March 2024

Ashley:
This is Real Estate Rookie, episode 377. We’re going to hear about losing $40,000 from a partnership and then talk about what are the things you need to consider when getting into a partnership. Then Tony also mentions which fast food napkins work best for contracts. I’m Ashley Kehr, and I am joined with my co-host, Tony J. Robinson.

Tony:
Welcome to the Real Estate Rookie podcast, where every week, three times a week, we bring you the inspiration, motivation, and stories you need to hear to kickstart your investing journey. We’ve got some great questions lined up for you today. We’re going to cover what to do when a tenant absolutely trashes your property, what a HELOC is, and how it impacts your credit score, but first, we’re being joined alive by someone from the Rookie audience who wants to ask a question to me and Ashley, and he’s coming live from Miami.

Ashley:
Miami-yami-yami.

Tony:
For those of you who don’t know, that’s the famous Will Smith song, and Ashley is dying to sing that one for the Rookie audience today.

Ashley:
Jerryian Francois, welcome to the Real Estate Rookie podcast on our reply episode. We are so excited to have you today to ask your question live with us, so welcome.

Jerryian:
Yes, glad for you guys to have me here. I’m super excited, guys.

Ashley:
Okay, well, what question do you want to throw at us today?

Jerryian:
Okay, well, hey, Tony and Ashley, I’ve had a partnership over the last few years and made many mistakes. There was no structured partnership roles, no defined percentages, and just a signed piece of McDonald napkin to validate our partnership.

Ashley:
Before you go any further, I just have to ask, what did it actually say on the napkin?

Jerryian:
It said that we’re going to be in business and everything from this point on would be 50/50. That’s just all they said.

Tony:
I think the first mistake, Jerryian, is that it was a McDonald’s napkin. You always got to go Chick-fil-A napkins instead. That’s my fast-food place of preference, but please, continue.

Jerryian:
In a result of that, I lost about almost over 40K. I learned a lot from the situation and I know I would need partnership to utilize, to scale. My question is, what should I look for, what traits, what experience, basically, what buy box, what I would need for me to step out into partnership again?

Tony:
I think you touched on a lot, and I’m sure Ash and I were probably thinking in the same direction here. You said, hey, we had no structured partnership role, no defined percentages. I think before you even go out and start looking for a partner, you’ve got to identify what exactly is it that you’re hoping this partnership can fulfill.

Jerryian:
Exactly.

Tony:
Because there’s different reasons that people will partner. When Ash talks about her first partnership, it was like, man, I’m just so scared to do this by myself, and I don’t have a whole lot of capital to go out and get this thing done. For me, it was like, hey, we’ve got the experience, we’ve the skillset. I’m super confident in making it happen. I just lost my day job so I couldn’t get approved for the mortgages. I even had capital set aside to put down. I just couldn’t get the mortgage approved anymore. It was like, you got to think about what are the different reasons you’re looking for that potential partnership, and that’s how you start to build out what those potential roles are.

Ashley:
While you’re in that identifying moment for yourself, identify what your strengths and weaknesses are, so what are you going to bring to the table, and then what do you need someone else to do? Or you maybe have no idea about rehab, construction and you want to bring someone on that has that kind of experience. Literally, sit down, write a list of what your strengths are, your weaknesses are, and then flip those for a potential partner. Another thing that I wanted to add is you could do a personality test too, like a DISC profile on someone. Do it for yourself and do it for somebody else, too. There’s also an Enneagram too, because having great communication with your partner, you’re going to learn how to actually communicate with them. Sometimes it’s not that anybody is a bad person or they’re not doing what you think or you don’t think they’re treating you right.
It’s literally just the way they communicate, and when you can understand what Enneagram someone is, it can help you understand the situation better, but also, learn how to communicate with them too. Then they can also learn how to communicate with you too. I think that’s getting to understand your partner, and Tony jokes about the love languages, but I think that’s also something to make you compatible with a partner too, is understanding how they show appreciation. That may not be showering them with chocolates and things like that, but that could be acts of service where they like, Jerryian, I know you appreciated me getting that deal under contract because you brought me lunch today. Like, thank you, I value you as a partner. Things like that.

Tony:
Just out of curiosity, Ash, I don’t know if we’ve ever talked about this, but do you know your DISC score where you score the highest?

Ashley:
Yeah, it is an I.

Tony:
Gotcha. I’m like a low I, I’m a super high C. Super high C and super high S, just like the structure.

Ashley:
The other three are kind of level with me.

Tony:
I think the only other thing I’d add as well, is you talked about the no structured percentage, Jerryian, I thought that’s a super important thing to try and figure out upfront as well. Before you guys go out and any money exchanges hands either between the two of you as partners or buying this property, whatever it may be, you should sit down and have as tough of a conversation as you can about, hey, what exactly is the structure of this partnership? What percentage do I get and what duties and responsibilities do I need to fulfill to obtain or to earn that percentage? What exactly are you partner going to be doing and what is your percentages for doing that? Then just start to think worst case scenarios, what happens if one of us wants out? What happens if one of us dies? What happens if one of us gets divorced? There are different questions you want to ask to try and identify how to structure this.

Ashley:
Jerryian, I want you to think of some of the things that went wrong in your partnership, and can you even think of different ways that you could have had more transparency as to what are some of the things that happened with your partner and maybe we can help you come up with ideas of how to prevent those things happening again by creating that transparency.

Jerryian:
Well, he was able to probably steal 40K from, because like Tony said, we didn’t have any structure on percentages, so he was always the type to be in control of the bank accounts and stuff in that nature. It was really tough for me to even be involved in the business because it was his way or no way. That situation kind of pushed me back a little bit with that.

Ashley:
I think that’s a great example of what Tony was just talking about is clearly defining your structure and your roles and responsibilities, having it in writing. Yes, one person can be in charge of the finances and everything like that, but I think that’s where having the transparency of any single time you could log into the bank account and look at it.

Jerryian:
Exactly.

Ashley:
For my business partners, I control all the bank of accounts, I manage the money, but they would all have the apps where they can look on their phone. I’m pretty sure one of them has never even logged in, but they can go in at any time and just look through what transactions are happening, but also, sitting down every month or every quarter and going through the financial statements too, as to you have the right to see what the financial statements are and if your partner isn’t giving them to you or there’s delays or things like that, that might start the red flag sooner so it doesn’t get to the point where it’s 40,000.

Jerryian:
Exactly.

Tony:
Jerryian, I think the biggest thing is to not let the, I don’t know, I guess the fear of another partnership going off the rails stop you from pursuing that in the future. Because you’ve got two options here, it’s either you learn the lesson that partnerships are terrible and they’re never worthwhile and you’re just never going to do them again. Or you can learn the lesson to say, hey, I know partnerships have a time and place to be effective and I just maybe didn’t go about it in the most effective way to begin with, and what are the lessons I can learn from there? What I like to tie the partnerships to, and Ash actually talked about the love languages, but I feel like there are some truths that apply to all different types of relationships, business, personal, whatever it may be. Are you married, Jerryian?

Jerryian:
I’m engaged.

Ashley:
Congratulations.

Tony:
Yeah, congratulations, brother.

Jerryian:
Thank you.

Tony:
When you think about your fiance and how your fiance maybe balances you out, what are some of those strengths that you feel your fiance brings to the relationship?

Jerryian:
She definitely keeps us organized, I could tell you that much. Just having everything easy and well-to-do, that’s her right there.

Tony:
You’re more maybe the big picture guy and she’s the detail person. Now you know when you go start looking for a partnership, you don’t want another big-picture person because no one is going to do anything. All those little details are going to slip through the cracks. It’s like, okay, can I find someone that compliments me in the same way that my fiance does?

Jerryian:
Yeah, exactly. I’m actually in partner with her now from leaving that situation, so I feel like I found the best partner now.

Tony:
There you go.

Ashley:
Because it is mutually beneficial because it’s one household and when you are partners with someone else, it could also be their spouse, their kids. You have two different families that you’re trying to support and each person is territorial towards their own family and they want the best of that. When you’re in one household, it definitely makes it a lot easier to know you’re loyal to each other in the business and that you’re trying to benefit each other.

Tony:
I just want to quickly share some ideas in terms of where to find that potential partnership, because obviously, you’ve partnered with your fiance, which like I said, I think is a great place if you and your significant other can go down that journey. It is fantastic. My wife and I have done that as well. For other people who maybe don’t have a significant other, spouse, fiance, whoever that they feel that they can partner with or maybe who’s interested in partnering, I think you’ve got to start to expand your network in ways that exposes you to different and new people. Going to local meetups is a fantastic place to spark some of those partnerships. Going to bigger conferences like BPCon, a great way to spark some of those relationships. Just being active in the BiggerPockets forums, the Real Estate Rookie Facebook group. Because you can start to build connections with people virtually now easier than ever before. I think the more people you can start talking to, the more connections you can make, the easier it becomes to start to identify, okay, who’s the right person for me to actually partner with?

Jerryian:
Yeah, I definitely agree with that, 100%.

Ashley:
Thank you, Jerryian. Before you leave, we actually want to see if you have another question, so start thinking of another question for us. We are going to take a short break and we’ll be back to answer that. If you, listening, are loving this format, love having Jerryian as our guest and you want to be a guest on a live episode of Real Estate Rookie, you can go to biggerpockets.com/reply to submit your question and maybe we’ll get to talk to you live on the show. We’ll be right back. Okay, we are back with Jerryian. Jerryian, do you have another question for us?

Jerryian:
Yeah, I have one question that I wrote for you guys.

Tony:
Yeah, please.

Jerryian:
How do you balance your short-term cash flow needs with your long-term wealth building in your investment?

Ashley:
Well, I can tell you how I started out doing it and how I do it versus now, I guess. Starting out, I was just 100% cash flow because I was thinking that I would have, even if I didn’t have appreciation in the property, that I would have debt pay down to build equity in the property. My long-term wealth was these properties, they cash-flowed now, but in the future, they’d be paid off because the tenants were paying the rent and that was my wealth builder. Now, I’ve built myself a comfortable cash flow standpoint, and now I’m a little more focused on appreciation because that’s going to give me even more wealth down the road. I still like to see some cash flow. I did recently buy a property that’s probably just going to literally break even, but it has a huge, huge potential for appreciation to sell it five years down the road.
One thing I’m trying to do is stagger things so that it’s just not all cash flow at once, but no appreciation, but in five years in this area, I know that I could sell this if I wanted to or refinance it and build wealth that way. Another thing too, is you can do 1031 exchanges and do the stack method where you’re maybe buying a single-family duplex now and then you’re just going to do a 1031 exchange where for tax purposes, you will sell the property and then purchase another one and not pay taxes on that gain of selling the property and you’re just rolling into bigger and bigger and bigger properties. James Dainard talks about this a lot. You can find him on YouTube on ProjectRE. He will describe how he does the stack method and that’s how he’s been able to build wealth is redoing the 1031 exchange, but just starting small and continue to build up, build up.

Tony:
I think for me, Jerryian, a lot of it comes down to how you would prioritize those goals, those motivations, because usually, people get into real estate investing either for cash flow, appreciation, tax benefits. Those are the three big buckets that drive people. If you know that today cash flow is what’s most important to you, like generating cash today, then I probably focus on activities that prioritize that. My thoughts on this have evolved over the last couple of years. It’s like, say I were starting from zero today, I would probably focus on something that’s a little bit more active income to begin with.
If my goal is to leave my job as fast as humanly possible, I would probably focus on things that are more active income, like flipping, wholesaling, property management you can scale relatively quickly. I consider that active income as well. Then once you get that business to a certain point where you can walk away from the day job, now you can start maybe putting some additional cash away to start buying assets. I think if I’m starting from zero, my biggest focus is cash flow, that’s probably the approach that I would take.

Jerryian:
Perfect. Love the answers, guys.

Ashley:
Hey, Jerryian, before you go though, I’m curious, what does your portfolio look like right now?

Jerryian:
Right now, I have two duplexes. One is with three units, and I’m actually house hacking one that I’m in right now.

Ashley:
Congratulations. That’s awesome. Next, we have to get you on for a full episode to tell us all about that.

Tony:
Yeah. Well, thank you for coming on, Jerryian.

Jerryian:
Thank you. I really appreciate the opportunity, you guys.

Tony:
Of course. You’re actually the very first person we’ve brought on for a live question during a Rookie show. You’re going to be hanging in the, yeah, you’re hanging banners in the Rookie Hall of Fame right now, man.

Ashley:
Well, Jerryian, thank you so much for joining us today. We really appreciated you taking the time to come on and ask your question. Hopefully, it was really beneficial to other Rookies to hear your experience and to have some answers for finding a partner. If you’d like to find more about building out a partnership, you can go to biggerpockets.com/partnerships to purchase Tony and I’s book called Real Estate Partnerships. If you’d like a discount on the book, you can use the code partner 377. Jerryian, thank you so much for coming on.

Jerryian:
Thank you.

Ashley:
Okay, Tony, that was amazing, wasn’t it, having Jerryian on the show? I think that we should continue to do this with having guests on live.

Tony:
Yeah, it’s a different dynamic. I love being able to actually interact and the guests being able to ask follow-up questions. Guys, again, biggerpockets.com/reply, get those questions in. We want to hear from you live on the show.

Ashley:
If you’re watching this on YouTube, give the big thumbs up and let us know in the comments if you want to hear more people on as guests during the reply episode. Now, let’s get into our regular format and get to some more questions. Our next question is from Mike Woodruff. What are some recommendations on how to best protect myself as an investor? I am purchasing a rental and trying to figure out what is the best type of insurance and or ways to protect me personally. I know an LLC would probably be best, but have heard of mixed answers if I should be able to transfer it after closing if there’s a loan on it. Another option I have heard is just to get an umbrella policy. Also, are there any specific disclosures or terms you make your renters agree to? We got a couple of different options there and a couple of questions.
Let’s start back at the top here. He’s purchasing a rental and trying to figure out the best type of insurance or ways to protect himself personally. The first answer is that you’re going to talk to your agent and you’re going to get a landlord policy. This is where you are not living in the property, but you still want to ensure you’re building your property. If there’s a fire, you’re building burns down, you still want to be able to build new. You can either get replacement cost insurance on that or you can get actual value insurance on that. Then another thing you want to look for with insurance is that since a tenant is living in there, the tenant’s contents are not included in your insurance policy. You want to make sure they have their own renter’s insurance policy to cover their contents because your policy will not cover theirs.
Then ways to protect yourself, you’re going to want to make sure that, that landlord policy has liability attached to it and it’s going to be up to a certain amount. This is where, as you had said in your question that you have heard of getting an umbrella policy. If you have your landlord policy, that covers up to a certain amount of liability protection. Let’s say it’s 300,000, that means that if somebody sues you or there is a claim or somebody has hospital bills they’re wanting you to pay because of something that happened on your property, the insurance is going to pay up to $300,000 to hire an attorney and actually fight the lawsuit for you. Or they’re just going to settle and pay out a claim so that they don’t have to deal with it and it ends up being cheaper than I’m hiring attorneys.
What you can do is purchase an umbrella policy, which is an all-encompassing policy that works like an umbrella. It goes over your other policy. Your first policy, your landlord policy will kick in first. Then after that, if you exceed that first 300,000, then maybe you have a million of liability coverage in that umbrella policy and that’s when that policy will actually kick in. In that example, that’s $1.3 million that you have to cover any kind of lawsuits or claims against you. That’s what you can do if you have your property in an LLC or it’s in your personal name. You can put those two types of insurance policies on your property with either of the options of LLC or you, personally. The difference between an LLC and having in your personal name is who the person is actually going to sue.
Is it going to be your name personally that they’re suing or is it going to be the LLC name? If your LLC owns the property, part of the reason of an LLC is limited liability protection, hence, LLC. This is going to, they’re going to sue your LLC and they only have stake or right to the content, so the assets of your LLC. If you just own this one property in the LLC, you don’t have a ton of equity in it, maybe $10,000, you just bought it recently, there’s not going to be a lot for them to actually take from you. If they sue you personally and you have your primary residence paid off, you have like three sports cars sitting in the garage, you have all of these assets and have a high net worth, they’re going to have a lot more to go after than just you having to sell your rental property to give them the equity in it.
A lot of times this can be a personal decision whether you should go the LLC route or the personal route because if this is your first time buying a property, you bought it seller financing, 100% seller financing. You don’t even have any equity in it right now and you are just getting your little bit of rental income and slowly saving it into a checking account. You rent, you don’t own a car, you have a bike, you don’t have any assets to your name except for this one rental property, it’s probably going to be okay because nobody can take anything from you if they sue you because you don’t have anything else to give, but you do get the great financing. Tony, do you want to talk about the financing piece and how that should be considered when deciding against LLC in your personal name?

Tony:
You made so many great points, Ash. It makes me think of episode 105, back when we interviewed Brian Bradley who specializes in asset protection for real estate investors. One of the things he shared that’s always stuck with me and that I try and repeat as many times as I can on this show is that, and this ties in exactly with what you were saying, is that your level of asset protection should scale with your business. Because does it make sense to go out and spend tens of thousands of dollars on asset protection when your net worth is $10,000 or $50,000? If you go back and you listen to that episode, he does a really good job of talking about the different types of asset protections at different levels of scale. The person that’s got decamillionaire, their level of asset protection is going to be different than the person that’s starting off with zero.
I want to caution our Rookies from maybe going too far off the deep end with the asset protection upfront. You want to find the level of asset protection that fits where you’re at. There’s people that are setting up these holding companies and this and that. Before you know it, you’ve got eight different LLCs for one property. Is that really serving the purposes you’re hoping it’s serving? Back to your point, Ash, about how sometimes the financing can play a role and how you take title to these properties. For us, we bought our first couple of short-term rentals using a 10% down vacation home loan. We bought one in Joshua Tree, we bought one in Tennessee. As we’re using this type of debt, the loan does allow you to rent it out on a short-term rental basis when you’re not using it yourself, but it is technically a loan that’s meant for personal use, not business use.
I couldn’t enclose using a 10% down vacation home loan while also closing in the name of my LLC because my LLC is a business entity. The loan itself is supposed to be for personal use, so just make sure you’re triple checking. For example, if you wanted to go buy, say you’re house hacking, you can’t get an FHA loan and put it in an LLC. You got to make sure that the loan supports the type of entity you want to close in. It’s just another thing to be aware of. One other thing I’ll add on that Ash is, aside from the loan and the entity matching up, you just also want to make sure that you’re being super transparent with your insurance provider about what this property is being used for. Because I’ve seen them talk to some other investors who are buying a property and they plan to rent it out, but they’re their mortgage person, they’re telling their insurance provider, they’re just going to live in it themselves.
While you might get maybe slightly better terms, maybe your insurance policy is a little bit cheaper, if something did happen, you’re not going to have the right protection. We’re very clear, if we’re flipping a house, we tell our insurance provider like, hey, this property is going to be vacant. We’re going to have people working in this home. No one is going to live in there for probably six months. If it’s going to be a short-term rental, we tell our insurance provider, hey, we’re going to have 12 to 15 different groups of people coming through every single month for as long as we own this thing. Just make sure you’re being transparent with your insurance provider because the more information you give them, the better, more comprehensive coverage they can give you to match what you’re using that property for.

Ashley:
I actually had a situation where I forgot to notify my agent of a change that we were doing. We had purchased this property and it was going to be just a slight little cut two-week cosmetic update and then we were going to rent it. Well, then we started to decide that actually, we wanted to make this a higher-end rental and we started to build out a scope of work that was more intensive and now it went from a couple of weeks to months of rehab. With that, was we never notified the insurance agent that we were doing the switch. When the insurance company came to do their inspection, they were not insuring this, the place is vacant, there was people there working.
This was supposed to just convert into a rental property right away, and so they gave us a notice of cancellation. Having a great insurance agent on your team is very beneficial because the agent right away went and rewrote it before the cancellation. They give you like 30 days’ notice or whatever that they’re going to cancel it, rewrote it that it will be vacant and is going under construction and we got the new policy in place with the same carrier and things like that. It is so important because if something would’ve happened there, we wouldn’t have been covered at all.

Tony:
One last thing I want to mention too, we just recently interviewed Natalie Kolodij on episode 360 at the Rookie Podcast, so if you go back and listen to that one. The other, I guess potential downside of getting too crazy with the asset protection is that if you end up having a lot of LLCs, there are tax implications and additional cost implications associated with that as well. We just got a quote back for our 2023 taxes. We have some entities we’re paying like $6,000 to get our taxes filed for one LLC. It depends on how much activity is going on and things like that. You want to make sure that you’re including the maintenance, the cost of maintaining those LLCs with your decision as well.

Ashley:
We’re going to take a short break, but when we come back, we’re going to talk about HELOCs and debt to income, and does that actually affect your debt to income when you take out a HELOC? We are back from our short break and our next question is from Nick Solder. If I take a HELOC, which is a home equity line of credit out on our primary residence, does that impact our debt-to-income ratio? I have no plans to use it for now. I don’t want to run into an issue when purchasing another investment property in the next six to 12 months. Any experience with it? Thanks in advance. Tony, have you taken out a HELOC on your primary before? Actually, I don’t even know.

Tony:
I haven’t, actually. We don’t have a HELOC on our primary, but I think before we even answered the question Ash, about HELOC, I just want to, because I hear a lot of Rookies who get confused between the HELOC and the cash-out refinance, so I just want to quickly define the differences.

Ashley:
Yeah, great idea.

Tony:
When you buy your primary residence, unless you’re paying cash, you’re getting a mortgage to cover the majority of that purchase. For round numbers’ sake, let’s say that you buy a home that’s worth, I’ll use super small numbers here, but $100,000. Say that you put down 20%, so you’ve got an $80,000 mortgage on that property. Over the years, let’s say that, that property, the value increases and you bought it at a value of 100. Now, say it’s worth $200,000, and maybe your mortgage has been paid down to 50,000. Now you owe 50, the home was worth 200, you owe 50, the home was worth 200. You have $150,000 of equity that you can tap into.
When you have this equity in your home, there’s two different ways you can play it. You can either get a HELOC or you can refinance or you could sell if you want. Assuming you didn’t want to sell, HELOC or refinance. With a refinance, you are essentially paying off the original mortgage. You would pay off that original balance of $50,000, and let’s say you put in a new mortgage for maybe $150,000. Of that 150,000, 50 goes towards paying off your balance on your first mortgage, you get to keep the additional $100,000 and then you have a new mortgage in place at $150,000. The old mortgage is gone forever, it’s never coming back. With a HELOC, again, same numbers. You owe 50,000, the home is worth 200.
You can, instead of replacing your original mortgage, it stays in place, but you then get to take out, think of it almost like a credit card with your home as like the collateral, but you get this revolving credit account and maybe you don’t get the whole 150. Maybe you get, I don’t know, maybe they’ll give you up to $100,000 or whatever it may be, but you get some number, some amount of that equity that you can then use. Your original mortgage stays in place and now you’ve got this line of credit that you only have to pay on if you start using it. With the cash-out refinance, when you put a new mortgage in place, it doesn’t matter if you use that $100,000 or not, as soon as you close in that refi, you got to start making those new payments. There’s pros and cons to each of those. I just wanted to lay out what that difference is.

Ashley:
Now, actually, answering the question.

Tony:
It’s like, Tony, stop talking so much. Just answer the question.

Ashley:
I’ve never taken out a HELOC either on my primary, but I do have lines of credit. The way the lines of credit work against my debt to income is if I have a balance drawn and I am making monthly payments, my credit report will draw with that interest rate or that minimum payment just like a credit card. If you were to pull your credit, it may say that your monthly payment for your credit card is $53 because on that month’s statement, your credit card is reporting that you owed $53 as your minimum payment. Even if you paid off, say it was $1,000, you paid that whole thing off, it’s still going to just show what that minimum payment was, and that’s what’s calculated into your debt to income. If you continuously pay off your credit cards, it’s probably not even going to show anything.
With your line of credit, you’re going to have that interest expense depending on how your line of credit is set up. If you have an interest payment that you’re making every month, then that is going to show on your credit report and will go into your debt to income because you do have that monthly payment. If you don’t have any balance withdrawn on that, then there should be no minimum payment or monthly payment and should not be factored in. It will only be factored in if you have drawn from your line of credit. I think you’re pretty safe with that if you haven’t used the balance and just letting it sit there. That’s one of the benefits of doing a line of credit compared to refinancing because when you refinance, you’re getting that money and you’re paying interest on it right away and it is going towards your debt to income.
Our last question today is from Adam Keys. Traveling nurses just left my unit after a three-month stay. The home is so awful that their deposit doesn’t even cover the full bill for repairs and cleaning required. I’m itemizing everything and sending an invoice, but expecting no additional payment. Aside from leaving a negative review on Furnished Finder, I’d assume the cost to pursue legal action may not be worth it. Are there any other options that we have? Tony, I have to say, this is my first time ever of hearing traveling nurses trashing an apartment. Usually, everyone is saying these are the best guests that you ought to have in your unit. They stay long, they treat it like they’re home.

Tony:
Adam, first, hate to hear that you had this experience, but it is part of just being a real estate investor, especially in this medium-term, short-term stay environment. Now, one thing I will add is that for all the flack that Airbnb gets amongst hosts in the community, one the benefits is that they do have a process for damage claims like this. Maybe moving forward, Adam, and I don’t know if it’s going to happen every single time, obviously it won’t, but had you had them book through Airbnb or Vrbo, one of the OTAs, then you’d have a path for collecting that income back. I’ll just quickly give a rundown on how it works on those platforms. Vrbo, I actually like really well, because when someone books your property through Vrbo, you can require them, make it a requirement that they buy damage protection insurance. For them, it’s a cost of like, they can choose, I think it’s like 70 bucks, 80 bucks or like 100 bucks.
At each one of those levels, there’s a different coverage amount that they get. Say they spend 100 bucks, there’s like $5,000 in protection that they get by paying that insurance policy. Now, the insurance policy, it’s nonrefundable, so when they pay that, it’s paid for. If there is damage, they don’t have to worry about the host coming after them to get repaid. For you as the host, it’s great because A, it’s mandatory, they have to buy the insurance, and B, if something happens, all you have to do is claim the amount that you need and you automatically get that amount back. On Airbnb, a slightly different process where Airbnb plays a mediator and you might not always get back exactly what you’re looking for, but at least there’s a process in place to get above and beyond whatever a typical security deposit may be.
Adam, just something to consider is that maybe for your future medium-term rentals, even if they’re finding your listing through Furnished Finder, maybe still have them book on a platform like Vrbo or Airbnb so you can get that damage protection. Or if you’re going to self-book, if you’re going to self-book, do a direct booking, there are companies out there that you can also require from your guests to sign up for that still offer that same type of damage protection. There’s a company that I know called Superhog, and Superhog basically acts the same way as an Airbnb damage protection or as Vrbo’s damage protection as well. That when your guest book, they have to pay a non-refundable fee upfront that covers their insurance policy during their stay. If there is a claim, now you’re just billing against their policy versus having to go after the guest themselves. Superhog is another option for you to look into as well.

Ashley:
Tony, that’s awesome. I never knew that. That has always been a fear of direct booking because we always do Airbnb for the short-term rentals obviously, but also for all of our midterm rentals. We have stayed on Airbnb. When we first started them, we talked to a couple other investors and some had done it the way Adam did where you get them through Furnish Finder, but you do a lease agreement using Rent Ready or something like that, but you send them a traditional lease and it’s just for three months or whatever time period they’re staying. I ended up going the Airbnb route because of the air coverage and the protection and having that mediator for the platform. I definitely agree that checking out a different way to actually book people can help. Since you are more on the long-term rental side, I’ll say right now because you had them sign the lease agreement, depends how much information you got from them.
Did you get a copy of their license? Did you get their social security number? Did you do a credit check? Things like that. Because first of all, you can take them to small claims court, so whatever town your property is in, you can go to small claims court. You can fill out the paperwork yourselves. You don’t have to have an attorney to do this. It really depends how much information you have from them, and then if you have proof. Hopefully, you took a lot of pictures, things like that, what the property looks like beforehand, and then after they have left the unit. You can file a claim against them in small claims court where if you end up going to court, they come, they can state their case, or if they don’t, a judgment will be issued against them. I’ve done this before. There’s somebody who I have a judgment accounts for like $5,000, I think. We’re in year, maybe eight of this judgment, and it’s a 10-year judgment.
After 10 years, if they don’t pay, the judgment is gone off of the record and they never have to pay it. One caveat to that is if they ever sell anything, it’s supposed to be a lien on that property. If they sold a house or sold a car, I was supposed to be paid from the proceeds first before anybody else would get paid. Obviously, they haven’t sold anything. It hasn’t been tracked well enough, I’m not sure. Then the next thing that you could actually do is put it into collection. If you have enough documentation, you have enough proof and you have all of their information, you could send it to a collections agency too, to call them and nag them to try to get it. Well, that wraps up our last question today for the Real Estate Rookie Reply. I’m Ashley, and he’s Tony. Thank you, guys, so much for listening. Make sure you check out the show notes. You can follow us on Instagram, the links are in the show notes and we’ll see you guys, next time.

Skylar Olsen, Zillow Chief Economist, joins ‘Fast Money’ to talk Pres. Biden’s proposes solution fo the U.S. housing crisis.

Dave:

Hey, what’s up, everyone? Welcome to On the Market. I’m your host, Dave Meyer, and today we’re going to step into the macroeconomic global economy. And I know on the show we normally talk about real estate and housing, and we are still talking about that tangentially. But we’re sort of going to zoom out and talk about what is going on a global stage, and how things that are happening in China, the conflict in Israel, the war between Ukraine and Russia are impacting global economics, and how that might translate to our investing decisions here in the United States.

To do that, we’re bringing back one of our most popular guest ever, Joe Brusuelas, who’s the principal and chief economist at RSM. He was actually named the best economic forecaster in 2023 by Bloomberg, so you’re going to want to pay attention, especially at the end here where he gives some very specific predictions and forecasts about where he thinks the US economy is going.

Before we bring Joe on, I just want to caveat that some of the stuff that Joe’s talking about is a little bit more advanced. It’s a little bit extrapolated from direct real estate investing decisions. But I encourage you to listen and pay close attention to what Joe’s talking about, because he really helps explain what’s going on in global stage, and then translates that back to what it means for you and me and our personal investing decisions.

So with that, let’s bring on Joe Brusuelas, the principal and chief economist at RSM. Joe, welcome back to the podcast. Thanks for joining us again.

Joe:

Thanks for the invite, and I always look forward to talking with you.

Dave:

Likewise. Well, let’s just dive right in. I want to start here by talking about China. Can you give us a broad economic overview of what’s happening in China and why their economy seems to be taking a bit of a nose dive?

Joe:

So the Chinese have entered a period of debt and deleveraging. I’m not going to call it a crisis, but one economic era in China has ended and a new one’s beginning. In some ways, it looks a little bit like what Japan went through in the nineties, and what the United States went through between 2007 and 2014. There’s an enormous debt overhang in their banking sector, in their housing sector, and their commercial real estate sector, and that’s really caused the economy to slow to a crawl.

Now, China, who for the past four decades has relied on a model that basically revolved around state-directed investment in infrastructure, housing, and commercial real estate. That development model now has reached an end. They’re in what economists would call a middle income trap. They’ve gone about as far as they can go with the current approach, and it’s going to have to change, but the problem is the political authority is not comfortable with changing that up. Essentially, they’re going to have to spend the next seven to 10 years working down that debt. They’re going to be selling properties around the world to repatriate capital to deleverage. Now, anybody out there who’s listening, this should resonate because this is what happened in the United States after an epic housing bubble that burst, which obviously caused real problems and came close to causing the United States domestic banking system to collapse.

Now, because China’s a one-party authoritarian state, they’re trying to slow drip to work their way through this. The current policy path isn’t to reflate the housing sector to absorb the excess inventory; it’s to redirect risk capital away from housing, buildings, infrastructure towards manufacturing. Problem is, they can’t mop up that excess supply. We already for the last about a half a year or so have seen an export of deflation out of China. China is going to attempt to export the burden of adjustment to its trade partners, primarily in North Asia and Southeast Asia. It’s going to cause a problem, because China is really trying to protect its employment base. They don’t want to see a significant increase in unemployment from already current elevated rates.

Now, what that means is if you trade with China, when you buy their industrial goods and you produce industrial goods yourself, you’re going to have to accept a smaller share of manufacturing as a percentage of global GDP. That’s going to cause an increase in tensions both economically and likely in the security side through all of Asia. Now the Chinese just, again, aren’t going to be growing at 7-10% anymore. India’s the one that’s going to do that. China’s going to be slowing to probably that 2-3%. Even the 5% they reported for last year is highly dubious. So we really are in a different world when it comes to Chinese growth.

Dave:

That’s super interesting. Thank you for setting the stage there. And just to make sure I understand what’s going on, they have extended themselves too much in terms of debt, and that’s mostly revolved around real estate development, right? They’ve poured a lot of money into building, like you said, commercial real estate. You see a lot of residential towers that have gone empty.

I’m just curious. Because, as you said, China is a one party authoritarian state, how did this happen? Because in the US, in retrospect, we can sort of trace this to lax lending standards and a lot of different debt practices that happened in the private market. But how does this happen in state-controlled investments, as you said?

Joe:

Well, when you look at China’s… The composition of how their economy is organized and where it’s directed, we often in the West make the mistake of thinking it’s a one-party, communist-controlled state, and Beijing controls everything. That’s not the case. A lot of the development was driven by the prefects, the states or the municipalities, the cities. Not just in the state-owned banking sector, not even on the private real estate developers or the private commercial real estate developers, but the debt at the states and municipalities is anywhere between $15-66 trillion depending on who you listen to. So their development model, in many ways was locally driven in a way that didn’t have proper oversight or accounting. So they’re in a real difficult situation where they’re going to have to work down that debt.

If you remember 2007 to 2010, Ben Bernanke’s heroic move to create a bad bank inside the Fed to take those distressed assets off the hands of the financial markets, the banks and other owners of that debt, and to create a situation where we could buy time to deleverage. This is going to be difficult. Right now, the Chinese just haven’t moved to create that bad bank that’s going to have to be created.

Another example that some of your listeners might remember is the savings and loan crisis from the late eighties, early nineties. Essentially, we created a long-term workout strategy vehicle set up by the federal government, and it took until literally the eve of the great financial crisis, 2008, when it was really getting intense, for us to actually have worked through all the backlog of all that bad debt, all those overpriced properties. It took a good 20 years.

And so the Chinese haven’t even really got down the road on that yet. That’s why the policy pathway they’re taking is quite problematic. I’m not convinced that it’s going to work. They’re going to need to simultaneously reflate the financial system and the household, the Chinese household, in order to absorb the excess capacity.

What that does is it creates a situation where what’s happening now, they’re just turning and taking on more bad debt, which is going into unproductive investment in a situation where industrial policy amongst the advanced developing nations has returned. And it’s going to be difficult for the Chinese to sell anything other than low-value added materials into the West, and that’s not what they’re really building right now. They’re building value added goods that no one’s going to be interested in buying.

So the next three years with respect to China and its relationships with the West and the rest is going to be fraught with difficulty and very tense.

Dave:

Okay, so now that we’ve discussed why China is in such financial trouble, we’re going to discuss how this impacts the US and global economy right after this break.

Welcome back to On the Market podcast. We are here with Joe Brusuelas. I just want to ask one follow up first about the bad bank that they created here in the United States. Can you explain that a little more detail and how that helped the US over the course of 6, 5, 6 years get through the debt crisis, and how that differs from the Chinese approach?

Joe:

Sure. In some cities, we had a 50% decline in housing crisis. People were underwater. Those were distressed assets on the balance sheet of banks. Those assets had to be removed so that those banks stayed solvent, because we went from a liquidity crisis to a solvency crisis. Right? Federal Reserve was buying those assets. They were injecting liquidity or flooding the zone with liquidity, which then reflated the banking sector. We prevented a great depression, but the period from 2007 to 2014 featured one of the more disappointing economic recoveries we’ve seen in the post-second World War era, and it wasn’t until 2014 that the economy truly recovered.

When you go back and you take a look at debt and deleveraging eras, typically it takes seven to 10 years to work through it. Now, we got through it in seven years. There’s a case be made that Japanese are just coming out of it four decades later. So the policies put forward by the Bernanke era Fed and were sustained by the Yellen era Fed in terms of using the balance sheet of the bank to smooth out fluctuations in the business cycle. In the case of Bernanke, avoiding a great depression, and then again during the J. Powell era of avoiding a serious economic downturn during the pandemic, which was a whole unique and a separate discussion, are examples of how the Fed or the central bank can use its balance sheet, in the case of Bernanke, to create a bad bank.

We know how to do these things. These are not unusual. We had the depression, we had several property crashes. Of course, the savings and loan crisis with the Resolution Trust Corporation set up by the Bush Administration is a prime example of a non-central bank approach, using the fiscal authority to do it.

The Chinese are going to be forced to do this. Right now they don’t want to because they don’t want to admit that their economic model has fundamentally changed to the point where it’s not sustainable. In an open, transparent democracy where you would essentially let things fall, cause an increase in unemployment, let bankruptcies happen, let the market work so it clears… Not friendly, very painful. Right? But you end up getting through these things a bit quicker than you do in sort of the closed, non-transparent systems that are… Again, the Chinese is one of the more opaque systems. So I am not confident that they’re going to bounce back anytime soon, and again, I think that the era of 7-10% growth in China is just now over. They’re going to be growing at 2-3% just like everybody else.

Dave:

Well, that was sort of my question, is that if everyone else is growing at 2-3%, what’s the problem here? Do they need to grow faster to pay off this debt and go through the deleveraging, or is it they just have broader aspirations than a lot of the rest of the world?

Joe:

Their unique challenge is the size of their population. For years, conventional wisdom said that if growth were to slow below 5%, they would have significant social problems because it wouldn’t accommodate the growth in the working age population, depending on which number you believe or are looking at. Youth unemployment’s clearly around 20%. In a democracy, that’s a crisis. Right? In an authoritarian state, that could be an existential problem that has to do with the stability of the regime. So China’s got unique challenges due to its size and the composition of its society and economy, and we shouldn’t compare it to Europe or the United States or even Japan.

Dave:

And I believe that they stopped sharing data for youth unemployment. They’ve just stopped releasing that data as probably shows the depth of how serious a crisis they see this as.

Joe:

Well, earlier I mentioned that I didn’t quite believe their 5.2% growth rate in 2023, but one of the reasons why is it’s an already opaque economies become even more so. The shop stopped sharing data. The alternative data that we were using to look at say like electricity generation has also clearly been constrained. So it’s difficult to get a sense on what the true growth rate is.

When you talk to people on the ground, it doesn’t sound or look like the official data, which causes me to tend to think that no, they’ve slowed and they very well could have contracted last year. If you listen to people on the ground, that’s what they’re saying. I don’t know that that’s the case, but something’s clearly not right, and they’ve definitely entered an era of debt and leveraging.

Dave:

So given this slow down and this crisis that’s going on there, how does this impact American investors?

Joe:

Well, what it does is it’s what you’ve seen. You’ve seen capital exit China. You’ve seen the dollar grow stronger. We clearly are past our problems with inflation. So my sense is that the United States is going to be the primary generator of global growth, along with India and a few of the other emerging markets. It’s likely because of the unfortunate geopolitical competition we’re now engaged in with China that it will lager better for investment in capital flows into the United States simply because it’s just not as risky as it is putting it in China. China’s moved to the point where it’s virtually uninvestable, I think. People have been saying that for a while, but based on what I’ve observed in the post-pandemic era 2023, I think that that’s true now.

Dave:

Wow, that’s a bold statement. It’s a big difference from where we were five or 10 years ago, isn’t it?

Joe:

Yes, and also the way we talk about China. Look, China’s going to be a problem geopolitically. They steal our technology. They’re going to be problems in the South China Sea and the Taiwan Straits. All that’s not going to change. But the idea of China taking over the world via their economy, I think is actually just simply not true.

Dave:

So before we move on, because I do want to talk about some of the other geopolitical stuff going on, last question about China here, Joe: Is there any risk that the turmoil in the Chinese property market spills into American banking or American property markets?

Joe:

Right now it looks to me like it’s more of a domestic local issue. It does not have the properties of a global systemic challenge, like what occurred after the United States financial system came close to collapsing. It’s been going on now for two years. And it’s been clear for a year and a half, two years that China was caught in a debt trap. Right? So the deleveraging in terms of the big globally important systemic banks has largely occurred. Now, this does turn into a crisis inside China. We’ll have to watch closely. Because it’s not what we know it’s what we don’t know and then the risks taken. But right now the answer would be a qualified no.

Dave:

Okay, so we’ve gone through what’s happening in China now, and next we’re going to delve into what’s going on in Europe and Israel right after this quick break.

All right, so now that we’ve sort of gone deep on China, and thank you for your insights here, there are two other major conflicts going on in the world. Obviously we have Russia-Ukraine, and the conflict in Israel. So I want to talk just economically speaking, how are these things? How do you see this confluence of geopolitical instability going to impact the global economy?

Joe:

So when you think about the global economy, the first thing you should think about is commodities. The foremost of those commodities are energy and wheat, oil and grains. So let’s take what’s going on in the Eastern Mediterranean, Red Sea and the Middle East. Clearly, that’s roiled the region. The Israeli economy contracted at a significant pace and is in recession. But we did not see a disruption of oil prices other than a modest period of volatility.

But when one is looking at the US economy like I do and the global economy like I do, you have to always think about the risk matrix. And in this case, the channel through which that risk would be transmitted is the oil and energy channel. In many ways since October 7th, my assessment hasn’t changed. As long as the conflict does not involve the attack and/or destruction of oil producing facilities in Iran, this is something that’s going to be largely contained with periods of enhanced volatility.

So that’s a risk, but it’s not dragging down either the global economy or the US economy. With respect to Ukraine, the invasion of Ukraine created the conditions where we had a massive spike in oil. That was largely a reason why US CPI, the inflation moved up to above 9%. But we’ve come back from that peak and we’re through that. The other component of that is the export of wheat out of the Crimea, out of Ukraine, and then that’s caused problems in emerging markets. But again, we’re two years past. The United States, Argentina, Australia, Brazil have flooded the world with those same products to the point now where food prices have come back to earth. Right? So when you’re thinking just purely about the risk matrix, the commodities channel, it’s grains and oil.

Okay, now there’s a bigger question out there around Ukraine and Russia that’s got to do with the political dysfunction inside the United States, which is how to fund the Ukrainian war effort by the West. We’re beginning to see the entertainment of very unorthodox ideas. Today, the Secretary of the Treasury, Janet Yellen was talking about unlocking the value of those frozen Russian assets, IE the $300 billion in Forex reserves sitting in Europe and the US, a little over $200 million in Europe, a little less than $100 billion here in the United States.

Right now the Western powers are considering something very unorthodox, which is not confiscating the assets, but taking them, putting them in an escrow account, using them as collateral to float essentially zero interest bonds to finance the war effort. Now, that may be over 20 or 30 years, but that would create a series of incentives for one, the Russians to not continue with this; two, it would fund the defense of Ukraine; and three, it would avoid the confiscation of those assets because the idea is they’re just being used as collateral. They’re going to be paid back, and the Russians can have them back after 20 years.

This is some very difficult terrain we’re now caught in, and the innovative financial mobilization of the deep reservoir or pools of capital in US financial markets and European capital markets, it does represent the next mobilization of Western power in approaching this fight, and I would expect this is going to be part of the narrative going forward in global financial markets and the global economy and international security over this next couple of years. These are extraordinary things that are happening in real time that we really haven’t seen since even like 1914, when John Maynard Keynes was called the London to come up with a plan to prevent the collapse of the UK financial market, which was then the center of the world economy. And it was during a week when two-thirds of the gold reserves in the Bank of England were basically withdrawn in three days. We’re not quite in that sort of emergency here, but we are seeing the sort of same innovative proposals put forward by the community of economists and financial professionals in order to think about how to deal with all of this.

Dave:

Do you think these types of proposals represent, I don’t want to say desperation, but an increased risk to the market because we’re traditional methods or what we’ve been doing so far haven’t been working?

Joe:

Well, I don’t think it’s risk. I think what it is that your situation where you’re acknowledging the reality of the difficulties of the US political entity. So we’re thinking about how to get innovative until that can be ironed out. My sense here is that the West has been reluctant to mobilize its most powerful asset, one of those financial markets and those deep pools of capital. They’ve done things on sanctions, they froze the assets due to the illegal action by the Russians, but they have yet to really even push secondary sanctions onto the Russians. But the fact that they’re doing this means it’s getting a bit more serious.

Now, I don’t think it’s a point of desperation at all. The risk is that you would ruin the reputation for reliability, the rule of law and contracts in Europe and the United States when it comes to investment. That’s why it’s important that this not be a seizure, that it not be a confiscation, that it just be a more innovative proposal that retains ownership. But we’re going to use this because what you did was not a good idea and is actually illegal. It’s a challenge of the rules-based order that the United States and Europe is in charge in, and we don’t intend to see that go. What’s the use of all of this capital, all of this wealth, if we’re not going to defend that which is most dear, and I think that’s essentially what’s happening here.

Dave:

Got it. Well, that’s sort of fascinating. I hadn’t heard of this, but it’s certainly going to be interesting to see how it plays out. Before we get out of here, Joe, I’m just curious, what’s your outlook for US economic growth? You said you think US and India are going to lead global growth. Do you think that’s going to start this year, or is that more of a long-term forecast?

Joe:

It already started. Right now our forecast for the year was that we had 1.8% growth right at trend, but it’s looking that it’s going to be quite a bit stronger, quite possibly in the 2.5-3% range. Unemployment will range between 3.7-4%. By mid-year, we’ll be at 2% in the core PCE; 2.5% in PCE, that’s the Fed’s policy variable; and by the end of the year, CPI will be back at 2.5%. In other words, price stability will have been restored by the Federal Reserve, which you’re going to see is as inflation comes down. That means the real wages of people increase, and that’s going to support overall spending, which is why we had significant risk to the upside of faster growth on our annual forecast. We put the forecast together last November and we haven’t changed it. We had a 15, that’s one 5% probability of a recession, and a 25% probability that the US economy would outperform our 1.8% forecast. That looks like where we’re going.

Now with respect to rates, we thought we’d see 100 basis points of rate cuts. That’s 425 basis points starting in June. Pushing down the front end of the curve, we think that due to the issuance of treasury supply and the decline in the cash on hand in the reverse repo program, you’re going to see rates begin to move up here pretty quickly. We’re already between 4.25 and 4.3. I expect we’ll move closer to 4.5, and then down to 4.25 at the end of the year, and that’s our year-end target.

We had a good year last year. Bloomberg named us as the best rate forecaster along with our colleagues at Goldman Sachs. So we take that portion of the forecast and all the forecasts significantly, and we’re very serious about that.

We think that by the end of next year, you’re going to have a positive upward sloping shape of the term structure, and this is going to be the first time we’re going to see something like this approximate, really since before the great financial crisis. Essentially, that period of zero interest rates, real negative interest rates as a tool of policy, is effectively in the rearview mirror. The normalization of the rate structure is upon us, and the economy will adjust accordingly. Now we think the United States is well-positioned to take advantage of that and do well.

Last thing I want to share with you, the most constructive and encouraging development in the US economy has been the boom in productivity over the past three quarters. Productivity in the United States has increased by 4%. This is an extraordinary thing. We haven’t seen levels like that since the 1990s. For economists, once you start thinking about productivity and growth, it’s hard to think about anything else. That’s that magical elixir or that mythical tide that lifts all boats. It means we can grow faster, have robust employment, low unemployment rates, low inflation. Most importantly, it lifts the living standard of all who participate in the economy.

That’s not something we’ve been able to say in a long, long time. You know what? We can continue to see productivity anywhere near the vicinity of 2.5%. That’s a game changer, and we’re going to be having a very different discussion around the economy at that point. One that doesn’t so much involve risks, but upside potentials and good things.

Dave:

Wow. Well, thank you so much, Joe. We really appreciate your insights here and your very specific forecast and thoughts on the economy. For everyone listening or watching this, if you want to learn more about Joe, we’ll put a link to all of his information where you can contact him, all that sort of stuff in the show description below. Joe, thanks a lot. Hope to have you on again sometime soon in the near future.

Joe:

Thank you.

Dave:

Another big thanks to Joe for joining us on this episode. I hope you all learned a lot. I sure did. The global macroeconomic climate is not something I study as closely as the housing market here in the United States, but I think it’s super important to just help you set this context and backdrop for your investing decisions. It’s super helpful to know are there a lot of risks outside the country that could start dragging on the US economy, or are there things that can increase geopolitical tensions. Because sometimes those are blind spots for us as investors that we might not see, and so we wanted to bring on Joe. In the future, I’d love your opinion on if we should bring on more people like this, because I personally find it helpful and think that it’s worthwhile for real estate investors here in the US to listen to, but would be curious about your opinion.

I do want to just clarify two things Joe was talking about at the end. He was talking about the yield curve and a bond yield. We don’t have to get all into that, but he was basically saying that at the end of the year, he thought that long-term 10 year bond yields would be around 4.25%, and that is important because that means if you extrapolate that out to mortgage rates, because bond yields and mortgage rates are highly correlated, that in normal times we would see mortgage rates around 6.25%. Normally the spread between bond yields and mortgage rates is about 190 basis points or 1.9%. Right now, they’re closer to 3%. So that means if Joe’s forecast is accurate, we’ll probably see mortgage rates at the end of the year be somewhere between mid sixes to high sixes. And of course, we don’t know if that’s for certain, but I just kind of wanted to translate what he was saying about bonds into the more tangible thing for real estate investors, which is mortgage rates.

The second thing he talked about, which I didn’t know and I think is super important, is about productivity. Now, productivity is basically a measure of how much economic output the average US worker creates, and it is super important in terms of economic growth. When you try and figure out GDP and how much economic growth there might be in a country, there’s really only two basic variables. How many people are working in an economy and how much economic value do they produce? And so if we’re in a time where our population isn’t growing as much as possible, and there’s only so much population growth and contributions in additions to the labor force that you can make at this point, and so the better way to grow the economy, according to most economists is to increase productivity. Now, a 4% increase may not sound like a lot, but that is huge, and as Joe was saying, if that trend continues, that could bode extremely well for long-term American economic growth.

Again, I hope this types of more global, more macro level look at the investing climate is helpful to you. We’d love to hear your feedback if you’re on YouTube, or you can always find me on Instagram and send me your thoughts about this episode where I’m at, the DataDeli, or you can find me on BiggerPockets and do the same.

Thanks, you all, so much for listening. We’ll see you for the next episode of On The Market.

On The Market was created by me, Dave Meyer and Kaylin Bennett. The show is produced by Kaylin Bennett with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.

In recent years, a sizeable amount of criticism has been leveled against what many see as endless sprawl and “lifeless” suburbia that surrounds many American cities. In fact, it happens so often that I’m actually a bit surprised that while the difficulty and opportunity of rural investing comes up fairly often, there isn’t a large amount of discussion regarding the merits and challenges of urban versus suburban investing (although there is certainly some in the BiggerPockets forums).

Regardless, for those who haven’t noticed, amongst urban planners and the growing car-free movement, the suburbs represent a capitalist conspiracy created by ruthless developers and a dastardly plot by General Motors to create an atomized, soulless, car-reliant hellscape Ponzi scheme that has indebted local governments up to their eyeballs and will soon come crashing down catastrophically. A few “anti-car activists” have even gone so far as to commit low-level terrorism, such as deflating random people’s tires while posting threatening letters. 

Given real estate investors are rather dependent on the cities they invest in not collapsing, the truth of this matter should be of some interest here. Unfortunately, this topic is quite large, so I will cover it in two pieces.

Here, we will cover the complex origins and unique characteristics of the American suburb. Part 2 will cover its critiques in more depth and look at the viability of suburbs, particularly for real estate investors. 

The History of the Suburbs

The biggest problem when critiquing (or defending) the suburbs is that the definition is rather squirrely. Google’s dictionary just defines “suburbs” as “an outlying district of a city, especially a residential one.” 

And by that definition, the suburb has existed since the invention of the city. As far back as ancient Jerusalem, Rome, or Persepolis, cities have always had a central district (or several) that is the most dense and then gradually becomes less dense and more residential the further you get from it.

Indeed, this partially mirrors the layout of Medieval castles. The lord’s castle was typically surrounded by the farmland and villages of his serfs. When threatened with an attack, the serfs would retreat to the castle and defend themselves from there. 

In other words, the suburb, as defined, is nothing unusual, and criticizing it would be absurd. Indeed, the word “suburb” came into common English speech in the middle of the 18th century, long before the “car-free movement” argues the modern American suburb was created. 

Instead, what “smart growth” promoters complain about is the particularly car-centric model of development that became extremely popular following the Second World War. As Strong Towns—an advocacy group critical of suburbia—describes the “suburban experiment” as a model of development that “isn’t defined by the automobile” but “scaled for cars” and “based on the assumptions of abundance and endless growth” while being designed “to accommodate a living arrangement based on automobile travel.”

Think of the sprawling subdivisions of similar-looking houses splitting off from major roads lined with almost identical-looking strip malls, retail outlets, and the like—places where owning a car is effectively mandatory to get around.

This model of development likely found its start near the end of the Great Depression. In 1938, the federal government created Fannie Mae with the express interest of increasing homeownership. Then, after the war, when the last remnants of the Great Depression were finally over, Congress passed the GI Bill, which provided zero-down, low-interest loans for veterans. And given that 16 million Americans served in World War II, this bill applied to an enormous number of people. 

The effect it had on homeownership is rather obvious when looking at it graphically. 

This was likely the high point of American optimism. The United States was victorious in the biggest war in human history and, unlike the other major victors, wasn’t nearly bankrupt (Britain) or devastated (the Soviet Union). In fact, in 1945, the United States accounted for roughly half of the world’s GDP! (Today, it’s fallen to 24%.)

The term “American Dream” was popularized in 1931 but came into its own in the late ’40s and early ’50s. The image of every American family having their suburban home with a big backyard perfect for barbecues, with their trusty Chevy sedan in the driveway, might be a bit stereotypical of the times, but it definitely resonated back then. 

There were certainly simmering issues just underneath the surface. After all, the civil rights movement was just getting started, and the counterculture movements of the 1960s were just a decade away. But economically, Americans had never done better, and the suburban home represented the epitome of it. 

A Conspiracy to Create the Suburbs?

What I’ve described is true, although only part of the story. In fact, some would argue it’s simply a sanitized account that leaves out the critical factors. As noted, another account sees the suburb as a conspiracy of rapacious capitalists to increase profits to the detriment of the inhabitants and the city’s long-term viability. 

The most popular of these is the General Motors streetcar conspiracy, popularized in the 1996 documentary Taken for a Ride and film Who Framed Roger Rabbit?

The allegation goes like this: General Motors bought up the numerous electric streetcars you see in footage from the 1920s and 1930s. They then started their own bus line called National City Lines. Then, they started removing the streetcars one by one so that the only mode of public transportation remaining were their buses. 

Thus, there was less public transportation, and at the same time, those pesky streetcar tracks were out of the way, which made more room for cars. This also meant GM provided the carrot and stick to increase consumer demand for automobiles.

The smoking gun to this theory is supposedly that GM was convicted in 1949 of conspiracy. However, this is where the theory—at least for the most part— falls apart. As Mark Henricks noted, the conspiracy GM was convicted of was for “conspiring to monopolize the market for transportation equipment and supplies sold to local bus companies,” not destroying public transportation in the United States.

Cliff Slater wrote a 20-page takedown of the streetcar conspiracy in Transportation Quarterly, which pretty thoroughly discredits it. First, he notes that the story had only first started circulating in 1974 (almost three decades after it supposedly happened) when a newly hired antitrust attorney for the U.S. Senate named Bradley Snell stated that the government had charged “…General Motors and allied highway interests for their involvement in the destruction of 100 electric rail…systems… throughout the country.”

Again, GM had actually been convicted of trying to monopolize transportation equipment and supplies. Snell’s arguments were debunked in the same Senate hearing by UCLA professor George Hilton, the Federal Transit Administration, and the “pro-rail” New Electrical Railway Journal, but that didn’t prevent those accusations from taking on a life of their own.

What really happened to the streetcars was much more mundane. As Slater explains:

“The streetcar made no significant technical advances during the 1920s, whereas the motor bus changed beyond recognition. The motor bus was not taken seriously until about 1920, but from then on, growth was explosive. Manufacturers made significant improvements to chassis and engines during this time. The improvements in speed, handling, and comfort made buses less costly and more comfortable. America’s cities were rapidly paving their city streets, and this helped the bus.”

Streetcar ridership, on the other hand, peaked in 1920 at 13.8 billion before declining to 11.8 billion in 1929. National City Lines didn’t even start until 1936, at which point, over 40% of cities relied exclusively on buses for public transportation.

Thus, we see streetcar ridership fall below bus ridership as early as 1922 and to less than half by 1948.

Many companies other than GM owned streetcars, but all of these still decided to eventually remove them. Several cities, such as San Francisco, had municipally owned streetcars and still chose to remove them, as did many other countries, like the United Kingdom. 

Slater finishes his case by summarizing the research on the cost efficiencies of streetcars versus buses:

“In 1936, Fortune magazine reported, ‘The average large bus can be operated for about four-fifths the cost of running a trolley.’ In the United Kingdom, ‘By the thirties, costs per passenger on buses were comparable to those on (streetcars), instead of more than twice as high as they had often been around 1920.’ 

“Buses continued to reduce their costs relative to streetcars and electric trolleys, and so generally replaced them. By 1949, San Francisco would report their average hourly operating costs as $4.50 for buses versus $7.11 for streetcars—37% less. When Philadelphia changed from streetcars to buses in 1961, they reported their operating costs for rail lines as a prohibitively high 93.5¢ per mile versus the cost of the bus at 47.7¢ per mile—nearly twice as much.”

I like a good conspiracy theory as much as the next guy, but this one falls flat. It was not the destruction of the streetcars that increased the number of cars, but the increased availability, affordability, and efficiency of cars (and buses) that made the streetcars mostly obsolete. 

One of the major advantages cars had over streetcars (or most other public transit, for that matter) is that they are not bound to a fixed line and thereby remove the problem of only having transport for part of your trip. Even buses have much more flexibility in their routes than streetcars. Thus, other than in very dense urban areas, the streetcar no longer made sense.

How Policy Did (Help) Create the Suburbs

Yet, there were corporate initiatives and government policies that contributed to the rise of the suburbs. The main one from the government was the Interstate Highway System, which began in 1956 and was largely motivated so troops and military equipment could be moved from one side of the country to the other in case of a Red Dawn scenario. 

Cold War paranoia aside, the interstate system made it not only much easier to travel by car around the country but also much easier to traverse urban sprawl, i.e., to live in the suburbs and commute to the city for work.

The highways also required the widespread use of eminent domain to confiscate private property (with compensation) and build roads where entire neighborhoods once were, uprooting entire communities.

On local levels, many city planners were also pushing toward a more car-centric model of development. New York City Parks Commissioner Robert Moses epitomized this trend by building all sorts of roads, bridges, and tunnels throughout New York City, and famously got into a heated debate with urban activist Jane Jacobs regarding urban planning in general, Washington Square Park in particular. 

All of this road construction directly followed the urban renewal of the 1940s, which culminated in the National Housing Act of 1949. The legislation authorized the construction of 810,000 public housing units, but there was a dark side, namely slum clearing. As an article on Smart Cities Dive says:

“The government fell far short of its goal to build 810,000 units of new public housing by 1955. In fact, the Act’s urban redevelopment programs actually destroyed more housing units than they built.”

Such a program also uprooted many communities, pushing many people out into the expanding suburbs. Indeed, more conspiracy theories follow urban renewal given the embarrassing performance, with some black leaders as well as leaders of some predominantly Catholic ethnicities believing it was a policy to break up the ethnic strongholds one thinks of when looking back at that period (i.e., Little Italy, Chinatown, etc.) to reduce these group’s political power. But that’s a bit of a tangent. 

Instead, let us turn to the business side of the equation, most notably with a man named William Levitt. 

As USHistory.org notes:

“Contracted by the federal government during the war to quickly build housing for military personnel, Levitt applied the techniques of mass production to construction. In 1947, he set out to erect the largest planned-living community in the United States on farmland he had purchased on Long Island, New York. Levitt identified 27 different steps to build a house. Therefore, 27 different teams of builders were hired to construct the homes.”

This means William Levitt became a sort of Henry Ford-like figure, bringing an assembly-line approach to home construction. While his basic homes weren’t anything special (the first group were all two-bed, one-bath, with no basement), they were immensely affordable, especially when paired with the aforementioned GI Bill. 

Indeed, each home in Levittown sold for a mere $8,500 (even today, only about $111,000)!

These types of developments became the model for developers across the country. Thus, suburban homes were and have continued to be significantly cheaper than urban properties. Given the baby boom of the late ’40s and ’50s, families needed more space for their kids, too. This provided another incentive for suburbanization, as square footage was cheaper in the suburbs.

Suburban infrastructures also began to fill out. For example, the first American mall—the Southdale Mall—opened in 1956. 

As noted, the idea of the American Dream grew in prominence, as well as phrases like “keeping up with the Joneses” and even the idealization of the white picket fence. Owning a home in an American suburb became synonymous with having become a productive member of the American middle class.

1960s Riots and White Flight

The last major cause of the suburbanization in the United States was a combination of increased crime during the ’60s and 70s and the urban riots of the mid-to-late ’60s in places such as Watts (1965), Detroit (1967) and throughout the country following the assassination of Martin Luther King Jr.

The 1960s certainly saw some major accomplishments, like the Civil Rights Act of 1964 and the Voting Rights Act of 1965. Unfortunately, it also had some not-so-good things, including a soft-on-crime approach and the introduction of welfare programs that saw subsequent skyrocketing dependencies and fatherlessness rates. 

For these and a variety of other reasons—including a more youthful demographic after the postwar baby boom—crime skyrocketed in the mid-’60s. The murder rate more than doubled from 1960 to 1972, and the urban murder rate increased threefold. Other crimes increased at a similar rate. 

Given this, many people with the means fled the cities. Since most of those with means were white, this became known as white flight. 

This also represented a capital flight. The combination of fewer people, more crime, and less money led to increased urban blight and deterioration in the quality of the schools. These factors increased the “push” incentive to leave for the suburbs, while the affordability and desirability of Levittown homes and others like them provided the “pull.”

This process of urban decay culminated in New York City requiring a federal bailout while teetering on the edge of bankruptcy in 1975. Indeed, the urban decline permeated the pessimism of the 1970s in everything from films like Taxi Driver to Jimmy Carter’s famous (infamous?) malaise speech.

This trend didn’t really begin to reverse until crime began to decrease and gentrification increased in the 1990s. This trend has flipped once again in recent years and is notably ignored by many activists for urban densification.

Final Thoughts

The American suburbs are not just the less-dense area that surrounds the city center, as in cities from years past or even in many other countries today. The United States’ large land mass, along with the car and a variety of cultural, political, and business decisions, have contributed to its unique character and growth.

A discussion regarding the desirability and sustainability of the suburbs, as well as their likely future and prospects for real estate investors, will be addressed in Part 2.

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Ashley:
This is Real Estate Rookie show number 376. So some people like myself may browse Craigslist to find properties, but today’s guest found his own property listed for sale. You won’t believe how much it was listed for and how he found out about it. My name is Ashley Kehr, and welcome to the Real Estate Rookie podcast, where every week, three times per week now, we bring you the motivation, inspiration, and the stories to help you get started. Okay, so today’s guest is Matt Drouin, and Matt’s. We are so glad to have you on the show. He is a seasoned investor from New York. He believes if you are not a rookie at something that you’ll never grow. He had a newsworthy story to share, kind of almost like Leka’s if you haven’t listened to that episode yet. But he’s going to share with us an eviction that eventually almost cost him his property. So, Matt, thank you so much for joining us today for a little therapy session to tell us your horror story.

Matt:
I have so many horror stories in this business, so this is one of my favorite ones. But thanks for inviting me on. I am excited and terrified at the same time.

Ashley:
Yeah. Well, I’m excited to go over some other things besides just your horror story to kind of get to know your market because you are investing in New York, and I’m sure everybody’s thinking, “How could there be horror stories investing in New York? It’s such a wonderful place to invest.” And then also we’re going to hear about your first mixed-use deal and then how you handle the tenants during this nightmare. So lessons that we can all learn from. So, Matt, let’s get started with this Craigslist house. First of all, I am a little upset with myself that I didn’t actually see it listed for sale, and if it was a good price, jumped on it and bought it. So you want to start off with that day, I guess, as you’re looking at the Craigslist.

Matt:
Right on the clock. I didn’t actually find this on Craigslist. I got a phone call in the middle of the night. It was like 10:30. I was turning down to go to bed and I got a call from an unknown number, and this guy asked me, “Hey, do you own the property at 123 Main Street?” And I said, “Yes, I do. Why do you ask?” And he’s like, “Well, I just walked through it. And there’s a person with a pseudonym that sounds like a fake name, wanting to sell the house for $45,000.” This house is, I sold it recently about a couple of years ago, for $150,000, and that’s how the story started that evening.

Ashley:
So what was your initial thought? You get this phone call, and you’re like, “Is this guy scamming me?” What was your mindset going through at this point?

Matt:
Well, I knew this guy, and I was like friends with him; met him at a couple meetups and that sort of thing. And when he first told me, I was like, “Hey, listen, it is okay. It’s probably just another, a Craigslist scam or a Facebook marketplace scam where somebody stole the pictures on a rental that I had listed years ago and reposted them and is basically just trying to do wire fraud scam in terms of wire me 500 bucks and I’ll send you over a purchase and sale agreement and so on and so forth.”
And so, I tried to brush it off that way, and he was like, “No, Matt, I actually just walked through the property. There was somebody that’s there with groups of buyers and me being one of them, and this guy is trying to sell the house.” And I was like, “He can’t sell the house.” By the way, he hasn’t paid rent in two years, so there’s no possible way he could ever sell the house. He doesn’t have title to it or anything like that. So that’s kind of how that started. And obviously, I did not sleep well that night.

Ashley:
So you mentioned you knew this guy that had called to give you that information. How did this guy know that you owned this house? Had he had seen pictures of it on your Facebook before, or how did he kind of put that connection together after he walked through the property?

Matt:
Well, his instinct started creeping in, and he was like, “This seems a little bit sketchy.” So he looked up the property information on public record, saw that it had a mailing address. He looked up the mailing address, seeing what other LLCs were tied to this mailing address. And so saw one of the LLCs is my main company at the time. And so, that’s what led to the phone call. We were friends on Facebook. Him and I are both really active in the real estate community. So it definitely does pay to get yourself out there and network and build your network of people and your business, not just for being top of mind for potential deals and what you’re looking for, but also for things like this.

Ashley:
So you don’t sleep at all at night; your mind is racing. What’s the first thing you do in the morning?

Matt:
I emailed my property manager right away. It’s a good thing that he was actually a former police officer, so that definitely gave me some confidence. And so, I told them what was going on, and I was like, “Who is this person?” It’s a male. “And I signed a lease with a little old lady back a few years ago. So, what’s going on? Why does this person have possession of the house?”

Ashley:
Had you been getting rental payments from that old lady? Were you still getting a check every month for that property?

Matt:
No, no. The payment stopped. She was literally the sweetest lady I could possibly imagine, good income kept the place up really well. When I first walked through the house to introduce myself, the first thing she said was like, “Oh my gosh, you’re gorgeous.” I was like… People just don’t say. I was like, “Do you say that to all the guys?” But what happened after my property manager did some research with the person? Because this is a pretty large company, and so they got back to me and they said, “Okay, the son called after rent payment stopped, and we started issuing them notices and said that his mother died.”
And then when we said, well, “Who are you? You’re not on the lease if you’re 18 years older; you need to be on the lease. We need to screen you and all that other stuff.” And so he quickly said, “Let me call you right back.” So a few days later, after a property manager followed up with him, they called him back, and he said, “Oh, actually, my mom didn’t die. She’s just really sick, and she’s in the hospital.” So they started going through the eviction proceedings, that sort of thing. This was like in 2019, and actually it was early 2019, late 2018. And then, by the time that we got a court date set, the pandemic hit, and then the eviction moratorium.

Ashley:
Did you try to Google this lady’s name to see if there was an obituary or anything for her?

Matt:
I was almost like… It was so set; it was so sad. I did not do that. I was like, “Okay…” What I did, and the reason why this was sad, is because when she originally moved to the house, she was like, “I don’t have the money right now. I don’t think I can mortgage. Can I buy this house when it’s right?” So I actually built a relationship with her, connected her with NACA, Neighborhood Assistance Corporation of America, which is a nonprofit mortgage loader and generator for 0% down houses, basically for people that are moderate incomes, that sort of thing. So I got her into that program with the full expectation that I was going to sell this house to her and sell it to her for actually a price below market because nobody in her family tree had ever even owned a home before that she could think of. So that’s what was really sad is that that never happened. And then it turned to this nightmare story.

Ashley:
Did you ever find out if she was still alive or not? As to what the truth was there?

Matt:
Yeah, she definitely had passed away, and that was the other sad part too, because she was such a sweet lady.

Ashley:
Okay. So you’re trying to figure, there’s been nobody paying, somebody’s trying to purchase your house, you’re trying to talk to people as to what you should do. What are your next steps?

Matt:
My next step, is I call everybody that I know that is affiliated with the news. My friend Matt, who called me the prior evening, said that there was a dozen people walking through this property that evening. So first of all, I didn’t want anybody getting scammed because this guy couldn’t legally transfer title to anybody. All he could do was collect cash deposits and scam these people. So I wanted to get on the news so that there would be visibility for people to not get scammed. And also, so that I was like, “All right, if this is on the news, then maybe this guy will feel the heat and not do it anymore and maybe even leave because of the amount of heat.” The second thing I did was, like I said, my property manager was a former police officer, so I was like, “Hey, I got the Craigslist ad. I have this person’s phone number. Let’s set up a sting operation.”

Ashley:
That was the first thing I would want to do too.

Matt:
So I went on Facebook Live I set up an appointment here. I was like, “Hey, I have cash. I’m super interested.” That sort of thing. So my property manager was like, “Don’t park in the driveway; park across the street so they don’t see our car and that sort of thing.” So we walked up to this house, knocked on the door expecting to see this guy, and I was like, actually, I had my phone in my pocket to try to get… Now looking back on it, this was probably not the smartest thing to do in terms of, because who knows? I didn’t know. I didn’t know the son or what he was capable of, but I have to tell you, this is what happened, smart or stupid. And so, the guy ghosted us, and I was like, maybe he got tipped off and just basically ended up not getting spooked.
So I texted him, I was like, “Hey.” The pseudonym was because I want to protect the names of the guilty, but the pseudonym was Lexi Hernandez. So I texted him, and I was like, “Hey Lexi, we’re here to see the property. We’re super interested, blah, blah, blah, blah, blah.” And so he was like, “Hey, can we meet back a couple of days later?” So at this point in time, my property manager was like, “Listen, this guy’s just going to ghost you again and that sort of thing.” And so I was like, “I’m sorry, we’re no longer interested.” So 24 hours goes by, and Lexi texts me and says, “Hey, if you want to see the house, I just dropped the price to $15,000.”

Ashley:
Okay, Matt, I’m going to stop you right there because I feel like we’re getting into the nitty-gritty of this story here and we’re going to take a short break, but when I come back, I want to talk about how I missed out on an opportunity to purchase a $15,000 house. So we’ll be right back. Okay, we are back with Matt, and we are talking about how you can get $15,000 houses on Craigslist by illegally purchasing someone else’s house. So Matt, this guy, Lexi, it tells you that he is going to drop the price to $15,000 if you’re still interested. So, what do you say?

Matt:
So I didn’t respond to the text message. A couple of days later, the news story came out on TV, and this was on a Wednesday. And so I was like, “Okay, great, this is out. We can stop the scamming.” Hopefully this [inaudible 00:11:16] went viral on Facebook and social media, and the local networks network sort of thing. And so I got a call from a unknown number, and it happened to be a police officer that worked in the jurisdiction of where this house was. And he said, “Hey, are you Matt? Do you own the property at 123 Main Street?” I was like, “Thank God, I’m getting some help here in terms of rectifying the situation.” I was like, “Yes.” And he said, “Okay, well, great. Do you happen to know the tenant that lives there?” And I was like, “No, not really. I have a tenant; I have a lease signed with the other tenant, his mother, who passed away.” And so on and so forth.
And he was like, “Well, we just picked up, arrested a kid who used counterfeit money to buy a pack of gum at the 7-Eleven around the corner, who got this counterfeit money because he ‘sold an Xbox’ to the tenant that’s in your house.” And so I was completely floored that, and then this got me thinking, so I was like, “Okay, well, I don’t have persons. I mean, I have the person’s contact information; I can get them to you. I’m not sure if it’s a burner phone or whatever.” And so I knew right from then, after I was thinking…

Ashley:
What point did you realize that you’re working with a criminal mastermind here? I mean, making counterfeit money, selling someone else’s house.

Matt:
I know this poor kid who’s trying to buy a pack of gum and got arrested. So I started thinking, and I started putting my game theory hat on. I was like, “Okay, this guy’s collecting deposits to sell a house he doesn’t own. He’s buying property using counterfeit money using this house.” I was like, “This guy can. There’s no possible way that this guy can be living there anymore.” So what I ended up doing is, I ended up calling one of my contractors because my property manager wouldn’t do this. And I think this is beyond a statute of limitations. So what I did was not technically kosher from a eviction standpoint, but I had a contractor change out the locks on the property. We also conspicuously posted signs around the house saying, “No trespassing; properties under video surveillance.” I got a SimpliSafe system on there. If anybody tried to break in, I would be alerted to that.
And we just waited because this guy was getting entrance back in the house and was locked out. He probably would’ve called the property manager and was like, “Hey, I’m locked out of the house. Can you let me in?” We’re just trying to make contact with him. And this guy just disappeared, never came back. Two weeks passed. And so we just ended up keeping this stuff stored in the house, and then after 30 days we just ended up cleaning out the house, repainting it, and I was like, “All right, I’m done with this property.” And I just ended up selling it to an owner-occupant.

Ashley:
So what would you do differently now, looking back at that experience? We’ll kind of go into the details here, but overall, looking back, what are some things that could have prevented this whole thing from happening?

Matt:
Here’s the thing. Is there some things that will happen that are bad despite all of the preparation you put into it? Right. This tenant had perfect credit. This tenant had great income. Character-wise, she called me gorgeous the moment she met me, and she kept her own house up really well. My property manager always made sure to drop by a house and see how they lived to make sure that they kept care of their place. And so, we did everything the right way on the front end. This was one of those things that are just completely unpreventable, despite the amount of preparation you do. And so, I think the things I would’ve done differently is I probably wouldn’t have put my life and limit at risk trying to do the stupid sting operation.
And then also I probably, I should have consulted and listened to an attorney in terms of what the proper process was. I was just scared to death that somebody was going to “buy this house” and move into it. So I wanted to get possession of the property as quickly as possible, despite the legal gray area of changing the locks out with the property. So that was probably not kosher to do in New York State, but I had to weigh the possibility of somebody thinking that they bought this house and being scammed out of, let’s say, $40,000 or $15,000 for somebody who couldn’t afford to lose that.

Ashley:
That actually happened to James Dainard, an investor out of Seattle; he’s On The Market podcast, he’s one of the hosts on there. He actually purchased a property where somebody else had sold it, and they didn’t actually own the property. And he had to go through this whole thing, and the property just sat there forever because they were trying to clear title on it and things like that. But that can really, especially if somebody is pouring their life savings; maybe this is their first investment or this is their first home that they’re buying; that really can be detrimental to them financially and even emotionally if something like that where… They were to be scammed in that sense.
Yeah, so one big red flag: if you guys are on Craigslist and you see a house that should cost $150,000 and it’s only listed as $15,000, that may be a scam. So just be cautious out there. Some of the similarities I saw was one thing that you did do that seemed to really help you, and this is the same thing Leka had done on episode 360 was go to the news and get that kind of attention on social media and things like that. If someone is trying to do that, they’re in their own situation where they want to attract media coverage. What are some ways to actually do that? How did you get the media’s attention?

Matt:
I’m really involved in the real estate community and the housing advocacy community on behalf of housing providers in Rochester. So I was kind of always… And here’s the thing, is to make a friend with somebody that is on the news and being very available, and these people, when they get their news story for the morning, they literally have to get their footage before four o’clock that day. So I always made myself super available. If my friend needed to get coverage on some sort of housing-related story, I would always move my schedule around and be there. So that definitely helped having those contacts. And also, it helped because the story was so crazy; you just can’t make this stuff up.

Ashley:
So the power of networking, you just showed a great example of that right there, and even though you weren’t getting anything in return being useful and helpful to other people upfront, it paid out in the end. But you mentioned Rochester, and we haven’t talked about your market at all. So do you want to give us a little insight of after this deal happened, did you shoot out of Rochester and go across country to invest in somewhere else? But give us a little insight on why you have chosen Rochester as your market, and what are some of the pros and cons of investing in Rochester?

Matt:
Absolutely. Rochester is an awesome place to invest. The problem is that there is, you have really great areas, and then you have areas that are stricken with abject poverty. So a lot of out-of-town investors that call themselves cash flow investors look at properties like a duplex that’s for sale for $30,000, and they run the spreadsheets on it. They’re like, “How could this possibly go wrong?” The reason why it’s so cheap is because nobody wants to live there. At least people with means don’t want to live there. So great areas are great for a blend of between cash flow and also appreciation. I also want to bring people up to speed with… Rochester’s typical story you look at is the downfall of Kodak, Xerox, and Bausch + Lomband, and those titans did lead to a population outmigration in Rochester. But sort of the phoenix that has risen out of the ashes is that we’ve gotten a extremely diversified economy that is undergirded by medical and education.
We have seven universities that are surrounding our city. We have three to four major hospital systems that are world-class that employ a ton of people, a ton of people with great jobs, and also we’re surrounded by abundant fresh water as well, which I think, like, my brother lives in Arizona for instance, and he’s like, “I don’t know if there’s going to be any water in the next 10 years in Arizona.” So I was like, “All right, well, we have the Finger Lakes and we have the Great Lakes.” And stuff like that, and we don’t have tornadoes and hurricanes and volcanoes, and that sort of thing. So I just think it is important for people to come to Rochester if they’re looking to invest from out of town and really, really get in tune with the neighborhoods, because everything’s street by street and block by block in our community, and you really want to be come very knowledgeable about that and buy where people and where you would want to live.
That being said, the reason why I continue to invest in Rochester is because it’s in my own backyard. I know every street, I know every block, I know all of the players that are around town, and that gives you an extreme competitive advantage as an investor, investing in your own backyard. And so I’m a huge advocate for that. And every single market has its own investing strategy that works. And we’re just a blend of cash flow and appreciation; meager appreciation that is two to 3% per year is pretty typical for Rochester. It’s not going to be 10 to 15% per year or anything like.

Ashley:
That. What do you think is the best strategy in Rochester right now?

Matt:
Best strategy: I’m always a fan of buy and hold. Small multifamily properties is a great way to get started in our area. There are properties that will meet debt-to-income to, and also debt service coverage ratio. If you’re getting commercial financing of 1.2 to 1.25 on a lot of deals, so you can put 20% down and investment property in Rochester, and the numbers will make sense. Other markets of the country, you got to put 40% down in order for the numbers to make sense when you put financing on it. So that’s really, it’s a great place to get started. It’s a great place if you live in the area to get started. House hacking through multifamily property is a great way to start too.

Ashley:
Okay, Matt, so let’s say you can no longer invest in Rochester. You already bought all of the property there, and now you need to go out of state into a different market, and you don’t know a lot about it. What are some of the things that you have learned from your own market? With knowing everything about it, that you could take those skills and go to a different market to analyze? What would be some of the things that you would look at to make sure this market would be a good product for you?

Matt:
If I lost everything or if I bought everything and I couldn’t buy anymore.

Ashley:
Let’s go with the latter one.

Matt:
I think, I look at other markets, I passively invest in other markets with other operators to achieve my goals, which is not necessarily cash flow but an equity multiple in terms of being able to double and triple my money over a long period of time. And so, the things I look at in terms of other markets is strong economy. Diversified economy as well that’s not hinged on one company, like, let’s say, Amazon. If Amazon goes out of business, I’ve gone through that before. Every single one of my family members used to work for Eastman Kodak, and Eastman Kodak downside, they laid off my entire family. I’ve seen what that does. So having a diversified industry base, population stability. Also, I would concentrate on metropolitan areas. It doesn’t have to be a huge city. It could be a small to medium-sized city. You have a velocity of population of people moving in and moving out.
So you have people that are buying and selling, and renting in that market. And then, also look at specifically getting granular down to the actual neighborhood is I look at what is the one, three, and five-mile radius in terms of area median incomes on that property. I want to be in the middle or at the high end of incomes in the area. I don’t want to be at the very bottom in terms of incomes for a neighborhood, for instance, or a submarket in a metropolitan area. So those are just some of the criteria that I use just to make heads or tails of it. And then, if I like a neighborhood, I go to Google Street View, you can find a lot on taking your little orange Google man and dropping them down under the street.

Ashley:
One thing with that is to be cautious of is when the date was. So in some of the areas I invest in, it’s from 2020, and that was four years ago. And some of that data has actually changed. There’s different buildings and different things in there, but…

Matt:
That house ain’t there though no more.

Ashley:
So my next question is, where are you getting this data from? What are some resources that everyone can go to actually find the answers to these different data points you’re looking at?

Matt:
Great question. Typically, most realtors have access to this information because part of their membership dues, they pay as part of being part of the MLS, and the local board of realtors is they get access to other tools besides just the MLS to be able to pull actual market data such as incomes and that sort of thing. So that can be a great resource, and some of these realtors may not even know that they actually have these tools at their disposal, but they have a menu of tools that are part of the benefit of being a member of their board if they can’t find the answer. The Federal Reserve website is really helpful for me. Federal Reserve Bank of St. Louis is something I go to all the time to find out information about zip codes in terms of area median income and that type of stuff. But I mean, I think first things first is going to your local realtor and trying to find that data.

Ashley:
Yeah, some other ways you can get the information is also from the census, but you got to remember the last census, big census was done four years ago too, and we got to wait another six years for that. But just looking at different governmental websites and then also going to the websites of large commercial brokers, and even like Crexi, things like that. They’ll put out reports; Millichap will, a bunch of them. And then also On The Market, great podcast to get data. Dave Meyer put stuff onto the BiggerPockets website, especially if you’re a pro member of BiggerPockets. You get all of these exclusive articles that he writes, and most of them are on the data and everything and statistics of investing in different markets too.
So we’re going to take another break, and when we come back, I want to ask Matt about tenant screening. So in his years of experience, what are some of the things, the policies and procedures that he has implemented and getting the right tenants in and how you can prevent putting the wrong tenants in, even though, as we found, he had a perfect tenant in place and still it went wrong. So we’ll be right back.
Okay, Matt, we are back from our short break. So let’s talk about tenant screening here. What are some of the policies and procedures that you have implemented to really protect yourself from having evictions and having bad tenants?

Matt:
Yeah, super rigorous tenant screening is very important to the business model, especially in New York State, which laws have been passed recently that have been very tenant-friendly. So in addition to buying in great locations, you definitely want to make sure that you have a certain amount of rigor around tenant screening. So the systems that we use, we use a property management tool called AppFolio. You can actually input your income requirements and also your credit score requirements that are in there. We go on income; we require at least three times monthly rent in terms of income to qualify for apartments. So we start there. Anybody who’s paying more than 30% of their income is considered rent-burdened by HUD. And so we do not want to rent to somebody that we’re going to set them up for failure and possible displacement because we know what that looks like in terms of how it shatters families.
So we don’t want to be party to that. I think that credit score is definitely a good indication. I don’t run my management company anymore. My partner runs a management company, but once or twice a year, he’ll bring up a application that just doesn’t fit in a box that we have, but other things look good. For instance, we have a tenant that has strong income but they have a low credit score. So he’ll escalate that up to me. And what I would really do is I would do a deep dive on their credit report history and seeing what’s on there. So if they just have low credit because they pay cash for everything, I’m going to take that consideration.
A lot of times, also, people have a lot of student loan debt. We really don’t rate student loan debt very high, medical debt as well we don’t rate that high. But if I start seeing auto repossessions, any landlord collections, utility bill collections, if you can’t pay your utility bill, then how are you going to be able to pay rent? So we will get granular and make policy exceptions once in a while for at tenants that are right on the cusp there that we feel good about.

Ashley:
Yeah, I do the same too where student debt and medical debt, we really don’t take into effect. And I think the important lesson to take away from your screening criteria is that you were able to just spew off your criteria. You actually have a criteria, and that’s what everybody needs to do. If you’re going to be screening tenants, even if you have one rental unit and you’re accepting three applications, those are three different screenings you have to do and have a list of what your criteria is. So each time you can just go through and yes, yes, no, and that first of all makes it so much easier because you’re not going by your gut or getting emotional because their dog really wants that backyard to play in or whatever it may be. And plus then you’re also following fair housing laws, where you’re not rejecting somebody just because you think the other person will be better, even though you don’t even have a basis or a criteria to follow.
So that is something; if you don’t have that right now, sit down and write out what that is. And if you have property management software, you can incorporate your criteria right into the software. So the software will say automatically just this did not meet your criteria or this needs a manual review. So for us, it comes up if there’s student loan debt that is affecting that income, and that’s where we go in and do the manual review and usually end up approving it, or if they meet all the criteria approved, okay, we can continue to move on, but we have a record of all of the screening that we’re doing and we’re documenting it, and documenting it. So that’s a big lesson to take away here is building out that criteria. So Matt, before we wrap up here though, I love diversifying, and so I’ve learned that you have gone into a new asset class for you. So tell me a little bit about this transition and this pivot going into a new asset class.

Matt:
I love multifamily. What we found is that during 2018, 2019, prices started getting out of whack, where we couldn’t make numbers work anymore on multifamily deals. And we still wanted to fulfill our long-term objectives of growing our portfolio. So we started thinking about what asset class do people not like. So I started finding these mixed-use buildings where retail investors, usually these have retail on the first floor. Retail investors don’t like them because they’re residential, and residential investors don’t like it because it has retail. It scares the crap out of them. So I to, I said, I was like, “Okay, maybe we can find a market inefficiency in acquiring mixed-use buildings.” And so we kind of went down that road and told everybody we knew that we were looking for mixed-use properties. And to that end, through that networking, I was at a meetup, and this guy came up to me, and he was like, “I have this off-market broker pocket listing deal. I don’t want the retail in it, but it’s got a good amount of residential units.”
Had about 24 residential units. So we took a look at it, and I really was intimidated by it at first. First thing, the thing needed a ton of work. And secondly, this retail thing was new to me, but the good thing was that both the tenant spaces were occupied on the first floor, the commercial space. And when I was stress testing this deal, I was like, “If those two spaces are vacant, I’ll still be able to pay my bills with the property, the mortgage, the taxes, insurance, the repairs and maintenance, all that stuff.” So that’s really what gave me the confidence to kind of start diversifying into a new asset class. And that’s really what led me to having the confidence to start going into more commercial stuff like office, industrial and other fully retail buildings was from that experience and being able to dip my toes in the water without getting a hundred percent exposure to a new asset class I wasn’t familiar with.

Ashley:
And Matt, just because we love the numbers, how did you finance this deal, and is it any different to finance a mixed-use property than it would be commercial or residential?

Matt:
Yeah, so anything that’s mixed-use is going to be considered commercial. So typically, you’re not going to be able to get a 30-year fixed-rate mortgage on it. It’s going to be something that’s going to have to be with a community bank, typically, or credit union where they have a commercial lending department. This deal, it was actually a package; it was a mixed-use property that had a four-family property that was right behind it on a separate tax parcel, but it was adjacent to it, it shared a driveway. And so, when I was underwriting this mixed-use deal, I was buying the package for $775,000. And when I was running the numbers, I was like, “The big building alone would appraise for $775 all day long.” So I got to thinking, I was like, “Okay, how can I creatively structure this thing where I’d be able to get into this deal with none of my own money?”
Because at that point in time, it’s like a growing real estate investor is always running out of cash. So you start to have to either get creative or learn how to raise capital. And so, I had a hard moneylender that agreed to lend $180,000 on the four-family property. And so how we structured the contract was we amended it and broke it into two different contracts. The big property was going to be $775,000, and the four family was going to be at a dollar, contingent upon the sale and transfer of title of the bigger property. So this is the part that was crazy when we closed this thing, we used a credit union to finance the big property that already had a mortgage on it. So we did a mortgage assignment, saved some substantial amount of closing costs by doing that.

Ashley:
Can you just explain what a mortgage assignment is real quick?

Matt:
Yes, absolutely. So at least in New York State, when you put debt on a property, the local county will collect what’s called mortgage tax. And so a certain percentage of the actual mortgage amount on the property, and you, as the buyer or if you refinance the property, have to pay that. So one slick trick that you can use is you can ask your attorney, is it possible for the bank to assign the mortgage to the new bank so that the mortgage tax that we would pay would be on any additional debt placed on the property above and beyond the original mortgage. So in this case, the original mortgage was like $500,000. So we were able to actually have them assign that. So we saved about $5,000 in closing costs, which was pretty big for this deal.

Ashley:
That’s awesome. I’ve never heard of that. Let’s explain the difference real quick of the difference between that and assuming someone else’s loan too, because assuming the loan is where you’re actually taking over their loan with the same bank, but all you’re doing is having it transferred to your bank and the loan is in your name, everything like that, that’s really interesting. I never knew you could do that. And now I’m definitely going to try it out sometime because it’s what? 1%, right? That mortgage tax in New York State is 1%, which definitely adds up to quite a chunk of change. So that’s a really cool strategy that you used to do that. And so, what did you end up having to put down on this property?

Matt:
So let’s fast-forward to the closing table, right? So the property did end up appraising, I think for $785. We’re buying it for $775. And when it was time for closing, we had the closing for the four-family property with our hard moneylender’s attorney in one office at this attorney’s office downtown. And so we got the check for the $180,000 for the mortgage, and my attorney already had checks cut. He got the check and basically essentially walked the check down the hallway to the other office, where we had the closing for the bigger property. And so the hard money loan proceeds from this property provided a hundred percent of the down payment and closing costs for the acquisition of the total package. And also, we had some loan proceeds in excess about 11,000 bucks. So it allowed us to actually have some startup cash to start figuring out, “Okay, what do we want to do with this thing now?”

Ashley:
I want everyone to take a minute and to rewind that and map all of this out in their brain as to how creative this was to get this deal done. So you have the, what was it, a four-unit, the apartment building and back?

Matt:
Yes, correct.

Ashley:
Yeah. So you have the four unit where he’s going and getting hard money on it for $180,000, but on paper, it actually looks like he’s paying $1 for it. But his hard moneylender is giving him $180,000 for that property, which there’s going to be a lien on it, everything like that. It’s just for the county record; it’s saying he bought it for $1. Then you go to the other property that he’s purchasing for $775,000, the big commercial property, and he’s taking that 180,000 and using that for his down payment on that property and then getting a mortgage for the rest of it. So that’s a wonderful thing about commercial lenders, is if this was a residential unit and maybe you were house hacking it, they would say, “Well, where’s that down payment coming from? I need to see your bank statements, your mother’s bank statements, your dog’s bank statements.”
But in commercial, if the deal still works and the property can support the payments, you can borrow money from other sources for the down payment, and they’re not as stringent as to where that down payment comes from. And way more flexible with getting creative as to how the deal is put together. The bank just wants to make sure that on the commercial end, the rents can support you paying them and whatever other debt you borrowed to make this deal happen. And of course, your monthly expenses. And if it does, they’re usually good to go. So when you’re looking at commercial properties from now on, I want you guys to think of Matt and think of this deal and think, “How can I be like Matt? What would Matt do?” Okay. So, Matt, thank you so much for sharing that example with us. Is there any last things you wanted to add about that deal that made it remarkable? How’s it doing today?

Matt:
It’s doing great today. The original tenants we had has retail, that originally occupied the property was Rent-A-Center, which is a company I have a bone to pick with because they take advantage of low-income people. And also, it was a nail salon that was on the other side, and they were… Pretty sure they were doing human trafficking through that place because there was cots in the basement and that sort of thing. So I booted both of those tenants out, and I got a crumpet shop, which, Ashley, if you come to Rochester, New York, you can know what a crumpet is.

Ashley:
Yeah, I was just going to ask, is it like, here’s going to be, my guess is it’s like a chocolate or a candy or something, a crumpet?

Matt:
No, you have no idea. So it’s an English; it’s like a, think of a cross between…

Ashley:
Oh, like tea and crumpets, right? Tea and crumpets.

Matt:
Correct, yeah.

Ashley:
Yeah. Okay, okay. I still don’t know what it is. I’m assuming like a baked good, maybe? Is that what it is?

Matt:
It’s kind of like that. Yeah. Yeah. It’s crossed between an English muffin and a pancake kind of. It’s savory, so it’s what you put on top of it is what makes it. And I was also able to place a vintage clothing and home goods store next door in where Rent-A-Center used to be. So it’s really changed the complexion of the neighborhood. It was a really fun project. Looking back on it, I lost a lot of hair and earned a lot of gray hairs in the process, which is a completely different show of that story. But fast-forward to today; it is been a joy in my life.

Ashley:
Well, Matt, thank you so much for joining us today. We appreciated you sharing your nightmare horror story with us, talking about screening tenants and also about the Rochester market, in case there’s anyone that’s interested in investing there. They have an idea of where to start when analyzing a deal in that market. So thank you so much. And also mixed-use; you guys know how to get creative with putting your commercial deals together now. So, Matt, thank you so much for joining us. I am Ashley. You can find Matt’s information in our show notes, and also you can find me on Instagram, and we’ll link that into the show notes. Thank you, guys, and we’ll see you next time.

David:
This is the BiggerPockets Podcast show 907. What’s going on, everyone? This is David Greene, your host of the BiggerPockets Real Estate Podcast, the show where we argue with the information that you need to start building long-term wealth through real estate today. And today we have a Seeing Greene episode. If you’re watching on YouTube, you see the green light behind me and you know that only means one thing, I’m filming this in front of a traffic stop at an intersection. Just kidding. It means that we are doing Seeing Greene, and I brought some help. We start off the show with James Dainard who helps answer a question for me from one of the BiggerPockets staff members actually, which he does from his yacht. And then James realized in the middle of the interview that he did not want to be on the interview, he wanted to be yachting around, so I brought in Rob little yachty Abasolo to sort of support me with this and he’s here to take over the second portion.
In today’s show, we get into some really good stuff, such as why expensive markets tend to appreciate more than cheaper markets, what to do about turning your primary property into a rental if it doesn’t cashflow, when your house hacking strategy doesn’t go according to plan, when you can count expenses for a rental property and when you can’t, and more importantly, what you have to do to make it eligible to count those expenses and more.
But first, we’ve got a question from Noah Bacon in Colorado. So Rob, why don’t you go check out the vacancy on our Scottsdale property and make sure we’re getting that sucker filled and then be back lickety split?

Rob:
Okay, but before I do, if anyone here is listening and you want to submit a question, remember you can always go over to biggerpockets.com/david to submit your questions for the next episode of Seeing Greene.

David:
Noah Bacon, the Bigger Pockets community manager, Noah representing BP, what you got for us today?

Noah:
Hey guys, thank you both for taking the time to answer some of my questions and it’s really great to hang out with you guys here today. So I started a house hacking in 2021 in Colorado, Springs, and it performed really well when I was house hacking. Since I’ve moved out, it hasn’t really performed all that well. On paper, everything was great, was going to cashflow about 300, $400 when I moved out. Turns out, went through an eviction, rental rates dropped a little bit now that it’s not in the summertime and insurance rates have really skyrocketed here in Colorado. My HOI fees went up 100% this year alone. So just immediately from 2021 on paper, everything looks great. Now we’re here in 2024, I’m breaking even.
So it’s not like it’s a terrible asset at this point, but it’s breaking even and I’m seeing the next two to three years on the horizon and I’m like, “Do I take the equity in the property and deploy it elsewhere or do I kind of go along this path and potentially be at a negative cashflow in two to three years and let the equity build since set a 3% rate?” I know a lot of people are in this great problem to have with the 3% rate in equity building, but the cashflow monthly is going to start to go on the downside. So when is a time do you guys think to scale, to start to think about different things? Should I ride this out? I guess what have you guys been hearing about things like this?

David:
I’m going to turn it over to James. Before I do, I’m going to give you my 2 cents on why I think this is happening because more people than you think, Noah, are in the exact same position. I saw 2023 was like the year of this, right? My opinion of why I think this is happening is we have really bad inflation. We printed a whole bunch of money. Inflation doesn’t come right away. It’s like if you have an earthquake in the middle of the ocean, it takes a while for that wave to build and actually hit the shore. But we’re seeing it continually go up and up and up.
A lot of people measure inflation through the CPI, which I don’t like because those things can be manipulated. But if you actually just look at your life, how much are you paying for steak at the grocery store? How much is milk cost? How much is gas costs? It’s really high. And I’m seeing homeowners insurance Skyrocketing and no one’s talking about it. I mean it’s not like it went up 20%. It’s like it’s doubling or tripling on some of these properties in one moment or another one, like you said, the HOA fees. It’s like, oh, it was 150. Now they’re coming back and saying $400, okay?
So rent can only go so high because rents are largely and loosely based on wage increases. Well as inflation is making everything more expensive. That doesn’t mean that companies are just paying their employees more. They’re actually kind of getting away with giving people pay cuts if you keep their wage the same, but everything becomes more expensive. So HOAs are going up because of inflation, insurance is going up because of inflation. I bet the next thing you’re going to see is municipalities start increasing property taxes because of inflation having it there, yet rents are not going up because people are kind of already tapped out with what they can afford. And it’s created this odd squeeze that I’ve never seen in real estate where rents are not going up with the same degree as the cost of goods and services because people couldn’t afford to pay them. You’d have tenants to say, “Well, I can’t make my payment if you raise my rent because I’m already not getting a raise at work and everything else is becoming more expensive.”
So James, what do you think? Did you see something similar or you have a different take on it?

James:
No, I mean the rising costs are eroding cash flow. Insurance is a huge expense for us as landlords, also as a construction company. I mean, our builders risk policies, it’s expensive and what we all have to do is our performance… The great thing about our performance last two years is we would blow them up with way more income coming in. We did a lot better than we thought. Now what’s happening is the expenses are starting to catch up. And honestly, people are starting to feel the real cash flow of real estate and a lot of investors are feeling this right now because as you buy real estate in your newer and real estate, and I did the same thing, it’s like you buy them, you get a couple hundred dollars a month in cash flow. And then the economy starts leveling out or something bad happens, you have to maybe pay for that asset because these are investments. Investments go up and down.
What I would do for any investor, Noah, especially you, is going what is your long-term goal that when you’re thinking about what to do with that property, you really need to know what is your one year, what is your three year, what is your five-year goal. And by doing that and listing down where you want to be with your passive income and your cash flow, that’s going to kind of tell you the direction you want to go. But personally for me, everything’s tradeable and I can always increase my cash flow position. And the great thing is, you made a very smart investment and you’ve made $100,000 in equity.
Now, you want to figure out what to do with that because equity is only good if you utilize it. It’s just sitting there. It’s not even a real thing. And at the end of the day, I still factor that into my return. So every year I run return on equity on every one of my properties. Is my return still meeting what my expectations should be? Or what can I do with that equity and trade it out? Because the great thing is you made that decision, you have $100,000 in gunpowder at that point, your issue is you don’t want to pay for your property every month, which is understandable. No one really does. I would trade that for another property that has a whole lot higher cash flow. You have 100 grand. You don’t need to add into any other property. That’s your down payment. And you can take that three to $400 a month or even break even and you can 3 to 4X that by making the right trading, getting maybe some more doors, trading into a little bit cheaper market, but it has to be your goals. “I want cash flow.”
If you want growth, I would take that property, I would 1031 exchange it into a value add property so I can double my equity position. If I’m buying it below market, improving with rehab, then all of a sudden my $100,000 in gunpowder might turn into 200,000. And then you’re talking about trading that for some serious cash flow. But write down those goals. It’s going to tell you your plan of action. But even if you have a 3% rate, who cares? It doesn’t matter what your rate is if you’re not making money. I would rather pay 10% and make money than 3% in breakeven. Capital is just a cost of the deal. And if the deal is worth it, pay whatever rate it is. And so I would just say write down your goals. Where do you want to be? Cash flow? Equity? Do you want to expedite the process? Go value add. If you want steady cash flow, trade into a lower market, get more doors. And then you can weather storms more because your cash flow is greater.

David:
Noah, we have to take a quick break, but I will give you a chance to react to James’s advice right after we get back.
And we’re back with Noah Bacon, the investor and house hacker in Colorado who is struggling with increased costs and the handcuffs of a low interest rate. Should he sell to tap the equity or keep the deal? What do you think, Noah?

Noah:
Yeah, that’s really well said. And I think I’m at a point too where it’s one property that I have, if it goes wrong, like we were just talking about James, it’s like two months of paying, two mortgages now, how can I potentially mitigate that risk? And I think like you’re saying, it’s time to stop looking at that 3% in the equity build over the 30 years of the 3% rate. I’ve been hanging onto that since the day I bought the property and it’s like it’s time to let that fantasy and reality go and start to scale. It’s just now that the environment’s different, I wasn’t expecting expenses to go so much more rapidly than what income was. I’m just like, “Okay, new year. I really got to think about these things.” So I really appreciate that because I really do think I need to start looking in potentially different market because I’ve seen on the forums, places that I’m in Colorado specifically with natural disasters are having massive increases on insurance. So I think I just really need to start looking more macroly instead of my own localized market now.

David:
And maybe get ahead of what the competition is going to be doing. So my guess would be in the next five years or so, more people are going to have a similar experience where their HOA jacked up rates a proportionally very high amount. Insurance went up because of natural disasters in that area at a disproportionate amount.
Some of the other costs that you can’t control are going to go up more than what they did in the past. So it’s not just HOA fees, but let’s say you own a condo and it needs to have the roof replaced. Well, roofs are three times more expensive than they were five years ago or so because like James just said the cost of construction is super high and the wages that they’re paying these employees are high. And so those special assessments used to be kind a mosquito bite and now they’re a dragon flame. It’s killing you, right? So you can avoid this by looking for properties that don’t have the danger of having these costs go up. Single family homes instead of condos. Properties that are not in an HOA, but they’re still in a decent area.
And even if they don’t cash flow right away, if you pick the right location over the next five years, the rents are going to go up in those areas more than the others and the values are going to go up in those areas more than the others because as other investors and homeowners start to realize how bad it is to be in an HOA if you can’t control the cost going up or an area where insurance is really high, they’re going to move into the areas that I think you should be looking for right now.

James:
So Noah, you house hacked this house, correct? You lived in it for a certain amount of time. And if you lived in that property for two years and talk to your accountant, you can take the homeowner exemption and your $100,000 could be completely tax-free. Because if you live there for two years, you’re going to qualify up for up to $250,000 of tax deferment at that point.
And actually after one year, your 100,000 might be totally tax-free. And if you look at that, your 3% rate, yeah, you’re saving something right now because you’re going to have to pay 6.5, 7% pretty solid, but you’re going to make $100,000 with no tax on that. And then what you can do is you can take that portion of your taxes, go reinvest that into your new multi and you might be able to buy two properties and you only have to defer it. You have a clean tax basis, you’re saving on 100 grand, you’re going to save at least 20 grand in taxes, you’re putting that back in your property and you can roll it into a new property to increase your portfolio. So utilize the tax credits to if you’ve got to trade up your rate, at least you’re getting a big benefit on the taxes.

Noah:
With my first property, I only lived there for a year and then I purchased my second house hack 12 months after. So I’m coming up on two years on the house hack I’m currently living in and it’s also townhouse in an HOI and I’m just expecting the same rainy day that I had on the rental property that I turned into. So I’m like probably when it comes to two years at the property I’m living in currently, I’ll think about that, deploy the capital and take the tax exemption. But with the property that I lived in previously, I only had one year, so I’m not going to be able to hit that tax exemption unfortunately.

James:
Yeah, but you can take a portion of it. I would talk to your accountant on it to see. And then that might tell you… So again, going back to your goals one year, three year, five year, you might be really comfortable in your house that you’re in now and you want to stay there and that’s perfectly normal, right? You got a low rate, you want to stay there for a long time that meets your goals or you don’t really care. Like for me, I’ll trade any house. I have no emotional attachments for housing anymore. Then I would utilize both.
And then you can go maybe pick up a new primary on a value add, start creating that equity again for another tax-free gain, take the portion and go buy one or two more rentals and get better cash flow out of those. And you’re going to really over a three-year period, you’re going to 2X your return right now because you’re going to pick up the value add on your property that will be tax-free over two years. And then if you’re increasing your cash flow, it’s helping with your monthly expenses. And if you buy on value add, you can increase that equity even further. And so it’s that domino effect, right? Every time you make a trade, pick up another trade, I never trade like for like. I want to improve my equity position every time because the equity position and the equity is how we really get financial freedom.

David:
It doesn’t have to be cash flow or equity, which is how the argument often gets phrased. I think it should be cash flow after equity. So if you think about how much control you have over cashflow, it’s very little. You can’t control what rents are. They’re going to be what they are. You could try to control expenses, but there’s only so much you could do. Your mortgage isn’t going away, your taxes aren’t going away. And when the insurance goes up or the HOA go up, you don’t have a choice. The only expenses you really have any measure of influence over are vacancy, maybe how much you pay for maintenance if you can figure out how to get some kind of handyman to be good, and even CapEx you can’t really control, right? So it’s incredibly difficult to build cash flow because you don’t have as much control over it.
But equity you have a lot of control over. You control how much you pay for the property. You control what area you buy in and where they’re going to be going up. You control what value add you do to the property. You control the whole project if you pay attention to it and how cheap the expenses are kept for the rehab. So if you have more control over something, you are more likely to be successful in it. My advice for most real estate investors, especially when they’re younger, is not to just race to cash flow and quit their job and then say, “Hey, I made it” because those people end getting back into the same rat race that they claim they quit, unless they sell courses and they live off of that and pretend like they’re living off of the rent.
My advice is just snowball equity like what James said. Every deal you pick up, you buy it under market value, you add value to it, you sell it, you go into another one and you build up this snowball. And then near the end, you convert all of that equity that you’ve built into cash flowing property, which is going to give you a lot more cash flow than if you take the approach of, “I’m going to keep acquiring your properties at $200 a month.” If we lived to be 900 years old like Methuselah, that would be a good strategy. Unfortunately, life is too short for that to work out.

Noah:
I’m thinking about this with a small mind until today, and I think it’s time to really start expanding the portfolio a little bit more and see what other options are out there. But I can’t thank you guys enough for your time today and helping me think about where my portfolio heading into the next year.

David:
All right, Noah, thanks for coming on.
And I hope you’re enjoying the shared conversation that we have so far and thank you for spending your time with me. Make sure that you like, comment, and subscribe to this video. Let us know in the comments what you think.
In this segment of the show. I like to take questions from the forums and answer those since it’s an awesome forum on biggerpockets.com. We also read some of the YouTube comments or address any of the reviews that were left where you can leave a review where you listen to podcasts. So go leave us a review and let’s talk about what y’all have been saying.
Our first question comes right out of the forums and it was a topic that was labeled, “WTF. What’s wrong with investors these days?” Rob, this is some good stuff. So basically, this was from Angelo Romero and he has a turnkey company that also helps manage properties in Toledo, Ohio. He has people that reach out to him and say, “Hey, I don’t want to buy any of your product, but I was hoping that you could help me to find a deal. Also, do you have any contractor, lender or agent referrals? Oh, and by the way, I’d love to have you manage properties that I bought with somebody else but not from your company.” And he was a little peeved about this and he says, “It seems to me that everyone wants something for nothing nowadays and nobody is willing to put in the work or pay the margin for the person who did put in the work.”
Now I can relate to this a little bit because people come to me as an agent and they say, “Hey, can you help me get an off-market deal? Or do you have any off-market deals?” And agents only get paid when the deal is indeed on the market. So it doesn’t really make sense to ask a real estate agent to represent you, but then they don’t get paid. So I am in this situation all the time. I just kind wanted to get your 2 cents before we dive into this, Rob.

Rob:
Well first of all, he caps this one when it says, “Folks want to own a monkey, they want to play with the monkey but not carry the monkey or clean its S-word when it does one. Hi-hi.” So that’s pretty funny. Well first of all, let me ask you when you’re getting it off-market deal, I assumed if you’re brokering that deal, there’s still some kind of finder’s fee, right?

David:
You actually can’t do that. So when you’re a real estate agent and you’re a licensed person, if somebody wants to help put something together that’s off market like wholesale, almost every brokerage is going to tell you that you can’t do that because when you’re licensed, you have a fiduciary duty to the people you’re working with and they expect that. And it’s a massive liability to help somebody that when you’re not covered by your license or the insurance that goes under your license.

Rob:
Yeah, so I guess the problem here is that people are asking for quite a bit. There’s a little bit of entitlement in that they expect you to do a lot of things for them, but they’re not providing the value upfront. So I probably try to go out of my way and see how I could provide value.

David:
We’re not trying to sit here and be negative on the show, but I do think that there’s a lot of people that are in the BP world that just don’t understand that the podcast is free and the blogs are free and the forum is free and the books are cheap. There’s so many things that are free, but the people that make their living from this that are on here sharing free advice, that doesn’t mean that they’re going to work for free.
One of the comments in the forums here said, “I guess we’ve gone from, ‘How do I invest with no or low money down?’ to, ‘How do I get other people to do all the work for me and I benefit from the deal without paying them?’.” And we’re only bringing this up because there’s a very good chance that people don’t realize that’s how they’re coming across. I don’t think anyone is conscious of the fact that when you go to a turnkey provider who’s basically digging in the streets trying to find that deal and putting blood and sweat and tears into getting it, and then you say, “Hey, can you just give me one of those so that I don’t have to do the work?”, that it’s going to be offensive to them.

Rob:
Provide value in a way that’s like a clear need that someone has and try to make a win-win out the gate. Instead of saying, “Hey, come in and teach me your ways and I’ll work for you,” that’s really hard because then you have to kind of show someone how to do that thing and that’s worked for us, it’s very different to then come in and say, “Hey, the thing that I am a master at is communication. I’ll come in and handle all of your communication with your vendors, with your guests, with your contractors, everything. That’s what I’m good at. In return, I’d like for you to do X for me.” And then there’s an actual value exchange there that doesn’t put so much pressure on the other person to, I don’t know, teach and mentor and provide the value.
I want this to be an insightful question of just this guy is right, “What’s in it for me?” And you have to understand that you have to try to answer what’s in it for them. If there’s no actual value or any kind of monetary compensation, then you really have to figure out how you can lead with value and make it a no-brainer or a win-win for them to actually help you. Otherwise, as nice as many, many people are, you’ll just never get the time of day asking for something without offering something very clearly valuable in return.

David:
And then you’ll be frustrated because you keep reaching out to people asking for help and they kind of blow you off or they just ignore you or they very politely misdirect what you just said and you’re like, “Man, how come no one’s out here to help me?” Well, that’s what we’re here to tell you. This is why they’re not helping you.
I tend to look at real estate like you got a bone with a lot of meat on it, and that meat is equity. So there’s some seller out there that has a property and everyone’s trying to find how they can get it under contract for less than what it would sell for on the open market its after repair value. Well, if you go find that seller yourself, it’s a lot of work, it’s a lot of rejection, it’s a lot of pain, it’s a lot of risk, but you get all of that equity. Now, what people do in the real estate space is they slowly start to slice off chunks of that equity to pay themself to help you with that process.
So just think about, “What are the things I don’t want to do and how am I willing to pay someone and who do I want to pay for those things?” as long as your expectation, “I want all the meat and I don’t want to have to pay somebody else for it and I don’t want to do the work myself.” Once you find your lane, that’s where you’ll get good at that lane. You’ll build up some experience and you start building the momentum, acquiring the properties, and you’ll get to be like Rob Abasolo here and show up wearing a G-Shock watch with a printed tee and a perfectly teased coif talking to the masses.

Rob:
And by the way, on top of the forum just being a really great place to get answers to your questions, it’s also a very therapeutic place to go and find other people that might be able to relate to your personal situation. So definitely everyone, take advantage of the BiggerPockets forums. It’s free and it’s a very easy way to level up.

David:
And we’ve got more in store for you. So stay tuned right after this quick break.

Rob:
Welcome back to the BiggerPockets Real Estate Podcast. Let’s jump back in.

David:
All right, moving on. Our next review comes from Apple Podcast. This one is labeled inspirational. “I’ve been listening to BiggerPockets for years and they offer stories, different ideas on how to approach a journey to get to a real estate investment level. I would say that you get what you give as far as my personal investment on time and effort that you put into finding deals and resources. I’ve found three and I found BiggerPockets played a role in that.” From Dave Scruff on the Apple Podcast app. Well, thank you for the 5-star review, Dave. People like you keep this episode reaching the masses.
All right, we love your guys’ engagement and we appreciate you listening to us. Please continue to comment and subscribe on our YouTube page, as well as leaving us your five star review wherever you listen to podcasts, Apple Podcasts, Spotify, Stitcher, whatever it is.
All right, let’s get into our next question. This comes from Joe Ademic in Boston.

Joe:
Hi David. Thanks for all the great content you’ve been producing. I found it really educational and I’ve learned a ton. My name is Joe and I’m located in the Boston area. I’m just getting into real estate investing and looking for a house hack soon. So my question is really, a couple episodes ago you kind of mentioned that a higher priced area like San Francisco will appreciate more than a lower priced area. I was kind of curious in the logic behind that, because I feel like a higher priced area, the prices are so high that they won’t be able to grow as much. I’m just curious if you’re suggesting that will the gap between a higher priced area and a lower priced area would just widen kind of thing in the future. And I guess any more tips on how to house hack your first property. And thank you.

Rob:
Solid question. Basically he wants to know what’s the logic as to why we would say a higher priced area will appreciate more. What do you think?

David:
Yeah, that’s a great question. I mean, I love this stuff. We get to talk about the fundamentals of real estate. And personally I think you and I, Rob, put the fun in fundamentals. Everybody else is boring, but we make it cool.

Rob:
I’ll put the mental bruv.

David:
All right. So the reason that they are priced higher in the first place is because there is more demand than supply. So think about it like people have to be willing and able to pay the price of a home or rent for that matter. Same goes for short-term rentals. How much are they going to pay per night? They have to be willing and able.
Willingness is a function of supply and demand. Is there other options? Well, I’m not willing to pay you 500 bucks a night If I could get something similar for 200 bucks a night. I’m not willing to pay $500,000 for that house if someone else is selling one for 300,000. Pretty sensible.
Now the other part is able. If wages have not increased in the area, even if someone was willing to pay that price for the house, they’re just not able to. The same goes for if they were willing to pay you that much for their Airbnb, but the economy’s really bad or they don’t make enough money, then they’re just not able to. So people have to have both. The areas with the highest price homes, have people that are willing and able to pay that price. And then you just let the free market do what it does. So he was saying, “Why did those areas appreciate more?” It’s because the people that have the money that are willing to pay for the homes are always going to drive the prices up more than the people that do not have the money or are not willing to pay for it. Does that make sense?

Rob:
It does. Let me ask you this because just from a basic math fundamental question, if the average appreciation on a city is let’s say 3%, well that’s going to compound faster on an $800,000 median price point than let’s say a $200,000 median price point. So just from the sheer value of a property, the more expensive it is, the greater that appreciation ends up being at an average appreciation rate of whatever the national average is, right?

David:
Yeah, that’s a great point. If a $800,000 house goes up by 3%, that’s 24,000. If a $2,000 house goes up by 3%, that’s 6,000. And you compound that over five years, right? The cheap house went up by 30 grand, the other one was like $120,000 or so-so.

Rob:
Yeah, I think there’s a lot more to all of this statement with the whole like, “Yeah, a more expensive house appreciates more.” I think all the economic factors that you talked about before I said that all play into it as well. But yeah, typically the more expensive a home is, the greater that appreciation is just in the way that compounding appreciation works.

David:
All right. Thank you, Joe. Hope we helped you there. And you didn’t ask this question, but I’ll just throw this in for everybody listening here. When you’re looking at rental properties that you want to cash flow, you will typically be looking at the $200,000 houses that Rob described. So the lower price points tend to make better rental properties because the price to rent ratio is more favorable on cheaper houses. Once you get into more expensive homes, they get further and further away from the 1% rule as they go up in price because there are less tenants that want to rent a million-dollar house than there are that want to rent $2,000 house.

Rob:
Yeah. Bonus answer here because he did ask for house hacking tip. I’m just going to say this house hacking is great. I would say if you can expect your expectations to not necessarily have to be to offset your entire mortgage payment with the house hack, then you’ll have way more options on the table. Too many times people are trying to make money on a house hack or have no mortgage at all as a result to all the money that they make from renting out rooms. It doesn’t have to be that. I think paying half of your mortgage through a house hack is a perfectly beautiful way to enter that game.

David:
All right. And our next question comes from Joseph Chavier in North Carolina. “Hello, Coach Greene. My fiance and I are 23 years old and purchased our first primary residence about six months ago with an FHA loan. Our plan was to save money to purchase another primary residence in two years. We underestimated ourselves drastically and have saved more in the past six months than we thought we could in two years.” Way to go, Joe. “The only problem with this is that the rental values of our current home has not gone up enough and we would be breaking even or even losing money if we include the vacancy rates and the maintenance. We have a long-term mindset and are thinking about retirement. While cash flow would be great, we’re more concerned about setting ourselves up for success in 10, 20 or even 40 years from now. My question is, should we stay put and keep saving and wait for rents to go up, eat the $200 loss and purchase another primary residence, purchase another property as an investment property or something else that we aren’t thinking of?”

Rob:
Yeah, this one seems right in your wheelhouse. I mean, first of all, congrats on saving more in six months than you thought you could in two years. That’s amazing. I’ve never heard anyone say that before. So that’s a really, really great thing.
As to whether you should lose money or not, we’ve done episodes on this on if the appreciation will ultimately make up for it. My question back to them would be like, are there ways to increase rents? Is there forced appreciation or forced equity play? Could they convert a basement or a garage into an extra room? Is there something they can do to try to get their rents to catch up with market value? I would probably explore that route first and try to maximize the income on one property before going out and buying another investment property.

David:
Great point there. I think the problem is he was saying, “Hey, we plan to leave our house and get the next one, but rents didn’t go up enough that it would cash flow if we left it. So is it okay to buy our second house if the first one isn’t cash flowing like everybody talks about?” So this is a good problem to have frankly, because you’re going to have some equity there. If you don’t want to lose that cash flow and you can’t do what Rob said, which is bump the rents up somewhere else or add another unit to it or use it as a short-term rental or whatever options that you have there, you can just sell it. Sell it and take the equity out and put it into the next one. If you don’t want to sell it because you think it’s going to keep going up in value, well then hey, keep it and lose a little bit of money there because you’re gaining more equity than what you’re losing in the cash flow because that’s why you wanted to keep it.
And if you don’t like either of those options, you could just keep saving money and staying where you are and delaying finding the next property. But you’re not in a rush to move. And that’s what I love about this. You can really look for the best possible house hack to buy for your next deal. And if the next one is going to save you even more money a month than this one because it’s so good, maybe it has a lot more bedrooms or the rents are a lot higher for different reasons, well then if you’re losing a little bit when you move out of this one, that’s covered by the savings that you’re getting of the next one so it’s still a net gain.

Rob:
Yeah, I’m very anti-losing cash flow on a rental in general. And if we know that you’re going to lose money on this, if you can’t force appreciation, force equity, all that stuff and increase your rents, I think there’s absolutely nothing wrong with selling it, taking the money that you make and putting it into a new primary and then just build your nest egg of equity. And one day, that equity will be great. You’ll be able to retire on that equity if you keep it until you retire.

David:
All right. Our next question comes from Taylor White in Atlanta. “We’re moving our primary residence to another primary residence and we will keep and rent out our previous home. At what point can we start counting expenses against the revenue that the rental will bring? Do we need to wait until closing in our new home before buying things for the rental? Do we have to wait until the rental is available for rent before we can expense? If so, when does it technically become available for rent? Thanks for all you do for the BP community.”
My thought would be, the minute you move out of it, you call it a rental property. And it’s available for rent, you just haven’t advertised it yet because it’s not pretty, but it’s still a rental when you move out of it. But we’ll just have to clarify that. They need to verify that with a CPA.

Rob:
So I basically want to know if they list their property on the first, but they don’t actually get it rented as a long-term rental until the 15th, can they start marking expenses on the first of that month? Now that sounds like like a tax question and you should always talk to your CPA for these types of things, but I happen to be friends with the best CPA in the world, Matt Bontrager. So let me give him a call really fast.

Matt:
Yes, they will be able to take those expenses, but it’ll just be capitalized either to the cost of the property or they will be able to just take those as expenses against the income. It’s just you can’t start to deduct those expenses at least in that year until that property is placed in service. So the fact that they’re… We’re really talking about a two-week lag, that’s totally fine. But yes, they need to end up getting it placed into service, which is actually, if it’s a long-term rental, just has to be available rent. If it’s a short-term rental, they actually have to get it rented.

Rob:
So that’s the question, when is it actually available for rent? Does it have to be advertised on websites like Craigslist?

Matt:
[inaudible 00:32:16] long term rental?

Rob:
Yeah, it’s a long term rental.

Matt:
Exactly. Once they start to advertise it and seek tenants.

Rob:
All right. Thank you very much. You heard it here first, everybody sue Matt Bontrager. Thanks, man.
Okay, so we just talked to Matt Bontrager over at TrueBooks. He says that it just has to be available for rent. And that means that the moment you list it on a website like Craigslist or whatever, that would count as being available for rent. So there you have it.

David:
So there you go. Put your property up for rent as soon as possible. If you don’t have pictures ready, well then just don’t put those in the Craigslist ad and just describe the property. And then collect the emails of the people that are interested in it. And then when it is ready to be shown, that’s when you can arrange for the showing. And then when you get the pictures and they’re all nice and pretty, you can upload those to the Craigslist ad. And make sure you verify this with the CPA just to make sure this is all up and proper.

Rob:
Wait. One noteworthy thing here though. He did say that it’s different between a long-term rental and a short-term rental. So if it’s a long-term rental, it just has to be placed… It just has to be made available, so say on Craigslist. If it’s a short-term rental, it actually has to be rented for that to start counting. So there is a small difference there depending on which route you

David:
Take. All right everybody. Thank you all for being here with us on Seeing Greene. We love doing these and we love being able to help you all. As a reminder, head to biggerpockets.com/david and submit your question that we can answer on Seeing Greene. And thank you Rob for being here with me today.

Rob:
It’s what I do best, my friend. Good to be here.

David:
If you’re listening to this on YouTube, make sure you leave us a comment. Let us know what you thought about today’s show and what you didn’t get answered. And if you’d like to know more information about Rob or I, our information and social medias are in the show notes. This is David Greene for Rob, putting the R in the BRRRR method, Abasolo, signing off.