Richard

David:
This is the BiggerPockets Podcast Show, 708. I think something to consider so far is typically when we’re looking at real estate investing, we’re mostly looking at the value of the property itself or maybe the area that it’s in. This isn’t going to be the most accurate way for you to approach it. You’re mostly just looking at revenue. This is almost like buying a business because if you’re looking at having glamping or yurts, the improvements on the property aren’t going to be as big of a piece of the puzzle. So I’m just reminding Rob and I, that as we’re giving you advice, we need to keep this in mind that you’re not going to have some of the traditional safety nets of, the business didn’t work out well, but the real estate did well. The land improved in price, right?
What’s going on everyone, this is David Greene, your host of the BiggerPockets Podcast. Here today with my lovely, beautiful, and talented co-host, Rob Abasolo. Bet you weren’t expecting that, but it’s still true. Today we have a unique show that I think you guys are going to love. If you were at BPCON2022 in San Diego, we announced that we are going to be having a contest where we were going to select several people to be mentored by both Rob and I in accomplishing their real estate goals. Well, today is the day.
It is the first episode where we’re going to be introducing you to the winners that were selected, getting to know them better, and helping figure out the progress they should be making. In today’s show, we get into their goals, the plans, and the actions they should be taking, in that order. Which is ways that Rob and I help determine what our most important next step should be. This was a lot of fun. Rob, what’d you think about today’s show?

Rob:
Oh, it was great. They all remind me of a young me, you know what I mean? No, I’m just kidding. They’re all probably older and more accomplished than me, but it’s really great. I think it’s really nice to go back to the drawing board for some people. What’s really nice is I wish I had this. I wish I had someone teaching me all this stuff when I was younger because I just didn’t really know there’s so much information out there. I think one of the things that we were able to accomplish with our three new mentees, is we’re just helping them cut through the information, and really help fine-tune what direction they should be going in.
Sometimes, I think personally, in real estate it’s not necessarily about researching and knowing all the information. Most of the time you probably know all the information that you need to know, but you need to really start slicing through that information and figure out what information you actually need to execute quickly. Too much information sometimes leads to analysis paralysis. So I’m excited to hop into their journey, ask questions, poke holes in their plans, and push them along, to hopefully become what you dubbed at the end of the episode, future millionaires, if they’re not already.

David:
Absolutely. We also want to welcome everybody into the brand-new year. This is an exciting time full of possibilities and renewed focus, which we hope lasts for longer than seven days, which is what it usually does until people fall back into their real patterns. For today’s quick tip I’d like to remind you, ask yourself the question, what can you get done in the next 90 days? It is so incredibly important that you start the year off on a good track, building momentum and building habits that will sustain you for the entire year. This is why we do our goal setting episode because it’s important that you sit down and write out your goals.
Once you’ve got your goals, you need to come up with a plan that you’re going to use to achieve them, and then focus on taking the action that is needed. We’re here to help you with that. So throughout the year, we’re going to be going back to these people and asking questions to keep you on the same path. What can you get done in the next 90 days to set the right habits in place? Rob, you’re smiling at me. Why are you smiling like that?

Rob:
I was just thinking, what if every time you gave the quick tip in your Batman voice, you just gave a tip about watching Batman movies. You’re like, “Watch out specifically for this scene. There’s this Easter egg here.” And then we just never address why you always give Batman tips.

David:
You just had that thought running through your head, the whole quick tip? That would be a lot better than what I said, wouldn’t it?

Rob:
Well, it’s like that, I was talking about, you remember that thumbnail where they switched our hair or whatever, and I was saying it’d be very funny if we switched the thumbnail to actually be that. But we never addressed it. We never talked about it. That’s just the thumbnail of BiggerPockets.

David:
And no one knew why.

Rob:
No one knows why. I think it’d be funny.

David:
That would be very funny.

Rob:
So your Batman quick tip would be, in the scene with Bruce Wayne and Catwoman, there’s a part where she disappears on him, and he says, “So that’s how that feels.” Ask yourself, in what way are you needing a taste of the medicine that you give other people so you can have a deeper understanding of why you are the way you are?
Batman quick tip here is that Christopher Nolan directed Batman, and if you want more of his amazing catalog, he’d also directed Interstellar.

David:
Interstellar.

Rob:
Make sure to check that out.

David:
Are you serious right now? All right, let’s get to today’s first mentee, Phillip Fernandez, we met you for the first time a couple of days ago, and now we are here in person diving into your plans to build a real estate empire. How are you today?

Philip:
I’m feeling good. Thank you so much for this opportunity. I’m stoked.

Rob:
Yeah, for sure, man.

David:
Your background looks fantastic, by the way. It looks like right out of a Pinterest page.

Philip:
I wish I could take credit for this. This is my fiance’s… She’s a therapist.

Rob:
It feels very therapeutic. I feel very at ease now. Well, awesome. To recap, Phillip, I’m really excited to jump into your story here. You’re from California, you own properties in LA and Cleveland.

Philip:
Yeah.

Rob:
You’re looking into getting into multi-family and maybe Glenside opportunities. And then, if I remember correctly, you also raised about $200,000 towards your next real estate investments, ala Amy Mahjoory’s Mastermind, which is really great. You’re also a high school teacher of Espanol.

Philip:
Yes, sir. Yeah, that’s a good overview.

Rob:
And also, if I remember correctly, whenever David asked you how committed you were on a scale of zero to 10, 10 being you’re going to knock on doors to get into that next deal, you put yourself at a 9.78. You said, “I may actually be willing to go knock on doors if I have to.”

Philip:
I’m super committed. I’ve been teaching for 14 years, and I’ve been feeling like it’s been such an incredible opportunity to teach, but that I’m ready to transition out of teaching. That’s super terrifying. Even just telling that to my fiancé and my friends and family was something I never thought I’d say, but I’m ready to do what I have to do to be in control of my life, really.

Rob:
Excited for you, man. Well, we’re going to jump into what we’re calling your GPA, actually, which is relevant to the fact that you’re a teacher. But it’s your goal, your plan in action. So if you were explaining your goal for the next 90 days to your students, what would you say your goal is?

Philip:
My goal is to close on a property for a retreat center. My fiancé and I, we’ve been looking at properties for the last six months. We had some property under contract, we had land under contract. We got so far as having 500K in soft commitments for building out the land and doing a glamping village and retreat center. I just learned some things about the land that we had under contract, that this is not the right land. We’ve been looking for other properties since then. We have a property that we’re in negotiations for right now, 20 acres, a couple of hours outside of LA. That’s something that I’m fired up to keep working on and to make it reality.

Rob:
Cool. All right, so I want to refine the goal just a little bit here because I know you said you want to start a retreat center.

Philip:
Yeah.

Rob:
You also mentioned a glamping village. So just so I’m clear, your retreat center is going to be a glamping village, correct?

Philip:
Yeah, I’ve had a lot of time in meditation communities and different communities doing retreats, week-long retreats, and that has been a huge positive thing for my own life and progression. Right before COVID started I was like, I want to sit on silent retreat, I’m super stoked on this, and I could not find anywhere within eight hours of LA that was not booked out three months in advance. And it just lit a fire in me that this is something, that there’s a business model that will support it, and it’s something that will benefit people. A space where people could come, and we could support teachers of meditation that want to rent that space. We could support people that want to come for a week-long stay. That’s definitely something that is a priority for us.

Rob:
Awesome. So that I’m just really zeroing in here, do you have an idea or a goal for an amount of units that you want to launch with? In your ideal mind, phase one, let’s focus on phase one of this, how many units or what does that actual retreat village look like?

Philip:
Phase one is something that could host a group of at least 20 people for a week, with a vision of building out enough facilities for up to 30 people maybe for one-day, two-day, events. Maybe even more people that are not necessarily staying on the property, they’re not all staying on the property, but that we have a space for yoga retreat or meditation retreat that can can support facilitators and support teachers that want to hold these kind of offerings.

Rob:
So the 20 or so, would this be 10 tents, for example, that can host two people per tent? Would that fulfill your goal?

Philip:
Yeah, so I’ve had a couple of mentors in the space that have retreat centers, and they’ve done it in different ways. We’ve had to adapt as we’ve looked at different pieces of land. The land that we had under contract first, was in central California. It was really nice weather. We were looking at a glamping tent. I have some folks that have similar properties where they’re doing similar work with glamping tents essentially. That’s what we were looking at.
Lately we’ve been looking at places that are higher elevation, so places that are colder really. So maybe a glamping tent’s not going to cut it. We’re even thinking, what is potentially a tiny home or a yurt need to look like that will be comfortable for someone to stay? It doesn’t need to be the most fancy thing, but we don’t want people to be uncomfortable and freezing.

David:
That’s a good point. I think something to consider so far is typically when we’re looking at real estate investing, we’re mostly looking at the value of the property itself or maybe the area that it’s in. This isn’t going to be the most accurate way for you to approach it. You’re mostly just looking at revenue. This is almost like buying a business because if you’re looking at having glamping or yurts, the improvements on the property aren’t going to be as big of a piece of the puzzle. So I’m just kind of reminding Rob and I as we’re giving you advice, we need to keep this in mind that you’re not going to have some of the traditional safety nets of the business didn’t work that well, but the real estate did well, the land improved in price. So considering we have a good understanding of what your goal is, tell us about your plan for how you’re going to make this happen.

Philip:
I have agents in a couple of different markets that have been looking for me, and I’ve been underwriting properties, and like I said, we have an offer out on a property with 20 acres right now, that is pretty well set up for a lot of the first stages of putting it out. But really, I’ve just been having agents send me stuff and I’ve been underwriting it. I think one of the big challenges for me has been, I did a lot of boot camps and education and mentorship actually, with multi-family people. I’ve been working with Andrew Cushman, actually, really to vet multi-family deals because that was where my focus was for almost a year.
Even though I wasn’t able to close on anything, I really feel I got a lot of skills with the underwriting of those kind of properties. Transferring those skills into underwriting these properties has been a little bit of a challenge. Knowing how to do that, and what is the expected return that I want to be able to offer investors, and what are some of the pitfalls that I might be seeing, that’s definitely been a challenge for me. If I was going to say the other challenge has been the deal flow. I was very close to, maybe I need to start off market, just a direct-to-seller campaign in Ojai or some of these places that are really nice. There’s acreage, and it hits a lot of the boxes for how close it is to LA, for us.
But also, I’ve never done a direct mail campaign. I’ve done some direct to seller stuff, but I haven’t done a ton. So I was like, “Okay, am I just going to waste $4,000 on a direct mail campaign when I don’t really know what I’m going to do with a lot of the properties if they don’t fit my criteria.”

Rob:
Well, let me ask you this. Have you considered, because as much as I love the idea of taking raw land and transforming it into this vision, as someone who has done this and is doing this now, about 99% of the time, that actually ends up being a lot harder than if you could just find an existing campsite or RV park or anything that’s in that wheelhouse and converting it into what you want. So have you considered just the notion of taking a campsite that might be a little more dilapidated and investing money into rehabbing it to be a little bit closer to your vision?

Philip:
Yeah, I’m totally about that, really. I would say the problem has been the deal flow. I’m just not seeing stuff that’s a built-out campsite that’s within two hours of LA, that fits our criteria as far as what our purchase price is, or what our numbers are. Maybe I just don’t know where to look in the right way. Maybe I’m just not looking in the right way.

Rob:
Yeah, I think one of the hard parts is that you’re in LA and you’re trying to stick close to LA in an area that is notoriously one of the most expensive real estate markets in the country. So I wanted to just ask you, why are you married to the two-hour away from LA location versus executing this somewhere else in California or in maybe neighboring states?

Philip:
I think ultimately the goal is not just to have one site or one place, but I am very cognizant of the fact that I have never managed or I don’t have the little details of the operations for running a site like this. So jumping into I’m going to outsource all of the operations, I’m going to outsource all the management, or that I even know the numbers that I need to put in my underwriting to do that responsibly, I’m not so confident in that. I do have a very strong community in Los Angeles that is able to support, and some people that are even running centers like this, offerings like this, that are down to support within the distance of LA.

Rob:
Didn’t you just interview someone on the podcast that sells lots or that they have some kind of business model around exactly this wheelhouse?

David:
Yes, we did. And that’s exactly what I was thinking of. We’re on the same wavelength there, Robbie. So Philip, there’s a website, I believe it’s discountlots.com, where we interviewed the two founders. What they do is they put together wholesaling campaigns like what you were talking about. They talk to the owners of land, they buy the land from them at discounted prices then they resell it to other people at discounted prices, but you’re allowed to pay for it with monthly payments. You don’t have to come up with the full amount right off the bat. There’s a small down payment, and then you make a monthly payment to them. You buy it as an installment contract, but you have the right to use it while you’re paying it off.
You could probably go to that website, talk to those guys, and see what they have available throughout California. And if the land is cheap enough, a lot of these deals will probably pencil out because you’re not having to come out of pocket with nearly as much. You might not even have to raise the money from the investors. You might just be able to have a small down payment that goes right to them now that you don’t have a significant portion of either equity or debt that you’re going to be paying to other people, a higher percentage of these deals should work.

Rob:
And actually, if you guys want to go and catch that episode, David, you really masterfully interviewed these guys on the power of this business model. It was really cool. So that’s episode 704. Go check that out to learn everything. I think you guys are going to be really inspired by that one. I remember thinking, “Oh man, if I was in that interview, I was going to ask so many questions that probably took us so many rabbit holes.”
Philip, I had one recommendation I actually wanted to throw your way. There are realtors that specialize in every type of asset class. There are realtors that will specialize in single-family acquisitions, there are realtors that specialize in multi-family. I actually didn’t realize this until a couple of months ago, but there are also realtors that specialize in campgrounds. Someone brought me a deal for a four million dollar campground in Sallisaw, and they gave me the information of the realtor/broker that was working that deal.
I struck up a conversation with this realtor and she was really, really, really nice, and it turns out that she’s so good at campground sales, and she used to actually manage campgrounds that she is, I want to say either the official or the unofficial realtor for a lot of the KOA campsites in the country. So whenever a deal becomes available, they just send it her way. A lot of the times it may never even hit the market because she’s got a list of people that she just sends it out to.
What I was going to say is you should try to see if you can find a realtor that might specialize in campgrounds or RV parks. There’s something in this world that might be able to feed you some of these deal flows because a lot of this isn’t necessarily what you know, it’s who you know. So if you can connect with the right realtor, they might be able to feed you some of these leads that you’re not able to find on your own.

Philip:
Yeah, I think that’s great advice. Finding a realtor that knows a lot about land development has been really challenging. We’ve had some really great help from a realtor in Central California, but also, she was learning. She was learning with us, and that became a little challenging when some of the land development stuff came up.

David:
All right. So now we’re going to move into you taking action based on what we’ve said so far and what you’ve been thinking, all coming together. What’s your most important next step, and what’s the timeline that you’d like to have it done by?

Philip:
I’d definitely go into discountlots.com. That seems pretty easy. I can just Google search that and have a conversation with them. I guess, where do I find the realtors that specialize in the campgrounds?

Rob:
I think an important next step on that is you call different realtors. You would find different pieces of land, or let’s say, you could even go to LoopNet, for example, and find a campground. You would find the broker or the agent that is listing that property and ask for a contact, or you can take the advice that David gave me one time when I was looking for a short-term realtor in Arizona. David told me to call the top brokerage in the city and ask for the top dog that knows everything about short-term rentals. So I called and I was like, “You listen here, bub, David Greene told me to ask for the top dog.” So they actually gave me the contact of the realtor that we ended up using, who was super knowledgeable in short-term rentals in Scottsdale. That was super valuable for us in that process.
I think you might be able to do the same thing. Call a broker and really hammer them for a contact that actually knows that world. You might have to make phone call after phone call after phone call, but eventually, I think you’ll make a little bit of progress there.

Philip:
Cool, thank you.

David:
I would also listen to episode 704 and get the names of the gentleman, find them on social media, and actually say, “I’m looking for something like this. Do you have anything in your pipeline, or can you look for something for it? This is what I could pay, or this is what I’m hoping it would do.” They might have some properties they’ve come across that they didn’t actually put into contract, but if they know that there’s an end buyer for it, they can go back to those people and say, “Look, we can pay you this much money for the land.” If you like the price, you might be able to get something that’s not in their current inventory.

Rob:
Fun fact about them, they were actually some of my Glamp Camp students, my program on glamping. So you might even just be able to pick their brain. You might be able to say, “Hey, I talked to Rob and David, they said to reach out to you. I know that you’re in the glamping space and you sell land. Here’s the situation I’m with. Do you have any contacts that might make this a much easier journey for me?” You can use this conversation right here to maybe strike up a relationship and propel you even further. Obviously that’s not going to be sustainable for every single one of you, but in this particular instance, that’s a really great example of using your network to basically make your daily goals happen.

Philip:
Sounds good. Yeah, I’m down.

David:
All right. Any last questions for us, Philip?

Philip:
In the back of my mind, with all of this stuff, I am doing a bunch of other things also at the same time. I’ve got a couple of rehabs in Cleveland right now, I’ve just raised money for someone else’s deal. What would you guys say as far as how to focus my energy, how to choose what not to do, given that I do have a very aggressive timeline for being in control of my financial freedom?

Rob:
I would say that you want to stagger all of your different projects in a way that actually allows you to maintain some level of cash flow because I’ll tell you what, as someone in the space of doing the glamping retreats and everything, that’s not something that’s going to make you money for, I’m going to say, two years. You’re going to be two years out before the cash flow actually hits. So I know that you had an aggressive goal of quitting your nine-to-five job eventually and doing this full-time. That means that you still have to have other projects, other irons in the fire, that can actually produce income to sustain you while you build towards this larger, more intangible goal.
The glampsite’s more intangible right now because it’s not actually built, but if you have a couple of flips going, you’ve already raised money, those are tangible things that you can continue to execute on. I wouldn’t leave those behind because those are going to be your bread and butter, your moneymakers until you actually achieve that larger goal, if that makes sense. I would just really focus on what you’re good at and what you’ve proven success at and use that to fuel this labor of love that will eventually turn into a cash flow machine for you in two years, if that makes sense.

Philip:
That’s great advice, thank you.

David:
All right. Thank you very much, Philip. We’ll be in touch.

Rob:
And just as a larger tip for everyone at home, I do want to say there are so many like-minded people everywhere that want exactly what you want. You just have to find them, right? I think a very easy way to do that, you can go to the BiggerPockets forums, for example, and you could, if you’re trying to build a glampsite or if you’re trying to get into a multi-family property, or if you want to learn about partnerships, you can go and ask that question. You can go onto the forum and say, “Hey, here’s what I’m dealing with. I’m in this cit. I’m trying to achieve this goal. Is there anyone here that can connect with me, hop on the phone, and meet up for coffee, I’d love to learn from you.” Or you can just ask for it in the forum.
You’d be very, very surprised at the amount of people that will reach out and support you and your goals. So find out a way to get in the room with other like-minded people. You can do that by getting into the BiggerPockets forums, you can do that by hosting a meetup. There’s so many ways you can do it, but if you’re trying to figure it out on your own, it’s going to be a lot harder and a lot less inspiring than hearing someone that’s been successful at it.
All right, so before we let you go, Philip, I wanted to leave you with a little bit of homework that you can bring to the table the next time we meet. Is that cool?

Philip:
I’m down.

Rob:
All right. So I just gave you the idea about the brokerages. So I want you to contact five brokerages and ask them for someone that specializes in land acquisition/bigger properties such as RV parks, mobile home parks, campgrounds. Five brokerages that can do that. David, you got anything on your end?

David:
Yeah. When you call those brokerages, they’re likely to say, “I don’t know.” Or “No one here does that.” Ask to speak with a team leader, a manager, a broker, someone of prominence there. They may have different names, but you could just ask who runs this place? So that’s Tom or that’s Mary. And when you talk to her, say, “Mary, I’m trying to find a realtor that specializes in campgrounds, what advice would you have for me of how I could find him?”
A big mistake people make is they call, they ask the question, they get to no, they give up. Or just say, it’s Rob asking someone when he calls, “Hey, I’m looking for the top realtor in town and I want to do short-term rentals.” And Rob says, “Do you have short-term rentals?” “No, I don’t really have any. I could help you if you want, but that guy over there, he’s the expert in it.” Which led to Rob being connected with the right agent.
So I don’t want you to stop at no. After they say no, you say, “Okay, well what would you do if you were in my position?” That forces people to actually think about how to solve your problem, not just check the box, get you off of the phone, and move on to the next thing in their life.

Rob:
Yeah. I want to say to you put yourself out there in three different ways. I want you to ask for help three different ways, all right? One way, I want you to do it on social media, make a post on Instagram, on stories, on Facebook, wherever, and ask people, “Hey, do you know any campsite owners that I could connect with? Is there anyone in your network?” Go to the BiggerPockets forum and post, “Hey, I’m looking to get into this. What are good resources for finding campsite owners in California, or something like that. And then find a third way to put yourself out there and ask for help. Because researching is one thing, but actually asking for help tends to attract people that want to help you. So find three creative ways to ask for help outside of the brokerage.

Philip:
That’s great advice.

Rob:
And let’s see, I think that’s pretty much it, on my end. I mean, I also would say, I don’t know, David, maybe you’d agree or disagree on this one. There are wholesalers that do this kind of thing. So could you find a way to get connected with wholesalers that are actually dealing some of these campsites or mobile home parks or anything like that? I get emails for this stuff every single day.

David:
I would Google that to try to find them and let that lead you down the rabbit trail of Facebook groups and different landing pages, and try to find if you could actually get a person’s contact info.
There’s a lot of people, Philip, that if you say, I want this, and they know what you would pay for it, that will reverse engineer how they would go find you what you’re looking for. And they have the skills, the resources, the tools, the experience to go find it. You trying to do it on your own is going to be a very sloppy, slow process, that’s going to take you away from a lot of the other things you were saying that you have going on.

Rob:
Yeah, just remember, putting yourself out there is what creates the opportunity to arise. If you take Amy Mahjoory’s advice, every time you meet someone, when they say, what do you do, if you say, I help people get double digit returns through real estate, right? I don’t remember the exact 13-second power or four-second power pitch, but-

David:
That’s it.

Rob:
By you saying that, you open up the gate for them to say, “Oh, tell me more.” No one’s going to know to ask you more questions about your campsite developments or anything like that unless you put yourself out there. So always be willing to make yourself uncomfortable.

Philip:
Sounds good.

David:
All right, thank you, Philip.

Philip:
Thanks guys.

David:
All right, next up we have Wendy St. Clair. Wendy, you live in Long Beach, but you also live in Colorado part of the time. You bounce around like me. You work in high tech marketing, which is cool because that tells us right off the bat that you have some experience with solving problems and understanding complex situations. You’re not going to be looking for the easy answer and everything. You currently have nine single-family rental properties and you’re ready to branch out of the turnkey model, which is very exciting. So thank you for that. In order to help craft your goals, help us understand where are you stuck right now and where are you trying to get to?

Wendy:
Great. Thanks, David. So excited to be here with you guys. So like you’ve said, I live right now in California. I have nine properties that are turnkey rentals, primarily. One of them is a nice home that I used to actually live in that I have lots of equity in right now. It’s not a turnkey rental, but the others, my goal initially was to do that and then also do my high-tech marketing. But as I learned more and more about the business, and I really love real estate and have become super passionate about it, I’d like to find a way to get out of making money, doing high-tech marketing and somehow find a way to turn my passion for real estate into something that is more permanent.
Initially I looked at BRRRR model, I’ve looked at some flips, and I’ve been considering all different sorts of things, but I keep going back to the training wheels, if you will, of turnkey because it is safe and it is easy, but it’s not really giving me the dollars that I would like to have to eventually retire with. It is a long game. So I keep doing the turnkeys and staying in my business because it’s safe, but my goals really are to retire in the next three or four years. When I retire, I’d like to have a certain amount of dollars that are making me some passive income. I think that to get there, I need to use the equity that I have left and maybe find ways to raise more money to build my little mini empire, of whether it’s long-term rentals, midterm rentals, etcetera.

David:
I’m guessing the reason you got into turnkeys, you said they’re safe, but it’s not just safe, they’re convenient, doesn’t take away time that you’re putting towards work and the other things that you’ve got. Is this something where we still have to work around the commitments that you have to your marketing?

Wendy:
I have quit twice and I’ve gone back every time because it’s like the blankie that you can’t get rid of. I don’t want to keep going back. While I appreciate the employer that I have today, I would much rather spend my 45 hours a week building my own business and finding ways to see the fruits of my own labor with my own business. I’m not afraid of the hard work. I’m not afraid of being a project manager. I’m not afraid of doing all of the things. I just haven’t found the right path.
Part of my goal was, and really why I was interested in this mentor program-ish, is to find a way to network more effectively with people. Find someone that I could saddle up next to, be a big help to them in their business, and learn, and just have someone to bounce more ideas off of. I think one of the biggest fears I have is that I’m just doing this all by myself. I’m divorced now. When I was married we did some things, but it’s just a different world when it’s all the decisions are on you. I always fear that I’m not making the right choice.

Rob:
I understand that. I mean, you have nine properties, so we know that you at least have the ability to get to nine, which is a lot of people work their whole life to get to nine. This is the good news. I think I want to understand a little bit more about are you willing or are you able to put more work into those nine units to make them cash flow more or are we trying to just leave those as is and then get into new stuff?

Wendy:
They’re all fairly new to me and they were all renovated when I purchased them. So I think they’ve got about a two to three year window where they’ve just got to sit and earn a little bit of equity. They’re not in particularly fabulous neighborhoods for the most part. Three of them are in Indiana, Northern Indiana. Four of them are in Baltimore that are brand new to me, and two of them, those aren’t even rented yet.
I’ve got the property managers just getting those going. The one that I have, that is kind of my crown jewel, is my home in Colorado that I used to live in. One of the things I’m actually thinking about is moving back into that house next year and maybe using that as a house hack. It’s a 3500 square foot house. I’ve got a finished basement. I’ve got two or three bedrooms downstairs, another two or three upstairs. So I could do a short term, not short term, but probably a midterm rental with that and save myself a lot of money and use that to then build more equity to branch off and buy some more multi-family. I guess I’m interested mostly in multi-family, moving forward. No more dodgy neighborhoods, single family homes in turnkey neighborhoods.

Rob:
And from I guess, ability standpoint or a capital standpoint, do you have capital? What are you working with to actually get to that next property? Or is that the difficult part right now?

Wendy:
If I had to scrounge it together today, I probably have $50,000 right now, and that’s it, that I could invest in something additional. There is some equity in the other properties, but the main equity is in my house in Colorado, which I think I owe $230,000 on. It’s worth 800 today. So that money is just sitting there. That’s one of the other reasons I thought about moving back into that and finding a way to get a HELOC on that property, I mean, at three percent interest or something on that loan. So I don’t really want to exchange the loan, but maybe a HELOC would be a good idea.

Rob:
Okay, good to know. Well David, unless you have any other questions about the goals, I think we could get into the plan here and maybe start putting together some steps.

David:
The only question I have about your goal, it seems like you don’t hate your job, so what is it that’s appealing about… Do you hate it? Is that why you’re like, “I just don’t want to do this anymore?”

Wendy:
Well, in the unlikely event that someone from my company might be listening to this podcast, no, I don’t hate my job. But if I had the opportunity to work in real estate in some other fashion, and oh, by the way, I almost did get my realtor’s license. I went back and forth and back and forth, but I don’t want to be that person on Sundays making cookies in a-

David:
So that was my question because there’s ways to make money in real estate other than being an investor. In fact, being an investor is a very, very difficult way to do this full-time. It was less difficult 10 years ago, definitely less 20, 30 years ago because you didn’t have competition. There’s so much more competition over these assets we’re trying to get. You have to wait a lot longer before they start performing the way that they used to perform. It used to be if you could just talk somebody into putting 20% down on a house, getting double digit returns was fairly simple right out the gate. That is not the case anymore.
Being a realtor is not the only way, but have you looked into buying more rental property but supplementing that income by doing something else that works in real estate, an escrow officer, a title officer, a real estate agent, an owner of a real estate brokerage, a real estate broker themselves, a loan officer, a marketing person, starting a turnkey company and selling house to other people, there’s a lot more options than just buying real estate. Is it that you’re in love with buying it or are you open to some other ways that you could work in the field of real estate and make income?

Wendy:
I’m open to it, I just haven’t found it yet. Realtor was the natural one that came to me and I thought, no, I don’t really want to do that. I actually applied at a couple of software companies last year like, “I love real estate and I want to get into real estate.” I got close to some of them there, but it just wasn’t the right fit for whatever reason. I keep getting back into marketing because it’s what I’ve done for 25 years. And so people say, “Oh, marketing. Well let’s just do this again. I just keep getting stuck and hired in those same roles.

David:
Do me a favor, when you say marketing, tell me what you do for a living without using the word marketing.

Wendy:
I am a writer. I write content, I do lead generation, I do website design, limited. I’m sort of a jack of all trades, but most recently, I do a lot of artificial intelligence positioning and messaging for software products.

David:
So you’re helping sell more software

Rob:
Eventually the AI, you’ll make it so good that they actually do replace you.

Wendy:
Yeah.

Rob:
Yeah, eventually.

David:
Thank you, Rob for making the AI joke that everybody makes every single time this thing comes up.

Rob:
But she’s actually doing it.

David:
The reason I’m asking Wendy, is I could tell just from talking to you, you’re very intelligent. You’re going to be good at whatever you do. It doesn’t make sense to be good at buying turnkey properties. There’s better stuff out there for you. If you’re in a position like that you have a lot of responsibility. People depend on you to create sales. Most W-2 workers, statistically, they’re there to serve something someone else has already done. So someone built an entire system and they just have to be there to greet someone at the door and get them to a table or something like that.

Wendy:
Right.

David:
That’s not hard. Those people really struggle when they move out of that world into an entrepreneurial world. It’s like they’ve never done exercise and they’re thrown into climbing a mountain or working a CrossFit workout. You’ve been exercising incredibly intensely for years. You’re going to be good.
I would strongly urge you to consider becoming a real estate agent, becoming a loan officer, something that you can take these marketing skills and market yourself. Starting a property management company. You’ve got a very, very good skillset that you can use to raise money, advertise your own company. You don’t have to sell other people’s software. You could be managing short-term rentals or managing long-term rentals, or excuse me, working as a loan officer, helping other people to invest in real estate. You’ve got this pedigree of properties you own yourself. What worked? What didn’t work well.
I definitely want you to keep that open as we work through this process with you, and not just assume, “Okay, I’ve got 50 grand, how can I replace my income? That would be incredibly difficult to do. If you look at it like, “I want to invest, but I want that to be icing on the cake. I’m okay working a different type of a job as long as I’m working for me and it’s in real estate.” Man, you’ll have a lot of options that you can really enjoy.

Rob:
Yeah, that’s solid advice. I mean, Wendy, you’ve got a great persona, you got a great voice, people very much underestimate the power of writing, and certainly underestimates the power of lead generation. If you’re good at lead generation, imagine if you were generating leads for yourself over and over and over again instead of somebody else. If you could generate multiple leads for yourself as a loan officer, or as a real estate agent, you could make a lot of money doing that.
That’s a really good point, David. I think a lot of people sleep on the skills. They want to just quit their nine to five job that they’ve been so good at for the past 10, 15, 20 years. They don’t really think about the fact that they’re really good at it. So what if they just did that, but for themselves? There’s a lot of money there to be made, I think.

Wendy:
I wouldn’t mind the property management aspect at all. I do manage some of my own properties, and I have managed my properties before. It’s hard to do it remotely, easier now than it ever was before. I think what has stopped me from even getting my real estate license is I haven’t been able to commit to a certain state. Am I going to stay in California? Am I going to go to Florida? Am I going to go to Colorado? That maybe has been a barrier for me to do some of that.

David:
We should talk about you being a loan officer, because the one brokerage does loans all throughout the country, all over the place, and a lot of them do work remotely. So if you’re good with numbers, if you’re good with, I don’t want to say being convincing, but you have to be passionate. That’s the thing. A lot of loan officers, they get very dry, they just give people information. They don’t understand that people don’t make decisions off of just information. They make decisions off of, “Does the person I’m talking to really believe in what they’re saying?” I can tell you don’t have a problem with that. At your job, when you step in there, you grab the wheel and you take that car where it needs to go. You have a vision, you understand what you’re doing it. That’s a rare skill to have.
I’m constantly looking to hire people that approach things that way. Most people are like, “I’m here. Tell me where to go. Tell me where to do.” Every single small business owner listening to this is face palming right now, “Yes, that’s what my problem is.”
Companies need more people like you. We call that intrepreneurship, where you take your skills and you work within a business somebody else has formed rather than trying to build something from the ground up completely from scratch. And you’re clearly, what’s the word, passionate about real estate, and that’s what I want more people in our industry to be. There’s too many agents that are not passionate about doing a good job, that don’t understand what investors are even looking at. There’s too many loan officers that are not passionate about putting together the system in a way that maximizes the effectiveness for the client or anticipates things that might go wrong. They just react to whatever pops up.
So the industry definitely needs more people doing what you’re doing. And the cool thing is, if you could make good money in those things, it makes it easier to now buy more real estate.

Wendy:
Right.

David:
When you quit your job to be a full-time investor, it’s so hard because you have to live off the money that real estate’s making, but then you don’t want to buy more of it because you’re afraid of what if things go wrong and you have less money to invest into more of it. So what happens is, by default, when people live off their income, they end up out of fear sliding into these $50,000 houses where it’s very difficult. You end up in the bad neighborhood, you end up with the, you called it the dodgy type of a property that the turnkey companies provide, right?

Wendy:
Yeah.

David:
When you’ve got stable income in some other source, you can play the long game and you start catering more towards the best locations, the best areas, the best properties. You’re like, “Well, if it takes two or three years to get to the cash flow I’m looking for, I’d rather have that with tenants I love than try to get it right out the gate and end up just banging my head against the brick wall.” Which is I’m sure what you’ve got going on with the plan you have right now.

Wendy:
Yes.

David:
Those turnkey properties give you this impression that is very elusive about progress. I got another one, I closed out another deal. You do all this work and then you get this house that’s worth $900 more than you paid for it, five years down the road, and the rents are going up five bucks a month every time there’s a lease renewal.
And you’re like this, “There’s no way this is what everyone’s talking about when they’re talking about passive income. I’ve got nine of these things and it’s still not working.” You could probably sell all nine of those, buy one short-term rental that you manage yourself, and you’d make more money and have a better time than letting somebody else manage nine of them. So those are the ideas that I want you to be considering here because you’re not afraid of work.
And like Rob would tell you, when you’ve got a short-term rental, you’re marketing it. You’ve got to think about it like that. You’re trying to get guests to come back again. You’re thinking about how well it performs, how efficient the whole thing is. You’re anticipating problems. All the stuff you’re doing in your current job. You get a couple of those, much better situation for you.

Rob:
Yeah.

Wendy:
How do I go about finding what are the right opportunities for me? Someone had said to me once, I went to visit one of my turnkey guys, and he said, “You should get into syndication.” And I said, “What, like Grant Cardone? I don’t know that I want to be the next Grant Cardone.” They said, “No.” So I was like, “Well maybe I’ll look into whatever that really would look like or what that means, but I don’t even understand it.” So I’m trying to find things that I would be good at doing. And for the life of me, I need that book, What Color Is Your Parachute, for real estate people.

Rob:
Yeah, that’s fair. I mean, you do have to remember, because I remember my wife and I, we used to work out together back in the day when we first got married. I remember we went to the gym and I was like, “All right, let’s go. Let’s go lift these dumbbells over here, do curls or something.” And then I remember she was like, “Well, I don’t want to do that. I don’t want to look like a bodybuilder.” And I was like, “Well, you have to do that 2000 times over the course of five years for that to happen.”

David:
I love this analogy. I love it.

Rob:
It’s a slow it process.

David:
Everyone’s afraid if they touch the weight, they’re going to wake up the next day looking like the Incredible Hulk. Then you have these people that are completely, utterly committed and focused and they care about nothing else other than eating insane amounts of protein and lifting the heaviest weights they can, and they still can’t look anything close to that. That’s a perfect example of where we get afraid of, “Huh, I don’t want to have so much success so quick that I’m not happy.” It doesn’t usually work out like that.

Rob:
Yeah, you’re dabbling and you’re really kind of exploring each phase and you’re seeing what you like about it. So a very actionable step is, go find three creators in each segment or each category or niche that you’re trying to get into and just go down a rabbit hole and binge the content. So if you are interested in, let’s say syndication, go find three people on YouTube that do syndications full-time and watch it and see, does this interest me? If you’re interested in being a loan officer, go to YouTube, type in loan officer and just see what loan officer creators are out there that will tell you the harsh realities and the good realities of being a loan officer. If you’re interested in becoming a property manager, go type in property management realities on YouTube, whatever. You’re probably going to get a list of people that talk you through it.
Look at the good, look at the bad, and weigh that against which one you actually want to dive into a little bit. Another one we talked about was being a realtor. Instagram, there are so many realtors out there that put out content that teach you how to be a realtor. They talk about the good stuff, the bad stuff. They all do it through reels. Just go binge the content and say, “Is this the life that I actually want?” Or, “Hey, is this exciting?”
Once you find which one of those excite you the most, then start clicking into that, right? And doing more and more and more. That’s usually how I do. This is the really good and the bad thing about YouTube University is that it always teaches you the really highs and the really lows. That in between stuff is hard to find. The only way you can do it is by really just looking and watching a lot of raw built content, no, I’m just kidding, a lot of content on YouTube.

David:
Let’s shift a little bit back into picking what kind of investments you want to do. Okay, so let’s assume you’ve got another job, you’re making money, you’ve built your 50 grand up into 125, and now you’re trying to figure out where do I want to invest? First question I want to ask you, how did you end up falling into this turnkey purgatory? What was appealing to you about that niche?

Wendy:
It started with a phone call to one of the providers. The person that I was talking to on the phone probably did a good job of saying, “Look, we’ve got providers all over the country and they do a good job and you can put your 20% down, and you can make this percentage back.” I’ve done all my research on the numbers, I’m not upside down on them right now, but it’s maybe one to $200 a month per door is what I’m bringing in after all is said and done. Some of them have a $3,000 eviction, and some of them have a tree that was 1800.

David:
That’s what I mean by purgatory. You can’t ever get out of it. You’re just on this treadmill.

Wendy:
This year I sold a house in California that I had bought for 400,000 and I sold it for 700,000. This was going to be my exit out of turnkey. So I went to Savannah because I was very highly interested in Savannah. I felt like I had my big girl panties on and I had a realtor and we went and we toured Savannah and we looked at all these properties, and I started making bids. I made offers on three or four or five different houses. There were duplexes. There was a duplex. There was a quad. I was so excited I was going to make it. I was going to get out of turnkey.
I was going through a 1031 exchange and all happened very fast. So I make these offers on these houses in Savannah and I come back and they do the inspection, and it turns out that what I thought was a duplex wasn’t even a duplex, it was a single family house that some guy had. The heating and air conditioning wasn’t separate. There was no separate things. They weren’t quads, they were in single family neighborhoods, but they weren’t zoned as duplexes or quads. So in the end, the value wasn’t going to come back to me in a quad or duplex way, and the foundations were upside down. So that’s when I realized I’ve gotten over my skis.

David:
So it felt safer to go back to turnkey? I hear you.

Wendy:
Yeah. And I had 45 days. So next thing you know, I owned four houses in Baltimore. Now I’m like, “I did not want to buy four houses in Baltimore.”

David:
That makes total sense. That is the 1031 backdoor trap that has sucked many of us into a similar situation. So now you’re not in that position. You could take your time, you could figure out what your next step is. So as far as your most important next step to determine, you got to get a dual headed approach here. On one hand, what type of industry do you want to get into to work in? And on the other hand, what type of assets do you want to buy? I’d like you to give me a most important next step for both of those directions.

Wendy:
So if I were to pick an industry that I’d work in, that I could still make money, best case scenario, it is location independent. I’m not saying I want to go live in Portugal. I’m saying I cannot decide if I want to spend my time in California or Colorado or Florida or Atlanta today. That’s why realtor has always been out. It’s because I need it to be available. What was the second part of the question, I’m sorry?

David:
How do you want to figure out what type of assets you want to be learning more about and pursuing?

Wendy:
What type of assets? I think I would like to do more multi-family. Small multi-family is fine. Actually, up to 10 is probably fine for me, if that’s what you’re referring to. I did have a tenplex at one point in time when I was married. We were able to manage that pretty effectively. And then house hacking is a possibility for me.

David:
I need you to tell me what you’re going to do when we get off this call to go look into, if you think your first step should be house hacking, if you want to get right into a duplex. I love if you say house hacking is a possibility because that 50K is now a pretty solid number. You’re not facing a lot of challenges. You don’t have to put the HELOC on the house. You’re not forced to move to Colorado. So if that resonates with you, I want you to come back and say, I’m going to figure out what neighborhood I’m going to invest in. I’m going to figure out how many bedrooms it has to have. I’m going to figure out if I’m going to do a multi-family or a single family. I need you to be looking into those questions and get a little bit of clarity on what type of asset you’re open to house hacking.

Wendy:
Okay. Well, initially, the house hacking thought was the house in Colorado, that I could house hack that, use that as an excuse to move back in and get a HELOC on it. But because right now, I’m literally considering sitting on $600,000 in equity, I’m probably never going to sell that place, but I’ve got a very solid tenant in there and I make a few hundred bucks on it every month. But I feel like that equity’s just sitting there.

David:
Your return on equity is not very strong. So you could do that, but you’re going to get this equity out, you still got to go spend it on something. Is that where you’re going, Rob?

Rob:
Well, I was going to ask, why do you have to move in to get the equity? Those aren’t connected.

David:
Because it’s hard to get a HELOC on an investment property. That’s why. It’s much easier to get it on a primary residence.

Rob:
But you bought it as a primary residence, no?

Wendy:
Yeah, but I think I quitclaim or warranty deed, a quitclaim deed it to my LLC a few years back.

David:
Even if you didn’t the bank would check to make sure you live there. They’d want to see some kind of utility statement or something.
But I guess what I’m saying, Wendy, even if you can pull 600 grand out of it or 400 grand out of it, you have to invest that into something else. So I need you to have some clarity on what you’re going to go invest into so that we can narrow down what those options look like and come up with a nice clear target.

Wendy:
Okay.

David:
And as far as what industry you want to work in, you said you wanted to be location independent, top two things that come to my mind would be property management and being a loan officer.

Rob:
Definitely. Yeah, realtor would be out. The other thing I would want to just maybe toss out there, Wendy, I don’t know if you’ve done this yet, but maybe just run the numbers on some of your properties to see if they work better as short term rentals or medium term rentals. Or, I was actually just talking about this on a previous episode with David, what I call reverse arbitrage, which is basically you rent out your house to someone who wants to host on Airbnb, and if market rate is, let’s say 2000 bucks, you charge them a premium, 2,500 bucks for them to have the ability to list it on Airbnb. So that gets you out of having to actually do any of the stuff involved with the Airbnb, but you actually make more money on the cash flow.

Wendy:
I don’t think any of my Indiana ones would be good ones for that, but maybe Baltimore, but it’s a sketchy neighborhood sometimes, but I will look into that. It’s a good idea.

Rob:
Okay, so we’ll just leave you here with some homework, Wendy. Homework is run numbers as short term rentals, medium-term rentals. Maybe contact a couple of medical staffing agencies, see if they have clients that they’re looking to place. What [inaudible 00:54:56] they might provide for those clients if they were going to place them in your home as a medium-term rental. And then second piece of the homework on top of that is to just go down the content rabbit hole of the three creators in let’s say, property management and being a loan officer. Do a little bit of research to see if any of those lifestyles would fit you. Wendy, I’ll even send you a calculator that might help you comp out your properties just to see how it all lines up, all right?

Wendy:
Awesome. That’s great, thanks.

Rob:
Okay, third up, his name is Danny Zabada, and I wanted to just run us through the background here. So software engineer by day, he’s a dad, owns small multi-families in the Sacramento area, two duplexes, a four and a sixplex, and he is just looking for that next bigger step. Did I encapsulate all of that correctly, Danny?

Danny:
That was pretty good, except it’s actually Zapata, so a slight correction there.

Rob:
Zapata?

Danny:
Yes, sir.

David:
Like Emiliano Zapata?

Danny:
Exactly. I was in high school, one of my history teachers used to call me shoes, which luckily didn’t stick past that.

Rob:
All right, so we got Danny shoes here on the BiggerPockets podcast. So let’s jump into your goals here, man. Can you tell us what your why is?

Danny:
For me, my biggest why is time. As the late great Tony Stark once said, “No amount of money ever bought a second of time.” But I disagree with that because I feel like if you have that money and you have that life set up where you’re not an employee, you’re on the other side of the cash flow quadrant where you’re a business owner, you’re an investor, then time is all your own. And for me, that’s the most important thing. I’ve had a lot of loss over the last few years, and just really impressed on me how important time is. I have an 11-year-old daughter and I absolutely want to spend more time with her, my friends and family, doing good for the community. I want to be there and just be able to free up and make it my choice what I do on my time.

David:
That’s pretty awesome. Okay, so if you had all your time back, what do you think you’d spend it doing? Do you know that yet?

Danny:
Yeah, I mean, primarily it’s family, spending time with family. I’ve gotten over the pandemic. I’ve gotten really good satisfaction gratification from doing charitable giving. I feel like that’s something that really feels good to me and something that I want to continue. I work in high tech and there’s a real estate investor group, and I really get a lot of joy of bringing folks along with me. When they see what I’m doing, I document my journey there, they come to me and say, “Hey, how can I help? Can I get your opinion on these things?” And I really, really enjoy doing that kind of stuff and bringing people along with me and making them successful.

Rob:
Yeah. Are you the kind of person that, because I find this is the ultimate entrepreneurial conundrum and it comes down to what kind of entrepreneur you are, but the more successful I become and the more I hit my goals towards getting my “time back” the more that happens, the less time I actually give myself because I’m like, “Oh, it’s working. I’m just going to keep doing this over and over and over again.” How do you feel like you fall on that spectrum? Do you feel if you were actually successful with all of this stuff, are you the kind of person that would actually disconnect and go spend that time with your family? Or would that always be a struggle being split between family and business? I’m just curious here.

Danny:
No, it’s a great point. First, I feel like that would be a great problem to have. To even have that choice, I think, would be amazing. So getting there. I’m fairly driven. I’ve worked at startups and I really like the high tech world, so it’s not something that I need to jump right out of immediately, but I want it to be my choice. I think with time, I feel like I can carve out some time. I’ve got enough hobbies in the back burner over the years that I’ve touched upon and different things that I can find ways to fill it and be fulfilled.

David:
All right, what about the stuff? Because we always look at time, I think everyone is aware of time they’re spending on something. I don’t think we look enough at energy. This is something, that as I’ve gotten a little bit older, I think about it a lot. I was just having a long talk with my best friend, [inaudible 00:59:30], about. We don’t ever feel like we’re working if it’s fun stuff. If it feels light, if you’re excited, if you’re passionate about it’s not work. No one cares about what they’re spending time on when they love what they’re doing. It’s time spent doing crap, we hate. That we’re actually trying to get rid of. So what are the elements of real estate investing so far that you are interested in, that you have fun doing? If you could do that for the majority of your day, you’d be happy and excited?

Danny:
Great question. When I started, I spent a lot of time driving around Sacramento, looking at properties and looking at the potential. I thought that was really cool. I’ve listened to you a lot, David, over the years and thinking about how you can take one property, which may not work for most people, and you can transform it by adding rooms or moving walls and doing really interesting creative stuff. So for me, I think that’s probably the most fun of it. All of my projects have been value add, from buying stuff that’s beaten down to bringing it up and repositioning it as something successful. I think it’s really satisfying. But I think if I had to narrow it down, I think it’d be that portion of it.

David:
So small multi-family or residential single-family that is converted into multi-family use are the kind of things that you would have the most fun doing?

Danny:
Yeah, even just transforming anything, making it more than what it was intended to be.

David:
So as far as a plan for how you’re going to get there, tell us what you’ve thought of so far.

Danny:
I’ll give you a little background first. My last project was a sixplex that I bought in Sacramento in 2020. It was an 1890 building, full gut remodel. It turned out to be on paper it was an amazing deal. I have two other partners. We were going to cash flow, it was going to be done in nine months and perfect. As it turned out, it turned into a two-year project, which I’m just finally repositioning now. It was a slog. I recognize that I probably got some burnout from that and my team got burned out from that. So for me, I think my plan would be, as a software engineer, we have these things called retrospectives where we do a few months of work and then we look back on it and say, “Hey, how did that go? Are there things that we should stop, start, continue?”
And for me, I think the first step, now that I’ve outed that project, I’ve had a chance to go to BPCON and kind of reset my head. Got into this amazing program with you two, I think now it’s the right time to go and take all the lessons learned, do a retrospective on that project, and make sure that we don’t repeat the same mistakes as I look to scale larger.
I see a lot of value in scaling larger, and I think I want to take what I learned and apply it. I think the first thing would be to get that resync, that retrospective. I already recognize there are a couple of parts of my team where they’re not as good as they should be. In particular, the contractor who we won’t be using again for a large project. And I want to make sure that referencing your book, your long distance book, the Core 4. I want to make sure they’re solid plus a few other players around that.

Rob:
Cool. I might have missed this, that project you said you had a little bit of burnout. Is it done yet? Is it sold? Is it being rented? Where is that project currently?

Danny:
We just filled the last unit, the sixth unit of that. So we refinanced but did not get all our money out. But we’ve got enough out that we feel okay and we’re good to hold it for a couple of years before rethinking about pulling more money out. It’s a fairly steady state right now.

Rob:
Okay. And then is it cash flowing? I know you didn’t get your money back out. No? Okay cool.

Danny:
No, not at all. But it’s right there, flat basically.

Rob:
Oh, okay. Okay, cool. And that’ll be after you rent out the last… Or you said you just filled the sixth unit in it?

Danny:
Yes.

Rob:
Okay, cool. Nice. What exactly are we working with to get started with here? Do you have capital to put towards your next project? Are we having to be pretty scrappy here? What is the actual financial state of Danny shoes himself?

Danny:
Oh man, I can’t believe that stuck. I live in Redwood City, I have this house here. We’ve remodeled it, pulled out some equity, but not all. We’ve left it largely intact. I have a HELOC that I’ve been using for all my investing, so I kind of use that to do the cash offers when I’m acquiring and rehabbing things. But as you’re scaling, I recognize that you can’t do that all alone and it gets very expensive, which is why I brought in another money partner. For this next project, I envision it being well beyond what cash I have. I have cash, I’ve raised money, I’ve had folks because I talk about what I do with real estate to everybody I meet, there’s been a lot of interest over the years, “Hey, let me know about this project or what your next thing is.” And I’ve actually been able to get some private money that way.
So the way I envision it is if conceivably this large project, I think the acquisition cost is going to be a little different versus where I had just done a cash offer. I think it’d probably be financed because it’s going to be too much. But funding the rehab part of it shouldn’t be an issue. So that’s roughly how I’m looking to split it.

Rob:
Okay, cool. So we have access to capital. The question now is it sounds like you’ve learned some valuable lessons from your last flip or your last renovation BRRRR. Is that what you want to do again? Is that what we’re feeling? Or are you interested in other avenues in real estate as well?

Danny:
Rob, listening to you on the podcast and your short-term rentals have been super interesting, but I’m trying my best to not get the shiny object syndrome, especially coming out of BPCON, where you’ve got the midterms, you’ve got the short-term, you’ve got all these things coming at you. So for me, I think the value would be to take what I’ve learned and keep applying it to bigger and bigger projects. So I’m pretty good on getting something bigger in the same area to leverage everything that I’ve done so far.

Rob:
Okay. So what would that look like? Can you give us a purchase price, a unit price, a budget to nick away at here?

Danny:
At that scale, I’m looking at commercial size. So over that, and as I’ve learned with this last project, that turns into commercial lending and the property basically dictates the lending for you. So I am good with going double, triple, quadruple, the size that I’ve done. I’m not quite the 10X comfortable yet, but I think taking almost Brandon Turner’s domino effect, one and a half times bigger, so I want to at least have my next project be over 10 units. I’m comfortable with 20 units as long as the numbers work. I haven’t thought too much about per door price or that kind of stuff, but this is stuff that I like to plan out and make sure that after everything’s repositioned, that it turns into something that’s worth my time, and all the time and effort that I’d be doing.

Rob:
Cool. All right. So we know that we want to do something bigger than you’ve done, minimum of 10 units is what you’re looking at. We have not looked at budgetary things quite yet, but we at least know what we want. We want to stay focused on multi-family, and even though short-term rentals and mid-term rentals are attractive, you want to be good at the thing that you’re good at, right?

Danny:
Right. At least for now.

Rob:
That’s good. I’m very envious of that discipline. I don’t have that. When I see something cool, I’m like, “I’m going to try it.” And I probably would’ve scaled a lot faster if I just stuck with the same thing. But that’s really good. You’ve realized this early on. I think, David, if you’re cool with it, I think we could probably move into the action size here and start discussing the most important next steps. Maybe a line here on a timeline of how fast you’re looking to execute and maybe give you something a little bit more tangible to work on before we send you out into the world.

Danny:
Sounds awesome.

David:
Yeah. So do you have anything planned for actions that you were thinking about taking yourself?

Danny:
I was just talking to my wife about this earlier. I think I’m going to make a trip to Sacramento this weekend and reconnect with my agent. I’d like a little bit of advice around that because I have an agent who’s a great guy, he’s been in the area for 30 years, but he’s really largely a single-family. I brought all the knowledge and kind of digging into BiggerPockets and reading all the books. I’m the one that pushed it along in terms of this is the multi-family that works. He’s really good at relationships and fostering those with people and getting the deal done, but he doesn’t have the experience around the multi-family that I do. So would you suggest that I continue to educate and keep building on that foundation that I built there? Or should I look at it fresh and look at someone who has that multi-family larger scale experience out the gate?

Rob:
Are you talking about the person that you’re partnering up with, the private money or the capital that you’re raising?

Danny:
Just the agent.

Rob:
Oh, it’s the agent.

Danny:
[inaudible 01:09:20] Deals, yeah.

Rob:
I used to be more flexible on working with agents that may not be exactly in your wheelhouse or at the exact same level of your education. I think right now, in this economy, it behooves us to be extra conservative and lean into the people that know more than you. It’s actually really refreshing when realtors do know more than you or at least can squabble with you if you will, in the expertise that you bring to the table.

David:
Yep, I would agree. I don’t know that you’re going to find that in multi-family real estate, though. In general, you don’t have buyer’s agents in that space. Majority of it is listing agents and they’re expecting you to understand how to come in. They’re not looking to walk you through the deal as much as they’re looking to vet you to make sure that you’re the one that they want to sell to. So it’s going to be tough for you if you’re trying to find it from a real estate agent. I like the idea of continuing your education by learning from being in a group with someone, especially if it’s reasonably priced, where you can learn from someone who owns a lot of multi-family because they’re not just going to teach you the fundamentals, like how you analyze it or how do you use the calculator. They’re going to say, this is why I like to buy these type of properties in this area, and this is why. You’re going to learn a lot of their experience that they had, what went wrong.
I bet if someone came to you and said, “I want to buy this sixplex.” The advice you would give them would be very different because you went through all the work of this one and then it didn’t cash flow like you thought, right? So you’d see angles now you didn’t see in the beginning. That’s the benefit of having a mentor or person that you’re learning from in a space that understands it because they’ve been doing it. If you’re buying fourplexes, duplexes, triplexes, of course, you can get a buyer’s agent there. Those are considered to be single-family still, even though they’re multi-unit, and you can have someone that’s having your back. So I think Rob’s advice would apply to two through four units. But if you’re going to be getting into something bigger than that in the commercial space, you’re going to absolutely need to have some kind of a mentor that can help you anticipate things you might not be seeing.

Danny:
Okay, that’s good advice. Thank you.

David:
All right, anything you want to ask us, Danny?

Danny:
I’ve been listening to you and reading books for a while. I’ve gone through a few contractors already, which is a super common problem. I’ve read some tips around going to Home Depot at 6:00 AM and finding that person. You famously say, rock stars, no rock stars. So kind of connect through there. Any other angles I should be thinking about around that?

David:
As far as how to get yourself around the right people?

Danny:
The contractors, in particular.

David:
Well, it’s easier to get a contractor now than it has been in the past. They’re not as busy because the market’s going down. You’re probably more likely to get referrals from other investors about the people that they enjoy. We’re very protective of them. When the market’s hot, it’s hard to get them. But now that there’s not as much stuff going on, people are going to be more likely to share who their contractor is that they really enjoy. And that contractor’s going to be more likely to give you prices to make a lot more sense.
They’re probably not going to start at that. So when they give you the bid, I’d be more aggressive at getting them to come down on the price for certain things because no one’s going to start at low, but they’d be willing to go low that they wouldn’t have been in the last couple of years. So I would just try getting around older investors that own more assets and then enjoy teaching and sharing stuff. They’re the ones that are going to actually want to help versus the younger people who are in acquisition mode and see you as competition. They might actually probably give you bad advice to slow you down.

Rob:
Yeah, I think that’s a general tip for everyone out there, is for the most part, people have been very close to the chest. I certainly have been very close to the chest with my vendor list, but since I’m not doing as much, I do genuinely want my vendors to win. And so I’m definitely a lot more open to sharing that kind of stuff with people in my network and stuff like that. So if there’s anyone listening to this right now and you’re looking for a contractor and you’ve asked someone before, I think if you go back and you ask them now, you might have a better chance of them actually imparting their vendor list. If you’re going to do that, offer some kind of value back to them.
No one likes to be the person that’s always asking for advice but never giving something back. Say, “Hey, can you share a contractor with me?” And also, “Hey, what can I help you with? Do you need something? I have my own list of people that I’d love to share with you as well.” That way it’s not quite so one-sided. I think the one-sided stuff is where people tend to get burnt out in the whole sharing resources world.

Danny:
I haven’t made any connections in Sacramento around experienced investors. A lot of folks are purely new and are actually reaching out to me. I do know some very experienced people in Southern California, but then that’s a different market. So I’m going to have to get a little more aggressive about finding these folks.

Rob:
Yeah, and I mean honestly, one of the most important ways that I’ve actually found my contractors is through my realtors. So if you have options on who your realtor can be, and you’re trying to narrow down which realtor you want to use, ask them who’s on their dream team. “Hey, do you have a contractor or a plumber or a tile guy or whatever. Do you have any of these people that I can use for this project?”
If you’re interviewing four realtors, for example, chances are one of them will probably have the resources you need. That’s always been how I found my vendors. That’s just something to keep in mind as you start going down the rabbit hole of which realtor you want to work with because a firsthand recommendation is worth its weight in gold.
All right, Danny, so we’re going to send you off with a little bit of homework here, all right? So I think it sounds like contractors are going to be a need for you. So find three investors in your market that you might know or get in contact with and ask if they have a contract referral. Three people.
Interview the different realtors that you’re talking to as well, and ask them if they have a contractor. And then here’s a little bit more of a tangible, you’re going to have to work on this. Go find a neighborhood that is always just getting remodeled, one of the most prosperous neighborhoods that’s just totally being revitalized, and drive around for 30 minutes and look for those giant dumpsters in front of the house where the house is being remodeled, and then walk inside and ask to talk to the contractor for that property.
I’ve also found a lot of my contractors that way. And actually, some of the best vendors I’ve ever worked for have been by walking to a house where there’s a giant dumpster. I’m like, “Can I talk to the contractor,” getting their info and actually having them quote out a job for me. All right, so that’s going to be three different ways. Three investors in your network, a realtor, actually boots on the ground at a construction site.

Danny:
That is awesome. I’ve never heard the dumpster technique before. Thank you.

Rob:
It helps if you know Spanish, but if you don’t, it’s okay. It usually still works.

Danny:
I know a little bit.

Rob:
All right.

David:
My homework for you is I want you to get my email. We can get it after we get done here or if you go to my Instagram page and you look at contact, it’s in there. Email me. I’m going to connect you with Johnny, one of the agents on my team. We’ve had him on the podcast before, he’s done a couple of others. He’s a real estate investor and one of my top agents. Very good at looking at things creatively just like you do. You guys are probably going to have a four-hour conversation, but please don’t have a four-hour conversation because I keep Johnny really busy. I’m going to have him giving you some creative ideas of where you can find properties, how you can add value to them. I think when you’re done talking to Johnny, your questions are going to be how do I raise enough money to go do what I want to do with some Bay Area properties? Because he’s in a similar area to you. He lives in San Jose and he helps a lot with the South-based stuff that I have, as well as other areas too.
You’ll really enjoy that. And then I want you to look at what’s worked with Rob’s homework, and ask yourself how you could apply that to other things. I heard you say, “Oh, I never thought about doing something like that.” Try to teach your brain to look for that same opportunity in other scenarios. That was how you find a contractor. Would that work for finding a real estate agent that knows the area well? Would that work for a subcontractor, not a general contractor? Because sometimes you can save a lot of money if you go right to the people that do the drywall or they do the flooring or they can do the exterior or the paint or whatever it is. You go to a general contractor, they’re going to charge a lot more than if you could just find a very skilled handyman that can do a little bit of everything, and then you just avoid projects that need electrical work or extensive plumbing or any of this stuff that becomes very expensive.

Danny:
Awesome. Thank you, I appreciate the connection.

David:
Absolutely. All right, Danny.

Rob:
Go forth and prosper, my friend.

Danny:
Will do.

David:
All right, that was our first ever call with our coaching mentees who were selected after the announcement that we made at BPCON2022 in San Diego. That’s pretty fun. Rob, what are you thinking?

Rob:
That’s good. We got three candidates with very, or not candidates, mentees. I guess they were candidates, now they’re officially under our wing here. But they all have very different, I don’t know, battles or things that they’re going through. So I’m excited to work with it.
We had Phillip, he wants to develop a glamping retreat center. He’s currently a high school teacher who wants to quit and make real estate his full-time job. We have Wendy, she’s currently in marketing and she’s looking to just figure out how she can dive more into real estate and get out of turnkey and trying to find out what path can lead her towards, I guess, more financial freedom in the real estate space. And then we have Danny, Danny shoes as he self-dubbed himself, who is already relatively experienced. He has a couple of multi-family properties, but he’s looking to go bigger, better, and he’s wanting to scale up into something that’s just bigger than he is ever done before.
And he’s really at that phase where I think a lot of investors and a lot of people at home are listening right now can all relate to where we’re like, “I’ve done it here. I’ve done it on a small scale. I’m really good at it now I’ve got to go bigger and I’m scared to do it.” I think that’s where he’s at. I think we’re going to help him be able to do that too. So it should be fun. Should be a fun couple of months.

David:
Yes. And everybody’s going to get to learn on the journey. So even if you were not chosen as a mentee or you didn’t even know that there was a contest going on, you’re still going to win. Because we all get to follow along with what everybody’s going through. These first episodes are not very tactical. It’s like in the initial stages when you’re first meeting with a client who wants to buy a home. So as a real estate agent, let’s say, this is very common. We don’t even show you what houses are out there. At least if you’re good, you don’t. We ask what your goals are, we ask what your fears are. We ask how much capital you have to work with. We get a feel for your life to know how big of a project can you really take on, or what would work best for you? What would be exciting?
It’s only after you get that why, that understanding of where they’re trying to go, that you actually start to put together a plan of how to get there. And then every one of these check-ins will get more and more detailed and eventually more and more direct about the tactical approaches to what do I do when this or that happens. It’s not very often that people get to see the chicken when it’s first coming out of the egg, but we’ve got a bunch of chickens who are just poking their beaks through today.

Rob:
Yeah. I think everybody’s just so antsy always to say like, “Oh, I’ve got to get started. How do I get into the first house?” There’s a lot of strategy and philosophy that goes into actually doing that. So patience is actually the most important skill you need when you’re first starting out, because you need to be able to patiently think through your strategy before going all in.

David:
Yep, absolutely. Well, great job as always, Rob. I’m glad to have you here with me on these. I’m excited to see what advice you give these fine folks as we lead them to future millionaire status. Actually, some of them could be millionaires right now, we didn’t ask that. But suppose it doesn’t matter. It just matters if they get to the goal that they have. All right, I’ll get us out of here. This is David Greene for Rob, will you be my mentor, Abasolo? Signing off.

Rob:
I’ll always be your mentor, baby.

Ashley:
This is Real Estate Rookie, episode 248.

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

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

Tony:
25?

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

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

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

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

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

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

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

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

Ashley:
Yeah.

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

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

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

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

Tony:
Ashley, this is dollars sounds.

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

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

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

Tony:
That’s a great idea.

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

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

Ashley:
Yeah.

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

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

Tony:
Sell that property.

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

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

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

Tony:
Leverage.

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

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

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

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

Ashley:
Yeah.

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

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

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

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

Tony:
25?

Ashley:
Every year for the annual filing fee.

Tony:
800 in California.

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

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

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

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

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

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

Ashley:
Yeah. Me either.

Tony:
I’m not even sure.

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

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

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

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

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

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

Ashley:
Mm-hmm.

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

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

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

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

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

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

Mindy:
Aw, Scott that’s so sweet, you’re going to make me cry. Scott and I are here to make financial independence less scary, less just for somebody else. To introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.

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

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

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

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

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

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

Parker:
That’s correct.

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

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

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

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

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

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

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

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

Scott:
I’ve done that.

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

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

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

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

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

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

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

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

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

Parker:
It’s in both our names.

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

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

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

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

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

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

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

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

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

Parker:
Exactly.

Scott:
It may.

Mindy:
Well, then you can insure it.

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

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

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

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

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

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

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

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

Parker:
Yeah.

Scott:
Okay.

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

Parker:
Okay, that sounds good.

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

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

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

Parker:
It was tough.

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

Parker:
100 years.

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

Parker:
We’re due.

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

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

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

Mindy:
Let’s call it 400 a month.

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

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

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

Parker:
So they make you refinance basically.

Mindy:
You will lose-

Scott:
They could.

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

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

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

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

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

Parker:
That makes sense.

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

Parker:
Not going to sue myself.

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

Parker:
Yeah.

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

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

Scott:
So you used tenants in common.

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

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

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

Parker:
It’s a month to month lease.

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

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

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

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

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

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

Parker:
Yeah, that all makes sense.

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

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

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

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

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

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

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

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

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

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

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

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

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

Parker:
That’s true.

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

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

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

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

Parker:
Yeah, 36 something.

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

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

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

Parker:
Yeah, pretty much.

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

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

Mindy:
Why did you stop?

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

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

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

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

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

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

Mindy:
Do you have a match at your company?

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

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

Parker:
Yeah, I am, I am.

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

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

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

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

Mindy:
That’s hard to argue with.

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

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

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

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

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

Mindy:
Aw, thank you.

Scott:
Thank you.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Ben:
Thanks for having me guys.

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

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

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

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

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

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

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

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

Ben:
Residential is probably the best.

Dave:
Oh really? Yikes.

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

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

James:
That’s working smart.

Dave:
There you go.

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

Dave:
Never heard that term.

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

Dave:
Oh okay.

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

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

Ben:
Hundreds of billions.

Dave:
Billions.

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

Dave:
What! Is it just…

Ben:
Yes.

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

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

Dave:
Really?

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

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

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

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

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

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

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

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

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

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

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

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

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

Dave:
Yeah, right.

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

Dave:
Yeah, it doesn’t make sense.

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

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

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

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

James:
We’re overdue really.

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

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

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

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

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

Ben:
Okay.

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

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

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

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

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

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

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

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

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

Dave:
Wow.

Ben:
It’s so messy.

Dave:
It’s the brand new debt.

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

Dave:
That must be a fun debate to have.

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

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

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

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

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

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

Ben:
Yeah, thanks for having me.

James:
Thanks Ben.

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

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

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

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

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

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

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

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

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

James:
Oh, I’m a hundred percent in.

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

James:
Yeah, go Hawks.

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

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

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

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

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

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

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

David:
This is the BiggerPockets Podcast show 707.

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

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

Ryan:
Very good. How are you, David?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Ryan:
Yeah, absolutely.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Ryan:
Yeah.

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

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

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

Ryan:
Not without paying taxes.

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

Ryan:
Correct.

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

Ryan:
Yes.

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

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

David:
What are the other two rules?

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

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

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

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

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

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

Ryan:
Yeah.

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

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

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

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

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

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

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

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

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

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

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

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

David:
The tenant is a big one.

Ryan:
Yes.

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

Ryan:
Yes.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The First Half

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

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

The Second Half

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

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

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

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

What Will Happen In 2023?

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

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

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

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

Will Affordability Improve? 

Affordability is made up of three factors: 

• Real wages
• Home prices
• Mortgage rates

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

Real wages

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

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

Housing prices

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

Mortgage rates

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

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

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

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

Conclusion

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

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

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

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

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

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