February 2024

David:
What’s up, everyone? Welcome to the BiggerPockets podcast, the biggest, the best, and the baddest real estate podcast in the world. I am your host, David Greene. I’m here with my skilled, talented, handsome, buff, and brilliant co-host, Rob Abasolo.

Rob:
Thank you. I appreciate that. That’s what I needed on a Wednesday, my friend. How are you?

David:
I’m good. Did I leave anything out? I suppose I could have said ripped, artistic, wonderful lover.

Rob:
Two out of three is not bad. Listen, for everyone at home, we have a pretty incredible story for you today. We’re here with Donovan Adesoro. Donovan started investing in duplexes right out of college in the Houston market, my backyard. He has grown quite a portfolio in his short time as an investor, and has started building duplexes himself.

David:
So if you’ve ever been frustrated by the lack of inventory, wanting to get deeper into real estate, but traditional paths don’t seem to be yielding much fruit, today’s show is for you. You’re going to hear about how Donovan selected a product that was needed in his market, saw where the demand was, and move forward mitigating risks on how he did it. What an awesome story and incredible young man. Let’s bring him in.
Donovan, you started investing in duplexes right after college, not something that everybody does. What year was this, and why did you choose duplexes specifically?

Donovan:
So, in 2020, after I bought that first duplex, I realized there’s just not too many in Houston given how vast the land is. So, duplexes was a small niche market, and I felt like I could be a little bit more competitive there than compete with the major single family home builders.

David:
What year was it when you were graduating college?

Donovan:
2019.

David:
All right, so 2019, you get out of college. You’re stepping into the whole COVID matrix, and you decide, “I’m going to buy duplexes.” Give me a better understanding of what you were looking at when you surveyed this vast array of land that you describe of and why duplexes stood out to you. What caused the shining light of brilliance to shine upon the duplexes?

Donovan:
After college, I was listening to BiggerPockets podcast on the way to and from my engineering job. A big thing was having multiple exit strategies, and when I was looking at the numbers on a single family home, they just wouldn’t pencil as a rental if worst case scenario we had to keep them. So, the downside of the duplex was like, “Hey, if we can’t sell, it’s okay. We can refi, and make 8%, 10% cash on cash.” So, having those two exit strategies was really what drew me towards it.

David:
Okay, so you were not a purely cashflow buy and hold investor. You were actually looking to buy properties, improve them, and sell them, I’m assuming, and then you thought, “Hey, if I can’t sell it, at least it’ll cashflow. I could hold it.”

Donovan:
Exactly. Yeah, I wanted to have both options available.

David:
All right, and were these new properties that you were looking at, or were these existing inventory?

Donovan:
There were all new that I was looking at, so I bought… The one I moved into was brand new, construction, house hack, and it was because I can barely change a light bulb, so it needed to be hopefully maintenance free for a couple of years.

David:
Perfect. How much did you pay for this deal?

Donovan:
This one was 275, right at 275.

David:
Whoa. Did you say where you’re buying these at?

Donovan:
Houston, Texas.

David:
Houston, Texas. Rob, you didn’t tell me that you could buy duplexes for $275,000 out there. Have you all been keeping secrets?

Rob:
Well, back in 2019 maybe, but have those numbers changed pretty substantially since then, Donovan, or is it still in line with that?

Donovan:
Absolutely. That same duplex is 430 now, give or take.

Rob:
Okay. So, you spent about $290,000 on your first duplex. Walk us through some of those numbers. What did you put down? Give us the whole rundown on that.

Donovan:
For sure. The duplex put down 0% technically. The way I did that was there was a mortgage through… At the time, it was Cadence Bank, but yeah, they had a 0% down program for a one to two unit, so brought like $3,000 to closing just for closing costs. The projected rents were about 1,350 per side, and the mortgage payment with taxes and insurance was like 1,886. So, it wasn’t a perfect house hack, but because it was a new construction, I felt a little bit more comfortable being a little bit more thin on the cashflow.

David:
Folks, take note of how Donovan said they were about 1,886, which is funny that you said about with the number that specifically accurate. That is not a coincidence as to how Donovan went on to be successful with his story that we are going to be getting into. I thought that was hilarious. They were about $1,880.37 cents a month, give or take two cents on either side. So, you got this property, which I mean most people listening to this would be salivating in just the thought of these numbers. Maybe I should ask, were they in good neighborhoods? This just seems a little too good to be true even in 2019.

Donovan:
You probably have to change your definition of good, but I thought it was reasonable. The location was good. It was 15 minutes south of downtown. It was close to the medical center. It was still in an early gentrifying area, but because I was living by myself, I was willing to suck it up to be honest with you.

David:
There you go, so realtor speak, up and coming neighborhood. All right. You mentioned a program that you used to buy the house. Can you tell us more about that?

Donovan:
I think it was called the Affordable Home Loan or the Freedom Home Advantage Loan. The purpose of it was 0% down up to two units as long as you bought in a LMI tract or a low to moderate income tract. So, that was another… one of the reasons why I had to buy in maybe an up and coming area. It’s because I really wanted that 0% down.

David:
Smart. How did you find the lender that had that loan program?

Donovan:
I actually was about to go under contract on another deal on the listing. They were pitching, “Hey, buy this duplex with 0% down,” and so I found it through a previous listing, and then just took that same lender to this new construction duplex.

Rob:
Makes sense. So, you put 0% down on your first deal. Obviously, that’s more so because you’re actually living in it, and it’s available to that first time home buyer is my guess. But how did you scale your business after the first deal? Because I imagine you started to probably be in need of capital to start buying more properties, right?

Donovan:
Exactly. Yeah, and I didn’t have any capital. That $3,000 I brought to closing was 60% of my liquid net worth, so it was all tied up in that. So, I was able to raise money from investors to go on to build new construction, because I didn’t have any capital myself at the time.

David:
Bro, did you just calculate 60% of $3,000 in your head while doing this podcast?

Donovan:
I like 5,000 liquid, and so I brought 3,000 to closing. I think that’s 60%.

David:
It’s a round number. That is 60%. I just still think this is hilarious that you pay attention to this much detail. I don’t know why we say the devil is in the details, because the success is in the details. You don’t think about success when you think about the devil, but this is great. All right, today’s guest, Donovan got started with $3,000 and a little bit of other people’s money, but how did he scale from there? We’ll hear about that and how he continue to find funding and the smart way that he structured his deals right after this break.

Rob:
Welcome back. We’re here with Donovan Adesoro who said no housing inventory, no problem, and literally started building his own duplexes.

David:
All right, so now, this first deal worked, but you had no money. We got no food. We got no booze. Our pets’ heads are falling off, and you’re still able to pull this thing off by pulling all the strings. How did you scale after that without having cash?

Donovan:
It was a combination of just leveraging social media to be honest with you. So, I leveraged social media on the investor front to find partners who could bring the capital, and then I also leveraged it on the front to connect with wholesalers and realtors to send me their off-market land deals, because I still was working my full-time job at this point, so I didn’t have time or money to spend on marketing. So, that’s how I leveraged social media in those two ways.

Rob:
All right. A lot of people come on the show, and they say, “Hey, I use social media, and I think conceptually, we understand that the power of social media can actually help you get those lenders or those partners or private money partners.” Could you just give us a tangible example of something you did that actually resulted in some level of result?

Donovan:
Absolutely. One of the first investors I got, I think he was my second investor. I was in the real estate rookie Facebook group, and I saw an investor comment about out-of-state investing. They were just asking some general question, and I would specifically target out-of-state investors posting. I would say, “Hey, would you like to partner on a duplex in Houston? I’ll be your boots on the ground.” Now, again, I’m oversimplifying it. I got rejected probably 30, 40 times before this, but eventually found an investor who was like, “Hey, I’m interested in that. I’m willing to partner with you.” That’s just one example.

David:
All right, Donovan, it sounds like you had this moment where the first duplex worked out, and you knew you were going all in on duplexes, which is not something I think I’ve heard a lot of other people say. Paint me a picture for what was going on mentally when it clicked, and you said, “No, I got a duplex. I want to get a fourplex, or I want to flip a house.” Most people experiment in the beginning with different elements. When did you say, “I’m going all in on this strategy?”

Donovan:
After I closed on that first house hack, I realized that it took me six months to do that, and there’s tons of other people like me in my shoes, early college graduates or mid-20s, early 30s, and they just couldn’t find anything. So, the first idea was, “Hey, I want to build fourplexes or triplexes,” which is what everyone looks for. The issue there is in the city of Houston, anything three units or greater is considered commercial, so you have to go through an entirely different commercial permitting department. It’s a bit confusing because we’re taught residential mortgages are for one to four units, which is true, but on the permitting side of things in construction, it’s been treated as commercial.
I was like, “Okay, I’m all in on duplexes,” because that’s the best and highest use of land I can get while still going through the residential permitting department, which is a lot quicker and cheaper.

Rob:
Now, you had the luxury of buying your first property. I think you said it was a new construction, right?

Donovan:
Correct.

Rob:
Okay, so you’ve never really understood the pain of buying an old creaky house. What was your strategy moving into the next set of properties?

Donovan:
It was definitely to continue on what was working. I had evaluated a couple flips, but I could just never get comfortable with the thinner margins. Even though I’ve done this a few times, I still make tons of mistakes, and so I like to have a good healthy margin of error, and with new construction, I felt like I had that, versus on the flips, the margins were just a bit too tight for my liking.

Rob:
So, as you moved on into your partnership, I think you said that you found someone social media. They fund it. Are they funding a brand new property? What type of property was this?

Donovan:
They’ll fund the land acquisition, so me and the partner will create a new LLC. We’ll split it 70/30, 60/40, give or take. They’ll put in the money for the land acquisition, as well as for the permitting fees. Then we’ll use that land as collateral for the construction loan so that we’re not coming out of pocket any additional capital. Then the lenders is funding all the construction.

Rob:
When you went into the idea of partnering with people, bringing on private moneylenders, was the strategy to basically build new construction duplexes or multifamily with them?

Donovan:
Exactly. So, I had my pitch deck, and it was specifically for a new construction duplex in this zip code. So, I got really granular with what I wanted, and I felt it made it easier for the partner to come along.

Rob:
There’s such a long payback though with new construction, because you have to permit it. You have to find the land. You have to actually do the construction. How was pitching that to investors that, “Hey, I’ve got this really cool opportunity, but there was a bit of a waiting period before we see tangible results?”

Donovan:
For some people, they were definitely turned off by it. Then for others, they were like, “Well, I can only make 8%, 10% in the stock market anyways. So if I’m waiting…” At the time, it’s about a year, give or take, four months for permitting and six months for construction, maybe another month or two to sell it. They were like, “20%, 30% is still better than what I can get in the stock market.” So, that’s how I compared it.

David:
Did you think, Donovan, about how much work you’re going to be taking on, because that 30% with what you’re doing is not the same as 30% in the stock market, right? This is significantly harder, and there’s more risk. How did you factor all that together to know this was the right move for you?

Donovan:
I don’t think I factored quite how much work it would be. I was like, “I can figure it out.” It’s that mindset I took, and once I got into it, I was like, “This is a lot of work for maybe little relative return compared to how passive the stock market is,” but my whole thing was I really want to get the experience so I can leverage that into bigger projects one day. So, for me, it wasn’t too much about the money. It was about making the investor happy, getting the experience, and hopefully parlaying that to something bigger one day.

David:
That’s brilliant. I’m glad you mentioned it, because you often see gurus post things like, “I’m getting 28% returns,” and so people compare that to 5% they could get on a CD in the bank. It looks better, but they’re not mentioning the risk they’re taking, the headache they’re taking, the work they’re taking, and the fact that sometimes you lose money on a deal too, and if you add that into the 28% return, it factors down to be much lower, but what you hit is really important. I’m learning something. I’m gaining skills. I’m learning how construction works, permitting works, engineering works. Tell me a little bit about some of the skills that you’ve built since you started with construction, particularly what it’s like working with architects, ways that you found to save money that maybe somebody else doesn’t know.

Donovan:
One of the things I like to do with the architect that I figured a little bit early on was to optimize the square footage a little bit. Most people, most buyers when they’re looking at a property, they’re primarily focused on the beds and bath, right? So, whether a house is three bed, two bath, 1,900 square feet versus three bed, two bath, 1,800 square feet. In the buyer’s mind, generally, they don’t really notice that 100-square-foot difference. To me, that’s huge because if it costs me, I don’t know, $120 a square foot to build, that’s $12,000 I can save, and still probably get pretty close to that similar comp that sold that was 100 square feet bigger. Because the delta on the square footage is not too large, the appraiser usually isn’t going to take too big of a haircut on you.
That’s one of the things I did was optimize the square footage to be 100, 150 square foot less than some of my comparing properties that I was looking to compete against.

David:
What you’re saying is you may have had a little bit less square feet, which would save you money on the building, but you made sure that the bedroom count, the bathroom count, the amenities, the type of kitchen, the materials that you’re using were the same or better maybe than your competition. So, an appraiser looking at two condos, one of them is 1,400 square feet. The other one’s 1,550. In their head, basically, that’s the same thing, but you’re spending less on the build.

Donovan:
Exactly. That goes straight to the bottom line.

Rob:
What do you mean by that? Can you explain that concept of going straight to the bottom line for people that may not be familiar with what that means?

Donovan:
Yeah, great point. In that example, saving $12,000 on construction, that goes straight to your profit. So, any money saved on construction is like a dollar earned almost in the sense of… It’s probably the same thing with the flip as well, right? Save money on the rehab, that goes straight to the profit generally as well. So, that’s what I meant.

David:
That concept works for haircuts as well, actually. I save money there.

Rob:
I think it’s a really overlooked thing to see the bottom line concept, because this is something we talk about with maximizing revenue in our portfolio where it’s so much easier to try to increase revenue on a property that’s already profitable, because every dollar that you increase revenue by goes straight to your bottom line, is an extra dollar of profit that you actually get to keep, versus going out and buying a new property or doing a new construction, and having to start all that work to start the whole process over, and try to be profitable there. It is just a very long-winded process, where I think trying to maximize from the get-go will make you the most money over time, which brings me to my next question.
Obviously, duplexes were your thing here, but did you ever go into the mindset of maybe trying a triplex or a quadplex? I’d imagine you’re already doing all the permitting. You already have the land. I’d imagine profitability is higher on those types of properties.

Donovan:
Yeah, we looked into it. Again, one of the big pieces was the difference in permitting. So, instead of going residential permitting, if you went a triplex or above, you would have to go through the commercial multifamily building department. Basically, that’s the same department as they evaluate 200-unit complexes. So, it just takes longer, probably double the time, give or take. It’s more expensive. The other thing too was as you build more units, you’re spending more on construction, which means you’re having to sell that at a higher price point. For example, if I built a triplex, I would probably have to sell it at 600, 700 plus. In Houston, the median is 350, so now I’m almost selling double the median.
In my opinion, I feel like there’s a smaller buyer pool for that as well. So, I was trying to keep in mind making sure it’s somewhat reasonable for a lot of first time home buyers as well.

Rob:
That point makes a lot of sense. Then if I’m hearing correctly from your first point, there’s a level of effort that goes into triplexes and quadplexes where the juice may not be worth the squeeze for you, because you found such a comfortable groove in the duplex world, right?

Donovan:
Exactly. Yeah, it would extend the timeline from 12 months to maybe 18 months, and so definitely impacts the returns a little bit from the investor point of view.

Rob:
Makes sense.

David:
All right, let’s talk about the construction process itself. Since at 27 years old, you’re managing entire ground-up constructions, which is incredible, and congrats to you. By the way, if you guys know anyone out there who’s saying, “I’m still young. I’m 27. I don’t have to take life serious.” We have a 27-year-old here who not only owns real estate, but is building it and selling it from the ground up. You are literally a real estate developer, so kudos to you, but I want to hear for those of us that have never including me, built something from the ground up, what’s the process like? Give me an overview of the steps, and then we’ll dig in on the details.

Donovan:
For sure. There’s probably five or so big ones basically. Like most things, you’re starting with the foundation, so you’re putting… In Houston, that’s generally a slab on grade, which is basically just concrete on top of the dirt, so pretty straightforward there. Then you’re going to frame the project with your lumber or however else you’re going to frame it. From there, you’re going to start on some of your rough ins, meaning your initial plumbing, initial electric, initial plumbing, electric and HVAC. Then from there, closing up the walls, putting the drywall up, and then that’s when you get into your finishes, so foundation, framing, rough ins, drywall. Then you’re finishing stuff like cabinets and tile and flooring, almost like a rehab at that point.

David:
All right. How long does it take from the point you start to the point where it’s finished and ready to be sold?

Donovan:
Generally, for me, it takes about five to six months from when we start and pour the foundation to when we’re finished. There’s people who are quicker, but my whole thing is my GC is a little bit slower, which is okay, because I get a pretty good price. So, it’s that balance of I want to make sure someone knows what they’re doing, but also needs to be affordable to where the project pencils out. So for me, about five, six months.

David:
All right. That is from the point that you said the foundation’s poured. What about getting the permits and getting the land developed? What’s that process look like for you?

Donovan:
Generally, that can be done in about three to four months, give or take, from when you first submit the plans to when you actually get the building permit and are ready to built.

Rob:
So in this entire process, talk about the funding a little bit. Obviously, you mentioned that you were working with investors. What’s the actual tangible loan product that you’re using to get this to the finish line?

Donovan:
We go to a construction lender. Sometimes it’s a bank. Sometimes it’s a hard moneylender fund that flip, where now they’re called upright. They provide hard money loans on construction, so you’re putting the land down as collateral, and then they’re giving you similar numbers to a flip, where they’re looking at 70% of ARV, and giving you and loaning construction amount based on that.

Rob:
When you say that you’re using the land as collateral, that basically means if you pay $50,000 for a piece of land, you’re buying that part cash. Then you’re going to the bank, and then you’re saying, “Hey, I’ve got this land that I own free and clear. You can take this away from me if I don’t perform on the loan?”

Donovan:
Exactly. Almost act as the down payment basically.

Rob:
Perfect. I think this is a very underutilized loan product. Just new constructions are really, really great. I tell people all the time that it is one of those things where you’re going to get the best return, in my opinion. You just have to wait for it, but I like this process so much more because you get a brand new shiny house. You don’t have to worry about all the maintenance and CapEx right at the very beginning of it. You have some time to build up to it. So, tell us a little bit. You finished this project. How do the numbers actually work out? What do you build it for? What do you sell it for? Run us through some of that.

Donovan:
For sure. One of the more recent ones, we probably buy the land for 70, 75,000. We pay that in cash. We’re getting a construction loan for about 200, give or take, and we’re selling them at 370, 375.

Rob:
So, does that put your all in around 270?

Donovan:
I’d say with permitting and closing costs, maybe it’s 285, 290-ish.

Rob:
You said you’re selling these for how much, 375?

Donovan:
375, yeah.

Rob:
Wow. Okay, cool. So, close to a six figure spread on that, but 80 to 100,000?

Donovan:
Yeah, and then the investment in that scenario is about the land plus 10,000. So, say they put in 80, we’re technically taking home 80 again before the profit split between me and the investor.

Rob:
Tell us about that. So, you work it out with your investor. From a partnership or equity standpoint, are you basically 50/50 on that, or how do you structure that?

Donovan:
I think on the initial Rookie show, I mentioned I was giving 70, 75% of the profit away. Now that I’ve done it a little bit more, it’s a little bit more favorable. So, what I have now is a preferred return for the investor. Meaning if they put in 70,000, I’m paying them 15% on their money upfront. Then they additionally get 20% of the profits as well.

Rob:
That’s interesting. That’s a really interesting way to do that. That’s a pretty high preference investor, but it makes sense. You’ve got the results. I feel like you could probably negotiate that down a little bit at this point. But that does get me into my next question here, which is you were doing this in the midst of a tough market. I’m sure you’re having to pitch this and prove yourself to investors. How did you even make sure that this specific niche in the real estate business would be so profitable? We’ll get into that and what Donovan is doing differently in current market conditions after the break.

David:
Welcome back, everybody. Rob and I are here with Donovan Adesoro, and he’s breaking down how he’s turning 80 to $100,000 of profit on the duplex is that he’s building in Houston, Texas.

Rob:
You were doing this in the midst of a tough market. I’m sure you’re having to pitch this and prove yourself to investors. How did you even make sure that this specific niche in the real estate business would be so profitable?

Donovan:
I guess going in, it was more of a… I felt very confident in the numbers, because I had the construction numbers. Then I had the land numbers, which were obviously that’s what we paid for it, and I was comparing it to the duplex that I bought. So, because I know the duplex that I bought was 275, I know that’s what the end value would be. Back in those days, you could be all in at 200 or 180. So, I’m not sure if I knew or insured. I guess, I felt comfortable enough that it was a worthwhile risk.

David:
All right, so give me an overview of your all-in costs of everything that goes into your typical duplex, what they sell for, and then how much of that is leftovers profit?

Donovan:
I would say we buy the land for 70,000. We have on our contract right now for 67, we’ll just call it 70, 70,000 for the land.

David:
It’s a big step for you, by the way, buddy, to round from 67 to 70. I see that you’re adapting here on this podcast.

Donovan:
I’m trying to make sure the less details. The construction is 190 with closing costs, added another 10 for interest and whatnot, so call it 200, 270 right now, permitting and impact fees, another five, give or take, so 275. Then we’ll throw on 10 for, I don’t know, contingency budget sometimes, so 285. Then 375 is what we sell it for before commission. I typically… I’m a realtor as well, so I’ll usually save the 3%, and we’re just paying 3% to the buyer, 375 minus the 3%. I then minus the 285 all-in would be, give or take, what the net profit would be.

David:
So, you’re at 365 minus the 285. What’s 65 plus 15? By $80,000 profit. Then you’re going to have short-term capital gains on that.

Donovan:
Correct. Unfortunately.

David:
Any way you figured out how to get around those capital gains, reinvesting the money, anything creative?

Donovan:
Nothing at the moment will be done. So on seven of the duplexes so far, we refinanced them, and so we’ve kept them for a year. Then there’s two that we… Once we’ve crossed that year mark, we go ahead and sell.

David:
Long-term capital gain’s a lot cheaper. Then are you 1031-ing when you sell, or just paying the taxes on the long-term capital gains?

Donovan:
The original plan was 1031, but now with the… We wanted to 1031 into a 12-unit or something like that, or slightly larger apartment building. The market in Houston’s tough on those right now. It’s just tough to make in pencil, so we just pay the taxes on those.

David:
My advice is you 1031 into one of Robuilt’s projects here. He’s always a little mad scientist behind the scenes putting together. He’s got a land with a host of porta-potties in the middle of nowhere that people will travel out there just to use them. He builds tiny home communities in the trees where he rents them out to forest elves, all kinds of creative stuff that Rob’s always coming up with. His dream is to visit the world’s largest potato, and stay the night there to put on his bucket list.

Rob:
I’ve recently launched a bachelorette pad called the Pink Pickles, so always brewing up weird ideas over here.

David:
There you go. So if you’re that type of clientele, DM Rob. Now, I want to know about your clientele, Donovan. Who are the people that you are building for, and who’s buying your properties?

Donovan:
Most of the people I’m selling to at this point are young professionals in a similar position as me. Either they’re a nurse or engineer, but somewhere in that 25 to 35 range, and this is usually their first home. On my Instagram, I try to talk about the benefits of house hacking, and so that’s where I get a lot of the buyer flow from.

David:
All right, and then give me the avatar of what the buyer who buys your properties is like. Are these young married couples buying their first properties? Are these investors who have already got a portfolio looking to scale? Who’s picking these things up?

Donovan:
Usually, a young single person generally, typically no kids, working professional, graduated school four or five years ago, looking to buy their first home, and no longer rent in the nice apartment downtown.

David:
So, they’re a house hacker mostly.

Donovan:
Exactly.

David:
Then how many of these duplexes have you kept, and how many of them have you sold? Do you have a ratio of what you’re trying to hit?

Donovan:
It’s more of depending on rates. We would love to keep more. We’ve kept seven of the… I guess we just about finished number 25 now, so yeah.

David:
Drives you nuts. That’s a harder number to do the math in your head. Seven doesn’t go into 25 really easy. I could read your brain as you were like, “Oh god, I hit the 60% number earlier so good. I’m going to ruin my reputation here at the end.”

Donovan:
Yeah, I need a calculator.

Rob:
Donovan, obviously, you have a really impressive portfolio. You’ve done a lot. You’re young. I don’t even know what you’re going to do by the time you’re 30, but obviously you’re crushing it. One thing I do want to ask though, because I think a lot of people, they’re seeing many of us who had success in the last five years, and things have changed a little bit. So, can you tell us a little bit how things are changing for your business now? Have you pivoted? What are the numbers looking like in 2024 as opposed to when you got started?

Donovan:
When I got started, pretty much, you buy any single lot in the area where I’m building, and you threw a duplex on it, it would sell. Didn’t matter what it looked like. It could be the most hideous things. I’ve seen a few. I’m no artist myself by any means, but there’s been some rough ones. So, design wasn’t a factor when rates were at zero, basically. Now, design’s a big factor, and land prices have caught up as well. So, one of the things I’m doing to be a little bit more creative is buying slightly larger parcels, and instead of only fitting one duplex, there’s some I have now where I can fit three duplexes. There’s a new ordinance that came out in Houston called Livable Places where I’m now doing a duplex in ADU, where I can get a defacto triplex while still going under the residential permitting code. So, those are some of the things I’m doing to make sure.

Rob:
Now, going into the triplex world, well triplex-ish, pseudo triplex with the duplex and ADU accessory dwelling unit, how would do those numbers look compared to a conventional duplex build? Is it more profitable, or is it just a wash now with the way rates are?

Donovan:
I expect it to be more profitable. This will be, I think, one of the first ones in Houston that I’m aware of. So, we’re very, I guess, conservative on the exit value. But to give you the numbers on that, the duplex and ADU, we’re doing a slightly larger duplex, so it should cost about 220 just for the duplex, and another 70 for the ADU, so like 290 construction. The land is 70, so 340, all in 350, 360, plus permanent cost, call it 380, but we’re expecting to sell at 550, a little bit larger spread, we think, because there are some just standalone duplexes selling for 550 themselves. So, we feel good about getting duplex and ADU to sell at 550.

Rob:
Interesting. One thing that stuck out to me is that you said that you’re building these duplexes now to be a little bigger when your initial strategy was to go a little smaller. Why the change these days?

Donovan:
We’ve seen that the two-twos is what I did previously, and I still do those now and then. A lot of the house hackers are looking for a three-bedroom unit just because it’s easier to rent out from their point of view. So, we’re doing probably a little bit less two-twos, and a little bit more three-twos as we see the demand for those increasing.

Rob:
Cool. Final question for me, because you’re good at raising money, you’re good at what you do. When you’re going out and pitching investors, how is that process these days compared to a few years ago? Is it still an easy sell for you, or do you have to work a little harder to get some of these private moneylenders involved? How’s that going?

Donovan:
I think it’s going well just because I’ve been, I guess, talking about my progress on Twitter specifically for the last couple years. The people who are maybe hesitant at first now I’ve seen like, “Okay, at least he’s done a few.” Then I explain to them now how my underwriting is a little bit more conservative, and I’m forecasting lower exit values, so just explaining my mindset. I think it’s still… My issue now is more not enough deals. Have the capital ready to go, just don’t have the deals.

David:
Ain’t that something? You don’t remember this, because you were just a twinkle in your father’s eye, but back in 2010, everybody had deals. Nobody had money, and they all complained about the fact that you couldn’t take them down. Then there was a point where there was an even amount of deals and an even amount of money, a nice little equilibrium if you will, but we couldn’t find a contractor to do any of the work. Now, there’s contractors that are looking to do work, and there’s money everywhere, but we have no deals, and that is how real estate works. It is always bouncing around with some form of unevenness, and you, Donovan, have figured out how to take advantage of one of those opportunities by building stuff from the ground-up.
If you can’t find a deal, build a deal. Maybe that’s how you could market yourself on Twitter. Instead of build a bear, you could be the build a deal guy, which is another question. Should I be posting on Twitter? I don’t think that I’ve ever done it. I never quite figured out how Twitter worked. What’s your thoughts on that?

Donovan:
Yeah, I think so. There’s, I’d say, a growing real estate community on there for sure. A lot of them are in commercials. There’s probably less residential, but I think I’ve learned a ton from being on there. I’d say a lot of private moneylenders are on there as well.

David:
Robert, do you have a tweet presence, a Twitter presence?

Rob:
I do. Well, sorry, I have a small following there mostly from people like Cody Sanchez tagging me, or random people, so I don’t curate the content, but I would like to. Maybe you and I could keep each other accountable. We can tweet each other.

David:
Yeah, there’s a situationship. What’s a Twitter relationship called? A twitch and ship?

Donovan:
Checks out.

David:
Very nice. Donovan, if people want to hear you on other shows, I understand you’ve done a different BiggerPockets recording. Do you happen to know the show number on that one?

Donovan:
I believe it’s 123 for Real Estate Rookie.

David:
I believe if you say it’s 123, I feel pretty confident that that is accurate based on everything that we’ve seen about you. Thanks for being on the show, man. This has been awesome, and big congratulations to you for making the moves that you’re doing, and not looking for the easy way around it. Man, I can’t tell you how frustrated I get when people come along and say something like, “David, every opportunity in real estate is hard. Where’s the easy one?” As opposed to you that said, “All right, it’s hard. I’m going to do it.” Maybe it was a blessing you didn’t know how hard it would be, because it might’ve stopped you from doing it. But now that you’re in there, you’re lifting the real estate weights. You’re getting real estate strength, and it is definitely going to pay dividends later in your career.
If I could buy stock in you right now, I would. So, let me know before you have that IPO, and I would definitely be one of your first investors. Rob, anything you want to say before we get out of here?

Rob:
I’m really excited to have you back on the show, Donovan, because what you have accomplished really in the last couple of years is insane. So, let’s have you back in a year, and see what the progress update is.

Donovan:
Let’s do it. Thank you guys so much.

David:
All right. If you want to know more about Donovan, his info is in the show notes as well as Rob and mine, so make sure you check that out after you’re done listening to this. Also, if you like the show, please go give us a five star review wherever you listen to podcasts. Those help us out a ton. If you’re listening to this on YouTube, you see how good-looking Rob is, how handsome Donovan is, and how… Well, I’m also here. This is David Greene for Rob, the perfect, prettiest, pink pickle, Abasolo signing off.

RXR Realty CEO Scott Rechler joins ‘Squawk on the Street’ to discuss why Rechler’s been so outspoken about troubles in the commercial real estate sector, if it’s too early to put capital to work in real estate, and more.

David:
This is the BiggerPockets Podcast Show 886. What’s going on everyone? Welcome to the BiggerPockets Podcast. I am your host, David Greene, joined today by Henry Washington and Dave Meyer. Gentlemen, what’s going on?

Henry:
Hey, hey, what’s going on, David? So when I record with both of you, is it like, “Who’s David and who’s Dave?”

Dave:
I’m Mr. Meyer. Please, call me Mr. Meyer for the rest of the episode.

Henry:
Well, I won’t be doing that, but we do have a great episode for you today. And you know when Dave Meyer is here that we’re going to be talking something about data or numbers or economics or foreign policy or something else nerdy.

Dave:
I feel like I’m getting typecast a little bit, like there’s this always that actor who’s always the really boring, weird uncle or something like that. I’m just only always, even in my private life, just talking about economics all the time.

David:
That is you, Dave. But see, that’s not fair because you’re actually a very cool guy, and we’re going to be picking your brain as we do a show about how to pick a market.

Dave:
Yeah, well, I guess some of the typecasting is fair. I do do this for a living, so I think that’s fair. But I am also a real estate investor, so I will take some credit there. But we are going to be talking about one of my favorite topics, something I spend a lot of time doing, which is figuring out what markets work for what strategies, and we’re going to jump into that today. And actually for this episode, I created something cool. It’s the first time we’ve ever done this, but I created a little worksheet that you can use to follow along. You can just go to biggerpockets.com/resources and get it for free. And it has all sorts of different market research tips, like what data you should be looking at and little areas where you can write it down and keep track of it. So, if you want to do that either while you’re listening or later, go get that for free at biggerpockets.com/resources.

David:
All right, make sure you check that out and let’s get into the show. All right, Dave, the first book that I wrote for BiggerPockets was called Long-Distance Real Estate Investing. So I frequently get the question of, “David, how do I choose a market?” Now, the book focused on the systems that you need to buy real estate in any market, but I do briefly cover things that I look for in a market. What are some metrics that you think investors should be looking for when determining what market to invest in?

Dave:
So I think when you talk about picking a market, there’s actually three different steps. The first one, we probably won’t get into too much today, but that’s really just figuring out what your priorities are. Because as we’re going to talk about today, there are different kinds of markets that are good for appreciation, some are good for cashflow, some balance them. And so before you actually dig into data and start looking at numbers and stuff, you have to figure out what your objective is, and that’s going to help you figure out what markets are best for you. So that’s like the first step. The second step is what I call building a short list, which is going from all of the possible markets in the country to a list of maybe five, maybe 10 if you want to be really ambitious, because you obviously can’t research every market in depth.
And so I recommend you either use a list that we provide on BiggerPockets or talk to other investors about where they’re investing and come up with just a short list of 5 to 10 markets that you’re going to do a deep dive into. And then you can move on to step three, which is the market research and what we’re going to get into today. But once you get to that market research phase, I think that there’s two different areas you want to explore. First is what I would call market fundamentals, which is like the background information about the economy, about what’s generally happening in this area beyond just real estate. And then the second part is looking into real estate specific stuff, like how much prices are, what rent is, the rent-to-price ratio and all of that. So does that make sense as a framework for picking a market?

David:
Yeah. So we’re going to be getting into population growth and migration patterns. Median home prices, that’s a pretty big thing that you want to think about because price rent ratio was so important when looking for cash flow. Inventory available ’cause you don’t want to be in a market that’s too hot where you can’t even get anything, or at least you want to know that’s what you’re stepping into. The price rent ratio itself and unemployment rates, et cetera. All right, so first question, everyone wants to know where do we find this data?

Dave:
So let’s first talk about market fundamentals. This is like the macro economic type of stuff and I recommend people first and foremost start on an aggregator website. There are a lot of different websites out there, most of them are free. That will pull together just various government data and various public sources. The one I like the most is called FRED. It’s the Federal Reserve Bank of St. Louis. They aggregate tons of data. It’s completely for free, but there’s also various different census. There’s something called Census Reporter you can check out, and those will have all the information on a market specific level about population growth, job growth and all that.

Henry:
And I think people want to do this research and then get overwhelmed by what it takes to aggregate it. And hearing you say it is one thing, but what’s the learning curve or the necessary skillset one would need? Can anybody hop on this website and put together data in a way that makes sense and it’s fairly easy?

Dave:
Yeah, it is really actually quite easy, especially in some of these aggregator websites. If you go to Census Reporter, for example, you could just type in the name of a city and it’ll pull up stuff like the population growth, medium household growth, unemployment rate. And also the other way to do this is plug these questions either into Google or into ChatGPT. ChatGPT can easily grab a lot of this data for you. So, if you wanted to say like, “What is the home ownership rate in Philadelphia?” ChatGPT will be able to do that relatively easy for you. I think actually the harder part is just knowing what numbers to get and to organize it, which is why we put together that worksheet, by the way, which you can download, is because people hear me name seven different things and then they forget. So it’s helpful to just have a checklist and a place to write down the individual metrics that you find on the internet.

Henry:
And what do you think about resources that a lot of investors use to just research areas in their backyard, like bestplaces.net? Do you find that that has accurate data? ‘Cause some of that already comes a little bit aggregated and you could just put in a couple of cities, and it’ll give you some of that information.

Dave:
Totally. Yeah. A lot of those websites are good. I don’t know, I’ve been on Best Places. I don’t know anything particular about their specific data, so I can’t comment on that. But those websites generally are pretty good. They’re all using basically the same data. And so, if you find a UI, like an interface, that you find easy to use and easily to interpret, use that. And there are a lot of good places where you can do that kind of thing. Just like Henry’s saying, personally, I like finding the source of the data, one, because then it’s more accurate if you can find the primary source. And the second thing is, I like to make my own comparisons. So I think it’s easier for me if I go on the FRED website, I can say, “What’s the unemployment rate in Dallas compared to San Antonio?” And I can see them on one chart when I’m trying to compare two markets.

Henry:
And the last thing I’ll add to this conversation in terms of research tools is, most large language model AIs have access to the internet. And you can very simply ask a question to AI about these metrics, “Give me a comparison of population growth in XYZ City versus ABC City.” And usually you can get pretty good results just from a quick AI search.

Dave:
That’s a hundred percent right. And I think that’s true for the stats and also some of the more subjective things. So within market fundamentals, we talked about population growth, household income, those are important, but sometimes one of the ones that’s harder sometimes is what are the biggest industries or what are the biggest employers in a city? So asking ChatGPT or something like that, that question can be really helpful. Or what are the best public schools in the Dallas metro area? Is a good question to ask a large language model. And one of the ones I like the most is, this is ambiguous, but is a metric I personally care a lot about when I look at markets, is what is the regulatory environment like? Are there any landlord tenant relationships or laws that I should know about? Are there any bans or restrictions on short-term rentals that I should know about? ChatGPT does a pretty good job identifying those things.

David:
Or what is their history of exercising eminent domain, which was never a thing I had to think about, but our buddy Henry here is dealing with a hostile takeover for the city of one of his own rentals. Apparently, that’s something that you got to think about. It’s coming from every angle.

Henry:
All right. Now, that we know what to look at and where to find the data, how do you use that information to make smart real estate decisions? And what is the most commonly overlooked risk factor you should avoid in a market? We’ll get into that after the break.

David:
And welcome back everybody. Henry Washington and I are here with Dave Meyer, the data nerd himself, and we’re talking about how to choose a market in 2024. All right, Dave, I think one of the issues that new investors get wrong is they ask the wrong question. Typically people will say, “Where will I get the most cash flow or where are the cheapest properties?” Because that can sometimes go hand in hand, at least it can on a spreadsheet, but it doesn’t always work out that way in practice. I prefer to ask questions of, how population and migration are playing a role in that individual market? What do you think about that strategy? How much should investors be looking at where people and jobs are moving?

Dave:
Ultimately, market analysis comes down to the same thing everything in economics do, which is supply and demand. And so that’s ultimately what you’re trying to get to. When you look at population growth, when you look at job growth, when you look at median age, these are questions that impact supply and demand. And that’s why, I think Henry mentioned earlier, people get overwhelmed, but if you can remember that all of these metrics are really just trying to figure out how many people want houses and how many homes are going to be for sale, that’s really what you’re trying to understand because that’s going to determine the direction of home prices and it will also determine rent and vacancy rates and all of the things that we care about as real estate investors. And so one of the most fundamental elements of demand, which is half the equation, is how many people live in a particular city and which direction that’s going in?
I hope you all can understand that if you’re living in a city that is growing, demand is going to go up. For very likely, they’re obviously caveats. But if you are living in a market that is declining in terms of population or household formation, then you might see a softer real estate market. And so in softer real estate markets, you often see higher cashflow. And this is why there has historically been a trade-off between markets that offer great cashflow and markets that offer great appreciation because the supply and demand dynamics are different. Actually, one of the first projects I did when I started making content for BiggerPockets about this stuff was looking at the historical relationship between appreciation and cash on cash for the entire country.
And what I found is that the markets that have the best cashflow have the worst appreciation. And vice versa, the markets that have the best appreciation have the worst cashflow. Now there’s a lot in the middle that offer some appreciation and some cashflow, but the extremes are the outliers for appreciation are negative outliers for a cashflow. And so that’s why I think it’s really important what you said, David, is that if you want cashflow, that’s fine, but you have to understand that you’re making a trade-off. And that’s why market analysis is so important is because it is very rare to find an exceptional cashflow market that also has exceptional appreciation potential.

David:
Now, another thing to consider when we’re looking at what type of people and how many people are moving into an area and what the industry is, is that’s going to be the tenant pool that you’re choosing from. If you’ve got an area where you don’t really have anybody moving into it, the same people have lived there for generations and generations, there’s not a lot of economic opportunity, you’re definitely going to get a tenant with a different set of ambitions than maybe when you’ve got fresh blood moving in, people graduating college and moving into a city to take a job there versus the type of area where maybe someone moves to because they want to raise a family. How much of a factor do you think that should play in choosing the market? Because as an investor, the type of tenant we get is going to have a very big impact on the type of experience we have investing?

Dave:
Yeah, I think it’s within a market that’s really important. It’s hard to, I think, categorize entire markets that way because sometimes it’s like, if you go into a market that is really struggling economically, then yeah, I think that’s very important. I think for most markets there’s a trade-off. And you have to decide within that market, do you want to be in a class A neighborhood? Do you want to be in a class B neighborhood, a class C neighborhood? Because that will really impact how much rent you can command, what vacancy rates there are, and any potential for rent not being paid or anything like that. So I do think that’s super important. And generally speaking, my opinion is that, and this is opinion, this is not fact, but my opinion is that places where the economy is growing and is likely to continue to grow offer the least risk for real estate investors, that might not mean that they have the best possible upside, but if you are one of those people who wants to mitigate risk, looking for strong economic growth is a very good way to do that.

Henry:
Yeah, I agree with you from that perspective. Economic growth is huge because if you’ve got economic growth and population growth, I think you’re on the right track in terms of putting your money in a market where you think it would be safe. But there are a couple metrics that I look at, as well, that I’m interested to see what your thoughts on them are. We touched on them a little bit early on in the show, and that being inventory and vacancy. So vacancy can be looked at a couple of ways, right? So you can look at vacancy, if a market has a very low vacancy, what that suggests is that you’re probably going to get higher rents because there’s less properties to rent and you’re probably going to have maybe not less turnover, but the time to find a tenant should be shorter than in a market that has a higher vacancy. And if the vacancy’s higher, it’s the opposite, right? You’ll probably get lower rents, but I think the secret sauce is somewhere in the middle, right? Where’s your head on this?

Dave:
Yeah, that’s a really good point. I think it boils back down to what your objectives are as an investor. For me, I think that one of the key components when I look for a market personally is how quickly you’re going to be able to fill your units. Because I think people really obsess over how much rent they can get and raising those rents. But if you miss one month of rent, that’s probably going to eat up your annual rent increases and more. And so I’ve talked to a lot of people about this, it’s like you’re going to kick someone out and raise rent 50 bucks and get a month. If your rent is 1200 bucks raising it 50 bucks a month, it’s going to get you 600 bucks a year. But if you miss one month of rent because of that, you’re losing $1,200 a year.

David:
Two years behind.

Dave:
Yeah, exactly. So I think vacancy is one of the most overlooked things. And I just think it’s really important to get a good feel for the market for these things, ’cause you can be in a market where there’s high vacancy rates, but if you’re buying quality assets, then you’re still going to be able to lease it. I think where that really comes into play is when you’re buying low quality buildings, low quality apartments where if things start to soften up and there’s more vacancy, that generally pushes rents down everywhere. And that means tenants, they’re still going to live somewhere, but they’re going to take that opportunity usually to move up in terms of quality, and they’re going to go up to maybe from a C neighborhood to a B neighborhood. And that is one of the reasons why I personally don’t like buying rentals that are really ran down is because you are at the whim of the macro economy and if things turn poor, you’re probably going to be on the short end of the stick.

David:
Little throwback, quick tip for everybody here. Much better to put somebody in your unit at a cheaper rent, like Dave said, to cut down on the vacancy and then raise rents once they’re in there because it’s a massive inconvenience to have to pack up all your stuff and move somewhere else to save a hundred bucks a month when the rent goes up than it is to try to get the top rent in the very beginning when they could be picky, not move into your unit and move into somebody else’s that is cheaper. Learn where you have leverage and where you don’t. And no one to hold them and no one to fold them.
Now, this whole idea of price-to-rent ratio, or as you called rent to price, is a big thing that investors need to be aware of because typically as investors, we’re going to be buying for cash flow, or at least we want there to be some hope of cash flow when we’re buying a property. The BRRRR method isn’t a great method if you end up pulling all your money out of a house that’s bleeding money every single month. So the end goal is always to have something that cash flows. And if the price of the property gets to be too high, rents typically don’t keep up and you’re not going to get cash flow. So what are some percentages that an investor should be targeting in today’s market?

Dave:
So just so everyone knows, the rent-to-price ratio is basically just a way of comparing the price of a property to the amount of rent that you can generate from that property. And generally speaking, the higher the rent-to-price ratio, the better. Now, 10, 12 years ago right after the great recession, there was something called the 1% rule that came out that said that to get a good cash selling property, you need to have a rent-to-price ratio over 1%. Now, there are still deals and there are still markets that offer 1% rule, but I think it is better and healthier for investors to recognize that that was actually a very unique time, not that it’s the normal one.
But 1% rule and being able to find markets who are 1% rule is very rare historically. And so we’re in an era where the average rent-to-price ratio across the country is closer to 0.6%. And so if you think about it that way, and you look at a market where it’s 0.7% or 0.8%, that is above average cash flow potential for a market. And I think what’s really important here is when I’m talking about a market at an average, if I’m saying that the average in Detroit is 0.8%, then that means by rule that there are deals that are better than 0.8% and there are deals that are worse than 0.8%. That’s how averages work.
And so that means your job as the investor is to go find the deal that is better than 0.8% so you can find the ones that are cash flowing better than the others. So that’s generally how I advise people is go look for markets where it has above average cash flow potential. So you’re not going to be looking at Los Angeles or New York City or something like that, but if you can find a place where the average for the whole metro area is like 0.6% or 0.7%, there are going to be pockets in that market that offer cash flow and you as the investor, your job is to go find them.

David:
Now, here’s some ways that you can make the price-to-rent ratio metric work in your favor. It’s not always about picking the cheapest market. Let’s say you find a market where homes are priced higher than the median home price across the country, maybe they’re 500, $600,000 houses where you’re not very likely to get close to the 1% rule. You’re not going to be buying a $500,000 house that rents for $5,000 a month, at least not as a single family home. But what if that property has a basement and an ADU, and you have three income streams that you can bring in that all add up to being close to $5,000 a month? You’ve now found a property that gets close to the price-to-rent ratio that you’re looking for that is also in the better neighborhood where you’re also going to get more appreciation and better tenants.
The same thing applies to small multifamily. Maybe it’s a triplex or a fourplex. You’ve got more to rent, or the people that take advantage of the rent by the room strategy. So if you just rented the house out on its own, maybe it gets $2,200 a month, but if you can find a property with six bedrooms and you can rent all of them out for $700, now you’re at $4,200 a month, which is significantly more. This is how investors that are savvy figure out how to use metrics like the price-to-rent ratio and make them work as opposed to just doing what worked in 2012, which was look at all the houses that were out there, 80% of them had a price and rent ratio that was favorable and making it work.

Henry:
Yep, I 100% agree, David. I 100% agree, David. I often tell people, if you can’t find the deal in your market, there is likely an opportunity where you can make a deal in your market. And so looking at rent by the room, looking at midterm rental strategies, looking at ADU strategies is a great way. Another thing you could potentially do is take your existing home and make it a multifamily. There are easy ways to make a single family a multifamily. Now, obviously you need to make sure that your zoning laws in your area are going to allow for it.
But there are ways you can take a three bed, two bath, single family home in an expensive market and make it a duplex that has a one bedroom studio on one side and a two bed, one bath house on the other, especially if it’s a split wing house where the primary bedroom is on one side of the house and then the other two bedrooms and living room and bathroom are on the other side of the house because then you can just close off the primary bedroom, add a one wall kitchen in there, you’ve already got plumbing, you’ve got water access, and so you can take a single and make a duplex.
Now, I know it sounds easier right now than it probably is, but it’s just as easy as calling down to the local city or municipality that that property is in and making sure a, that it’s zoned properly and getting some quotes from a contractor on being able to do the work. And you can essentially take something that might cost you $500,000 and then another $20,000 to $50,000 in renovations and now you can get the rent that would put this above or at the 1% rule.

David:
Awesome. Dave, Henry, we’ve covered some valuable info so far, like population trends to look at and how to think about the rent-to-price ratio. But we are about to get into one of the most crucial questions on investors’ minds today, how do you assess a market for cashflow versus appreciation? Stick with us. We’ll be right back after this quick break.

Henry:
Welcome back everybody. Dave Meyer is here schooling us all on how to choose a market in 2024.

David:
All right. Now, speaking about cashflow, let’s walk into the age old debate, the hornet’s nest of the BiggerPockets forums where everybody gets so worked up. Should investors be looking for cashflow or appreciation because the market you choose are is typically going to be suited to one more than the other. Henry, I’m going to throw this one to you first. What is your philosophy on which is better or which type of investors should be starting with which strategy?

Henry:
Man, I’m going to give the political answer, right? It goes back to what Dave was saying in the beginning of the show. You have to understand what your goals are. What are you trying to accomplish? What I may be trying to accomplish is different than what a brand new investor may be trying to accomplish. And if that brand new investor is, if their goal is, “I need to generate enough monthly income, so that I can leave my job, so that I can go do this other thing that I have a passion for doing,” well, then that sounds like you’re going to need some cashflow. And so you might want to focus on a more cashflow intensive market.
If your goal is maybe somebody like Dave who’s like, “Look, I love my job. I make a great salary. I enjoy real estate, I don’t necessarily need to make thousands of dollars a month off of my cashflow. What I need is to build long-term wealth through equity and appreciation, and get the tax benefits that come with owning rental properties to offset not just my rental property income, but my W-2 income because W-2 earners are one of the highest taxed people on the planet.” So that’s a completely different strategy, which would say investing in a more appreciation-friendly market would make sense. So that’s my general thoughts.

Dave:
I agree with Henry because, I mean, I basically wrote an entire book and took two years of my life trying to answer this question once and for all, which is that you need to think about your own personal strategy before anyone can answer this for you. So I’ll just say that, like Henry said, there are different approaches for different people. I’ll give you a couple of examples. I think most people who are earlier in their investing career should wait appreciation higher than cashflow. If you don’t intend to retire for 10 or 20 years, then you probably don’t need as much cashflow and appreciation gives you an opportunity to take some bigger swings and try and make some more wealth. And as you approach retirement, whether that’s early retirement or traditional retirement age, it probably makes sense to shift your focus more towards cashflow. So I think that’s just a general rule of thumb.
My personal approach is to look for properties that at least break even. I don’t want to come out of pocket, if it does a month or two, I don’t really care, but I look for a minimal cash on cash return. It doesn’t have to be great. That’s not what I’m doing for, but I want to get a property that will sustain itself in an area that is likely to appreciate and that has some value add opportunity like Henry was talking about. If I can buy something that off the shelf, breaks even, and then if I make improvements to the property, then it gets me a seven, eight, 9% cash on cash return, that to me is a winning strategy.

David:
All right. Now, certain markets are going to be more favorable for cashflow, others are going to be better for appreciation. What are some of the fundamentals that each of you think an investor should be noticing in choosing a market that would lead them to believe, “Hey, this is more likely to have properties that are going to be worth more in the future and this is a property that’s more likely to have a higher volume of cash flowing properties”?

Dave:
So in the beginning I said that my market research, basically I break it down into two different areas. One is market fundamentals, one is housing market data. I think for cash flow, it really comes down to housing market data. If you want to know cash flow, it’s like how much rent can you charge? What is the price of the house? What are your property taxes? What are your insurance? It’s really just straight math. The reason that appreciation is hard to predict is ’cause it’s not objective like cash flow. It’s just a little bit more subjective. And I think that’s why you need to also be looking at these market fundamentals. You want to look at long-term trends like, one, how many people are moving to the area? How well paid are those people? How many houses are being built in those areas? Because again, property appreciation sounds crazy. It just comes down to supply and demand. So if you can figure out shortcuts to measuring supply, measuring demand, that’s going to give you a good indication of which markets are going to appreciate the most.

David:
Henry, what about you?

Henry:
Yeah, for me, if I’m looking for cash flow, then what I’m going to look for is a market where the average rents are higher maybe than the national average or are going up at a higher rate. And then I’m going to look for if I can find a market that also has a median home price that’s at the average or lower than the average. So if I can see a market, it’s got high rents, but I can buy a house for lower than the national average, I’m going to just go out on a limb and say, “I’m probably going to get the cash flow that I’m looking for there.” And if I was looking for appreciation, I’m going to look, just like Dave said, I’m going to look more at the economics of that market and the population growth. So I’m going to look for a market that’s had population growth, positive population growth for at least the last five years.
And then if it’s got the population growth that I’m looking for, I’m then going to look at the economics. What is driving the jobs in that market? What industries? And I’m going to be looking for industries that are up and coming based on what’s happening in the world right now. So things that I would be looking for are fintech jobs, technology jobs in general, government jobs, and healthcare jobs because these industries aren’t going anywhere. They’re improving. Technology is improving them. And they’re high paying jobs typically. So, if I’ve got people moving into an area where there are new companies or companies that are hiring in technology positions and they’re paying a hefty wage, then you may be looking at a market that’s going to get you some appreciation over time.

David:
Right on. That’s a really good way to look at this. Some of the things that I look at when trying to figure out what are the strengths or weaknesses of a market, you can start with just median home price. If the homes are priced higher than the national average, that usually means that wages are going to be higher in that area, which means more people will want to buy homes, which means it’s not going to be a strong market for finding renters and it’s going to have a harder time getting cash flow. So the price of the home itself is one way that you can tell if it’s higher price, it’s probably going to be an appreciation market and if it’s lower price, it’s probably going to be closer to a cash flow market. Another thing to think about is the supply and demand dynamics here.
It’s really simple when you boil down and you understand the fundamentals. If the demand is growing but so is the supply, like let’s say that businesses all started to move into Topeka Kansas or something, they’ll just build more houses. So you’re never going to see a ton of appreciation in an area where they could just add supply. But if you find an area where jobs are moving into and you don’t have the ability to grow supply where it’s constricted, you are going to find that is a high appreciation market. Look at the highest appreciation markets the last decade or so, it’s been Austin, Texas, San Francisco, California, Seattle, Washington, Miami, Florida. All of these were cities that had a restricted amount of land where they could even build, but jobs move into there with high wages, which forced appreciation and made it not cash flow strong.
I think the mistake that investors make is they hear where everybody else is buying and then they just go, “Okay, I’m going to go by there.” And then like a bunch of locusts, they all settle on the same market and then you just hope that the fundamentals of that market were good. When you hear other people are buying somewhere, that should make you want to look into the market more and study it, not necessarily just piggyback onto what everybody else did. I’ve seen a lot of mistakes get made when people bought properties because it was the flavor of the month. Dave, Henry, any other tips that you can give for investors that are trying to figure out what market would work for them?

Henry:
Yeah, I think you touched on something pretty important there where you don’t want to rely on the research of someone else.

David:
Especially not me.

Henry:
I agree with you for the most part, but I think what was really essential there is that you said, “Hey, you can take their advice, and then that should trigger you to go do your own research.” Because along the lines of that, we do have to acknowledge there are large companies who have entire real estate teams, whose sole job it is to analyze these markets from a real estate perspective to determine if their company should go there. And so you can essentially follow the whales, but you’re right, it should trigger you to go and do your own research. And so I like doing things like looking at markets where there are minor league baseball teams. They do a lot of market dynamics to determine, are there people who want to live here who make enough to want to spend money on going to ball games?
And they typically put these teams in places where they feel like they’re going to be successful. And so if you find a company like that, who has demographics who might be that same demographic who’s going to rent your place, it is totally okay to piggyback off of where are they looking for properties, but that should trigger you to go dive in deeper and do your own research. Just because they’re moving there doesn’t mean you’re going to have success as a real estate investor. But even large companies do this. Even large companies don’t just, they say, “Hey, I hear so-and-so company is building a new place over here. Maybe we should dive into that market.” And then they do their own research from there.

David:
Dave, give us some advice for what an investor who says, “Tell me how to do my own research. What should I be doing? Where should I go? What should I be reading? And does BiggerPockets have anything that can help me out in this area?”

Dave:
Yeah, of course. So you should definitely check out this spreadsheet. We’ve talked about a lot of different things. It’s not a spreadsheet, it’s a worksheet. But we’ve talked about a lot of different metrics. And if you want them all just in a simple place where you can go and just go one by one and look at this, use ChatGPT, use Google, you can just get this completely for free. And I think the other thing is, we are going to be doing, stay tuned for this, it’s going to be in late February. I’m actually going to be doing a workshop on this, where I’m actually going to show people step-by-step, I’m going to screen share basically and show you how to do this thing one at a time.
But just with everything in real estate, the number one thing is just to start doing it. Go look up a couple of stats right now and see that it’s not that hard. If you sit around and wonder the perfect way to do it, you’re never going to make a lot of progress. But if you just start exploring a little bit, use your computer and Google, you’re going to be getting better at it all the time.

David:
All right, one last question before I get you two gentlemen out of here. Landlord-friendly states and laws. What are things that investors should look for or what are things that they should look to avoid? Dave, let’s start with you.

Dave:
I think, most of all, what landlord-friendly means is sort of subjective. So I think different people interpret certain laws as positive, some people interpret laws as negative. I just really think the most important thing is that you understand what you’re getting yourself into. So certain places might have restrictions on rent growth or might have really difficult evictions, stuff like that. Sometimes it’s really detrimental, sometimes it’s not so bad. But I really think you should spend some time either going to Arria, talking to your agent, or just looking on the local government website, the rules. I invest a lot in Denver and they have really good resources both for tenants and for landlords to look this stuff up, which I think is great. Tenants should know what they’re getting themselves into, in my opinion. and any property owner should know what they’re getting themselves into, and I think you can interpret for yourself what is landlord friendly and what is not. The more important thing is you know what you’re doing.

Henry:
I agree. I would look at this after you have figured out some of these other metrics and dynamics. If you’ve got it dialed down to two to three markets based on everything that we’ve talked about today, call a couple real estate attorneys in each of those markets and just ask them, “Hey, what’s it like when you have to do an eviction? What does it cost? How long does it take? Tell me the worst case scenario and then tell me the best case scenario.” And with that bit of information you will understand for yourself if that’s something you can stomach or not and how that might impact your financials if you had to actually evict somebody in those markets.

David:
Really good point. Here’s the last thing that I want to add, a little cherry on the top of this episode. When you make your decision based on states that have landlord-friendly laws, you’re making an entire investment strategy based off the worst case scenario in a real estate investment. When you’re dealing with a literal eviction, a tenant that won’t leave, remember that is different than a tenant that stops paying their rent and just leaves the place voluntarily. That sucks when that happens, but it’s not an eviction. Eviction is your worst case scenario. You’re planning your whole strategy around something you hope never happens, right?
It doesn’t happen a ton. So I try to invest in areas where I can be picky about my tenant and choose a tenant that has the most to lose. So if they lose their job, if they come across hard times, if something terrible happens and they send all of their money to some Nigerian prince or they get caught up in a crypto scam from one of the fake David Greene or Henry Washington profiles that are ripping people off, they just leave voluntarily because they don’t want to see their credit score destroyed by an eviction. You can avoid needing the laws to be in your favor by picking an area and a location in a neighborhood where people are going to have more to lose.
All right. That’s all I have to say on that topic and I had a great time with you two gentlemen today. Hopefully everybody learned more about how to choose the market to invest in so that they can start taking practical steps towards saving that down payment, finding the right property, and building that wealth today. If you’d like to know more about Henry Washington or Dave Meyer or myself, you can find our information in the show notes. So please do go look those up and give us a follow. And if you’d like to know more on this specific topic, my advice would be you check out the BiggerPockets forums where we have tons of questions on this very same thing with lots of information for you to check out. That being said, I’m going to let you guys get out of here. This is David Greene for Henry Washington and Dave “the Oscar” Meyer, signing off.

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

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

Common Tax Breaks for Real Estate Investors 

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

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

Property taxes 

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

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

Asset depreciation 

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

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

Insurance premiums 

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

Repairs 

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

Cleaning and maintenance 

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

Utilities 

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

Property managers 

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

Legal and professional fees 

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

Advertising 

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

Commissions and referrals 

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

Travel and transportation 

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

Office expenses 

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

Reporting rental income and expenses 

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

Final Thoughts

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

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

This article is presented by Steadily

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

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