, is your, whatever you pay for a property, you’re stuck with owing that dollar amount.

Lindsey:
Yes.

Ashley:
You owe that. So if you’re paying $300,000, no matter what the interest rate is, you’re going to have to pay that at some point or sell the property and cover it. But that debt or that cash has to be provided to pay for that property. But if you get that interest rate, that can change, you can change that interest rate. So whether rates are dropped and you go and refinance, you find a private money lender or you do something, you do creative financing, things like that.
But it just really, it was like an eye-opening thing for me is, you’re paying a lot, you can pay a lot less now and then, especially if you’re holding the property, a couple years down the road or however long down the road when rates do drop is going and refinancing and you’re going to be a lot better off because you purchased that lower price. So I am so glad we touched on that because I think that is such a valuable tool lesson that everybody can learn from this is that, the market was hot, it’s cooling off and interest rates are high, but how long do you, and that’s the thing nobody can predict is, how long do you have to cover that high mortgage payment until rates do drop-

Lindsey:
And don’t buy if you can’t afford it right now. And we’re also getting the sellers to buy down the interest rate. We’re negotiating killer deals right now. I just negotiated 2-1 buydown, we got $50,000 in credits. So the buyer can take, I think they’re doing a 3, 2, 1 buy down. They’re getting a crazy good interest rate and this property, they easily would’ve paid over 150 grand more for it eight months ago.

Ashley:
Can you explain that? If somebody’s agent isn’t doing that for them, how would they, what’s that process look like?

Lindsey:
Well, first call us, I’m just kidding.
But honestly, so basically, it’s a lot more likely because sellers are very fearful right now that they just want their house sold. And so they’re willing to, you’ll see some marketing that says like seller willing to buy down interest rate, but if they don’t, then you can find a way for the buyer essentially to get their interest rate buy down paid for by the seller. So when you go to buy property, in any case, there’s always interest rates that you can lock in. There’s par pricing, meaning this will cost you zero extra points. You can use lender credits to have less closing costs out of pocket, but have a higher interest rate or it can buy down the interest rate and have a lower rate that’s going to cost you more money. Right now we’re able to get the seller to pay it down.
And there’s a program that was recently released called the 2-1 buydown. It’s not an adjustable rate mortgage. Basically it’s saying, hey, rates today are 6%, we’ll do 6% for easy math. For the first year that you own the property, you’re going to have 4% interest rate. The second year you own the property, you’re at a 5% interest rate. Year three, you go to 6%. There’s no prepayment penalty and it’s not an adjustable rate where you’re subject to the market rate at that time. So in three years, if rates are 10%, 11%, 12%, we can’t even fathom that. But rates have been there. Rates were at 18% at one point. But so it’s not an adjustable rate mortgage, but you are essentially having the seller pay the interest upfront for you to have a lower interest rate for the first two years that you own the property. Really powerful.
So you have to qualify for the loan at today’s interest rates. It’s not a way for the buyer to be able to buy more or qualify for it, which I think is a really important point to distinguish. It’s not like, “Oh, I can afford this at 4% interest rate if we get the 2-1 buydown.” No, you have to qualify for the loan at today’s interest rates. You have the benefit of having a lower mortgage payment because you have a lower interest rate for the first two years that you own the property. So it’s great for short term rental owners because this only works for primary home buyers and second home loans. So if you’re doing a second home loan for a short-term rental, you essentially can have two years of a lower interest rate, paid for by the seller, again. And you can withstand, maybe if we have a downturn or market slows a little bit, you got your listing up and running, you can probably improve your cash flow for the first couple of years you own the property by having this program.
So we’re getting this paid for by the seller and we’re getting a lower price than list price. A list price is no longer a starting bid. List price is a suggestion now. And we’re saying, okay, is there a number that you have to hit to make this deal work for you? Let’s offer that. Let’s not be offensive, but let’s see what they come back with. And now we have healthy negotiations going on again. I love this market because we have negotiations. Both buyer and seller have to compromise and give a little bit. No one’s really having the full advantage right now, which I think it means a healthy market.

Ashley:
Lindsey, how much does that buy down typically cost? Have you seen that it’s, I’m sure it probably varies from the lender, but is there a typical percentage of the purchase price or what does that cost actually look like?

Lindsey:
Typically, what we’re seeing, and I’m not a lender. Talk to Dave’s lending team. The one brokerage, they’re fantastic at this. But typically we’re seeing anywhere from two and a half to 3% of the purchase price be enough for the 2-1 buydown.

Ashley:
Awesome.

Lindsey:
So it’s hefty. Sometimes we’ll work that into the sales price if it works. We’ll tell a seller, Hey, we’re going to take a chunk of your profit for the closing cost credit, but we’re going to add that back in to the purchase price in some way to make it a win for everybody.

Ashley:
It’s amazing to me how creative you can actually get with just your regular on the market bank financing deals. I mean, you hear creative financing a lot, but that’s usually off market seller financing, different things that are done with the creative financing. But there really are so many ways to get creative with traditional bank financing too. It’s always great to hear.

Lindsey:
It’s fun.

Ashley:
And learn more about.

Tony:
Well Linda, you’ve been like a wealth of knowledge and I’ve really enjoyed this conversation, but I would love to get us to our Rookie request line. That way our listeners can poke into that brain [inaudible 00:37:38] of yours and get some more information on how I can keep moving. So awesome. So if you guys are listening, you want to get your question featured on the Real Estate Rookie podcast, give us a call at 8885 rookie. And if the question is a good one, we just might use it on the episode. So Lindsey, are you ready for today’s question?

Lindsey:
I’m ready.

Tony:
All right, awesome. So today’s question comes from Schmidt, just the first name, like Oprah. I can’t find a deal anywhere. I do live in North Carolina, probably one of the hottest markets. I guess my question is, how should I start? Should I try to get a condo that is overpriced and has an HOA restriction on renting and just start there so I can start building equity and then move forward once the market cools off in a couple of years? I’m 30, so I want to get started sooner rather than later. But also my question is, do you guys think I should up and move? I work remote so I can move to a rural town that has an up and coming market, and start somewhere with lower prices. I have funding, I’ve been saving for years, but my comfortability is extremely low. I do plan a house hack and would love to hear your response. So what’s your advice, Lindsey, for Schmidt?

Lindsey:
This is a great question and immediately halfway through the question as it was going on, I’m thinking, you need to be able to make some adjustments and sacrifice. So I love that he is open to moving. I don’t know if you necessarily have to. I think it’s going to depend upon what he thinks is going to be a better “deal” for him. Is he looking for cash flow when he turns this into a rental or is he looking to let this stop the bleeding of rent and scale with equity, build quicker? If it’s equity position, then I would suggest staying where he is and buying the condo that he feels is overpriced. You could probably get a good price right now. And if realtors are telling you that, “No, it’s too hot,” find another realtor that’s a really good negotiator. Skills guys, is going to be more important in this market than ever.
You need to have someone representing you with the skills to get the negotiations done. So really be mindful of that as you’re searching for someone to help you. But if he is looking for equity, I would suggest staying where he is and find the best deal that he can. Suggest living in something that needs some work, add value to it over time. Don’t be afraid to get your hands dirty. You don’t have to live in the nicest and best unit and the best part of town. You want to live in a good part of town, have a unit that you can add value to over time that’s going to maximize the equity potential that will put you in a position to scale down the road. Either it be another house hack or buying more rental properties or what have you. If he is looking for less out of pocket, also depends on his budget too. So it’s going to be another situation that I don’t have information on.
But if he is wanting to be more cost conscientious and buy at a lower barrier to entry, then moving for a short period of time in an area that is growing, area that has population growth, job growth opportunities, something that he can do if it’s near a university, if it’s near a hospital where you have multiple extra strategies for that property in the future to hold onto as a rental, long-term rental, midterm rental, short-term rental, that’s going to be another great avenue too. So it depends upon what he wants to get out of this first deal and where he wants to be the next three to five years. I don’t have that from him. I would need a deeper conversation, and your realtor should be asking you the same thing.
But I hope that at least gives him a bit more of an idea on which direction to go. But I love that he’s open and not saying, “No, real estate doesn’t work. I’m going to keep on renting and I’m just going to hold off until the market goes down or what or whatnot. I was just getting in now, negotiating a great deal.” And just deciding what you want this deal to work and how you want it to work for you.

Ashley:
And you know what, I do love the questions too, where somebody has options. What’s a better position you could be in than having different options? So, congrats to Schmidt for wanting to get in, started in real estate investing and having those options. So you’ll have to write for us in the Real Estate Rookie Facebook group and let us know what you end up doing. Okay, Lindsey, are you ready for our rookie exam?

Lindsey:
I think so. I haven’t studied, but I think I’m ready. I’ll be okay.

Ashley:
What is one actionable thing rookies should do after listening to this episode?

Lindsey:
Oh, I have a two part to this and so I hope that I don’t get disqualified here. So part one of this, I want everyone to really take an honest inventory about where they’re getting their information from. There is such a hype of spreading fear, spreading the headlines that elicit a response and people are making decisions on their investing and their long-term goals based on these headlines. And so, if someone’s listening to you guys, if they’re listening to Rookie, Bigger Pockets, they’re involved in these kind of discussions, they’re already a step ahead, which is great. But just be mindful of where you’re getting your content from right now and who you’re allowing to influence your decisions on investing. Because these news articles, these sources, they want to make you feel a certain way. They want you to think a certain way. So almost try to think about when you read something, have some discernment.
Is this benefiting me? How are they benefiting from sharing this information with me? And just making sure that you’re not making any emotional decisions on your investing based on mass media. I think that’s a trap that I can see a lot of people who are nervous about getting started in investing falling into. I’m not saying don’t be prepared, don’t be well-informed, but just really try to have some discernment when you’re deciding who you’re going to allow to influence your decisions moving forward into 2023. Part two to that is also to evaluate your circle. I know from personal experience. I’m partnered with David Greene. That has done wonderful things for me in my journey. And I know that if you took an honest inventory of who you’re allowing to spend a lot of time with you, whose influence, whose opinions and is influencing you, really try to think about, are these people serving me?
They may be well intended, they’re probably very well intended, but maybe they just don’t get it right. Maybe they just don’t have the same goals or vision that you have. So really evaluate who you’re allowing to also influence you personally and look to elevate your circle in 2023. Meetups are great. I just recently joined GoBundance Women. I’m super excited about that. I know I need to elevate my circle of people that I look to for inspiration. So two parts to that, just be mindful of who you’re allowing to influence you and be intentional about that in this year.

Tony:
Absolutely love that answer. I love that answer. Your circle and the people you surround yourself with have such a big influence on you both consciously and subconsciously. So I think all of us should be more intentional about who we let into our lives and who we allowed to influence us. So love that. All right, question number two, what’s one tool, software app or system that you use in your business?

Lindsey:
Something I should use better as my CRM? You know, as you’re getting leads, whether that be for deals for clients, you really need to keep track of everything. And typically, us entrepreneurs are not very organized. And we hear CRM and we just, I avoided it. I’m like, “No, my notepad and paperwork’s just fine.” But we use a CRM called Brivity, and I don’t use it to its potential, but that’s at least helped me stay organized and focused. And then in terms of short term rentals with automation and analysis, I love PriceLabs and I love, PriceLabs, I think is what I use to analyze deals. And then Guesty for automation and taking that off my plate so that things don’t slip through the cracks and my Urban B guests don’t feel as accommodated because I didn’t message them right away or things like that. So those two, I gave you three, I’m sorry. I’m hoping for extra credit here. I’m giving you [inaudible 00:45:44].

Tony:
That’s fine. Totally fine.

Ashley:
Lindsey, with your CRM, what are some things you track in it besides just the person’s name and phone number? I’m just curious because my birthday was a month ago and I got a text message from this loan officer that I’m using that told me, “Happy birthday, I hope you have a great day.” And I was just like, okay, this is super random. Is this something he tracks and texts all of his clients or that, I’m just his favorite client and he happened to see it was my birthday today on a loan document.

Lindsey:
Maybe send me a copy of that text and I can say if it’s a template or not.
So really good question. I track important milestones and I track what they tell me. If they tell me that they’re going on vacation, if they tell me that they have big goals to renovate the house that they’re in, or this is where they want to be in a year from now, I track what’s important to them in the conversation. There’s a note section for every call that you make to prospects or a client. And that way, when I follow back up with them, I can relate to that. I can ask them a follow-up question so they feel, and they can see that I cared enough to remember that.
And I get pulled in so many different directions. My brain is always going a million miles a minute with our team and everything. So having those trackers about points of the conversation that I want to refer to later, next time I call them again, is really important. And then any objections that they have, I like to share that so I can make sure I address their personal objections and fears and not just blanket them with everyone else’s concerns too, so I can speak to them more on an individual basis.

Ashley:
I think that’s really awesome right there. And I think this doesn’t even just apply to clients, it’s just networking in general, is going to conferences, events, and writing those notes about somebody. What did they talk about? What made them light up, what excited them? So keeping track of those things so that when you do follow up with them or see them again, you’re going to be, they’re going to remember you because you remembered something about them too. And it’s going to make you stand out to them compared to somebody who’s just, “Oh hi, nice to see you again. Do you remember me from this conference?” And then somebody else who’s going, “Oh, how did your daughter like that car she ended up buying?” Or something like that.

Lindsey:
Or who are you looking to meet? I love asking people, who are you looking to meet? Who can I introduce you to?

Ashley:
That is another great point, that connection, being the connector. The matchmaker.

Lindsey:
Yes, absolutely.

Ashley:
Okay, so last question. Where do you plan on being in five years?

Lindsey:
I love and hate this question so much because if you told me five years ago I would be partnering with David Greene and running this big real estate team and having a portfolio, I’d be like, “You’re nuts. You’re crazy.” So I love this question, but I’m also like, “I have no idea.” So if I had to guess or goals that I have for myself and our family, I want my real estate team to be thriving. We would love to hit 200 million every year. We’re serving so many people. Our mission is to help everyone build wealth through real estate. Simple. So I really want to maximize that and grow and opportunities that come with that.
Personally, for our portfolio, I want to get into other asset classes. I’d love to get into self-storage. I’d love to get into other commercial spaces that are going to have more and more opportunity as things start, continue to shift. And I’m open to receiving leads or whatnot for those different ideas. I want to have a medium size rental portfolio. We’re more simple. I don’t want a huge portfolio. I’d rather have a handful of good performing properties and pivoting as necessary to keep that going. I don’t want to over complicate my life looking to simplify it. So I’d love to have a good handful, maybe 10 to 15 properties that are performing and performing well and now getting into other types of businesses and commercial asset classes.
And then I’d love to, this is silly, and you guys might laugh, but I would love to live on a farm. I want to buy land and we want to build a forever home, and I want to have the chickens and the goats and all the things, and just a simple life. I would love that. So if I can do that in the next five years and teach my kids how to grow their own food and be self-sustainable, I would love that.

Ashley:
Well, I can’t laugh because I live on a farm.

Lindsey:
I’m jealous. I love that life.

Ashley:
It’s a very, very working farm. We just have dairy cows. There’s no chickens, there’s no pigs. My nieces will sometimes raise a pig and we keep them at our barn. But it’s not the hobby farm, I guess, where you have all the cool animals and things like that.

Lindsey:
I would love that though.

Ashley:
No garden, really. Just crops to feed the cows.

Tony:
I’ve never felt more left out for not living on a farm in my life.

Ashley:
But you live near the cows?

Tony:
I do live near. There are some dairy cows that are near me. I’m not too far.

Lindsey:
Hey Tony. I’m from California too, so you never know. You may get exposed to farm life and be like, “I like this.”

Tony:
Fall in love with it.

Lindsey:
Exactly.

Tony:
Well those are great answers. You passed the exam with flying colors, Lindsey, as I thought you would. So as we wrap things up, I do want to give a shout-out to this week’s Rookie rockstar, which is David Long, and David says, ‘Seven years ago today at age 25, I bought my first rental property. It was four units full of drug dealers, which I didn’t know at the time. Right after closing, I drove down to the building filled with drug dealers, collected all the rent and cash, but it changed my life forever. I quit my job at 30 and never looked back. Now I make my own schedule. I started doing social media content creation, which I had no idea how much I liked or how lucrative it can be. Real estate opens so many doors when you can take chances that wouldn’t be possible being stuck at a desk all day. I now own 11 buildings with 31 units.” So David Long, congratulations. That is an amazing story. Love hearing the success.

Lindsey:
Why we do what we do. That fuels me, that gets me so excited. I love stories like that, and anyone can attain it. It’s not out of reach, really, and I love that.

Ashley:
Well, Lindsey, thank you so much for joining us today. Can you let everyone know where they can reach out to you and find out some more information about you?

Lindsey:
Absolutely. So I’m heavy on Instagram. That’s probably the best way to get to know me a little bit better. I put out a lot of content. I’m not great at reels. Tony and his team are just, you guys are all wonderful at the fancy reels. I just, I do stories and I share a lot of stuff with what I shared here on the podcast today, I like to share almost daily on my Instagram, so find me there. My handle is lindseyiskierkarealtor, and I’m also on Bigger Pockets, so you can reach out to me there as well. But I’m really heavy on Instagram. It’s probably going to be the best way to get ahold of me. If you guys want to talk to me and our team at all, you can go to [email protected] and we’ll make sure you guys get set up with a great agent to help you accomplish your goals.

Ashley:
Lindsey, thank you so much for joining us. We really appreciated all of the value that you had for us and to our listeners. We definitely learned some new things today and we really appreciate you taking the time to share that with us.

Lindsey:
Oh, this was fun.

Ashley:
I’m Ashley at WealthFromRentals and he’s Tony at TonyJRobinson. And thank you guys so much for joining us. We will be back on Saturday with a Rookie reply.

 

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