The 5 Keys to Building a Financial FORTRESS (Part 1)


You may know how to build a real estate portfolio, but how do you build an unshakeable one? Most real estate investors think that buying a few dozen dirt-cheap houses is all they need to do to make millions and live a life full of passive income. This is far from reality, as your entire net worth could come crashing down as soon as a housing market crash, correction, or new rental policy comes into play. So how do you build a sustainable real estate portfolio—one that will grow your wealth even during the worst of economic times?

David Greene has touched on this topic numerous times, often referring to “portfolio architecture” as one of the most crucial aspects of building wealth through real estate. This strategy not only helps you grow wealth but keep it even when everything goes wrong. Don’t believe us? Listen to David and Rob’s individual stories on what happened to their portfolios during the 2020 lockdowns and how quickly they bounced back while other investors had to completely rebuild.

In part one of this two-part podcast, David and Rob will go through the most common weaknesses in their real estate portfolios, what could cause everything to come crashing down, and the five most important keys to portfolio architecture. They also talk about diversification and how having just one type of real estate in one location could be a huge mistake.

David:
This is the BiggerPockets Podcast, show 705.

Rob:
Because that’s what real estate should be. It’s like you should always feel like you’re broke if you are investing correctly. And that’s a whole ‘nother probably episode of, I always call it the broke millionaire conundrum, where you actually are a millionaire on paper, but you’re deploying all of your cash to your investments. And so you’re always like, “Dang it, where do all my money go?” And it’s just tied up in equity, which is a good thing.

David:
What’s up everyone? This is David Greene, your host of the BiggerPockets Real Estate Podcast, here today with my co-host, Rob Abasolo who you just heard popping off with excitement about one of our biggest bookings to date, not just in the amount of money, but in the short period of time. And I hope you’re just as excited as we are. But today’s show’s not going to be about a bunch of wins, actually. You are going to hear about a lot of things that are going wrong in our portfolios, things that we didn’t anticipate that actually became hurdles for us, mistakes that we’re trying to work our way through, changes in the economy, just a bunch of stuff that isn’t going right because a lot of people are dealing with this. And how you handle mistakes is even more important than not making them.
Today’s show is a fantastic episode where Rob and I are going to go deep into our own portfolios, lives and businesses and share what we’re doing to handle the chaos and destruction that often comes for being a real estate investor. And I think you’re going to love it. Rob, what were some of your favorite parts?

Rob:
Oh, man. Oh, this is just filled with goodies because we talk about the multiverse, right? We may not be able to get you to get into Interstellar, but we can at least get you to talk about the concepts of the parallel universes, of the demise of our portfolios. And we even get to go toe to toe on metaphors and analogies. You talk about energy storage. I bring it with a battery analogy and I’m like, “Wow, the student has become the teacher.” And then lastly, we give a lot of just good thought about portfolio architecture, and how to structure your portfolio in a way that can help you weather any economic storm that we may or may not face.

David:
That’s exactly right, and that’s what I think is personally important. I’m talking a lot about how you build a financial fortress, not a flimsy shack that you could just throw together really quick, which frankly a lot of people did the last five or six years with the economy, there was people throwing things together that they never should have been, and they’re not doing very well. But there’s a way to construct your portfolio in a way that will stand the test of time, and that’s what we at BiggerPockets believe in.
Before we get to today’s show, a quick tip for the audience. Today’s quick tip is consider how your portfolio can be perfectly balanced, as all things should be. Consider yourself Thanos, and ask, “How could this all fall apart? And how can I create the amount of balance that I would need to prevent that from happening?” It could be seasonality with short-term rentals. It could be having a lot of money in the bank and then spending it all on a deal. Rob’s still trying to work out the balance. It’s harder than it looks, isn’t it over there?

Rob:
You got to see it on YouTube.

David:
Poke holes in your own portfolio. Make it a poke-folio, and look at ways this could fall apart and then be proactive about trying to prevent that as opposed to just living in fear, anxiety, and worry about what could happen, not having a plan for what you’ll do if it does.
With that being said, we are going to pull back the curtain and show you guys what’s been going on in our portfolios, how we’re handling those challenges, and what we’re doing to lock in and keep it tight.

Rob:
All right, David, I know you’re not a fan of Interstellar because you still haven’t finished it and you’re not really into the whole parallel universe thing, but I wanted to throw a couple of parallel universe scenarios at you and talk about it on today’s episode of BiggerPockets. Is that cool?

David:
I can probably get into the parallel universe thing. It’s kind of being forced on us all, if you like Marvel movies. You just have to accept it. Yes, exactly right. So we could bring the multiverse into the podcast.

Rob:
Okay, well let’s do it. So today what I wanted to talk about was we are relatively successful real estate investors. We’re in different journeys, different parts of our journeys, if you will, and we’ve done really, really, really well for ourselves. And I think we have enough systems in place and protections in place to really kind of weather any storm that’s approaching or that we’re currently in. But I wanted to flip the script a little bit today and talk about a world where our entire empire falls apart and talk about the scenarios that would cause the demise of David Greene and Rob Abasolo.

David:
I think that’s healthy. I think constantly planning for a paranoid worst case scenario can only make your portfolio stronger. So this would just be a multiverse scenario where Thanos is king and Iron Man has lost his armor and Captain America can’t find his shield and the Hulk has become anorexic. And how are the earth’s mightiest heroes going to manage these challenges without their superpowers?

Rob:
Okay. So yeah, I mean I’m curious, have you ever given thought to a world where your entire portfolio crumbles?

David:
Yes, I do think about it a lot. I think the challenge is that when things are going really well, you have the thought in your head of, it won’t always be this way or you got to prepare for whatever. But the emotional environment that you’re operating out of is very different. And the same is true on the other side, when things are very difficult, you have the thought in your head, I know I can make money through real estate, it can work, but your emotional state is just so negative and fear-based, it’s very hard to operate. So these exercises are good, because it forces you out of the emotional state you’re in right now based on temporary factors like the market, how your last deal went, or what you ate for breakfast this morning and into the mental side of it where it’s much more stable and beneficial to be approaching financial aspects from that perspective.

Rob:
But deep down, I know that you’re probably always comforted knowing that you have 10 million credit card points, right? Isn’t that your apocalyptic scenario, if everything is gone?

David:
Yes. That’s my one backup plan. So yeah, we were joking about how I have a lot of credit card points because having them there, it makes me feel better in case everything gets wiped away. If Thanos snaps his finger and half of my wealth disappears, I’ve still got these credit card points that I can live off of for six months without having to worry about going hungry.

Rob:
Yeah, David hasn’t really disclosed how many he has. That’s my guess. I will say that is the one thing, I’m more protective about my credit card points than I am my real estate portfolio. I’ve got like $12,000 worth of credit card points, I think. I don’t know. What’s 1.2 million credit card points, like 12,000 bucks? And I’m like, “I am never going to touch this.”

David:
That’s so funny, that and my Beanie Baby collection that I keep in various safety deposit boxes throughout the Midwest.

Rob:
I’ve seen that thing, man. That’s extensive.

David:
Yeah.

Rob:
Well let’s do it, man. Let’s talk about it. Let me just give my point of view before we get into it. I think, like you said, it is healthy to talk about the good and the bad and hey, what scenario, this and that. We have this mindset when things are going well that, “Hey, we’re crushing it, blah, blah, blah.” Honestly, I don’t care one way or another, this is probably a hot take, how the real estate portfolio does on a day-to-day. Like the cash flow is always nice, but I kind of stash it all in the bank account anyways and I really rely on appreciation anyways. So I have really good months. I have so-so months. Most of the time, they’re good months.
But honestly, at the end of the day, it’s a long game. And so I’m just like every day pushing that stone a foot forward, if you will. That’s not how it goes, but you know what I mean.

David:
Yeah. So from your perspective, when you’re… one of the ways you’re playing defense here is that you’re not going to spend the money from the cash flow. So you project the cash flow that you want to get, but you don’t rely on it. So there’s never an emotional connection you’re saying to your safety being relied to the cash flow.

Rob:
Yeah. Yeah. I’m a big advocate of having your real estate work for you and build wealth and everything, but to have a bunch of other streams of income that you can actually live off of… So I have probably 10 to 15 streams of income. That’s really what I live off of, so that I can always propel the real estate portfolio forward.

David:
I think that’s healthy. And the reason I think it’s good for us to bring this up, is most people don’t acknowledge that fact. The majority of the time, if you’re getting free information about real estate investing, if you’re paying someone, this could be different if you’re paying for coaching or a course or something, but if you’re getting the information for free, the person giving it to you has to make money somehow. So they’re usually going to be making money by trying to get you to… like for advertising, or to get views, to get attention to get followers. The quickest way to do that is to tell someone that they can make more money easier than what they’re currently doing. This has just been around forever.
So if there’s a girl that you like and she’s got a boyfriend, the first thing every guy wants to do is tell her all the reasons that her boyfriend sucks and how he would be better, right? The same thing comes true for if you want someone’s money, you got to tell them that the place they’re currently getting their money from could be better. “And if you come over to this world, girl, I’ll show you how to make some passive cash flow. Wouldn’t that be better than having to go to work every day?”
And so you’re frequently seeing TikTok and Instagram and social media scripts with little emojis in them that says, “Do you want to make $6,000 a month? Do you want to know how I make $300,000 a year without working?” And inevitably, this is some form of cash flow from real estate, and it’s true that in principle, you can make money passively from real estate. It’s also true that it is inherently less reliable than that W2 income that everybody is trashing.
So the new guy’s always going to tell you how he’s better than your boyfriend in all these ways. But then if you jump ship and you hook up with the new guy, you realize, “Oh, there’s a lot of stuff my boyfriend was doing that this guy doesn’t do that I maybe took for granted.” And for a lot of people, their W2 job is not the best thing they need to get out of it. But for others, you forget that when you’re having a bad week or you’re feeling down or you’re distracted or your kid’s sick and you’re not sleeping, man, that paycheck just keeps on coming. It doesn’t matter if you don’t perform.
You get into the world of real estate or entrepreneurialism and you’re not on your A game, that money might actually stop. And so it is worth acknowledging that income coming from a secure source has a value that income coming from an insecure source like cash flow doesn’t have. And it’s also worth acknowledging that this is never talked about in the real estate space because most people sharing the information don’t want to tell you that cash flow is unreliable. Because then you’re not going to follow them. You’re not going to subscribe to their channel, you’re not going to give them the like, you’re not going to give them the currency that they need to justify the free content they’re putting out.

Rob:
Oh yeah. It’s so funny because I’m always like, well on YouTube, in my content, or just my students, I’m like, “All right, let’s get you to $10,000 a month. I’m going to teach you how to do that.” And they’re like, “Oh my God, let’s do it.” I’m like, “All right. And here’s what’s going to happen when you make $10,000 a month, you’re not going to spend it.” And they’re like, “Wait, what?” I’m like, “Gotcha. I made you wealthy and I’m not letting you spend it,” because that’s what real estate should be. It’s like you should always feel like you’re broke if you are investing correctly.
And that’s a whole nother probably episode of, I always call it the broke millionaire conundrum, where you actually are a millionaire on paper, but you’re deploying all of your cash to your investments. And so you’re always like, “Dang it, where did all my money go?” And it’s just tied up in equity, which is a good thing.

David:
And that’s one of the reasons I’ve started referring to money as a store of energy and work as energy. I’m trying to move our thought off of the US Dollar, which has a value that’s constantly fluctuating with inflation. It’s very hard to know what a dollar’s worth, into an understanding of energy to where you can make a bunch of money, which was just you converting work into energy and then taking it in the form of money. And then you go trade that money for fancy clothes and fancy shoes and fancy cars and fancy vacations, and you’re just wearing your energy on the outside.
That’s all that it is. You’re not wealthier than other people. You’re just putting energy into things like cars and clothes, versus with real estate, we are constantly putting our energy back into the asset, back into the portfolio. We’re putting it into the future where it’s going to grow and replicate and create more energy, and we can pull energy out of the portfolio through cash flow, through cash out refinances. There’s these vehicles that we use to access that energy. But you’re right, the better way to grow your wealth is to keep as little of the energy as possible for yourself, and keep as much of it inside the vehicles where it’s going to grow more, which often leads to people wearing t-shirts just like you.

Rob:
That’s right. My one, my single shirt, I only own one. Actually, I think to use your analogy here, I actually think it’s better to think of your… Oh, this is really good. Okay. I got to work through it with you on the air here. But your money and your wealth is sort of a battery, battery storage, all right? And so you can store all your batteries for a storm, and when that storm comes, you can use it to weather the storm.
However, if you use your batteries for dumb things, I don’t know, RC remotes or RC cars or whatever, as soon as that energy is gone, it’s gone. You’re not getting it back. It’s a depleting source. And then on the flip side of this, batteries don’t last forever. If you just keep your batteries in the closet for 20 years, they lose power over time, which is inflation. So you have to be able to consistently move your energy to something that is going to produce more energy. I did it.

David:
I love it. Yes. And there’s so many people that think, “Oh, my laptop is charged. I’m at a hundred percent. I don’t need to plug it in.” Terrible attitude. You shouldn’t be like, “I’m rich, I’m at a hundred percent battery.” Plug it in. Keep the energy in the power source and have new energy coming in from the electricity to restore it, which would be new ways of making income through real estate, new ways of making income through entrepreneurialism.
Yes, you have a bunch of wealth stored inside of your real estate. Don’t just pull it out because you never know when you’re going to need it. You don’t know. What happens if the power goes out? Like you said, you can’t recharge that battery and you’re only at 4%, you’re only at 12% because you were too lazy to plug it in.
So in today’s show, we’re literally talking about how we prepare for that storm that’s going to stop you from being able to replace that energy, how you prepare for the storm that’s going to cut your battery life in half. How when everything is great and you think it’s always going to be great, we plan for when it’s not going to be great because those storms tend to not be the case all the time. We don’t have 20-year storms. They tend to be wicked, nasty hurricanes that come through in a couple years of devastation and then the economy’s better.
So overall, this is why we’re always doing well, collecting energy and collecting electricity in our portfolio when we’re investing it. But you’d be a fool to not plan for the fact that you’re going to have downturns, and the goal is just survival. How are we going to survive those short periods of time where the storms hit and we got to batten down the hatches, get in the basement, wait for it to pass, and then once it’s done, come out of there and go start planting our flag and scooping up all the real estate we can.

Rob:
Well, we just really, really masterfully put together a good analogy here over the last 13 minutes. I hope it actually makes it into the final episode. If you only heard one minute of this, just know there was a lot of good stuff that we just talked about.
But yeah, let’s talk about it, man. Let’s actually get into the structural weaknesses of our portfolios and what some of those scenarios are that could cause them to crumble. Obviously, they’re not likely, but we should consider what could happen to take us down.

David:
Yeah. So where do you want to start?

Rob:
Well I mean, the general question here is how could the whole empire fall apart? And I think that there’s a few ways that we could do that. So we could start with the question, like what are areas of possible weaknesses in your current strategy? Do you have anything to speak on on that kind of first bullet point?

David:
And I was just thinking before we recorded, I was having a conversation with somebody and we were talking about where business is going good and where business is going bad. And in general for me, the actual decisions I’m making are close to a hundred percent solid. I rarely make a bad decision when it comes to what to buy or how to manage it or how to manage the energy flow.
And so I will talk about that in the show, how I look at it so that I rarely make bad decisions, but I still have significant stress and problems and things that go wrong. So I was trying to figure out how is that happening if I’m making good decisions in all my investments? And what I realize is it comes down to two things and there are things that I cannot control. They are other people and they are things like regulations.
So I could look at a deal, analyze it from every single situation, walk into it with a really good plan, buy the property, and the neighbor complains about the construction and the city gets involved and they slow you down and it turns into a six-month project instead of a 30-day project and you lose 10 grand a month before you even get the property out and you’re $60,000 in the hole.
So then you don’t realize you need a second kind of permit. Well, that’s going to take another three months before you can get it, right? And then you go down this rabbit trail of just your construction, or your jump off part took nine months and you didn’t have $90,000 set aside, and the next thing you know, you went from being extra liquid to barely liquid at all. And then if you have another problem going wrong somewhere else in your portfolio, boom, you’re at that point where you’re not going to weather the storm.
So regulation is one thing that is very difficult for investors to navigate right now. And that is especially true with short-term rentals. You don’t know about what the neighbor’s complaining to city council and they come in and say, “This is no longer allowed.” Or an associate of mine recently had to sell three properties of his in Virginia because out of nowhere, the HOA just decided we’re not going to allow short-term rentals anymore. So what’s he going to do? He had to put the houses on the market and sell them. He wasn’t able to sell for a profit. Most of the money that they had been crushing it making over the nine months before that from all the work they put in, went to cover the closing costs and the realtor fees. And then after he and his partner split up the money, there was barely any profit that was made for nine months of hard work and success. Nothing that they could control.
So things like regulation can absolutely screw me up. And the other one is people. I was thinking about all the problems that I’m having. There are always problems from deals I did with other people. A partner in a deal got greedy or got lazy, or didn’t have the same value system as me and they made decisions that I wasn’t looking at that were very poor. So even though the plan and the property was perfect, the person was not perfect.
Or a business partner that you go into business with and you find out that the friendship you have with someone is not the same relationship you have once money gets involved. So I’ve had situations where we started an enterprise and they did really well really quick, and they completely changed. They don’t have the same values, they’re acting much differently. Their ego is more important to them than the success of the business. They’ve never experienced that much affluence that quickly, and it hit them in a way that I couldn’t have anticipated.
So those are typically the things that will cause stress in my life. And so trying to learn to limit how dependent I am on other people in these enterprises is the biggest threat to my portfolio. And most of the issues that I’m having right now come from that.

Rob:
Is that why you shut down your pink Volkswagen beetle rental service? I’ve always wondered why that went under.

David:
We had a ton of demand, and it was really good for my image. But yeah, the partner that I had decided, they didn’t want it to be pink anymore, they wanted to move into purple and I just couldn’t live with that.

Rob:
Creative differences. No, man, that makes a lot of sense. I think there are definitely… I mean regulations even go past, I think laws and short-term rental laws and everything like that. I mean we know that I am a short-term rental host. Obviously, we talk about it all the time, but there are other regulations that can really throw you for a loop. And I’ll give you one example of where someone’s empire might have crumbled. Mine did not, thankfully. I guess for the purpose of this podcast, we’ll say it was my empire.
I had a relatively successful Airbnb operation and a little glamp side operation that was cash flowing, a lot of money, things were going good, I was flying hot… Icarus, if you will, flying close to the sun. And then we got this little thing called COVID-19 pandemic across the world. And guess what? Airbnb canceled all of the reservations that we had for three months straight, and then the city shut down and they wouldn’t let you do Airbnb.
And so we actually had to refund 40 to $50,000 worth of reservations overnight. Now, I think for most people that are overzealous and very levered and don’t have a lot of reserves or anything like that, that would’ve eaten up most businesses. But my standpoint has always been to just keep all of our money in the bank account, don’t spend it. As I said, I try not to spend real estate money. So it was really no big deal. It was not a big deal for us to refund it. Obviously, I didn’t like refunding like 50 grand, but it was like, okay, we have the money, we’re just not going to make it. It’s not a big deal.
And then guess what? We ended up, because we were able to weather that, we were actually the most profitable we had ever been for the rest of the year. Whereas there were a lot of people in rental arbitrage, like master lease contracts where they had a hundred units, a lot of them went under during that time specifically because they couldn’t get tenants to rent their Airbnbs.
So even more of a global regulation could really cause your empire to crumble. Did you have any issues during that time with any of the rest of your portfolio, or were you okay? Did you have anything at all during your time when COVID-19 first hit that caused any structural cracks in your system or were you okay because you were mostly in long-term rentals?

David:
Well, the rental properties were more or less… Okay. I had a handful of tenants that didn’t pay, and I had one where the tenant didn’t pay for over a year. The problem with that was that I wasn’t watching the portfolio super close because of all the other businesses I have. So I don’t even know that a year went by or more than a year without this person paying. The property manager didn’t push it to the front of my attention.
That was the biggest problem with the rentals. The bigger problem was with the real estate team. Real estate agents were considered to be not essential. So we literally could not show homes anymore. Not just holding open houses. You can’t even get into a house to even go show it. Nobody was going to be buying homes. So this entire income stream was basically just shut down. You weren’t going to be able to sell anybody’s home and you weren’t going to be able to help buyers with buying it.
And it’s very easy from an emotional standpoint to see the money keeps rolling in. I can keep buying, I can keep spending, I can keep doing whatever I’m doing. And then COVID hits, which was a black swan event, no one would’ve ever thought, boom. They actually had a couple week period where loans wouldn’t fund. Fannie Mae and Freddie Mac loans, the government’s like, “We’re just not funding anything.” The only way you could buy houses with cash and the only way you could buy houses is not seeing it.
So no one’s going to be buying houses at that time. And so your portfolio as a whole is not just the assets that you own, it is your life, right? Like you mentioned saying you were over… you could be over levered. Everyone assumes that means taking out a loan on the property that’s too much of an LTV. No, you could be at 50% LTV really low, but what if your life is over levered? You’ve got massive car payments, you’ve got a huge house payment that you can’t afford. You’ve got a ton of debt you never paid off. You’ve got a lifestyle that other people are spending your money and you’re not paying attention to it. You can have prudent investments but run your lifestyle in a way that isn’t very disciplined and you can easily lose the assets because of what was going on on the other side.

Rob:
Yeah, for sure. I mean, I think speaking of the loan thing right now, another thing that probably a sticking point for a lot of people are bridge loans, or people that are flipping right now based on ARVs from six months ago that now that we’re taking maybe a… I don’t know what the correction is right now, but let’s just say it’s a 20 to 30% in the next six to 12 months if that’s what it is. I don’t know off the top of my head. But if that’s what it is, then it’s going to be a very tough to cash out and actually get your money back. Or if you’re even just selling, if you already had razor thin margins and you were only going to pull 10 to $30,000 of profit on a really light remodel, the correction of prices and then the increase in interest rates might cause buyers to not want to buy your flip and thus you are in this hard money loan or bridge loan that you can’t get out of.

David:
That’s actually happening to me right now on several properties. So I went on a buying spree right before rates went up, and then they’ve just continued to go up. So I’ve got a couple properties, like pretty big rehabs on million dollar or several million properties in the Bay Area where I locked in a bridge loan for 12 months at something like nine, 10% interest. At the time, rates were four and a half, maybe five, but probably less. And rates have gone up so quickly that to refinance out of my bridge loan, which is a form of a hard money loan, my 30-year fixed loan will be higher than what the hard money loan was.
And I can’t sell it because the values have gone down. They haven’t like crashed, but they’ve gone down less than where it was when I paid it because the rates have gone up so high.
So it is these perfect storms that we’re talking about. I had a lot of exit plans, okay, buy the property, fix it up, the ARV should be here, I’m going to get more than a hundred percent of my capital back out and I’m going to have this great asset. Well now, the cash flow is significantly less because rates were at five and then they jumped up to 10 and a half for this particular property I’ve got. And I can’t exit it by selling when the market was just climbing, climbing, climbing because the prices have gone down and they’re also in the middle of being newly renovated. So I have to finish the renovation.
And then of course, you get issues with the renovation, how long it takes, and then when you get permit issues that get popped up, new stuff just keeps starting to add on and you’re not able to collect any revenue for the property. You’re not able to sell the property and you got to keep putting money into it, until it’s finished so that you can actually have something that could be rented out.
And then when it is rented out, you’re not going to be making nearly as much as you planned because rates have gone up so much higher and you’re not going to get all your money back, or as much money back because the value went down. This does happen in real estate.
And the thing that you got to understand is it could not have been predicted. We didn’t know when rates were going to go up like this. We didn’t know when COVID was going to happen. You can’t know what’s going to happen. And the flip side of it is when you let the fear of something going wrong create analysis paralysis and you do nothing, and you watch everyone around you making money.
So you’re in a position where there is no risk-free move. You’re either going to lose out by not taking action or you’re going to take action like I did and you’re not going to get the result that you wanted. The only way that you mitigate that is that you don’t look at what’s happening in the immediate future. You look at what’s happening in the long term. I did certain things well, I bought them in locations that are guaranteed to appreciate much more than everything else around them, grade A locations, right.
I created additional units in these properties, so my cash flow will be more than a comparable property would be worth. At some point, rates will go down, I’ll be able to refinance and I’ll be able to get back to the numbers that I originally thought. It’s really just time that I lost. I thought I was going to be making a certain amount of money in six months, maybe it’s going to be two and a half, three, four years, hopefully less, but it could be that long before I end up making that money. So I just lost time.
But there’s still like, what if I’d have bought these in terrible locations? Oh, there’d be nothing I could do right now. You’d just be screwed, right? So the principles of real estate, this is where they come from, is we are planning for the worst case scenario. Did I think rates were going to go from five to 10 and a half for me? No. Did I ever think I’d refinance into a 30-year fix that was more than the hard money loan that I used to start the rehab? No. Did I think that the ARV would drop that significantly because the rates went up so high. On a $2 million house, if rates double, it hurts the value a whole lot more than a $200,000 house. No, I didn’t think any of those things. But what you do with your money and how you can struct your portfolio will allow you to survive those times.

Rob:
Well let me ask you this, just out of curiosity. When you go to refi those homes, you were saying you may not get the full… you may not get all your cash back, you’ll just leave cash in the deal in the house/

David:
Yeah.

Rob:
So it’s just energy that’s staying in the house, right, if you will. Yeah. I hate to use this against you, but in the Burr Bible you do talk about this a lot where people go and they rehab the house and for them, they want to get all their money back, but they may only be able to get 80% of their money back and they have to leave 20% in the deal and it’s like, “Oh, too bad.” Now you just have locked net worth into a home or whatever.
So I think at the end of the day, as long as you’re looking at it from a long-term perspective, you aren’t really losing… It’s hard to lose in real estate on a 20 to 30-year cycle, if you’re actually holding onto your assets.

David:
Almost impossible.

Rob:
Yeah.

David:
That’s exactly right. And that’s what we’re pointing out, is what I lost was time. I thought I was going to be at a certain point in my timeline sooner, and I didn’t. But I gained a bunch of time on the stuff I bought in the last eight years because inflation was so wild and rent increases were so crazy, that I got to where I should have been in 20 to 25 years in five.
I have some properties that I bought in 2013 that the rents have more than doubled. So a property, a fourplex is the one I use a lot. I bought it at rents for 700. Now rents are at like 1750, 1850 depending on which unit. That shouldn’t have happened for 20 or 30 years. That happened to me in eight or nine years. So I gained a lot of time on those deals. And on these ones where the market turned on around on me quickly, I’ve lost some time.
But yes, as long as you hold it for long enough, you’ll be okay if you’re following the right principles. But it’s not fun. Part of why we want to make this episode is so other people hear it. You’re not the only ones going through this. When the market shifts that rapidly and that unexpectedly, the rug is pulled out from underneath you, you don’t know which way you’re going to fall.

Rob:
For sure. Well, I guess on that note, I sort of wanted to talk about how liquid you can be with your portfolio to triage any major changes in the economy. Do you have liquidity in your overall portfolio to be able to exit? Because I know that this is something that probably a lot of people are going to have to face in the next year. They could be in the middle of loans, they could be in the middle of refinances, they can have a bunch of homes, they may have lost their job and they’re going to need money.
So through triage, what level of priority can you basically assign different homes? Can you get rid of them? What’s your flexibility right now with your overall portfolio?

David:
That’s good. My problems are based off of acquiring too many properties too quickly. Everything I’m doing is from the acquisition problems, the rehabs, the permitting issues. All the properties already owned are fine. So that’s just one thing I want to… I don’t want everyone hearing this to get scared and say, “Oh, David can’t even make it in this market.” Well if you bought 20 short-term rentals in a four-month period, anybody’s going to have some problems if everything doesn’t go perfect. So I just bought a lot of properties and hit the perfect storm at the same time that’s a problem.
As far as the properties that you already own, the question of, well how much liquidity do you want to, or equity do you want to keep in those properties? It depends on how much energy you’re keeping in your bank account. There’s a balance there.
So some people don’t keep very much energy in the property itself, so they don’t have a lot of equity, but that’s okay because they keep a whole bunch of energy in their bank accounts through the form of cash liquidity. So they’re fine. They don’t have to ever sell a property. If you’re somebody who’s thinking, “I don’t want to have a lot of cash on the bank, I want to just put it all in the properties,” maybe you’re the kind of person that likes to pay stuff off, so you feel good knowing, “Oh, my loan to value is only at 30%. I’m safe, I can sell.” Well that’s a person that can sell the property. But in order to access that energy, you have to sell. And I don’t ever like to sell in a buyer’s market. I don’t want to ever sell a property unless it benefits me to sell it.
The reason I don’t like the strategy of keeping your energy in the house instead of in the bank is the only way to access it is either to refinance it or to sell it or to get a HELOC, some form of that. And if values are down, meaning I don’t want to sell, rates are probably up, meaning I don’t want to refinance. There isn’t really a great scenario there, which is why I’m frequently confronting this belief that having your house paid down or paid off is not as safe as you think. I prefer to keep that money in the bank where I can use it for other things, or I can just make payments for longer.
So some people will have 300 grand in the bank and say, “David, I want to put 250 grand of this to pay down my $500,000 loan to a $250,000 loan.” I’m like, “Okay, so if you somehow lost the tenant and you couldn’t make the payment, wouldn’t you rather have $250,000 in the bank to make payments for nine years if you had to, than dumping it all into the house and cutting yourself really thin when it comes to your ability to make your note payments?

Rob:
Yes. Dude, I struggle with this one a lot. I’ll be honest. I know that the rule of thumb is always leverage and use other people’s money and all that kind of stuff. I am very much for that. Hey, let’s leverage, let’s use that to scale, use the bank’s money, right? But I am starting to feel a little bit more towards at least having your… if you could work towards having your primary paid off, that’s always going to be a… it’s a savings account that you have in case if you lose everything, you don’t have to pay a mortgage and you can stay in your house.
I kind of don’t hate that. You know what I mean? And if you really need to, eventually you can take a HELOC out. So I just think it’s personal preference there. I don’t say do that with your investment properties, but with your primary, I think there’s a little bit of comfort knowing I’m sitting on a half a million dollars of equity that if I ever really need to, I can take it.

David:
But you wouldn’t feel that same comfort having a half a million dollars in the bank?

Rob:
Not really, no. It’s actually pretty stressful.

David:
Is that because you’d be tempted to spend it?

Rob:
Not even that, dude. I mean I have cash in my accounts right now and I don’t like it. Because I just see it withering away, the value of it. And also I’m always… I don’t know, it’s inconvenient to move it around and to wire it to other bank, then the FDIC insurance, all that kind of stuff. I don’t know. I’m just like, yeah, it’s nice to have it. It almost feels good. But then it also is a reminder of all the employees that I have to pay to. I don’t know, this isn’t really real. This is more [inaudible 00:34:25]-

David:
No, but that’s how human beings… this is our relationship with money and energy that we’re talking about right now. It’s very real. It doesn’t make logical sense why you feel that way, but who cares, because that’s how you’re going to make your decisions. You’re going to see it. It’s going to cause you to have some stress.
And so I think this is part of the reason that you and I always want to feel like we’re broke. Because, the minute you feel like you’re rich, you start making decisions like money isn’t valuable, you start to lose respect for it. You’re just start spending it on things easily or letting people stay on the payroll that aren’t doing a good job or paying more than you had to for the house because you have the money.
When you always feel some form of broke or at least disciplined or a little financially stressed in a small way, you value the money a lot more. You treat it with more respect because you don’t have as much. I think that’s probably what you’re getting at.

Rob:
Definitely. So with that, how much money do you have in your bank account? No, I’m just kidding. All right. So I actually wanted to talk about the liquidity of my portfolio. Theoretically, a lot of my portfolio is actually pretty liquid. I have so much equity because I’ve purchased over the past five years and I’ve never really sold.
So I bought a house in Sevierville, Gatlinburg, Tennessee a year and a half, two years ago. I think I bought it for 500, thing gets in the 808 and 850 range. Lot of equity there. I bought a house for 300 that’s worth 550, 600. I’ve got all these houses that have six figures of equity. Almost every single one of the houses that I own have either six figures or multiple six figures of equity. And that’s not because I’m a genius, it’s just because I’ve purchased consistently.
And so if I really needed to sell, I could sell right now in a buyer’s market. Would I lose money for my equity? Maybe. But I still have the equity so it doesn’t… In my mind I’m like, all right, my tiny house in Joshua Tree, I built it for 165K. Whether I sell it for 300 or 350 doesn’t really matter to me, because the amount of equity that I’ve built, it’s obviously I want as much money as possible, but if I had to lose it 50K because of the market, that’s fine. The money is all play… like Monopoly money anyways. I’ve never realized it and so it’s not even mine. That’s how I kind of think about it.
So I would say the majority of my portfolio is like that, other than some of the more recent purchases, like our Scottsdale house. We bought that for 3.25 million. We have 20% equity in it from the down payment that we put on it. But if we try to sell it right now, well, I don’t know, maybe it would do okay, but with the, I mean the 6% in realtor fees would really cut into really a lot of that money for us. So overall, I feel pretty safe being able to sell my portfolio if I had to, but I don’t really want to.

David:
And you don’t ever want to be in a position where you do have to. You always want to be selling because it makes sense for you to sell. The leverage is on your side, if you’re going to sell.
And then selling is a complicated event in itself because you’re probably going to have taxes on that money you made and you’re going to want to do a 1031. So if you sell this house, do you have a place you can put the money or that you want to put the money? Is it going to create more stress in your life than it wouldn’t if you had just kept the property?
But constructing your portfolio itself so that you’re in a place where you never have to sell, I feel like is more than half the battle. The actual properties that you choose and the way that they work with each other is a pretty important component to making sure that you’re never in a position that you have to sell when you don’t want to. So what are some of the things that you’ve done, Rob, up to this point to maybe diversify what that portfolio looks like or buy different types of assets that will cover for you, so you don’t get in that position where, “Oh man, business didn’t go as well as I wanted the last couple months. I have to sell something.”

Rob:
So I am a big fan in diversification, even just with… I’m obviously mostly, if not all short… Well, yeah, short-term rentals are midterm rentals right now. But I’m a big fan of diversification. I’ve got 35 doors across the country, all right. I’ve got a couple in California. I’ve got one in… Well, I got a couple in Arizona, a couple in Tennessee, a couple in Texas, one in Wisconsin, several in West Virginia, 20 in New York.
So I’m all over the map. And people are always like, “Why would you do that to yourself? Isn’t it hard to hire your Avengers?” But for me, what I’ve found is I like to diversify across the country to combat seasonality. And this is something you talk about quite a bit too with portfolio architecture, which I want to get into here in a second. But for me, I have sort of staggered so many of my short-term rentals at different personalities that I’m never really hurting in one specific month.
I’ll give you a good example. If you buy a beach house and you close in May, you’re going to feel like a genius because you’re going to crush it from May to August. You’re going to be like, “Oh my god, I’m the smartest real estate investor that’s ever lived. I’m going to make half a million dollars on this house.” And then September rolls around and you’re like, “Oh, I am broke and I didn’t save any of my money,” right?
So to combat this, you have to understand that beach markets, for example, are highly seasonal and they only crush it for three months out of the year. Meaning that if you were going to pick up another property, you probably don’t want to do another beach property or else you’re only ever going to make money for three months out of the year. So what you would want to do is find another property that maybe for nine months out of the year, staggering it with the other three months, is actually making cash flow so that you always have money coming in.
And so this is something that I actually specifically experienced with, in a good way… or I’ve learned it really in a good way, like our Scottsdale property. We bought a 6,000 square foot mansion in the desert, enclosed in June when nobody goes to Scottsdale. And basically from June to November, I wouldn’t say it was crickets, but October was okay, November was a little slow. And it’s like, oh man, if anybody else that was not prepared for this stepped into a $17,500 mortgage payment, they would be hurting. They’d be like, “Oh my god, I’m going to go bankrupt.” But because the rest of my 35 units basically crush it, they’re all staggered throughout the year, it was no big deal.
And now we’re getting into December, we’re halfway booked, and then we just got a $7,000 reservation yesterday for January for five days, a $7,000 reservation. And that’s just one of the ones that came in. And now in January, we’re charging like 1500 to $2,200 a night. And now it’s like, “Oh, okay. Yeah, great. Note to self, buy a luxury property in peak season so that you’re not eating that mortgage payment for six months out of the year.” However, you and I were able to weather that storm because we have relatively diversified portfolios.

David:
That’s a very good example of portfolio architecture. You’ve got seasonality in short-term rentals. And it’s important because of the mental game. And like you mentioned, a lot of people spend the money that comes from their rentals because they replace their W2 income and you spend W2 income. So why wouldn’t you spend your passive income from real estate?
The problem is with traditional rentals, they lined up very, very closely, very well with the way that you manage your personal finances. So you get paid every month or every two weeks. And so you say, “I make X amount of money a month.’ Then your bills are all set up on a monthly thing. “I pay every month this many bills so I can put a budget together based on a month.” Well, if the tenant pays the same rent every single month, that fits in really nicely because you’re making a mortgage payment every single month.
Well, short-term rentals, screw this whole thing up because you can’t look at what you make in a month. We look at what they make in a year, because not every month’s the same. And so if you spend your money, oh, it’s so easy to get caught off guard, like you said, thinking that you’re crashing it, you’re doing amazing, now you’re dumping money into the property, maybe you shouldn’t be, or you’re spending more money than you should be. You’re justifying expensive trips to the property for stuff that don’t really have to happen because the money’s rolling in, and then you hit those winter months and it gets really bad, you’re losing money and now you’re feeling really bad. Your emotions are tanking versus, like you said, if you can get one that offsets the other, you never really have those huge spike, climbs up and the huge spikes down.
Another way that I think that the Scottsdale mansion worked out in a sense of portfolio architecture was that we knew we were not going to make a lot of money when we first bought it. I think we planned to more or less try to break even the first 18 to 24 months. And part of that was because we had to dump so much money into the property to get it ready. And also, we knew we weren’t going to know what goes wrong. We got to figure out a new market.
You can do that when your existing portfolio is cash flow solid. You can’t do that if this is the only property that you’re buying, this is the only one coming into your portfolio, you don’t have a ton of money, you would lose the property. We also bought this house with a long-term horizon.
We’re like, “We’re buying this whole thing for less than what the land itself would cost if we just bought land.” Okay, but we’re probably not going to realize that value for five to 10 years down the road. This was an area that we know we really like Scottsdale long-term, the type of people moving there, the way the economy is set up. We think that market’s going to do incredibly well, but you don’t have the luxury of cashing in 10 years down the line if you’re barely making it right now. If you’re like, “I want to quit my W2 job, this would’ve been a terrible house to buy.” So the reason we were even been able to-

Rob:
At the time that we bought it, at the month that we bought it, yeah.

David:
But even if we had bought it during a time when people visit Scottsdale, we still… Like the pool heater, we have to go replace and the water heater break in and the sport court that needs to be done. You can still step into this a couple hundred thousand dollars in the hole that you weren’t planning on when you’re buying a house this big in a new area. We were able to, because the stuff we had bought previous to this was performing so well that it bought us the ability to basically give ourself a huge windfall in the future. This is like you put a hundred dollars in your coat pocket and then 10 years later, you come back and you’re going to find out that it’s a hundred thousand dollars. It’s a kind of situation like that. But if you don’t have money to live on, you can’t put a hundred dollars in that coat pocket.

Rob:
Yeah, yeah, for sure. Yeah. And when I say the time that we bought it in, I meant more like we bought it in June versus January. So now I’m starting to get to that point where I’m like, “Oh, hey, we’re smart. Look at us. Look at this $7,000 reservation or this $10,000 one,” and now people are contacting us for events and all that kind of stuff. It’s just a little bit of a slow trickle. But like you said, we sort of planned our portfolios accordingly. I would never tell anybody to go and buy a $3 million property unless they had the ability to actually endure any kind of road bumps. But also just the financial aspect of having a portfolio that can be pick up the slack for you.

David:
You also would never tell anybody to just keep on buying $40,000 houses in the Midwest till you have 700 of them. That doesn’t work either, right? So there is a progression of how real estate investing should change. You started with training wheels or a tricycle, then you get into training wheels, then you get into a bike and you kind of move through asset classes as you’re learning. Keeping that in mind as you’re building your portfolio will help you to weather the storms of life that come.

Rob:
It’s true. And just let me just say, you did ruin real estate… How do I say this? You did ruin this for me in that when I wanted to go and buy 10, $300,000 houses, you were like, “Why would you do that? That’s a job. Go buy a $3 million house.” And I was like, “Ugh.” And then we bought it and I’m like, “Oh yeah, I shouldn’t buy these $300,000 houses anymore.” And so now I don’t.
So now it’s like I see these deals come across my desk all the time and they’re good deals, but as I’ve learned from you, it’s just not scalable to keep buying these onesies. And so now I’m very selective about the swings that I take in a bigger scenario. Right now, I’m trying to do 50 doors at a time or trying to do luxury properties, or trying to do things that are a lot more meaningful to my time. So I guess thank you on both ends of that. Thank you for ruining it for me, and thank you for transforming me.

David:
You were a cat and you were hunting mice and you were getting all of your caloric needs met from those mice. But my friend, you have grown into a lion and now mice are unbefitting of a lion of your stature and you are now chasing gazelles, as you should be.

Rob:
So David, when it comes to portfolio architecture, can you give us some of the, I don’t know, some of the pillars or some of the criteria that goes into actually assembling your real estate portfolio?

David:
Yeah. So when you’re looking at your portfolio as a whole, there’s five things that I like to try to create some kind of balance because these are all ways that you build sustainable wealth that you’ll actually enjoy. It’s a form of building like a financial fortress that will stand no matter what gets thrown at it versus a 3D printed home that you can just throw up really quick and scale fast, but when the first storm hits, it’s going to fall.
The first is equity. You want to have a lot of energy in that portfolio. Like you said, Rob, if you come on hard times, you can pull it out. This is where the big upside is in your portfolio. You’re going to build your biggest wealth through the equity that you create holding real estate long term. So that’s one of the first things that you want to think about.
The next is cash flow. You need cash flow, not just to replace your income, but also to make sure you can keep the property for a long time. Because cash flows are how you make sure you can make that payment, which allows equity to even take place, unless you stepped into equity right off the bat.
The next is liquidity. That’s not just in the portfolio but in your life. You need to have reserves. That’s a form of liquidity, money that you can tap into. Can you borrow out of a retirement plan? Do you have HELOC set up on property? If you’re in a pinch, if you get a good opportunity, do you have money that you can turn to right off the bat to go acquire a new property, fix something that went wrong, improve a property, whatever the case may be, that’s in the best health of your portfolio as a whole?
The next would be ease of ownership. You’re never going to build a big portfolio that does well if you hate owning it. If you’ve got 40 short-term rentals and you manage all of them yourself, you don’t have ease of ownership. That’s not something that you’re going to enjoy. If you’re buying properties in terrible neighborhoods, even if you’re getting great deals, you end up hating owning it and you’re not going to grow up big. You’re not going to get that equity or that cash flow. So you can have a handful of problem children in your portfolio. Sometimes they’re worth it, but it can’t be something where the majority of your portfolio is something you don’t like owning.
And you do have to consider that when you’re building. And the last would be scalability. Are you doing this in a way that you can keep scaling and you can keep going? Are you buying 10, $300,000 houses over and over and over? Well that sounds great on a podcast when we say, “Oh, you can borrow money from investors.” And we kind of construct the entire organizational chart of where every piece goes and it sounds great to an engineer, they’re like, “That works.” But then when you actually try to execute the play that you just drew up, you realize you don’t have the skills to do it or it doesn’t work in practice, like it did in theory.
So scalability is a super important part of your portfolio as a whole. And oftentimes, that will mean thinning out some properties that are too difficult to scale and replacing them with properties that are easier or moving from one asset class to another as long as your other four requirements are being met.

Rob:
Yeah, yeah, yeah. So it sounds like really what we’re looking for is a balance of a bunch of different things versus really going into one aspect and that makes sense. You asked me how I’m diversifying and I said, “Well hey, I diversify in location,” but that’s actually not just the only way I diversify when I’m like building my portfolio. I’m actually diversifying the types of units that I’m listing on short-term rental platforms as well.
So yeah, I’ve got them across Arizona, Texas, California, and New York. But I also have really cool units that I just like to have fun with. And sometimes I’ll buy a unit just because it’s a cool looking property. So I’ve got tiny homes, I’ve got yurts, I’ve got Airstreams, I’ve got chalets, I’ve got cabins, I’ve got mid-century modern cabins, I’ve got condos, I’ve got a little bit of everything.
And it’s really because I like to appeal to all the different types of audiences out there. That way, I know if something is trendy or if it’s just not as hot, which like a tiny house for example, people always love those. People don’t want to stay at tiny houses in a year or two, as much as they did this year. Well then I have all these other types of properties to meet all of that. So for me, I’m always looking for balance in my portfolio in the actual types of listings that I’m creating and the experiences that I’m serving up to people.

David:
That’s it. You got to be thinking like that. And when everything’s going great in the market, we don’t think about diversification. We don’t think about what if something goes wrong. We just think what’s the easiest, fastest and funnest way to scale what we’re doing. And that’s how you can build yourself a treehouse. You could build those really quick. In a couple hours, you can have yourself a treehouse set up, but it’s not how you build a fortress that’s going to withstand the test of time.

Rob:
Well I’ve been working on my treehouse village in Gatlinburg, Tennessee for about a year and a half now, but I just got the update on that today. And I actually think we’re breaking ground in like a month and it’s going to be four dome treehouses that are in the air, as I guess pretty standard for a treehouse, and then a tiny home, a tiny a-frame treehouse too. And so that also goes into how I’m diversifying. I want to go more into unique stays. But yeah, just so that I understand kind of your parameters for portfolio architecture, I just wanted to recap it for the audience. We’ve got equity, cash flow, liquidity, ease of ownership and scalability. Did I miss any? And with those five things, we want a good balance.

David:
That’s it. And you want that… so each of those things should be making up for the weaknesses in the others.

Rob:
Okay, awesome. Well this has been really good. I regret to inform everybody that we rift so much on the first half of this that we’re going to give you another… I guess, I don’t regret, I am excited.

David:
No. Two shows.

Rob:
Yeah, we’re giving you a part two of this where we get into some much juicier, maybe even profound questions. What are the actual challenges that we’re going through in our businesses, some of the pitfalls? If we were to actually lose it all tomorrow, how would we rebuild our portfolio starting from scratch with $0? That will be on the next episode of BiggerPockets. I’m really excited about it because I don’t know if I have the answers yet, but we are going to find out what they are soon.

David:
It should be very fun. These what would you do if you started over questions are always some of my favorites, because it forces you to pull things out of yourself that you normally wouldn’t have.

Rob:
That’s what it’s like every single time that you have your profound genius systems. And I’m like, “Uh-oh. I know my answer is nothing like that.” That’s good. [inaudible 00:52:49]…

David:
That’s why I would [inaudible 00:52:50] second because I’m a jerk.

Rob:
I know, I know.

David:
All right. Well, thank you, Rob. I appreciate some of the insights that you shared here and you also asked some really good questions, so thank you for that. I wouldn’t be able to give good answers if I didn’t get good questions.
And to you listeners, we hope you enjoyed this episode about all the things that can and do go wrong in real estate and what we do to mitigate that risk. In the next show, we are going to get into what we would do if we started over to help prepare for things going wrong, because wise investors don’t prepare for everything to go right. They make plans for what they’re going to do if things go wrong, and they prepare accordingly.
If you like this show, please do us a favor, give us a five-star review wherever you’re listening to the actual podcast, whether that’s Apple Podcast, Spotify, Stitcher, whatever’s your favorite. Just take a quick second, and please give us that review so we can stay the top real estate podcast in the world. And if you’ve got some time, listen to another one of our episodes. This is David Greene for Rob, has one t-shirt, Abasolo.

 

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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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