Blog

Californians might be facing new taxes, again.

Waves were stirred last week when Assemblymember Chris Ward (D-San Diego) introduced the California Speculation Act (AB 1771).

The bill is the Assembly’s latest attempt to curb rising housing costs and bludgeon investor profits. If passed, the Act would add an additional 25% tax on the capital gain from the sale or exchange of residential properties within three years of its initial purchase.

In other words, California lawmakers are trying to disincentivize investor activity in the state’s housing market. Yet, the bill’s language will also affect the traditional homeowner, including the most vulnerable.

An Overview of the California Speculation Act

The California Speculation Act carries the following provisions:

• Homeowners would be taxed up to 25% on capital gain if they sell their home within three years of purchase.
• The tax applies to all “Qualified Taxpayers”.
• Applies to most residential properties with few exemptions.
• First-time homebuyers and affordable housing units are exempted.
• Properties sold within three years are subject to a 25% tax. After three years, the rate declines by 5% each year until seven years have passed.
• Collected taxes would be put towards community investment, with 30% designated for affordable housing.
• If passed with a 2/3 vote in the Assembly, the bill would become law on January 1, 2023.

What’s The Story Behind It?

California’s housing market is notoriously expensive. San Francisco usually charts at number one for the most expensive real estate market in the U.S. State tax rates are also among the highest in the nation.

AB 1771’s intention is to lower home prices by preventing investors from taking advantage of the market with cash offers. According to the bill’s sponsor, Chris Ward, the Act will dissuade institutional investors who buy up homes with cash and flip them at inflated prices soon after.

“We’ve heard of people getting into their first home getting beat by cash offers,” Ward said at a news conference. “When investors fall out of the buying pool, that will give regular home buyers a chance to buy a home,”

For Ward, prices are a major problem. As a representative of San Diego, historically one of the more affordable spots in California, he’s overseen skyrocketing real estate appreciation that’s put San Diego on par with San Francisco, a voting issue that does not bode well for him.

Unfortunately for Ward, his bill is being faced with significant opposition.

According to detractors, the main issue facing California’s real estate crisis is the severe lack of housing supply. Demand has been through the rough over the past few years and supply has been exceptionally slow in catching up.

California housing starts in 2021 totaled about 120,000. That’s a slight uptick from 2020, but right on par with the last four or so years. It’s way down from 2004 or 1988 levels though, where total units rose well above 200,000. The state is also below its construction goals, which is targeted to fall around 180,000 units per year.

In essence, California is short several million housing units and is still not on track to meet demand. This, paired with high tax rates, has created a catastrophically overpriced market, locking out millions and putting an enormous amount of pressure on low-income and first-time buyers.

In fact, many real estate experts are pointing out that the Act would likely exacerbate the inventory crisis.

“California has a meaningful affordability crisis. Unfortunately, this bill would tax most homeowners and investors alike, leading to an even worse lack of inventory, one of the leading reasons for housing price escalation. We believe this is well-meaning legislation with significant unintended consequences,” said Nema Daghbandan, Partner at Geraci LLP, the General Counsel for the American Association of Private Lenders.

A leading issue with the bill is that it applies to all qualified taxpayers. Unless you’re on active-duty military service or deceased, you’re considered a qualified taxpayer. If you were to sell your home within a seven-year period, then you will be subjected to the tax, investor or not.

The argument, of course, is that most Californians don’t sell their homes that quickly, which is true. For instance, residents of Los Angeles tend to keep their homes for a median length of about 16 years.

However, it begs the question of whether it’s an infringement of the property rights of sellers? Let’s say you bought a home in Los Angeles in 2020 but were just offered a fantastic job in San Francisco. The catch is that you need to relocate.

Should you be taxed up to 25% for needing to move? A joint statement by multiple California real estate trade associations, including the California Association of REALTORS®, says absolutely not.

“According to the Neighbor 2020-2021 American Migration Report, over 20% of those surveyed stated they planned to move based on job changes, financial challenges, or additional space requirements. Under AB 1771, property owners with a growing family seeking to move into a larger home, downsizing due to the job loss of one of the occupants, or even those who must relocate to act as a caregiver for a loved one who became ill would be harshly penalized for simply needing to move” the letter stated.

The statement continued to scorn the bill, citing critical data that suggests investors who paid with cash only made up 3.8% of all transactions in 2021. It also ensured to address the bill’s primary reasoning, which is to lower prices.

“Further, [the bill] does nothing to ensure that first-time or other homebuyers are guaranteed access to homes, nor does it create more housing opportunities. Rather, the bill will cause unintended consequences for the market by reducing the number of homes available for sale. In January 2022, new home listings continued to drop by the double digits – with listings declining from 13,301 in January 2021 to just shy of 10,000 in December 2021. The reduction in listings would be exacerbated by this bill as it incentivizes investors to actually hold on to their properties longer and would force homeowners who need to sell to wait – further depressing California’s ownership housing supply.”

Closing Thoughts

Overall, the California Speculation Act is a senseless attempt to curb housing prices and will likely cause more harm than good to the real estate market.

By targeting all qualified taxpayers instead of investors specifically, it’s hard to see this bill as anything more than a government money grab off the backs of highly valued homes.

We’ll keep you updated on further developments.

On Wednesday, March 16, 2022, the Federal Reserve announced it would be raising interest rates for the first time since 2018. While the 25 basis point hike (one basis point=0.01%) was largely expected, the underlying shift in Fed policy will impact the housing market, and real estate investors should understand and pay attention to it. 

In this article, I will provide a brief overview of what the Fed is doing, why they are doing it, and how it could impact real estate investors. 

At the conclusion of the March meeting of the Federal Reserve, it was announced that the Fed’s target for the federal funds rate would increase by 25 basis points. The target federal funds rate is the interest rate at which banks borrow reserve balances from one another. It doesn’t actually impact consumers directly. 

However, when the target rate rises, it sets off a domino effect that ultimately hits consumers. An increase to the federal funds rate makes it more expensive for banks to borrow; this, in turn, makes it more expensive for banks to lend to consumers—the cost of which is passed along to consumers. 

This week, it got a bit more expensive for banks to borrow and lend. It’s a big shift from the stimulative policies the Fed has embraced since early 2020. 

The federal funds rate is one of the primary tools the Federal Reserve has to manage the economy. In difficult economic times, it is lowered to stimulate economic growth. We saw this after the Great Recession, and then again at the beginning of the COVID-19 pandemic.

By lowering interest rates, the Fed incentivizes business and consumers to finance their spending by borrowing money. For businesses, this could mean new hiring or expanding into new markets. For consumers, this could mean buying a new car or house while rates are low and debt is cheap. The impact of cheap debt is an increase in the amount of money circulating in the economy, also known as monetary supply. An increase in monetary supply generally stimulates spending and economic growth. 

There is a downside to so much money flowing through the economy: inflation. Inflation is commonly described as “too much money chasing too few goods.” So to fight inflation—and reduce the monetary supply—the Fed raises rates. As interest rates climb, businesses and individuals are less inclined to borrow money to make big purchases, which means more money sits on the sidelines, helping curb inflation. 

Raising interest rates is a bit of a dance. Rates must increase to fight inflation, but rising rates also put the economy at risk of reduced GDP growth—or even a recession. Again, the potential for reduced borrowing and spending that comes with increased interest rates can hurt economic growth. 

This is why people like me watch the Fed’s moves so closely; we want to know how they will balance their dual responsibilities of fighting inflation and promoting economic growth. It’s a tightrope walk. 

What happened this week was expected. As they have been signaling for weeks, the Fed raised rates by 25 basis points. There’s nothing particularly interesting about that announcement, in my opinion. 

The data that interests me the most, however—and the data that will impact real estate investors the most—is contained in the dot plot.

This graph shows what the people who actually make decisions about interest rates believe about where the federal funds rate will be going forward. Each dot represents the opinion of one Federal Open Market Committee (FOMC) participant. 

Another way to look at this data is presented here: 

From this, you can see that the median projection of FOMC participants is now about 1.875% for 2022—a very dramatic increase from where we are today. This shows a clear position by the Fed. They intend to raise interest rates aggressively through 2022 and expect rates to keep climbing to 2.8% in 2023 before flattening out in 2024. Over the long run, the FOMC would like to see rates at around 2.4%. 

For context, the highest the upper limit of the target rate has hit since the Great Recession was 2.5%, which is where it sat for most of 2019. The Fed is planning to go higher than we’ve seen in years, and then bring it back down a bit, presumably once inflation is in the 2%–3% year-over-year range that the Fed targets. 

For real estate investors, interest rates are hugely important. As I’ve discussed already, they impact the entire economy. Importantly, rates also impact real estate investors and the housing market more directly—through mortgage rates. 

The reality is this: Although the Fed announcements make for a lot of news, the Fed’s target rate doesn’t impact mortgages that much. Check out this chart: 

The green line is the federal funds rate (the chart hasn’t been updated to reflect the announced rate hike), the blue line is the average rate on a 30-year fixed-rate mortgage (owner-occupied), and the red line is the yield on the 10-year U.S. Treasury bond. 

If you eyeball the relationship between the green line (federal funds rate) and the blue line (mortgage rates), you can see that there hasn’t been a particularly strong correlation between the two variables, at least since the Great Recession. 

Instead, look at the relationship between the red line (yields on 10-year treasuries) and the blue line. There is a robust correlation. If you want to know where mortgage rates are going, you need to examine the yield on 10-year U.S. Treasuries—not the Fed’s target rate. 

Yes, bond yields are impacted by the federal funds rate, but they’re also influenced by geopolitical events, the stock market, and many other variables. I am not a bond yield expert, but bond yields have risen rapidly this year, and given recent events, I wouldn’t be surprised to see yields hit 2.5% or higher this year. 

If that happens, I think mortgage rates for a 30-year fixed owner-occupied property could be around 4.50%–4.75% by the end of the year. That would be a significant increase from where we’ve been over the last few years, although still very low in a historical context. 

Before the Great Recession, rates were never below 5%, for as far back as I have data. Keep that in mind as you navigate the current investing environment. 

Mortgage rates will rise, and this will put downward pressure on the housing market. Rising mortgage rates decrease affordability, which then lowers demand. In a more typical housing market, this would have a pretty immediate impact on housing prices. But the current housing market is different, and “downward pressure” on housing prices does not necessarily mean “negative price growth.”

Remember, there are other forces driving the housing market right now, many of which put upward pressure on prices. Demand is still high, driven by millennials reaching peak homebuying age, increased investor activity, and higher demand for second homes. Additionally, supply remains severely constrained, and as long as that is the case, there will be upward pressure on housing prices. 

What happens next is hard to predict. On the one hand, we have rising rates putting downward pressure on the housing market. On the other hand, we have supply and demand exerting upward pressure. Without a crystal ball, it remains to be seen how this all plays out. 

If I had to guess, I believe prices will continue to grow at an above-average rate through the summer, and then come back down to normal (2%–5% YoY appreciation) or even flat growth in the fall. Past that, I won’t even venture a guess. 

Although I like to make projections to help other investors understand the economic climate, in uncertain times like these, my personal approach to investing is not to try to time the market. Instead, I try to look past the uncertainty. In my mind, the housing market’s potential for long-term growth remains unaffected by today’s economic climate. Short-term investments, to me, are risky right now. (Full disclosure, I don’t flip houses even during more certain economic times.) But long-term rental property investing remains a great option to hedge against inflation and set yourself up for a solid financial future five years or more down the road. I’m still actively investing because inflation will eat away at my savings if I do nothing. And I know that even if prices dip temporarily in the coming year, investing now will still help set me up to hit my long-term financial goals. 

David:
This is the BiggerPockets Podcast show 586.

Andrew:
Do not fall for the temptation of actual cash value insurance policies. In most cases, a lender will not let you do that. But if you’re buying a property for cash or you’re doing some kind of non-traditional debt structure, don’t fall for the trap of, “Cool, I can save a little bit on my premiums,” because the minute you have a loss, that will come back to bite you big time.

David:
What’s going on everyone? It is David Greene, your host of the BiggerPockets Podcast, the show where we show you just how powerful real estate investing can be. Our guests include food servers and firefighters, counselors, and corporate execs, people with a wide range of backgrounds with one thing in common, they got the real estate bug, they got educated and they took action.
Now it’s our job to help you do the same. Now we are going to do that today by bringing in my personal friend and multifamily investing partner, Andrew Cushman. Andrew Cushman has been on this podcast several times. I believe this is his fourth appearance and he is a multi-family investing specialist. On episode 571, we dug into what he calls phase one of his underwriting, where he looks at would this property possibly work if everything went great?
In today’s episode, we get into phase two where we verify is everything actually great and could this deal work? Now, this is a very, very detailed, practical sort of information packed episode where you could take the information and literally create the same system that Andrew runs. And I hope that many of you do. If you’ve ever learned what goes into analyzing multifamily property, this might be the most important episode or piece of information that you watch ever.
This will teach you more about investing in multifamily property than you probably ever heard in your life. And that doesn’t mean that you need to actually go do everything we talked about, but this will give you amazing insight into what goes on that will give you confidence in your own investing and maybe help you understand if multifamily is a niche that could work for you.
There’s all kinds of different strengths and weaknesses associated with each asset class of real estate, and today we dig in pretty deep on what goes in to multifamily investing. Now there’s eight steps that I’m going to want you to follow. And at the end, Andrew and I talk about a deal that we’re going to be putting together that you can get more information on. So make sure you listen all the way to the end to learn about that.
And if this is your first time hearing about Andrew or multi-family investing, please go back and listen to episode 571 after you finish this so you can see what led up to it. Now, if you end up liking this episode and you’re like, “Man, I like learning about something new that I didn’t see coming.” Today’s quick tip is going to be to go to biggerpockets.com/store and check out the books that they have.
There’s books on all kinds of topics, and it’s good to read them just to get a feel for if you would like investing in that type of asset class. And if that’s really where you want to put your focus and attention and learning to grow, the other thing you can do is get on the BiggerPockets forums and ask questions and see how many other people are thinking the exact same things as you, and trying to figure out the same questions that you’re trying to figure out.
So many of us think that we’re on this journey on our own, and we’re really not. Everyone else is taking it with us. So get hooked up with some people on this hike and this journey to the top of the mountain that we’re all taking and will be very encouraging for you. Without further ado, let’s get into it with Andrew Cushman. Andrew Cushman, welcome back to the BiggerPockets Podcast.

Andrew:
Hey, good to see you again. I think it’s going to be a great day. I put the left earbud in my left ear on the first try, that’s always a good sign.

David:
Is that your barometer to tell how things are going to go?

Andrew:
Yes, it’s very predictive, yeah.

David:
I like it. People are getting in behind the scenes look on just how to be successful in real estate investing.

Andrew:
That’s the key right there, yeah.

David:
Now today’s show is going to be a masterclass on underwriting multifamily properties. So heads up if you’re not into multifamily, this is one that is definitely going to be focused on that niche specifically. But I think that there’s value that you’ll get out of this anyways because we’re going to go into really the fundamentals of real estate investing.
The specifics of how to evaluate multifamily are going to be covered but there’s always a why behind what we’re doing. Now, we had Andrew on episode 571 where we went over what Andrew first was phase one of his underwriting when it comes to multifamily properties. Could you give us a brief summary of what those six things were?

Andrew:
The phase one underwriting was just, and we won’t go through all of the different steps, but the phase one underwriting was just a quick and dirty like you’ve got 10 properties in your inbox, you did the screening that we talked about way back in episode 271, I think it was or 279 yeah, 279 and you said, “Okay, well these three look interesting.”
But you don’t want to spend eight hours underwriting them so you just go through and make some fairly positive assumptions about rent growth, expenses, your debt, all of that and look at it say, “Well, okay I spent 30 minutes, 15 minutes underwriting this.” Under the best case scenario, these rosy assumptions, the deal doesn’t work, trash it, right?
But if under those rosy assumptions, it does look like a great deal, that’s when you move to phase two, right? Because you’ve done the screening, you’ve done phase one, the cream rises to the top but turds float there too. And phase two is where you’re going to figure out that if the property in question, which one of those it is.

David:
The turd test.

Andrew:
The turd test, yeah.

David:
Brandon is not here so that’s probably the best that I can do coming up with names.

Andrew:
All right, well, we’ll take it.

David:
Okay, so we also talked about the four levers that really, really make a deal work. Can you go over those briefly?

Andrew:
Yes. And there are other levers, but as we discussed, these are probably four of the most powerful ones. One are your rent growth assumptions. So did you assume 2% rent growth or 3? And over a five year timeframe, that’s cumulative and it has a huge effect. The second one was, what are your cap rate assumptions? Did you assume cap rates stay flat? Did you assume they go up 100 basis points or 50 basis points over your whole time? That changes things significantly. Especially if you’re looking at IRR.
The third one is the time of sale. Are you planning on underwriting for a three year sale, a five year, 10 year? What if you’re going to hold it indefinitely? Moving that endpoint significantly affects how you underwrite and are you looking at IRR or cash on cash? So that’s another huge lever.
And then the final lever we talked about was leverage itself. Are you going in with 65% LTV debt, loan to value, or are you trying to max it out at 80 with a bridge loan? Are you trying to put preferred equity on top of that to get to 90? So those are the four levers that we went in a lot more in depth and that can very significantly affect your underwriting.

David:
And you really want to understand those levers because if you’re going to invest as a limited partner in somebody’s syndication, they might have fudged the numbers by putting these levers in places that aren’t natural. So for example, we mentioned cap rate assumptions. If you’re not super into multifamily, all that means is a cap rate is a measure of how desirable an asset is in any specific market.
The lower the cap rate is, the more people want it and the lower a return an investor will accept to get into that market. If a general partner or the syndicator is assuming that demand is going to go up, meaning cap rates are going to go lower, they can make the deal look a lot better on paper than it’s actually going to be.
When Andrew does deals and when we do deals, we assume the opposite. We assume cap rates are going to go higher, which means that there will be less demand. And it’s a more conservative approach. If the deal still works under those conditions, it’s much less likely to fail. So that was some really good stuff and just understanding how easy it is for somebody to sort of manipulate numbers when they’re making an offering, as well as you can talk yourself into a deal being a good deal by kind of playing with those levers.

Andrew:
Yeah, you’re a hundred percent right. It applies both ways. If you’re looking to invest as an LP, you want to understand the impact that those things have so that you can dive into their underwriting and make sure that either they are not intentionally pulling a lever they shouldn’t, or just unknowingly pulling it, or be maybe you just don’t agree with their assumptions.
And then yeah, if you’re doing your own, you can make a spreadsheet tell you anything you want. And so you got to be cognizant that you’re not doing that. Well, if I just assume the cap rate doesn’t move, this is a great deal. Real world is often different than spreadsheets so be careful.

David:
And we’ve all been there. That’s exactly right. So phase one like you mentioned is just, hey, if we assume the best does the deal work? Because if it doesn’t work under best circumstances, don’t look at it all. And it doesn’t really take that much time. And another thing I really love about the system Andrew has here is this can be leveraged to other people.
So Andrew, you have two people on your team that for the majority of these deals, they’re actually working phase one underwriting and they’re only coming to you or putting more time into it if it passes phase one underwriting. So anytime you can create something like what you’ve done here, it makes it easier on yourself to leverage anything you want to add on what things have been like since you made that change.

Andrew:
So it used to be me looking at everything and doing every step and it was brutal. And I started to get burned out on it where a deal would come to my inbox and I’d be like, “Oh geez, another deal I got to underwrite.” And I lost the excitement, right? Whereas now we have a virtual assistant that’s worked with us for a couple years now who does that screening process that we talked about way back on 279.
Then I have an acquisitions person who does that phase one underwriting that we talked about in our last episode. If a property looks like it’s cream and not a turd, then he sends that to me, we talk a little bit, he then goes into phase two and then he proceeds from there. So when you go to phase two is it’s screened well, it passed phase one underwriting and it looks like a property that you want to own and, or you think is at least worth putting an offer on.
And that’s a whole nother topic to get into on another time but there’s a lot of different reasons you’d want to put an LOI on a property even if you might not necessarily want to win the deal on the first bet. This is the process phase two that helps you decide what price in terms that you would consider doing that. And so this is definitely more time intensive. So you don’t want to do it on every deal, only deals that have high potential or properties that you think you’d really want to own.

David:
All right, everybody. So buckle your seat belts because you’re about to get some high level practical information that you can actually take away from the podcast and apply the minute that you leave into evaluating a deal. There’s going to be eight steps to underwriting phase two. Anything you want to add before we get into those?

Andrew:
Yeah. So if you’re used to listening to podcasts on 2X speed, don’t do that because I’m already going to be talking fast.

David:
That’s a great point. All right. So what is step number one?

Andrew:
Step number one, rent increases. So there’s a number of components to this. There’s market rent growth over time. There’s hopefully you have found a value add deal so there’s a component of bringing the property up to where rent should be today. And then we’re going to talk about actually step two, is loss-to-lease.
And they both factor into rent increases, but we’ll save loss-to-lease for just a minute. So far as regular rent increases. First, we’re going to talk about… We talked actually in phase one about market rent growth over time. That’s where you’re assuming, okay, market’s going to keep going up 2 1/2% or 3% a year. But how you determine where market rent should be today is we use what’s called a scatter chart in Excel.
And I’m going to pull up a visual here. If anyone is just listening and you’re not on YouTube, we try to explain this so it’s understandable but the best thing to do is go to YouTube and take a look at the chart that we’re showing. So what you’re seeing now is a one bedroom rent comp analysis. And by the way, these are real, we didn’t make this up.
These are from deals that we actually have offered on. We did take out the name of the actual property so we don’t have a hundred thousand people going to look at it, but this is real data. And in this example here, we’re looking at one bedroom rent comparables. And you’ll see on here there’s Oceanside, East Park, Laurel Creek, Westview, Whispering Pines, these are all comparable properties to the one that we’re looking at.
And on the chart, there’s a bar that’s labeled in red called one by one unrenovated. That is an unrenovated unit at the property that we are doing our phase two underwriting on. And how the chart works is the bottom access is the square footage, right? So as you move from left to right, that means a smaller unit to bigger unit. The vertical access is rent. So on the low end, this chart starts to 800 and it goes up to 1200.
And so what we do is you take all these… When you get a bunch of data from Axio or CoStar, wherever and all this different floor plans and different sizes and rents, it’s kind of hard to just look at all that and figure out, “Well, okay, where’s my rent?” Right? So you make it visual. And so what we do is we take all those data points, we put it into Excel and we create this scatter chart.
And then if you look there’s a blue dotted line that kind of goes from bottom left to upper right it’s called the regression line. There’s a nasty statistical definition of what that means, but basically it’s just a visual line that shows how the different data relate to each other. And what you’ll see is the reason the line goes up from left to right is because rent tends to increase in that market as the unit size goes up.

David:
As the property gets bigger.

Andrew:
Yeah, as the units get bigger. People generally are willing to pay more money for larger units. And the steepness of this line kind of tells you how much that submarket values a bigger unit. But the most important thing that we’re trying to show here is if you look at our one by one unrenovated unit, it is sitting at $900 a month in rent. Every other property is a thousand dollars or higher, right?
So by plotting these, you can immediately look at this and go, “Well, okay, I should be able to do a light renovation and at least get the rent from 900 to 1,000.” All right? And if you look at the chart, you’ll see that we actually have the one by one renovated is the one that’s in green at 1,025, which is slightly above two of the other data points.
Well, all right, Andrew, why is that one higher? Right? If the regression lines right at 1000, why do you have it as 1,025? Because part of our analysis is we looked at those other comparables and saw what the interiors were like and said, “Okay, well, if we spend $6,000 or whatever the number was, we can meet or exceed those plus our professional management with a lot of experience in that market, we have high confidence that we can get to 1,025.”
So that is what we’ve found to be the most effective way to quickly and accurately at the same time determine how much rent bump you can get, right? Again, there’s more like if you’re buying a property, you’re going to go visit these property and actually tour these comps and all that. But when you’re sitting at your desk doing phase two underwriting saying, “Okay, I assumed in my phase one that I can raise rents a hundred bucks a month or 150, is that true?” This is where you’re verifying if that rosy assumption was true. And based on this chart, these units should pretty easily get to about 125.

David:
Now I see you have several different complexes that looks like all the different names of them. How did you go about gathering the data that you put into this chart for what Whispering Pines gets Westview, Laurel Creek, et cetera?

Andrew:
Good point. So we try to get it from as many data sources as possible. So we’ll get it from Axiometrics, CoStar. And anyone who’s tried to sign up for CoStar is like, “Andrew, that costs an arm and a leg.” You’re right. So we don’t pay for it. We go to brokers and property management companies that do and say, “Could you please send us a report for this submarket or for this property?”

David:
Nice.

Andrew:
ALN is another source of data. But also what we do is we perform our own surveys. We will get online and look up every property just using Google, apartments.com, rent.com and get every property in the area, call them, get it off the internet, get all own data, and then ideally we have two or three sources for the same data set. We compare them and try to get them to line up as much as possible, and then plot them on this chart.

David:
Wonderful. Okay, so tell me how you would… Let’s say that you had a rosy assumption and then you pulled up this chart. What would let you know, “Hey, stop right there. We’re not going to be able to get the rent bump that we’re going to need”?

Andrew:
Yeah, right on. So if it’s one of those things where we had a call with the broker and they’re like, “Oh yeah, you can easily get these things to $1,200 a month. The seller renovated one unit and he leased it for $1,200 a month and you should be able to do the same.” So, okay, cool. In phase one, boom, $1,200 a month. Oh, this property looks great. We do this, sorry, no. It’s only going to be 125, maybe 150 best case scenario. So we go back, change the underwriting and it might kill the deal. So then that’s what you’ve… Again, you look just like in phase one, you’re looking for reasons to say no.

David:
There you go. This is the verify part of trust but verify.

Andrew:
Exactly. Yes.

David:
Okay. Anything else you want to cover before we move on to the next step?

Andrew:
Yeah. You know what? Just to get it all in, let’s go ahead and keep on moving. So the next part of this that I want to talk about is number two, is loss to the lease. And to be fully transparent, I was in the business for several years before I even fully understood what that actually meant. All right? So here’s what loss-to-lease is.
Let’s say you’ve got a tenured apartment complex, and you are advertising that your rent is a thousand dollars a month. But when people walk in the door, for whatever reason, maybe you’re asking too much, maybe you didn’t hire the right leasing person, whatever, when people walk in the door, you’re actually leasing it for 950, right? You’re marketing it for 1000, but when that lease is signed, it’s 950. So how that’s treated is you are losing $50 a month to that lease, right? So market’s 1000, but your lease is 950 so your loss-to-lease is $50 a month, right?

David:
Okay. Let me see if I can make sure that we understand here. What you’re saying is if you’re being told that the unit will rent for a thousand dollars a month, you’re putting it in to your rent estimator at a thousand dollars a month.

Andrew:
Right.

David:
But recognizing that’s not accurate, you looked and see, well, what is it actually renting for? Only 950? So you have to subtract that $50 from somewhere and you create the category called loss-to-lease to do it. It sounds very similar to how vacancy is used. When I was new at investing, I would say, “Well, it’s going to rent for $1000 a month, but I have a 10% vacancy rate so I’ll just put $900 a month in for rent.” That’s actually not the right way to do it. You should put in the full thousand and create a separate category for a vacancy where you take off a hundred. Is that the same principle working here?

Andrew:
Yes, it is. And so what happens is loss-to-lease sounds like a negative thing, and it is if you’re an owner, but if you’re a buyer, it’s an opportunity that you’re looking for. And candidly, loss-to-lease is my favorite value add because it has the lowest execution risk. We talked about the situation where you got 10 units, you’re marketing them for 1000, but you’re actually signing leases for 950.

David:
Can I interrupt you again real fast?

Andrew:
Yeah.

David:
What’s a reason why somebody would put a tenant in at 950 when they’re marketing it at 1000.

Andrew:
We saw this a lot during COVID. People were just nervous and like, “Dude, if I can get someone that’s actually going to show up and pay, I’ll give them a discount.”

David:
So maybe for whatever reason, they had a special running that month where they said, “Hey, get X amount off your rent or something,” that they don’t have to do all the time, but they were trying to lease it up. So they gave that person a discount off of what they normally would get for market rent. Is that accurate?

Andrew:
Exactly. And sometimes you’ll see where the entire tenant base in a property has it, other times you’ll see just a couple of exceptions because it was a friend or they felt bad or they were nervous because of COVID or maybe it was December and traffic was slow and there’s all kinds of reasons.

David:
Okay, thank you. Go ahead and continue.

Andrew:
I’m going to pull up another visual. And this is another scatter chart, looks somewhat similar to the one that we had on the previous slide. And this is another one where you’re looking for a visual to give you a quick reading of what the data is saying. So I started to mention before that loss-to-lease sounds like a negative thing, but in a up trending market like we’ve had for the last 10 years, as a buyer, loss-to-lease is a huge opportunity, and again, probably your easiest value add.
So what we have here on the screen, this is for a property that we actually purchased back in March of 2021. So again, this is real data, real property. And what we did is on the horizontal access, which if I remember from high school as x-axis, we have the date of every lease on the rent roll, right? And then on the vertical access again, is the rent starting at 1150 going up to 1400 in this case.
So you say, “All right, well Andrew, why would you organize the data like this?” Right? So the older dates are on the left, the newest dates are on the right. And then again, rent goes up from bottom to top. So what we did is we’re taking the actual rent roll from the property that has the lease rates and the date that that lease was signed.
And what happens when you plot that on this chart so that you can see the date and the amount that the resident is paying, it becomes very clear when you look at this chart, “Hey, wait a second. Every lease that was signed in the last six weeks, they’re getting 1,350, but the older leases all averaged 1,264.” Clearly, now you need to dig into it a little bit to find out well, did they do renovations or were not?
In this case, and I can tell you this because we bought this property, in this case, they had not done any renovations. They were just finally starting to catch up with the market. And I mentioned before, you might see one lease that’s kind of high, that doesn’t prove a trend. But when you have six weeks consistently of every lease that was signed is all of this is significantly higher, that’s a sign that you can probably buy that property and take all of those other leases, which are represented by very low dots on this chart and get them up to that 1350.
So what you’re looking for are two numbers. You take the rent roll and you average and again, do this by floor plan so this is a one bedroom. If we take every dot on this chart, the average in place rent, meaning people are actually paying it is 1264. But the last 8 to 10 dots on here were all 1350. So what that tells us is we can almost do nothing, just buy the property and manage it well, and then get the rent up from 1264 to 1350. That’s an $86 increase just for managing it and catching it up to market.
Now the reality was now that we’ve owned this property for nine months and the market has continued upward, we are multiples above this level, but this right here not only gives you a huge insight into the opportunity at the property, but it also gives you kind of a backdoor insight into how the overall market is trending. And we have found this chart to be one of the most powerful tools in our underwriting analysis.

David:
Yeah, this is brilliant. Let’s talk about a couple reasons why this is something that should be focused on a lot, but often isn’t. The first thing is like you mentioned, loss lease is the easiest thing to correct. It’s the least expensive and the fastest. You can walk in there and immediately see, “Well, we should be getting this rent so we can bump it up to this before we do anything.”
And you always want to take care of your easiest things first. So if you’re buying a unit that has a very small loss-to-lease or it’s insignificant, in order to increase the rents, it’s going to take a lot more work. You’re going to have to do something like add amenities or upgrade your units, you’re have to spend some money and some time to get there.
Looking for something with loss-to-lease if you were going to compare this to single family properties would be like, you’re getting it significantly under market value. There’s a lot of room to get up to the ARV but even before you do a rehab. Another thing is like when you mentioned, this shows you what’s going on in the market. What you’re referring to is that the higher the loss-to-lease across an entire market, the faster rents have been rising and the leases haven’t expired fast enough to catch up with it. And that’s where you want to be if you’re assuming that that trend is going to continue, which in most cases it is. Go ahead.

Andrew:
Yeah. And I was going to say for those listening who are afraid to buy right now, there is a window of opportunity I’d say for probably the next six to 12 months. There are so many property owners, especially in the, I’d say under 50 unit space where because of COVID fear, whatever, they have not kept up with the rent increases of the last year. And we keep seeing property after property where rents haven’t been raised in two or three years and they are 20% below market now. I don’t think that’s going to last forever, so again, this reveals a huge, huge opportunity.

David:
Yeah. You and I are still finding those deals if you know what to look for. And this is the big red flag that shines, it says, “Hey, come look at me. I am worthy. There’s something here where people are not taking advantage of me.” It kind of reminds me of that old movie She’s All That where you have the nerd that no one’s paying attention to, but really they’re the beautiful princess underneath it.
This is one of those things that you can see, man, this deal would clean up pretty nice. So understandably so that’s why you have it so early in your underwriting process. Because if there’s not a lot here, there’s got to be some that else about that deal that makes it really appealing, that makes you think that you could improve it. This is definitely the best to look for.
And I can’t highlight enough that metrics like this help you understand what’s trending in a market in general. So just imagine that if most leases are signed for 12 months and rent goes up over a 12 month period, let’s say it goes up a hundred dollars over the year, many of those units that signed 10, 11, 12 months ago are going to be at rents that could be going up. And sometimes the apartment complex just extends them on the same lease that they have, right? They’re afraid of vacancy or whatever’s going on. So this is how you can identify that there’s something juicy here. Anything you want to add before we move on to the next step?

Andrew:
Two things. One, if you’re looking for low hanging fruit, this is picked in a basket, sitting under the tree, waiting for you. And then, okay, well, how do you use this? In this case, there’s $86 loss-to-lease, right? That’s no renovations. So if you’re going to renovate the unit and bring it up to a higher level, you take your loss-to-lease, you add your renovation bump to that, that gets you your total rent increase that you are putting into your underwriting. And ideally, your underwriting model should have these as two separate items, loss-to-lease and renovation increase, and you want to be able to toggle and adjust those independently.

David:
That’s a very good point. This goes down to the principle of levers in real estate, which I don’t know if anyone else talks about but when you get into investing pretty significantly, you start to recognize. Like Andrew, you mentioned the four levers that make a property worth more. Cap rates going down might be the biggest lever of all. You can improve your net operating income to make the value of a property goes up.
But that pills in comparison to the power of cap rates significantly going down. It’s just a bigger lever that moves things more. I say the same thing with the BRRRR method. If you’re looking at ROI, you want to get a higher ROI. Well, you can improve your cash flow, that’s one way. But if you can decrease the amount of capital you put in the deal, that lever is way bigger and it makes your ROI skyrocket.
So the deeper you get into investing, the more you’re learning on where do I get the most bang for my buck? What lever do I want to pull on? The rehab bump versus loss-to-lease are both levers that make your rent go up. But loss-to-lease is the bigger lever that’s much easier to pull on. And you’d rather find properties that have that kind of opportunity. So there’s always going to be both, but this is ideal. You want it to be on the loss-to-lease side as opposed to having to manage an entire rehab to get the same result.

Andrew:
Yeah, again, it’s all risk reward. This loss-to-lease generally carries the lowest execution risk of any value add strategy.

David:
Love it. Okay, number three. What do you have for us?

Andrew:
All right. Let’s jump onto debt quotes. And I have another example here, and this is, again, this is real life. This is a debt quote that we received actually on a property that we are under contract to purchase. I did redact some of the specific information for the asset. But when you’re looking at debt quotes, what you don’t want to do is just get… Or I shouldn’t say you don’t want to do.
But in generally what we have found to yield the best results and the highest chance of you being able to perform and close on the deal is to work with a competent and trusted loan broker who will take all of the stuff that you’ve gathered on this property, package it together really well and put it out to multiple lenders to help hunt you down the best deal, right?
Now, you’re not going to do this, you’re not going to actually send this to a broker every time you kind of get interested in the deal. This is, I’d say a deep phase two where you’re actually going to send it to them. But I want to have an example to actually show people some of the key terms to watch out for.
But when you’re doing the, I’d say an initial phase two, you want to at least have, if you don’t feel like you already have a really good grasp of what current debt terms are, then you want to at least run the deal by a competent loan broker and say, “Hey, I’m looking at buying this for 5 million, I want to get a loan for 70% of the purchase price. And here’s the P&L and I think I can get rents up this much. Could you just give me a rough idea of what we might expect for loan options?” Right?
That’s what you want to do in the beginning. Because again, you don’t want to waste your time, but you definitely don’t want to waste anybody else’s time. You want your team members to know that if you send them something, odds are it’s going to go through and everyone’s going to get paid. So again, so the initial phase two is either you already have a sense of what your debt term’s going to be, or you do a quick email or phone call.
If you’ve done a phase two and now, oh, hey, this thing looks good and we’re negotiating an LOI, or we really want to strengthen our offer, that’s when you might have your loan broker send you what I’m about to go over. So you know once you get into it kind of what the terms are going to be. So if you look on the visual, and again, make sure you go to YouTube, BiggerPockets YouTube channel so you can actually see this.
You see three different options on here, and I’m not sure why it’s labeled 1, 2, 4, but it should be 1, 2, 3. So the first is an agency fixed rate, agency floating and then debt fund floating. So agency, that means Fannie Mae and Freddie Mac, which are your government sponsored agencies, debt fund, that’s kind of everybody else. That’s bridge lenders, life companies, actual debt fund, et cetera.
And we could do an entire episode on just structuring your debt properly. But the main things you’ll see here or the main things you’re going to want to take into consideration when you’re doing your underwriting is number one, the term, right? So if you look on this, you’ll see agency is 10 year and the debt fund is three year. Especially right now, I won’t say don’t do bridge because there are appropriate times to do that, but be very careful with loans that have short maturities, right?
Long term multifamily, I strongly believe is going to continue to do phenomenal. But what you don’t want to do get a loan that is completely due in two years or three years and you have no other option other than refinancing or selling. Because what if the debt markets aren’t favorable at that time? Right? You always want to give yourself a little bit of exit.

David:
So what you’re saying is that the shorter that the loan term period is, the less time you have to get things squared away where you’re safe and the less things are able to go wrong before you get hurt?

Andrew:
Exactly. The longer the loan term, the more flexibility you have to adapt to and overcome any adverse scenarios that pop up.

David:
In general, it’s a safety feature to have a longer term loan. And I think one of the mistakes that newer people make is they always assume, “Well, everything’s going to go right and on that timetable, this is where we are.” And that is never the case. Nothing ever goes right.

Andrew:
Yeah. You will never, ever exactly hit a proforma. You will always be a little below or hopefully a lot above, but you will never, ever exactly hit it.

David:
Well, the reason that you come out ahead a lot of times is give yourself this runway. All of your assumptions are always negative. You’re like, “Well, this is going to go wrong and this is going to go wrong and this is going… And if all that goes wrong, I’m still okay under these circumstances.” I think when the market gets hotter, it gets harder to stick to that sort of a discipline approach that we take when we’re buying.

Andrew:
Yeah. I’ve definitely missed a lot of good deals over the years because of that, but I also sleep well. So to me, it’s an acceptable trade off.

David:
Nice.

Andrew:
So the next big thing you’re looking for is loan amount. Different lender, size things in different ways, but you want to know, am I… And so on this particular deal, they were giving us a range of, okay, with agency, you’re going to get anywhere between 13.7 and 13.9 million.

David:
Can you define what agency debt is briefly?

Andrew:
Yeah. That’s the government sponsored agencies, Freddie Mac and Fannie Mae.

David:
Fannie Mae, there you.

Andrew:
Which are fantastic commercial lenders. In fact, they kept the market alive in March of 2020 when COVID shutdown down all the bridge lenders.

David:
I’m glad you say that because we rarely ever say anything positive about the government. But that doesn’t mean that nothing positive ever happens, we just tend to not give credit to that.

Andrew:
And it’s more fun and easier to complain, right?

David:
That’s exactly right.

Andrew:
Than it is to give credit. But no, yeah. Well, that’s the thing. So bridge loans are great, but especially since you brought it up, that is another risk, right? This is going to sound negative, but I love bridge lenders, we do use them occasionally. But bridge lenders are like roaches when you flip on the kitchen light at night, they scatter as soon as danger arises, right?
So you look back at 2008, you could not get a bridge loan anywhere. March of 2020, bridge lenders, every single one of them left the market. If you were going to get debt, it was going to be Fannie or Freddy, that was basically it. So they tend to come and go. And what you want to be careful of, okay, I’m going to get this great bridge loan or I’m going to refinance into one and if something happens like March of 2020 or 2008, those bridge loans may not be there.
So again, just something to be aware of, that’s in the additional risk. So I should think of a better analogy, because I don’t like to call our bridge lenders roaches because they’re great partners. But this is the idea of scattering into their…

David:
They’re fair weather friends, so it’d be a great way to say.

Andrew:
There you go. Fair weather friends. There you go, there you go, there you go. So again, and then if anyone who’s on YouTube, you’re going to see there’s probably about 15 terms on here. So we’ll hit the really high ones or most important ones. So the next one is implied rate. And basically what that is saying is what all the lenders do is they take some kind of index, might be the 10 year treasury might be SOFR, it used to be LIBOR.
And they’re going to add what’s called a spread on top of that so it might be 2% or they’re going to have a number. And they’re going to say, “Well, okay, the interest rate that we’re implying you’re going to get is X,” right? So if we look at this, it says, “Okay, fixed agency is between 3.25 and 3.35. If we go floating rate agency, which means the rate can go up and down as the market interest rates go up and down, because that protects them from getting locked into a low interest rate loan, they will give you a lower interest rate to start so that’s between 2.8 and 2.9.
And then the debt fund is 3, to 3.6. So you can see, depending on which route you go significantly affects the interest rate. So that’s something you’re going to want to know what those rates are. The next one is max as is loan to value. This is one of the downsides of agency right now. If you look on here, the agencies are only going to give us 63% of the loan to value.
So if you’re buying a $10 million deal, they’re only going to give you a loan for 6.3 million. Whereas the bridge lenders are willing to give 75% on a 10 million and deal 7.5 million. In today’s highly competitive market where everyone’s fighting to get the returns that are needed, that extra 12% leverage can be huge in whether or not your deal is appealing to investors or not or whether it hits a certain IRR. But just be aware higher leverage, generally speaking means higher risk.
So again, which route you go depends on your source of capital, your tolerance for risk and your business model. But these are all terms that you want to know. I have heard many horror stories of somebody assuming they were going to get 75% or 80, they get down close to closing and the lender comes back and says, “Oh, sorry, it’s actually 63 or 62,” right? You need to know that upfront because if you’re planning on 80 and you get 63, your deal just blew up. So you got to know this stuff in advance and properly underwrite it.
Another key one to help prevent that is to know what’s called your DSCR, that stands for debt service coverage ratio. So if your property makes $10,000 in net operating income a month and your mortgage payment is $10,000 a month, that means your ratio is 1, right? 10,000 divided by 10,000. You won’t get a loan on that from the agency. What they want to see is generally speaking is a minimum of 1.25.
And again, that changes based on market and property size. That’s the number you want to know. You want to ask your loan broker or whoever you’re working with, what is that ratio need to be? So if they say it’s 1.25 and you’re estimating your mortgage payment’s going to be 10,000, then that means your property needs to have a net operating income of 12,500. 12,500 divided by 10000, 1.25, right? That’s the number you need to know.

David:
Basically that means a lender’s looking to see, “Can you repay the debt we’re about to give you? Can you cover the debt service on this deal?”

Andrew:
Exactly. And they want to make sure you have a minimum of 25% cushion in case something goes wrong.

David:
Yeah. You want to know something crazy? In the residential space, there’s such a demand for lenders that want to be investing in there that a loan company can do a 0.8 debt service coverage ratio. And it’s a 30 year fixed rate loan. That’s how much money is floating around there in the residential world that needs to find a home, that they’re basically saying, “Hey, if the property brings in $8,000 a month, it’s going to cost you $10,000 to get this loan, we’ll still give it to you.”
Now that doesn’t mean that you should ever operate it where that is the case, but they’re looking at it saying, “Hey, they can make up the rest of it with their income.” So these standards are definitely… I’ve noticed they’re tighter in the commercial space, but that’s okay because nobody is buying commercial property assuming it’s not going to make money.
The reason you’re buying it is because it makes money. A lot of residential properties purchase for different reasons. You use it to vacation, you use it to live in, you can kind of make it work as an investment. But residential real estate was never intended to be income producing property like commercial property is.

Andrew:
Well, yeah. And yeah, geez, we could probably do, like I said, a whole podcast or a whole Q&A on this. But just keep it moving. I’m just going to kind of hit the next ones really quick. The next one you want to know is how many years of interest only, right? Is it three? Is it five? Is it 10? Most bridge loans are interest only for usually the full term so the first three years.
The next one is what’s the amortization schedule look like after its no longer interest only? So you mentioned residential loans are typically 30 years. Fannie Mae and Freddie Mac are often the same thing, 30 years. A lot of bridge loans don’t amortize. It just stays interest only. Some bank loans might be 20, 25 years.
So you need to know what the amortization looks like because it doesn’t sound like much. But the difference between a 25 year and a 30 year amortization can have a significant hit on your cash flow because you’re paying more principle. It builds equity so that’s good, but it’s not loose cash flow that you can use. Okay?

David:
So let’s clarify that very quickly. If we’re talking about an interest only loan, basically they’re going to… You’re only paying the interest on the money you borrowed, you’re not paying down any of the principle. So the downside is that if it’s interest only, you’re not building equity by paying the loan down, the upside is you’re actually keeping more money in your pocket. Is that a great way to summarize it or a good enough way?

Andrew:
Perfect. You got it.

David:
So it can make you… This is why I want to highlight it. It can make you feel wealthier than you are when your cash flow is very high, but your loan isn’t being paid down, right? It’s usually better for you and less risky because cash flow in the bank can be used to get you out of tough times rather than paying the loan down if you’re disciplined with your money. And that’s why I want to bring this up, is everyone’s always excited about interest only loans, but it can create this false sense of security that you have more wealth than you actually do because that balloon payment is still building and you’re not creating equity as you’re paying down the loan.

Andrew:
Yep, exactly. If you save it, it’s an advantage. If you spend it, might not be the case.

David:
And the reason most of these loans are structured with interest only first is they’re trying to give you that cushion, right? To build up your reserves, to handle things that could go wrong that you didn’t foresee. They’re making it easier for you and they’re kind of like training wheels for the first little bit. And then after the three or five years, whatever it is, that’s when the amortization schedule kicks in and your payment goes up because you’re also paying down the principle.

Andrew:
Yeah. And also, especially if you’re doing value add, they know that yeah, cash flow might not maximize until three years down the road. So another huge one is prepayment penalty. And this has caught a lot of very experienced operators off guard the last five years. Because we all thought rates were going to go up and they never did, they went down.
Prepayment penalty means if you buy a house, you can pay off your mortgage basically anytime you want, right? David, I mean six months, 12 months doesn’t matter. And you just pay it off, you’re done. In the commercial world, the lenders say, well, they’re taking that loan, they’re selling it on the secondary market and they’re promising investors that those investors are going to get a return.
So if you want to pay off your loan early, Fannie or Freddy will say, “Okay, Mr. Greene, you can pay off your loan early. But by the way, we promised our investors a certain yield so you have to pay us all that extra interest we are no longer going to receive so that we can keep our investors happy.” And that’s an oversimplification. It doesn’t quite work that way, it really is nasty stuff, all these symbols that I haven’t seen since my advanced engineering classes.
The idea of it is if you pay off that loan early, you’re going to have a large fee or penalty that you are going to have to pay. So if you’re going to sell the property in three years, don’t get 10 year fixed debt because you’re going to have a huge prepayment penalty. They also call it yield maintenance.

David:
There’s always fancy words to describe very simple things when you’re dealing with multifamily. You and I should make an article, right? Like yield maintenance, Dutch interest, even agency debt sounds much cooler than Fannie Mae loan. Loss-to-lease is a cool thing to say. There’s a lot of it. When you get into this space, there’s definitely words that get thrown around and you’re like, “What does that mean?” Even cap rate like, “Oh, that’s just the return you get if you didn’t take debt.”

Andrew:
Yeah, if you bought it for cash. So the other two things are, what kind of lender fees are you going to have? Is the broker going to charge you a point? Is the lender going to charge you a point? Is there an exit fee? Most bridge loans while they don’t have prepayment penalty, they will have an exit fee. Meaning like when you repay it off or refinance, oh, we’re going to charge you a point on the back end, right? Or a half a point or something like that.
Again, nothing wrong with it. You just need to be aware of it and make sure that you underwrite for it. All right, next one is insurance quote. Don’t have a visual on this just because it gets pretty dense, but we’re just going to touch on a couple of things. Number one, never ever, ever use the seller’s number for insurance, right?
I can’t tell you how many times we find sellers that are either underinsured or improperly insured or their brother’s sister’s cousin has given them a discount that you’re not going to get. There’s all kinds of reasons not to use the seller’s number. Another reason is a lot of times you’ll come across where situation where someone is ensuring based on ACV, which stands for actual cash value. You want to always ensure for replacement value.
I made this mistake in my first deal, fortunately it worked out okay because we didn’t have any claims. But if you have replacement value, it’s going to cost you more upfront because what the insurance company’s going to do is they’re going to say, “Okay, if your building burns down, it’s going to cost a hundred dollars a square foot for us to rebuild it.” All right?
And if your building does burn down, basically that’s how much they’ll pay you. Again, we’re simplifying. If you do actual cash value saying, “Well, geez I can cut my premiums in half if I go for actual cash value.” Then what the insurance company’s going to do when you’re building burns down is they’re going to come in and say, “Well, yeah, you know what? This was built in the ’80s and the roof was 10 years old and this was five years old.”
So they’re going to apply depreciation to it and they’re going to say, “Well, the actual cash value of this is 50%. So here, your $5 million building, here’s 2.5 million, good luck.” Now you got to come up with the extra 2.5. So do not fall for the temptation of actual cash value insurance policies. And most cases, a lender will not let you do that. But if you’re buying a property for cash or you’re doing some kind of non-traditional debt structure, don’t fall for the trap of, “Cool, I can save a little bit on my premiums.” Because the minute you have a loss, that will come back to bite you big time.

David:
Well by calling it cash value, that’s misleading.

Andrew:
It is.

David:
Oh, I’m going to get the cash, right?

Andrew:
Yeah, that’s why I did it the first time. Like, “Wait, my premiums are half and it’s cash value?” I’m like, “Okay, cool.” And then a little bit down the road, I figured out what that actually meant. Again, this was 10 years ago, we know this stuff now. I said, “Oh, you know what? Let’s go ahead and make this replacement value, thank you.” And again, I got my one year of premium savings and considered myself lucky and moved on, never did that again.

David:
It’s one of those things that in multifamily, there’s big words that can be used that can be misleading. I’ve said this before. I have a general rule that if anybody says finance, instead of finance, I have to look very closely at everything they say because I assume they’re going to try to pull the wool over my eyes. So don’t be that person at the cocktail party that tries to sound smart by saying finance. We all know what it’s actually referring to.

Andrew:
So we’ll speed through a handful of these other things. So they’re a little more self-explanatory. The two main things you were going to need to get an insurance quote are the total rentable square footage and the annual revenue, right? Those are the two main you’re going to get. And you send that to your insurance broker, he should be able to give you a good rough ballpark idea of what that’s going to be.
Some other things you’re going to want to know, the next biggest thing is is there a history of claims? Right? If they’ve got three other insurance claims, that’s called a loss run, which is the history of losses, your rates are going to be higher. Because the insurers, understandably, they’re going to be nervous about that at building.
You also want to find out, have there been any shootings or assaults? Right? So if you go on Google Maps, grab the little yellow man, drop him on the property and he runs away, you should run away too. Because what that means is if there’s been shootings or assaults or any kind of violent crime, you’re going to have an extremely difficult time getting insurance in the first place.
If you do, you’re going to pay more for it and they’re probably going to exclude incidents of violence, which means if someone gets shot in your property, it’s not covered by your insurance company and they go to sue you for 10 million because the shooting was of course your fault as the landlord, the insurance company’s going to say, “Well, good luck, David, that one’s on you. We excluded that.”
That’s part of your screening too, or hopefully you’ve already screened for this and you’re not looking at a property with shootings, but again, you’re going to really, at this point, you want to make absolutely certain. Now some other questions. Does the property have aluminum wiring if it was built especially ’60s or ’70s?
Is it sprinklered? That doesn’t mean it has nice irrigation for the landscaping. That means does it have those little sprinkler heads inside the units? And is it in a flood zone or not? Flood zone is a completely separate policy. And again, if you go back to our screening, we don’t buy in flood zones for a host of reasons. Doesn’t mean you can’t, that’s a business decision for us, but we don’t. And here’s the tip David, what do you think is one thing that flood insurance does not cover flooding from in the commercial world?

David:
Maybe your own fire sprinklers when they go on?

Andrew:
Actually we’ve had that happen, that’s covered. Rain. Flood insurance doesn’t cover flooding from rain. And you say, “Well, okay, where else would flooding come from?”

David:
A dam breaking [crosstalk 00:48:10].

Andrew:
Yeah. And here’s the thing. So we learned this a few years ago, fortunately, not the hard way, just by asking enough questions. So when you’re getting a flood… So what flood insurance covers, it covers flooding from a body of water, the lake overflows, the river overflows, the ocean comes in on storm surge with a hurricane.
If it just rains 12 inches and the water piles up in your parking lot because it can’t get away fast enough and floods units, that often does not count and often will not be covered. Most cases you have to specifically get that written into the policy that that is covered. And that saved our butts this year. We had a property in Florida we bought, we specifically made sure that was written in there.
One month after we closed on it, tropical storm came through, 17 inches of water in the parking lot because of rain not tied to a body of water. If we hadn’t had that clause inserted into the insurance, again, not in the flood zone, it’s not in a flood zone, it just rained too much, then we would’ve been out of luck some big bucks. So that’s a really big one. All right, so moving on to property taxes.

David:
Number five, property taxes.

Andrew:
Yes, number five. This one’s absolutely critical. This is another one where sellers and occasionally some brokers will try to get this past newbies and say, “Oh taxes are really low.” Especially in again, in markets that we’re seeing now where prices have been trending up significantly that property taxes are lagging, right? And this is something that is very unique to each county and state.
So we’re going to go over some general processes for estimating property taxes, but you’ve got to dig in and find out how your local municipality handles this. Everyone is different. So I’m going to go ahead and pull up an actual tax statement to show this. But basically the gist of it is you want to go to your county assessor’s website, download the current statement, right? And then use that to determine how and when they’re calculating reassessments and then estimate your taxes, future taxes based on your purchase price and how they’re doing that.
So I’m going to go ahead and pull up, this is an actual property tax bill. This is from the Valdosta area or so the Lowndes County in Georgia. And what you’re going to see here in this area, they do a fair market value. So they estimate a value for the land, value of the buildings. They add that together and then they use that value to determine the taxes. It’s not that simple though. For some reason, nobody’s been able to explain this to me.
And if a listener hears this and knows the answer, I’d love to reach out and let me know. They don’t just work from that fair market value. They take that fair market value, they multiply it by 40%, then they take what’s called a millage rate. And a millage rate is again, just another one of those fancy terms for a number that they’re multiplying by to come up with whatever number they want, right?
So there’s two levers that the municipalities pull to change your taxes. One is the value, two is the millage rate. So what they’ll do in this county is they take your fair market value, they multiply it by 40% because I think it’s… I guess it’s fun. Then they multiply that new value by the millage rate and that gives you your taxes.
So in this example, again, go to YouTube, I’ve highlighted these numbers in yellow so it’s a little bit easier to see. The fair market value for this parcel was 2,476,000. Multiply that by 40%, the taxable value is 990,000. They have it broken out, there’s actually multiple millage rates, one for the KIPP school, one for parks and recreation, great show by the way, one for the industrial authority, whatever. And so the total millage rate is 34.77.
Again, would be… You would think, “Well, I will just multiply by 34.77, no millage rate, I think stands for mills, which means you divide by a thousand first.” So you take your tax bill value, multiply it by 0.034, that gets you your net tax on the bottom right highlighted in yellow of 34,439. You say, “Okay, that’s great, Andrew. That just tells me what today’s taxes are, right? So how do you use that?”
Now this tells you how they are currently calculating taxes. So you take that formula, fair market value times 40%, times the millage rate equals taxes. You go in and you put your purchase price in there, right? So now take your new purchase price times 40% to get your new tax bill value times the millage rate equals your future taxes.
Now, what that does is that’s actually telling you your absolute worst case scenario. That’s telling you if the county comes in, says, “You bought it for this, we’re assessing you for that same price.” In most cases, that doesn’t actually happen. What we do is we take our purchase price, cut it to 80% and then put that number into this equation, right?
And again, there’s a lot of other factors. Some areas do this every five years, some areas do it as soon as you buy it. It’s different by state by county. But the gist of it is go pull a tax statement, number one, understand how they’re calculating it and then use their method of calculating with your new purchase price to figure out what your future taxes are going to be. And in many cases, yes, your taxes may double or triple when you get reassessed. And if you don’t factor that in, your deal just blew up two years down the road.

David:
Very good. And if this isn’t making sense because you’re listening on the podcast, check it out on YouTube, there’s a visual aid. You can see exactly what Andrew’s walking through. It actually makes a lot more sense when you can look and see. It looks like the millage rate is basically how the county is splitting up the property tax amongst the different municipalities or organizations that need the money.

Andrew:
Yeah. And generally speaking, you don’t need to worry about how they’re splitting it up, you’re just looking for the total. I did highlight parks and rec on there just as an example, but really all you care about is the total. So again-

David:
Is the total.

Andrew:
Yeah. So you use that total number in your calculations and if you’re interested in where it’s going, that’s fine, but it doesn’t affect your underwriting.

David:
Okay, that wraps up property taxes. Moving on to number six.

Andrew:
Yeah. Number six is property manager’s opinion. And is exactly what it sounds like. You should already, at this point on your team have a well qualified property management company that is part of your team that you can get their opinion. And you’re not calling them on every deal that you look at, but this is phase two, you’re getting serious, right?
So what we do is anytime we’re at this point with a property, we will email our property management company and say, “Hey, are you familiar with this property and are you familiar with this submarket, and could you please give us your opinion?” Right? And typically what they’ll do is and once in a… I mean, in the beginning, before we knew our markets and before we were screening, they’d say, “No, run away, stay out of there. We don’t want to manage that, you don’t want to own it.”
But now with the screening, that doesn’t happen anymore. So many cases, they know the property… A good property management company’s going to know the property and they’re going to be able to give you feedback. And ideally, they’ll send someone over there to drive it for you and be like, “Oh yeah, we drove over there and it’s a great property and a great location, but there’s trash everywhere which that’s an opportunity, that’s really easy to fix.
Doesn’t look like anyone cares, they have no marketing, but it’s on this great high traffic corner and you could put a playground and a dog park. If you added some landscaping based on… And by the way, we manage a property quarter mile down the street that’s getting $400 more a month. This one, not quite nice so you could probably get 200.”
That’s the kind of feedback you’re looking for, someone who’s already an expert in that market to give you feedback on the market and on that asset and give you their opinion of it. What you don’t do is you don’t send them a budget and say, “Can we make this happen?” Because you don’t want taint their feedback. You want them to come back to you with a blank slate.
And again, if you’re screening right, most of the time, that should be at least somewhat positive. Every once in a while you might miss something. But that’s exactly, is you want a property manager’s opinion of the asset. And then once they do that, you might go back to them and say, “Well, geez I’m planning on… My loss-to-lease says I can get $125 rent increases. Do you guys think we can do that?”
And they’ll either confirm it or say, “Nah, it might be 80 or not. Geez, you can get 150, no problem.” Right? So that’s exactly what it is. You want to get a qualified property manager’s opinion of the asset, the location, the submarket and do they want to manage that for you?

David:
Yeah and be careful that you don’t do what you mentioned when you start to fudge things on a spreadsheet to make it work. Sometimes you feed them the information you want them to give back and they of course, want the revenue that’s going to come from managing it. So they regurgitate that back to you and now you’ve tricked yourself into thinking that they are capable of doing it.

Andrew:
Exactly. Don’t feed them anything. Just blank slate ask them in their opinion.

David:
Very good. Okay, number seven.

Andrew:
Yeah, renovation budget. So if you remember from the phase one underwriting, we basically just did kind of a quick guess like, “Yeah, I think we can spend 8,000 a unit renovating this, and we’ll do 200 grand on the outside,” or whatever the number is, right? Because the broker said you can spend this much and it’ll be great so you do that on the first shot.
Page two, ideally somebody on your team, either you or the property manager has toured this property and you’ve walked through and you’ve identified things like… And again, this is an example from an actual property that we purchased. We’ve walked through and we’ve said, “Okay, well, we’re going to spend… And we don’t have time to go into the details of how we came up with this, but we’re going to spend 600,000 on renovating interiors.
And let’s see, we need to do about 25,000 in landscaping upgrades, parking lot needs to be resealed and restripped. We’re estimating that at 63,000. New signage, 31,000, fencing, 35.” So basically if you go on YouTube and you look at this, what we’ve done in phase two is rather than just a guess of eh, a few hundred grand inside and a few hundred grand outside, now it’s really coming down to it.
And again, we’re just underwriting, we’re not under contract. So we’re not having contractors go out and give us bids. We are leaning either on a combination of our own knowledge or if you don’t have that knowledge yet, go to the property managers and say, “Hey I’ve looked at pictures, I’ve toured this. I think these are the eight projects that we need to do. What would be your range of how much this would cost?
How much should I plan for redoing the parking lot? How much should I plan for putting in a nice, pretty monument sign?” Right? All of those things. So phase one, you’re just throwing in some high level numbers. Phase two, you’re breaking it down by project, right? So again, these aren’t hard bids, they’re just getting a lot more granular so that you aren’t going to…
Because you don’t want to underestimate and run short, but you also don’t want to overestimate and lose the deal that otherwise could have worked, right? And two other things I’d really want to highlight on here. You look at the bottom, you’ll see contingency 126,000 and long term CapEx reserve. Two very important things that I often see people leave off. If things go great, you getaway with it. If they don’t, you’re going to be in trouble.
Contingency is exactly what it sounds. That is, oh geez. You know what? Appliances just… Cost of appliances just went up 10%. It’s going to cost me more, right? Or just found a bunch of windows that are cracked and fogged, we got to replace them. Well, that’s not cheap. It’s just adding in some room for finding stuff that goes wrong. Or you might discover, “Well, geez, if we do this additional thing, we can bump rents even further.”
You want to have brought the money in up front to be able to do that and maximize the value of your investment. The second is long term CapEx reserve. For us, it’s just the number we’re comfortable with. It might be different for you. We just do a thousand a unit, right? Because we know we’re typically going to hold for five years. Things happen.
Maybe the roof gets damaged and you have a $200,000 deductible on your insurance policy. Well guess what? That’s either coming out of your pocket from your investors, which you never ever want to have to ask for, or your term reserve that you started this out with in the first place.
So that’s what that long term CapEx reserve is, something happens year three or four or five, or if you’re holding long term, maybe even year 10 so that when that comes up, you’re like, “No problem. I got this.” Your investment’s safe, your investors are good. That’s an absolute key line item. But yeah, lots more we could jump into but I know we’ve been talking for a bit, so that’s kind of the gist of what you’re doing phase two renovating or renovation budget.

David:
And there’s almost always going to be a renovation budget of some sort, because you’re usually looking to buy something that has meat on the bone. And if there’s meat on the bone, then there’s work you’re going to have to do to get there. So this is something that I know a lot of people have questions about, how do I know what the rehab’s going to cost? It’s kind of something you got to look at a lot, speak with different contractors, get a feel for a baseline of what that’s going to look like. But you definitely want to be comfortable with it because anytime you’re buying an asset of this size, there’s going to be some kind of renovation that needs to happen.

Andrew:
Yeah, absolutely. And I said there’s two types. There’s I would say required renovation, like deferred maintenance and then there’s opportunistic, right? Like, “Hey, if we do this, we can attract better quality residents and bump the rents.”

David:
Right, there you go.

Andrew:
And then those are two categories, yep. So all right the final one.

David:
Number eight.

Andrew:
Yes, number eight for today, final one for today is follow up on P&L items on the T12, which stands for trailing 12. That’s a profit and loss statement that is broken that shows you an entire year snapshot by month, right? So it’ll show the income and the expenses for each month, 12 months lined up in columns right next to each other.
Property P&Ls are like fingerprints, snowflakes and penguin mating calls, right? No two are the same. You’ll see stuff from handwritten on pieces of paper to beautiful Yardi printouts with every single account perfectly lined up and everything in between. And you will see stuff on P&Ls that’s sketchier than a photo of Ozzy Osbourne at church, right? And this is where phase two, you ask questions about that kind of stuff.
And I think we’ll… We didn’t want to do this on YouTube because those 12 month P&Ls are so dense, but we will provide one in the show notes for everyone to go look at after the fact. But some examples of things you’re looking for is anything that’s unusually high or unusually low, right? If you expect insurance to be $300 a unit and it’s 450 a unit, that’s a red flag. You want to find out why.
Maybe they just have a bad insurance broker or maybe they’ve had three fires and a shooting, right? And again, and some of this stuff gets redundant, but that’s on purpose, right? You want redundancy so that if something important gets missed on one step, you’ll catch it on another. So missing payments. I can’t tell you how many times we see the landscaping bill suddenly doesn’t get paid for two months.
Well, where did that go? What happened? Why? Or the utilities go way up and go way down. Does that mean they’re having underground water leaks all the time? What’s going on there? Often times you’ll see strange accounts, large credits are another big one. You’ll look at, “Oh wow, the repairs and maintenance on this property is really good. It must be a great property.”
But then you look closely at the P&L and wait a second, there’s a $30,000 credit. Where did that come from? Because if you just look at the end number, it’s going to be wrong. Because they’ve reduced that expense by 30,000. And there’s lots of legitimate reasons for that, but this is where you go ask, right? You’re looking for opportunities and traps.
So again, if their insurance is 450 a unit because they maybe have a, not a great loan broker and you can get it for 350 legitimately, that’s an opportunity. If it’s 450 because they had three shootings, that could be a trap especially if you assumed you could get 350 in phase one.
These are the things you’re asking questions for. Other things that you might run across are things like HOA fees. We’ve actually owned an apartment complex that had HOA fees. It’s not a problem as long as you underwrote for it in the first place, right?
Usually, you’re not going to assume that, you’re not going to automatically underwrite for it because most don’t have it. But if you’re on the hook for $20,000 a year for HOA fees and you don’t put that in your underwriting, all of a sudden you’re behind the eight ball when it comes to hitting your proforma. We actually saw a T12 one time that was a T13, meaning they had 13 months of data in 12 months, which means all the income and expense numbers were inflated.

David:
Artificially inflated, yeah.

Andrew:
Yeah, artificially inflated. I don’t know if it was intentional or not, but it was not accurate. Stuff like cell phone tower income.

David:
And I should probably say when we say T12, we’re talking about the trailing 12 months of profit and loss, right?

Andrew:
Yeah. And so they had for 13 months on there for some reason. You’ll see stuff like cell phone tower income, billboard income, people leasing out units corporately, things like that, all good stuff, but yeah, okay, well, does that transfer to you? Does that stay with you? And does that terminate? When does that lease expire?
Again, things to look into because we have a property with a billboard, it’s great income. But we had to make sure that when we bought the property, that that transferred to us, right? We found one, we had a contra account on it. And then I’m like, “What the heck is a contra account?” Basically, my understanding of the accounting definition in English definition, a contra account is an account that you use to adjust another account up or down to make it look like how you want to make it look, right?
So need to say that was something that we dug deeply into like, “Okay, why are you guys just putting in… Why do you have a contra account and why are you trying to use it to adjust these other accounts?” Right? It was definitely a red flag. And actually we never got a clear explanation and we didn’t end up buying that property.
So again, those are just some examples of the things that we’ve come across and you could probably list a hundred, I’m sure everyone’s listening, is like, “Oh my gosh, you should have seen this thing on here that I found one time.” But that’s what you’re doing. Anything weird or different on that P&L and phase two, you want to ask questions of either the broker or the seller to clarify what that is and find out is it an opportunity or is it a trap?

David:
Beautiful. Okay, that was really good. Like I promised everybody, you’re getting a masterclass in evaluating multifamily property. Can you give us a brief rundown, Andrew, of the eight steps in underwriting phase two?

Andrew:
Yeah. So underwriting phase two, the quick recap. Number one, rent increases. There’s two components of that market rent growth, we talked about last time and then this time we talked about renovation increases, bringing it up to market. Number two was loss-to-lease meaning, hey, you know what? The last five leases were signed for a hundred dollars more.
If I buy this, my research indicates that I should be able to at least get the remaining leases up to a hundred dollars. By eliminating that loss-to-lease, I effectively bring my rents up a hundred dollars so that can be a huge opportunity. Third one is debt quote. When you’re doing phase two, you’re getting serious about hopefully making an offer. You don’t want to just be guessing at your debt anymore because that’s one of the big levers.
You want to at least get a quick verbal or if you’re getting deeper into it, get an actual kind of like quote matrix like we showed where they’re saying, “Yeah, if you go this route, it’s this and if you go this route, it’s this.” Number four was insurance where again, you’re not having everyone go through the full process of getting an entire quote, but you’re going to give them the total square footage and the annual revenue at a minimum and say, “Hey, ballpark, what’s the cost? Is it 300 a unit? Is it 400 a unit?”
Number five is property taxes. You want to find out how does that municipality currently determine property taxes, and using that method after you buy the property, what does that mean for how much your reassessed taxes are going to be? That has a huge, huge impact on your P&L.

David:
That’s for all real estate. Don’t look at what a property taxes currently are, unless the values are going down, I suppose. When I bought my first property now that I think about it, it had sold for 565. I bought it two years later for 195. I paid property taxes in my import account up front on the higher value and I got a refund check.
But we haven’t seen that in a long time. It’s usually the other way where you’re going to get another check after closing that says, “Hey, you owe us more money.” So it doesn’t matter what the person is paying right now, it matters what the value’s going to be based on, which is usually your purchase price when you buy it.

Andrew:
Yep, exactly. Number six was the property manager opinion. Get someone who just knows that market inside and out and get their thoughts on it with… Don’t feed them. You’re hoping for good feedback and so it’s tempting to give them something to hand back to you, don’t do that. Just ask them blank slate.
Number seven is renovation budget. Again, you’re not having contractors go out there, you’re just trying to break it down and get a little more granular and say, “Okay, well here’s the list of projects and here’s how much I think those are going to be and that total’s up to this.” Because best as possible you don’t want to overestimate, but you also definitely don’t want to underestimate.
And the final one is this falling up on P&L items that either don’t make sense or that could be an opportunity or could be a trap. So those are the eight things that we covered and there’s lots of other little sub pieces and different parts that you could dive into. But those are kind of eight key ones that are part of phase two. And determining is this cream or is this a turd? And if it’s hopefully cream, then that’s where you decide, “Okay, am I going to put an offer on this?” And then get into, “Well, how do I write that offer? How do I decide the terms? What’s going to be appealing?” And go from there.

David:
Well, thank you. I actually get to brag a little bit. You made be very proud. Everyone, this is why this is my multifamily partner right here because he’s this good. So thank you for sharing how you put this system together. I’m happy I got to play a small role in encouraging you to leverage some of this stuff out to these other people because that’s grown into this incredibly detailed, very, very accurate way of analyzing properties that is leading into success. Do you mind sharing a little bit about what you’re up to right now? What properties are you looking at? What does your week look like and what success are you having?

Andrew:
Like I said, with this, going back to the loss-to-lease, that’s been created by the last year and a half, two years, there’s a lot of opportunity out there. We’re under contract on a couple hundred units right now and then we actually just got a offer accepted.
We’re not fully under contract so I don’t want to give out any specifics. But we got an offer accepted in a market where it’s one of the strongest, fastest growing markets in the country. We already own multiple properties in that market so we know it well. So we’re super excited about that one. And that is actually going to be our first ever 506(c). Well, I think we’ve done 16 or 17 506(b)s where we never talk about it basically you have to already know us just to find out about it.
But this one is going to be 506(c) and we’re doing that one with you, David. If that property, if we do get it fully under contract is something that you might be interested in, it’s investwithdavidgreene.com. Right David?

David:
Yeah. If they go to investwithdavidgreene.com, you can fill out a form that will basically end up putting us in touch with you where we can share more details about this deal if this is something you want to invest with Andrew and I on. Can you break down what 506(c) means?

Andrew:
That gets down to the SEC regulations. So 506(b) means if you’re raising money for a deal, you can’t solicit. And solicit basically means anything, right? You can’t talk about it on a podcast, you can’t post about on Facebook and LinkedIn. You have to have a preexisting relationship with anyone that’s investing. 506(c) means you are allowed to talk about it but anybody that says, “Hey, I want to invest,” has to be accredited and verify that they’re accredited. So that’s the difference. It’s just a different set of regulations and rules that the SEC puts out for syndicating.

David:
Now, if you don’t know what that means, that’s okay, you could still go to that website, you could register. We will let you know if this deal would work for you and the status you’re in, or if a different situation with me would make more sense. But Andrew’s being a little bit humble here. He found this deal off market, it’s a great area. The property that we bought just before this one has exceeded everyone’s expect times 10. This is the best part about Andrew, is he’s always super conservative as underwriting. He’s like Eeyore when he underwrites but he’s like Tigger when he performs.

Andrew:
I love that, that’s great.

David:
It’s perfect, right? So he always under promises and over delivers and that’s why I partner with him. So if you would like to partner with us, please go there. Now the last stage in the entire underwriting system, we’ve gone through phase one, which is, would this work? Phase two, is this cream or is this a turd? Phase three would actually be when you send the letter of intent and you actually go through the process of putting it in contract, can you share Andrew if they want to learn more about what to do at the last phase, where can they go?

Andrew:
Yeah, go to davidgreenewebinar.com. And I think what we’re going to do is David and I are going to do a webinar on how you put together an LOI. So I say you’ve been through all these steps, it’s a lot of work. Fortunately, you found one that looks really good, you want to own it. And we’ll talk about what kind of terms do you put in the LOI? How do you determine what can you say, do you put in references? Do you not put in references?
What if your offer seems kind of low? Do you still do it? Do you not do it? How do you communicate that with a broker? How do you communicate with that the seller? We’ll go through and talk about crafting the best offer that gives you the highest chance of getting the deal, but at a minimum, gives you credibility and builds your reputation in the market.

David:
Now we know not everyone listening to this podcast is going to go buy a $50 million apartment complex, you might not even buy a $5 million one. But you do now have the information that you would need if you wanted to do it. So our goal here was to basically show you every step, phase one, phase two, and then a webinar where we can talk with you with more length basically and we can answer more questions and we can actually get out in a podcast about what to do when you want to write an LOI and how you put a property in contract.
I can personally vouch for Andrew. He’s a great dude, he’s super smart, he’s very good at investing, we’ve made a lot of money investing together. And I feel comfortable telling other people this is the person that I invest with because that means a lot to me. So I would highly encourage you to go there and register.
There’s other webinars too. I do other stuff on lending practices or short term rentals. There’s a lot of stuff where I try to get back to the BiggerPockets audience. So I highly recommend everybody listening to this to do that as well as if you would to invest with us, that’s a great place to start. Any last words you want to leave people with Andrew?

Andrew:
Yeah, I would just say I know that was… I guess hopefully everyone’s still awake and I know that was a bit dense. But I mean, that’s the reality of what underwriting even a 5 or a 500 unit property is. In order to do it right, you have to get it down and dirty into the weeds of these numbers and these P&Ls. And if you’re saying, “Oh my gosh, I could do this for 30 minutes, then I’d run away screaming,” go partner with somebody that loves it or hire somebody that loves it.
But in order to properly underwrite, this is the type of thing that you need to do. And yes, there’s other ways of doing it, there’s other ways of looking at the data, this is just what we have found to work exceptionally well for us. But as long as you use the principles that we talked about, then you should be able to hunt down some really good deals for yourself.

David:
That is wonderful. You reminded me of something. When I was first in the field training officer program as a police officer, I worked for an agency that covered five counties. So when we were training, they would drive us through every county and go to the main areas that they thought we would need to know in an emergency.
This is the hospitals in these areas. These are the local police departments that if you ever need backup or you’re trying to figure out like, “What can I do in emergency?” Here’s places that you can go. Here’s places where the county stores equipment that we might need in the case of a flood or something like that. And they knew that we would never remember all of these places that way.
It’s impossible to remember that much information. But the thing is, they also understood when I was trying to find that place three years down the road, I would remember little landmarks that I saw or I would spot the building and say, “That’s the one that I’m looking for.” It sits in the back of your head.
Now I couldn’t walk you through turn right here, turn left here, but when I got close, I recognized I’m on the right path. That’s what a podcast like this is. You are never going to remember all eight steps plus the four levers we talked about before, plus the six steps in phase one underwriting, you don’t need to. No one is going to learn it like that.
It’s getting the concepts in your head and as you take this journey, those will stick out like milestones. Just like when you’re in the woods on a hike and you’re not sure exactly where you are, but you remember a certain mountain peak or you remember a tree that’s in a certain place and it’s like, “Oh yeah, going the right way.” That’s what information like this functions.
So don’t beat yourself up if you’re listening to this and you’re thinking, “I’m an idiot, I don’t get it. I’m never going to understand this.” Andrew didn’t understand this when he was first putting this together, I don’t understand this stuff. It’s something you have to do over and over and over like everything else in life. So don’t beat yourself up.
Instead think if you thought that was interesting, that was fascinating, that’s a good thing. That’s your fire. Add wood to that fire, build that fire, pour into that fire, invest into that fire. Build up that desire to learn more and as you stick with it and you stay in this world long enough, this stuff will start to make sense and you’ll start to get confident.

Andrew:
Yeah, that was an excellent recap. This doesn’t come on the first… This was built and honed out of looking through literally thousands of deals and properties. It’s not something that I or anyone else starts off with.

David:
Well, I’m really glad that you shared that thousands of properties expertise and experience with us here today. And I hope people join us on our webinar where we can talk about it my more and consider investing with us and getting some experience and making some money in the process. Anything you want to say before we get out of here?

Andrew:
No. Like I said, in the beginning, I put the earbud in the right ear first and so far, that’s working. It’s been a good day and it’s good talking with you and hopefully we do it again here soon.

David:
How can people get in touch with you?

Andrew:
LinkedIn, that’s probably the only social media platform where I am somewhat active, and then our website vantagepointacquisitions.com. There’s a couple of different tabs on there. If you want to connect, fill out the little form and that comes to my inbox.

David:
All right, you can follow him there. You can follow me at Davidgreene24 on social media. I also have a brand new spanking and website up, Davidgreene24.com. And I will be, or maybe by the time this releases already have released a free text letter that kind of explains what I’m doing, what I’m up to, what kind of properties I’m buying, where I’ll be speaking and how we here at BiggerPockets can help you to grow in your own education to achieve your goals.
So please consider following me there. And if you like this episode, go back and make sure you listen to episode 571 where we break down phase one of this process. And then do you remember your other episodes you’re on Andrew? Was it 170?

Andrew:
Yeah, it was 170 and 279.

David:
So this is your fourth time on the podcast. That’s how good you are.

Andrew:
Wow, I guess that’s a pretty small group. I feel honored.

David:
Yeah, if you’re on the Mount Rushmore.

Andrew:
Well, thanks.

David:
I have a really funny meme that says the Canadian side of Mount Rushmore and it has a bunch of the butts of the president, says they’re sticking their head on the mountain from the reverse side.

Andrew:
Oh, that’s awesome. I love it.

David:
Oh, I also thought that was funny. All right, I’m going to let you get out of here. This is David Greene for the BiggerPockets Podcast signing off.

Q: Do you trust “The market” for your real estate profits?

A: Those who trust “The market” are at the mercy of the market. 

I think this is folly. Hopefully, many of you agree. 

Here’s what I’m talking about… 

The real estate syndication realm is awash with new operators showing their investors dazzling returns. Profits that would astound investors from Wall Street to Main Street. 

And these syndicators are raking in massive profits along the way as well. I know many operators who were in high school during the Great Financial Crisis and working W-2 jobs just a few years ago who have joined the multi-millionaire club in this current rush to riches. 

But this scares me to death.

You see, the same “Market” that made them and their investors rich could also destroy them. The streets of history are littered with such casualties. 

Here’s how it looks in the real estate world…

The value of a commercial real estate asset is based on two variables: 

1. Cap rate
2. Net operating income

Value = Net Operating Income ÷ Cap Rate

If this formula is unfamiliar, check out this post. 

The cap rate is the market’s evaluation of the value of an asset. It is based on the interest rate, a risk premium, the desirability of that asset type, the location, and more. Factors outside the operator’s control. 

And of course, the net operating income is the gross operating revenues minus expenses. And this is largely in the control of the operator. 

As you can imagine, a seasoned operator focuses on the latter. They see intrinsic value hidden in an asset. They acquire the asset and do their magic. They put their team and technology to work to raise the income and create value for investors. 

Seasoned syndicators don’t count on “The Market” to do the heavy lifting.

(If The Market cooperates, their investors get a double win. But their “hope” lies elsewhere as we’ll see.) 

But rookie syndicators trust the market to do the heavy lifting. They hope for various circumstances to line up perfectly to turn a profit. Factors like: 

• Continually compressing cap rates
• Continuous low interest rates
• The end of eviction moratoriums and other pandemic fallout
• The continuing rise of inflation

Take away one or two of these factors, and their house of cards comes tumbling down. Because trees don’t grow to the sky. And hope isn’t a sound investment strategy. 

Newbies trust the uncontrollable market for their profits. 

Pros trust the market, too. They trust the market to lower their profits. 

Seasoned pros assume the uncontrollable market will lower their property values. Pros focus instead on the more controllable acquisition process and Net Operating Income. 

They trust their talent, team, and technology to create profits in any market. And they plan to hold assets through market ups and downs to provide investors a more stable and predictable source of true wealth. 

Warren Buffett’s folly?

Do you remember the late ‘90s tech bubble? Investors made billions in this runup in tech values. I can see some similarities between what is happening today, though the excesses were even more extreme then. 

Buffett seemed out of touch. He and his Berkshire Hathaway investors missed out on stupendous profits as the dot-com bubble ballooned to staggering heights. 

Buffett was only in his late ‘60s, but he was called senile. At his annual billionaire’s retreat in Sun Valley, Idaho, his colleagues wondered if he’d lost his touch. 

Buffett addressed the group, assuring them he was well aware of the differences between investing and speculating. He was happy staying on the course that had served him so well over many decades.  

In his 2000 letter to shareholders, Buffett stated this: 

“By shamelessly merchandising birdless bushes, promoters have in recent years moved billions of dollars from the pockets of the public to their own purses (and to those of their friends and associates) … Speculation is most dangerous when it looks easiest.” 

Of course, we all know what happened. The bubble burst…and Buffett emerged as the hero…yet again. 

Check out this graph showing the NASDAQ’s rise and fall. 

Wikipedia described it this way: 

The dot-com bubble, also known as the dot-com boom, the tech bubble, and the Internet bubble, was a stock market bubble caused by excessive speculation of Internet-related companies in the late 1990s, a period of massive growth in the use and adoption of the Internet. 

Between 1995 and its peak in March 2000, the Nasdaq Composite stock market index rose 400%, only to fall 78% from its peak by October 2002, giving up all its gains during the bubble. 

During the crash, many online shopping companies, such as Pets.com, Webvan, and Boo.com, as well as several communication companies, such as Worldcom, NorthPoint Communications, and Global Crossing, failed and shut down. Some companies that survived, such as Amazon.com and Qualcomm, lost large portions of their market capitalization, with Cisco Systems alone losing 86% of its stock value. 

Self-storage can be a profit center!

Are you tired of overpaying for single and multifamily properties in an overheated market? Investing in self-storage is an overlooked alternative that can accelerate your income and compound your wealth.

So, are you saying we’re in a bubble, Paul? And what can we learn from Mr. Buffett? 

I am not saying we are in a bubble. 

But I am saying that we need to learn from Mr. Buffett here. Buffett didn’t care about the price of NASDAQ or the billions his pals were making speculating. He didn’t care that his portfolio had underperformed the market for years or that people were calling him senile. 

Buffett cared about sound investing fundamentals. He cared about the same thing he had since he acquired Berkshire Hathaway in the mid- ‘60s. 

His goal was to invest in undervalued companies with sustainable businesses and products managed by competent management teams. That didn’t change because the market changed. 

Buffett wasn’t relying on THE MARKET to tell him how and where to invest. 

And I don’t think we should either. 

We can count on the market for one thing: to be the market. Just like the wind blows wherever it wishes. It is not in our control. 

Good sailors reach their destination in any weather. They are not dependent on wind or waves or temperature. 

A dozen recommendations for investors who believe this post 

If you are a Syndicator… 

Don’t overpay for assets. 

Don’t count on the market to make a profit. 

Don’t believe “it’s different this time.” 

Don’t count on the next decade to be like the last. 

Don’t overleverage with the belief that you can be just like the last guy who did it and repeat their success. 

If you want to speculate, do it with your own cash. Don’t drag investors in and call this speculation an investment.  

If you are a passive investor… 

Don’t invest with any syndicator until you’re sure they’re not a speculator. 

Don’t put all your eggs in that one basket. Diversify. 

Don’t swing for the fences. Slow and steady wins the race. 

Don’t invest before conducting careful due diligence on the syndicator and the opportunity.  

Don’t invest in overheated deals in overheated asset classes in overheated markets. (Remember, hope isn’t a sound investment strategy.) 

Don’t trust the market to generate your returns. Do trust a great operator with an excellent track record, a veteran team, and proven processes. 

Final thoughts

It’s possible to trust the market as a commercial or residential real estate investor or in any other asset type. Did you hear about the great Dutch tulip bubble of 1634 to 1637? 

Trusting your acquisition and operating skills will serve you well in any market. But please don’t count on the market to do the heavy lifting for you. 

BiggerPockets exists to help you grow in your analysis capabilities and make wise investment decisions, so you won’t have to rely on the unpredictable market. This includes bolstering your skills to navigate good markets and bad, plus connecting you to great investment managers and opportunities. Has this post helped you clarify these issues?

Mindy:
Welcome to the BiggerPockets Money podcast show number 285, where we interviewed JL Collins and talk about losing money in real estate.

JL Collins:
My lawyer, Wayne, pointed out that there was no real practical way to enforce that because of the cost of litigation that it would take. So when YP said, “You don’t like it. Sue me,” he knew my hands were tied. Well, when Wayne was saying to me, “JL, you have to close. I mean, the law says that when essentially it’s done and you’re just down to a checklist, you have to close. You can’t keep canceling these closings like you’re doing,” and you can imagine what I said to Wayne. I said, “Let him sue me.”

Mindy:
Hello, hello, hello. Hello. My name is Mindy Jensen, and with me as always is my smart cookie co-host, Scott trench.

Scott:
Oh, I’ll take that. That’s a pretty crummy introduction, but I guess it’ll work for today.

Mindy:
Scott and I are here to make financial independence less scary, less just for somebody else to introduce you to every money story even the ones that cause you to lose money in real estate because we truly believe financial freedom is attainable for everyone no matter when or where you’re starting or what kind of mistakes you make in the beginning.

Scott:
That’s right. Whether you want to retire early and travel the world, going to make big time investments in assets like real estate, avoid losing money in real estate by making smart to decisions 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:
Today, we have three-time guest, JL Collins, joining us again. He is going to talk not about the stock market, which is what he is known for, but he’s going to instead talk about real estate and his success is, Scott?

Scott:
Well, well, the success is he got an education in real estate investing based on this. No. What we’re going to hear today is we’re going back to 1979 when inflation’s looming, the economy is looking fairly bleak and the outlook is eerily similar to what I think a lot of folks are worried about in today’s economy here in 2022 and about how a tremendous amount of money was lost on a condo purchase that was intended to be a home and investment.
There’s losses at every step of the journey all the way through a long hold period. I think there’s a lot of information to learn from this. It was a really fun time. JL Collins is really great to talk about it with a sense of humor looking back, but you can imagine how scary and terrible that was going back. I think there’s a lot of lessons that are really important to learn from.

Mindy:
Yeah, absolutely. This is a great retelling of a story that is actually, I’m sure much worse to have lived through, and 40 years of hindsight makes it a lot easier to retell the story.

Scott:
The story we talk about today is fully documented in JL Collins’ new book titled How I Lost Money In Real Estate Before It Was A Fashionable: A Cautionary Tale. I had a chance to pre-read this book. I thought it was phenomenal. It’s a short, quick read. It’s very well-illustrated. It’s a very powerful message, and it gives all of the details and the specific numbers and the timeline behind some of the things we’ll talk about today. You can buy that book on Amazon, on his website, which we’ll link to in the show notes and the show notes, again, will be found at biggerpocket.com/moneyshow285.

Mindy:
Okay. You have listened to this show before more then you have heard our guest on episode 20, on episode 116, and now back again for the third time making up now 1% of our guests that we have had, Jim Collins, JL Collins, from The Simple Path to Wealth, from JL Collins NH. What else do you do? From Chautauqua. What else do you do, Jim? Welcome back to the show, Jim. Tell us all your things. Give us your resume. We only have an hour so don’t give us the whole thing.

JL Collins:
Okay. Well, I mean, jlcollinsnh.com is the blog. You can go there, and from there, I’m on Twitter and Facebook, and I’ve got two books out, The Simple Path to Wealth, which was the first one that I published in 2016, and then last fall, I just brought out the second one, which is How I Lost Money In Real Estate Before It Was Fashionable. Yeah.

Mindy:
The hard path to wealth.

JL Collins:
Yeah, Chautauqua, you mentioned. You’ve been to Chautauqua, and that’s our annual event where we take small groups of people out to some cool place for cool conversations in a cool environment, and that is finally returning for 2022 after two years of COVID-related hiatus, I guess is the word. Yeah.

Mindy:
So you’re all over the board. Where are you right now? Because it looks like you’re in a hotel room, Jim. You’re just tracing around the world.

JL Collins:
Yeah, I’m always in hotel rooms. We’re nomadic. So this particular hotel room is the St. George, Utah, which is in the Southwest corner of Utah. Beautiful area.

Scott:
Awesome. Well, today, I think we were hoping to learn more about how you did lose money in real estate and the full details behind that, and I think that’s-

Mindy:
Wait, wait, wait, wait.

Scott:
What is it?

Mindy:
This is BiggerPockets. We talk about making money in real estate. You can’t lose money in real estate. Right, Jim?

JL Collins:
Oh, I did, and in my experience, it’s surprisingly easy. All it takes is being naive and unaware, which by the way, I applaud you at BiggerPockets for trying to correct investors, but you were not around when I was making this series of tragic errors.

Mindy:
Yeah. Thanks, Josh Dorkin, for not foreseeing the future and being there when Jim needed you.

JL Collins:
I know.

Mindy:
Okay. So let’s set the stage. What year are we talking about?

JL Collins:
So we would be talking about 1979.

Mindy:
Oh, is this the beginning of-

Scott:
Tough year.

Mindy:
Yeah, very tough year, and isn’t this the beginning of really crazy interest rates?

JL Collins:
Well, it wasn’t the beginning of crazy interest rates. It was the middle of crazy interest rates. It was towards the end of a decade’s worth of stagflation, which was the hallmark of the 1970s. I think we finally broke the back of that around 1982 if my memory serves me. By the way, that’s one of the reasons that this particular inflationary environment that we’re entering has me nervous. It just seems very familiar somehow.

Mindy:
Yeah. I just typed that into the notes that Scott and I have. I’m like, “Stagflation? Hmm. That sounds very familiar over the last 20 years.”

JL Collins:
Yeah. Well, I don’t think we’ve had anything like it over the last 20 years, but stagflation was a period of a stagnant economy, which so far, fortunately, we don’t have and high inflation, which at the moment we do have.

Mindy:
Oh, oh, I thought stagnant like there was no inflation, like we have had such low interest rates since-

JL Collins:
Oh, no, no.

Mindy:
Okay. Okay.

JL Collins:
Yes. See, I’m dating myself and thank you for pointing that out, but just for our audience, stagflation was a term coined in the 1970s to describe the economic environment, which is I say lasted for about a decade where you had very high inflation rates in a very stagnant economy. As you pointed out, for the last 20, actually probably closer to 40 years now, we’ve had very low inflation and declining interest rates, so a totally different kind of environment. Right now, we have high inflation, which has sprung on the scene in the last year or so, and fortunately, we have a robust economy still.

Scott:
Awesome. So I think that’s great setting the stage from an economic point of view, but how do we set the stage from a personal point of view? What got you into this first investment and what were your life circumstances at the time?

JL Collins:
Yeah. So I was obviously a much young man at the time. I was in the first few years of my professional career, and I was doing pretty well, and I had a nice little apartment where the rent was cheap and I was perfectly happy, but everybody in the world at the time was saying, “You have to buy real estate. You have to buy real estate. You have to buy real estate,” and because I was young and naive, I thought, “Well, I don’t particularly want to buy real estate, but I guess I’d better buy real estate.”
Because I had zero interest in actually doing this, what it took was my old college roommate who lived in Chicago at the time, who was very eager to buy himself, and he was out diligently looking and he found this building. There was an old courtyard building built in probably early 1900s, 1910, 1920, something like that. The concept was they were gutting this building, this three-story building, and you were going to have this charming old building with brand new apartments in it, and that appealed to me and that appealed to my buddy, Steve.
So my first mistake was I figured, “Well, Steve’s done all the leg work. Why should I go and do any due diligence on this? I’ll just follow in his footsteps, and buy a condo in the same building.”

Scott:
So what happens next? Did it work out?

Mindy:
Yes, from episode 285. Everything was great.

JL Collins:
Yeah. If it had worked out, then I wouldn’t have done a book in it for me, which is the silver lining I had to wait about 40 years for, by the way. Yeah, no, it really didn’t work out very well. Steve’s father was a banker and he was also investing in real estate at the time and eager to see his son and my extension, his son’s buddy, benefit from real estate, which, of course, as we all know can only go up, but what none of us knew at the time was the Chicago real estate market was about to collapse.

Scott:
So your plan going in was, “Hey, this building’s going to get fixed up. My buddy’s interested in it and telling me all these great things. I’m going to buy it. Things are going to go up and I’m going to make …” Did you have a timeline? Did you have any expectations around it or really anything beyond “I’m going to buy it and it’s going to go up” or what was was the framework you were approaching the problem from?

JL Collins:
Well, the framework was, A, again, the advice that went unchecked on my part, and again, first mistake was you should definitely own real estate. Renting is not a good thing to do, and if anybody who reads the book and looks at the math, and it will see that at least in this case, renting was absolutely the thing I should have continued to do, but it would’ve been in January, February, and it’s testing my memory both from the time I wrote the book last year and, of course, 40 years ago, but early in 1979, my buddy Steve had actually put in a contract to buy his condo, and I followed suit and put in a contract to buy one in the same building.
The idea was because the building was being gutted, it would take about six months for these things to be finished. So we’d be closing and moving in sometime around, theoretically, sometime around August 1st. I could go into a monologue and describe the sequence if you want me to, but I’m not sure that’s best for the interview, but I’ll leave that up to you if you want me to do that or just go step-by-step.

Mindy:
I’m going to look into my crystal ball and say they didn’t meet the August 1st deadline. Did they, Jim?

JL Collins:
Well, your crystal is flawless as it turns out. You might have even read the book, which might have given your crystal ball a little polish.

Mindy:
Not only have I read the book, I’ve lived this story, too.

JL Collins:
Well, there you go. So yes, you’re correct. They didn’t meet the August 1st deadline and silly me. I had heard at that point the advice that if you’re involved in building something or doing a major renovation, you spent a lot of time going to the site and checking it out. Again, I was impossibly naive, which, by the way, is the title of one of the chapters. I was impossibly naïve, and I figured, “Why am I going to go to the site? I don’t know anything about renovating a condo. I’m a busy guy.” So I didn’t go to the site. I figured these are competent people. They would get it done. Bad thing to figure out at the time.

Mindy:
I’m sorry. I’m not laughing at you.

JL Collins:
Mindy’s evil laugh there. Wow.

Mindy:
I’m laughing at I’ve been there. I’ve been there.

JL Collins:
You’re laughing with me, are you?

Mindy:
I’m laughing with you.

JL Collins:
Well, I certainly deserve to be laughed at, I mean, there’s no-

Mindy:
No. It was the phrase, these are competent people.

JL Collins:
Well, yeah, right, which is a laughable thing to say, and it was an even more laughable thing to believe, but anyway, that was the assumption that I made. So there’s another mistake upfront. Along about the middle of July, it finally occurred to me, “Oh, this condo that I bought should be about done, and maybe I should go over and see how wonderful it looks,” and so I did, and it looked exactly the same as it did in February. I mean, it hadn’t been touched. Not a mode of dust had been moved, and it was gutted, I mean, as it had been when I had first seen. It was gutted to the … What do you call it? The lath in the old buildings, right?
I mean, I was horrified because, of course, I’d given notice at my apartment that I was … I thought I was being so clever because instead of saying I’m moving out on August 1st, which would’ve been really silly, I said September 1st. I thought giving myself that extra month was very clever.
Well, now, I’m looking at a place that is in two weeks from when theoretically it’s done and I’m moving in and closing, and it hasn’t even been started. So I was more than a little outraged. I was down in … I use his initials to protect his anonymity, although why I do that, I don’t know, but YP are his initials. I was down in his office with my fists on his desk leaning over and threatening to climb down his throat, and he was assuring me, of course, that everything would be done by August 1st, which even I wasn’t naïve enough to believe.
What’s interesting is what he had been doing, and you have to understand at the time the real estate market in Chicago had been red hot and like we’re seeing in the real estate market today, I would say, and the prices of properties were going up dramatically even within month over month.
So what YP was doing is he wasn’t even trying to finish these apartments that he’d sold, and there were 52, I think, in the building. So he’d sell them, he’d collect the down payments, and then he’d just sit on them. When the outraged owners would come storming in into his office like I did, what he would say is, “Well, why don’t I just give you your money back?” A lot of people were smarter than me said, “Yes, I want my money back,” and then he’d refund the deposit, and he’d simply turn the unit around and resell it for another 15%.
Well, this was wonderful as long as the real estate market kept cranking its way up, but on that July day, what neither YP or I realized is the Chicago real estate market, particularly the condo market, and condos seemed to get hit hardest first when the market turned sour was in the process of plummeting. So he said, “Well, why don’t I give you your money back?” I said another mistake I made, “No, I don’t want my money. I want the condo. I want to live in this place.” I so wish I’d said, “Yeah, give me my money back,” because within a month or maybe six weeks, all those apartments that he’d been able to successfully turn over and resell over and over again suddenly that merry-go-round stopped, and he wound up with a building that was half empty and at that point unsellable.
Of course, there’s no way he’s giving me my money back at that point. A month, six weeks later, I was demanding my money back and he was not only refusing, but he simply didn’t have the capability to pay it back. Then things got really ugly because now he can’t meet his commitments to the bank, and now he has to try to actually finish these units so he can close on them and get the balance of the money to satisfy the bank. Of course, as you pointed out to me, and I should have recognized, I’m not dealing with somebody competent. So getting the apartments finished was a whole another nightmare that didn’t go well.

Scott:
So you’re supposed to move in on August 1st. When did you actually end up moving in?

JL Collins:
So his memory serves, it’s probably October 1st, and in my defense, I probably moved in to the nicest department in the building because while I didn’t pay any attention in the beginning as I should have, after July 15th I was paying intense attention. I don’t want to say threaten the man, but I was an intimidating presence in his office on a regular basis. So I think my place got more attention than most, but the other thing is that he made a critical mistake. I made a lot of mistakes in this journey, but YP made a critical mistake at one point, and I think out of his desperation to get these things closed so he could get that money from the bank. He let me move in before we closed and before the apartment was fully done.
So now, I’m living in this place and it was essentially done. I had a checklist of things that needed to be finished and fine tuned, but it was perfectly livable. Now, I’m in it. I don’t actually own it because we haven’t closed. I’m not paying any rent so I’m living rent and mortgage-free. So I suddenly went from being in a very bad position being in a very good position, and I would refuse to close until they completed this checklist that I had.
YP would keep saying, “We’ll complete it and let’s set up a closing day,” and I’d say, “Okay. Let’s do that,” and they’d finish a couple things on my list. Closing day would come and I’d cancel it because the list wasn’t completed. Of course, that made him crazy. That made his lawyer crazy. That actually made my lawyer, who I engage, crazy, but my lawyer Wayne had said to me when I was so outraged in trying to get out of this deal because the contract had said, if it wasn’t finished by a certain time that he was obligated to refund my money and, of course, he just refused to honor the contract.
My lawyer Wayne pointed out that there was no real practical way to enforce that because of the cost of litigation that it would take. So when YP said, “You don’t like it. Sue me,” he knew my hands were tied. Well, when Wayne was saying to me, “JL, you have to close. I mean, the law says that when essentially it’s done and you’re just down to a checklist, you have to close. You can’t keep canceling these closings like you’re doing,” and you can imagine what I said to Wayne. I said, “Let him sue me.”

Mindy:
Okay. So I am listening to this and I’m thinking a lot of things. First of all, poor Wayne. I can completely understand what Wayne is thinking, and YP, I don’t feel at all bad for him because I’ve dealt with YP many times and, sorry, you should have honored your obligations in the beginning. Back to the beginning when you said you weren’t checking in on things, I don’t know if anybody else’s condo units were getting worked on at all, but the squeaky wheel gets the grease, and if you’re not there checking on your stuff, they’re not going to work on it at all. Were they working on anybody else’s unit?

JL Collins:
I think they were, but probably not as diligently as on mine because I was the squeaky as possible wheel. Again, he had a very small crew to do the work because he never intended to do the work. That wasn’t his strategy. He was just going to keep reselling these things, I guess, forever, because he like everybody at the time believed that real estate could only go up and that they would only be more valuable six months from now than they were at that particular point.
By the way, I absolutely agree with you. I have no sympathy for YP. He eventually fled the country, actually, went back to his home country and he just left the bag, hold the bag, and they auctioned the remaining apartments, which by the way, went for about half what I paid for mine.

Mindy:
Of course.

JL Collins:
To give you an idea, that’s just the beginning of the disaster that this-

Scott:
What did you pay for yours?

JL Collins:
So I put down $5,000, and you have to inflation injustice to make it significant, of course, and in the book I do that. My memory’s not good enough to do it for you in our interview here, but I put $5,000 down on a $45,000 condo. The base condo was 40 grand and I took all the options, which added 5,000 to it. Then when they went at auction and, of course, they didn’t have the options because the condos that got auctioned off were not finished, they were in various states of progress, so some of them were just shells. Some of them were, I guess, pretty far along, but they went for $20,000-$24,000 at auction, and there were about half the building.

Scott:
Were these luxury condos like really in a pretty nice place?

JL Collins:
I guess today with the hype around everything’s luxury, so I guess somebody selling it today would’ve called it a luxury condo. Mine was actually, when it was finally done, was a very nice place, a nice space. It was a one bedroom, one bath. I don’t remember how big it was. It wasn’t terribly big. Probably 700-800 square feet, something like that, but it was nicely finished. As I say, I took all the options and it did turn out to be basically a new apartment in a charming old building.
So the project had the potential to be really nice, and I think ultimately became a nice building as the owners themselves took over and finished their apartments. Then of course, the common areas of the building were not finished when he fled and left everybody holding the bags. So that required special assessments on all the owners to raise the money to finish the common areas.

Mindy:
Okay. I want to jump in here again and say to those of you who are listening who are thinking, “Oh, I want to get into real estate,” listen to Jim’s story. He said condos were going up month after month. Prices were just continuing to go up. That’s where we are right now in much of the world or, I’m sorry, much of the United States. There are some markets where this isn’t the case, but in most markets, we are seeing exponential growth month over month. What are we in Denver? It’s been 27% price increase over the last 18 months or 12 months or something like that. We just had a fire that has taken out a thousand houses in two cities just south of me that is going to affect the real estate market for years to come because that was a thousand single family homes.
The market is marching north, but that doesn’t mean that it will always go up. I mean, listen to Jim’s story. Real estate only goes up. May I remind you 2008, 2009, ’10, ’11, ’12. The market can go down. I wanted to have you on the show to share your story about how you don’t always make money in real estate because BiggerPockets can be really, really good at you to do these things, but we also try to encourage you to run your numbers and invest or buy like you’re buying an investment. It sounds like you bought because Steve told you to, which is I bought because I wanted to and Scott bought because Brandon told him to. You don’t just buy a house because you feel like you should get into real estate. You buy a house to … I was going to say you buy a house because it’s a good investment, but it’s not an investment, and it could be an investment.
I mean, my houses are investments, but that’s because I buy the worst dump on the planet. I bought those to condos that were not done. I forced the appreciation, but I don’t know where I was going with this. There’s a lot of parallels with this market that you were in and the market that we’re in right now.

JL Collins:
Yeah. It feels that way. Now, of course, we don’t know for sure where the market we’re in right now is going. I mean, it could continue to go up. As you mentioned in Colorado where you are and I happened to be in Colorado when that fire took place, I was in Golden, which is just south of there. What a tragedy. So I mean, there are factors like that are driving up the prices at least in Colorado.
As we travel around the country, I mean, I hear it everywhere we’ve gone how prices are going up, and we are in an inflationary economy. So I don’t know where this market is going. The same thing I say when I talk about the stock market, I have no idea what the stock market’s going to do next. I do know that the stock market plunges periodically. That’s a natural part of it, and real estate plunges periodically. That’s a natural part of the process.
You mentioned 2008. The time I’m describing, which was in the beginning of the 1980s are both cases of that happening. I wouldn’t, by the way, lay all the blame of my tragic story at the feet of my buddy Steve, although he was the one who lured me in this particular building, but everybody at the time, and I mean everybody was saying, “You have to buy real estate,” especially if you’re young and single and you were renting and renting is throwing you, all the same stuff that I hear today.
So it was an environment that I let myself get swept up in, and I was young and naive and I didn’t step back and say, “Wait a second. Is this right for me?” Setting aside anything macro because I don’t think anybody is much less I could have predicted that the market was about to plunge in 1979, but what I could have done is stepped back and said, “Wait a second. Is this really the right thing for me to do? Does it really make economic sense to give up an apartment that I liked, that I was enjoying, that I was paying $160 a month for,” and again, remember you got injustice stuff for inflation, “and move into a condo that was going to cost me $270 a month in mortgage and assessments and everything?”
By the way, of course, I had no way of knowing this at the time, it wound up being $570 a month, which with all the special assessments and everything that came later. So clearly, is that a good economic decision? Setting aside the fact there was no appreciation. In fact, as we talked about earlier, they went in auction at half what I paid, but doesn’t make any economic sense to give up $160 a month apartment that you like, that you enjoy to go into a condo that is going to cost you for sure $370, and actually turned out to be 570.
Clearly, the answer to that is no. That’s not a good economic decision to have made. Then I would’ve set back and said, “Well, does the condo offer me a lifestyle that is worth all that extra money to me?” The answer there, yeah, it was nicer than my apartment, but I didn’t care about that. It wasn’t that much nicer. I much would’ve preferred to have that extra money each month to invest.
So I think those are the kinds of mistakes I made, just some of them. The book is filled with many more, but those are the kinds of things I would suggest that anybody looking in this environment asks themselves. Go ahead.

Scott:
Yeah. So we’re in this spot now where you’ve got this condo, you’ve already given us a sneak peak that there’s special assessments that are coming down the road in addition to it being worth half what you paid for shortly after you closing the deal. What’s the next phase of the journey? Is our story over at this point?

Mindy:
I want to jump in here before Jim answers and say I have never owned a condo that didn’t have a special assessment. Never in my whole life that I’ve owned condos I’ve not had a special assessment. Okay. Jim, what’s your next story?

JL Collins:
Well, let me address that first, Mindy, and then I’ll go back to, if I can remember Scott’s question, we’ll go back to it, but at the same time, I bought a condo for my mother in Florida, and the only condos that don’t have special assessments that I’m aware of are ones that have very large regular assessments, and then they create a pool of money for when those big things happen.
The condo that I had bought for my mother was, she was retired, and it was filled with retired people, and they tend to have cash on-hand. So they wanted the smallest possible assessment monthly to cover their basic expenses, and then every now and again if they needed a new roof or they wanted to repave the parking lot or something like that, I’d get a notice saying, “Oh, we’re going to repave the parking lot, and there’s a special assessment of $5,000 and it’s due in two weeks.”
Well, when you’re old and retired, then maybe that’s not a big deal when you’re young like I was at the time coming up with five grand in the spur of the moment was a whole another frame of reference. I’m sorry, Scott, real briefly, your question was?

Scott:
Well, I was just going to ask you to continue the story and tell us what happens next now that you’ve got this place and it’s worth half what you paid for. You’re getting special assessments. What happens next?

JL Collins:
Yeah. Well, so what happens in the immediate future is now I’m living in this thing and in pretty short order, I’m paying $570 a month or the privilege of living in this thing. I’m just licking my wounds. As long as I don’t sell it, I’ve got a $40,000 mortgage, so if I can only sell it for say $25,000, I mean, I’ve got to come up with 15,000 just to get out from under it.
In the meantime, I’m dating the woman who is about to become my wife and we decide that we’re going to need a bigger place than this when we get married. So I went off and bought a two flat in Chicago, two flat is a term for, what would you call it out in Colorado? It’s a two-family house, basically, which, by the way, I did much better on because at least as painful as this first purchase was, it did teach me. It was a very expensive education, but I did learn.
So the two flat wound up pretty good, but when we moved to that, then I’m left with the conundrum of what to do with this condo, and as I say to sell it would mean taking not only a huge loss, but coming up with 15 grand to satisfy the bank, which I didn’t want to do. So I wound up renting it, and I wound up renting it to a wonderful woman. I actually forget how we found each other, but she was a terrific tenant. She paid her rent on time. She took impeccable care of the place, and then when she left after a couple of years, she actually found the next tenant for me, who was equally wonderful, but the problem with that was I could only run it for 370. Meanwhile, it’s costing me $570. So it’s hemorrhaging about $200 a month just to hang onto it. So that’s the second part of the incredible loss that this thing represented, and then-

Scott:
How long does that continue for? How long are you losing money on this property from a rental perspective?

JL Collins:
Well, so that continues for about five or six years-

Scott:
Oh, my gosh.

JL Collins:
… but it gets worse because as I say, my first tenant was kind enough to find my second tenant. The second tenant was kind enough to fine me a third tenant who was also … So the one bright spot in this thing is I was very lucky with the ease of finding tenants and the caliber of tenants that they were. They all took great care of the place. They paid the rent, exactly what you want with a tenant. Well, my third tenant, what a terrible woman she was, didn’t find me the fourth tenant. Of course, anybody who has rental real estate realizes that your tenant has no obligation to do this, and she certainly didn’t have any obligation.
Then it was unrentable. I began to realize how terribly lucky I’d been in not only finding good tenants, but finding tenants at all. So suddenly, and now, by the way, I have since moved away from Chicago. So I’m doing this long distance, and now I’m not hemorrhaging $200 a month. I’m hemorrhaging $570 a month, and that went on for about 18 months.

Scott:
Oh, my gosh. Okay. So what year is it? What year is it, the end of this 18 months? The loss are stacking up to thousands or tens. We lost $25,000 just in the value day one or in the first year or two. We’ve also lost $200 a month for three to five years and now we’re losing $570. So we’re in the 20, 30, 40, $50,000 loss range at this point.

JL Collins:
That’s before you account for inflation. So it’s actually, if you look at it at today’s dollars, it’s my much, much worse. Again, my memory isn’t good enough to do that calculation, but in today’s dollars, the total loss was well into six figures. Then I also do a calculation in the book where what if I just taken this money and invested it in the S&P 500, and that’s really depressing because that amounts up to over a million dollars.
So it’s not just the actual cash lost. It’s also the opportunity cost lost, but in any event, so now I’m sitting on this thing that I can’t rent. I also can’t sell. The market was so bad for condos I couldn’t get a realtor to take the listing. Now, think about that for a second because for a realtor to take the listing requires no effort on their part. They can just take the listing, sit on it, and if the thing happens to sell by some magic, they can collect a commission. I couldn’t even get a realtor to do that. That’s how bad the market was at the time. So I’m stuck with this thing that I for whatever reason can’t find a tenant for.

Scott:
What year are we in right now?

JL Collins:
We’re in ’85-’86, yeah, somewhere in that timeframe.

Scott:
Okay. Keep going. So you’re not able to get a listing. What do you do now?

JL Collins:
Well, so now I just suffer, I mean, as I say for about 18 months of no tenant and, of course, I’m trying to find a tenant, but when you’re trying to do this long distance, it’s difficult. So finally, what finally brought my pain … Are you ready to hear how my pain ends or at least before the IRS gets involved, how the pain ended?

Mindy:
Did it burn down and you didn’t have any insurance?

JL Collins:
Yeah, well, no, no, no. There’s a whole another thing with the IRS, but finally out of the blue, one of the good things to come out of this is that when I was still living in it and YP had fled the scene, and we were the owners of this building. We’re brought together in the way that only adversity can bring people together, right? So we knew each other pretty well. We worked hard together to get the common areas finished, for instance, and to come up with these special assessments that we all imposed upon ourselves to get the building in order.
Anyway, we had become friends and, shamefully, I forget this guy’s name, but he had become the president of the condo association and a good guy. One day out of the blue, he calls me up and he says, “I have somebody who might be interested in buying your condo.” Of course, I can’t tell you what wonderful news this is, right? It’s like somebody calling you up and saying, “I have somebody who has a pile of gold bars they don’t quite know what to do with and they want to give them to you.” I mean, the news could not have been any better than that.
He said, “No. The woman who’s interested, her boyfriend lives in the building and your apartment actually is adjacent to his apartment.” So not only does she want to be in the building, but as it happens, my unit was the most ideal for her purposes. So anyway, I immediately arranged a business trip to Chicago so I could meet with her. Of course, I was hoping that she was naive and silly and I could take advantage of her, and she wasn’t any of those things. She was sharp and smart and a lawyer, in fact, but she did want the apartment.
So she’s looking at it, and at one point she says, “So how much do you want for it?” Of course, I’m mentally doing the calculation. I’m saying, “Well, I paid $45,000 for it back in ’79,” and I realized, and talk about understatement, I realized that the condo market hasn’t gone up much since then. Yeah, Mindy, she was nice to the news. She didn’t burst out laughing in my faith, although she would’ve been justified.
I said, “I realized the market hasn’t gone up much since then, but I’d be willing to take what I paid for at 45,000,” and without batting an eye, she looked at me and she said, “I’ll give you 30.”
Now, at this point, 30 is like manna from heaven. I mean, at this point, I know that this woman and I are going to do a deal. The only question is, how can I get out from under this with, of course, I still basically owe the bank 40 grand, the 40 grand I borrowed because as you know, most of your payments in the early years are interest. It might have been down to 39 grand or something. Anyway, in my mind, I owe the bank 40 grand.
So we go back and forth a little bit and she agrees to buy it for $40,000. So at that point, you say to yourself, “Oh, for the great tragedy this is, you only ultimately lost $5,000.” Of course, that doesn’t count all the money that hemorrhaged out over the six years that I held onto it, which I do in the book total up, by the way. So that’s the deal that we struck and that allowed me to get out from under it without having to come up with extra money for the bank, but as I say, that’s before the IRS, before I had to pay tax on my capital gain. Don’t you want to know how you pay tax on a capital?

Scott:
The story doesn’t end here, huh? All right.

Mindy:
Yeah. Yeah. Wait a second. If you sold it for less than you bought it for, I’m not a tax expert, but that sounds like a capital loss.

JL Collins:
Yeah. Well, that’s what I thought, but the IRS explained to me that both you and I are wrong about that, Mindy. So in those days, I don’t think this is true anymore. I know when you own a rental because while I bought this thing to live in it, I converted it to a rental and I began writing off the expenses involved with it, including depreciating it. In those days, you could do something called accelerated depreciation, which basically meant that instead of depreciating over 30 years or whatever it was, you could say, “This thing’s wearing out faster than normal and, therefore, I’m going to depreciate it over some shorter period.” I forget what that period is, but it allowed you to take a bigger deduction for depreciation.
Of course, because I’m hemorrhaging so much cash in this thing, I am grasping at straws, anything to make the pain a little less, but when you take depreciation, as I’m sure you and many of your listeners know, that reduces your cost basis in an equivalent amount for when you ultimately sell it. So the depreciation I’d taken over those five, six years had taken my cost basis from $45,000 down to $25,000.
So the IRS said, “Yeah. You lost $5,000. You sold it for 40. You bought it for 45. You sold it for 40. You lost $5,000, but you’d depreciated it and, therefore, your cost bases is not 45,000. It’s 25,000, and you sold it for 40,000. So that’s a capital gain of $15,000, and we want our cut.” So that was the final bit of pain and injury and insult in the process.

Scott:
That’s phenomenal.

JL Collins:
Yeah. I’m laughing now, but it’s taken me years to see the humor.

Scott:
Oh, my gosh!

Mindy:
So it doesn’t sound like adjusted for inflation you lost six figures. It sounds like you lost six figures in the ’80s, too.

JL Collins:
I don’t know that was that close. I was probably 40, 50, 60 grand in those dollars. As I say, I run the numbers in the book and it’s comfortably into six figures when you take inflation into account for today. So in fact, I actually do a chart in the book. I don’t have a copy of the book with me or I’ll look it up. I do a chart taking all the numbers that I mentioned in the book because I mentioned that the numbers as they were at the time and I calculate what they would be in inflation adjusted numbers. So people, if they’re curious, can go and look and say, “Well, $160 a month for an apartment is stupid cheap,” and of course, even then it was a good deal, but you can look at what the equivalent would be today for that apartment.

Scott:
So if you could go back and think it through, what would you do instead of this purchase and the whole journey that we just unpacked here in great detail?

JL Collins:
Oh, Scott, I would’ve gotten a pack of about a $40,000 bills and I would’ve sat outside and lit them on fire one at a time, and it would’ve been less painful and more entertaining. No. Well, first of all, my apartment, when I first went to look at it in July and he offered me my money back, I should have grabbed that with both hands because he didn’t realize that the market had turned on him, and I had been an excellent tenant for the apartment where I was renting for a number of years, and my landlords loved me and I could have easily gone back and said, “Hey, I want to continue renting,” and they would’ve been happy to let me stay in my $160 apartment.
Moreover, even going back before that, when my buddy Steve was so excited about buying a place for himself and the world around him and around me was all saying, “You got to buy real estate. You got to buy real estate,” I should have taken a step back and said, “Well, is this really right for me? Is this really something that I want?” and the answer to that question even then would’ve been no. I mean, I was perfectly content in my apartment. Even if things had gone swimmingly with the condo, it would’ve been considerably less expensive to continue to live in the apartment. So yeah, I wish I had had the wisdom not to get swept up in the mania, in the common wisdom that you have to buy.

Scott:
What about once you’re in the deal, you got it, and you got to deal with it? Anything you would’ve changed following the purchase once you had the property or already in the whole and from that point on?

JL Collins:
Yeah. I’m not sure that there was anything I could do other than what I did. I mean, I think I made most of my mistakes in the beginning, but once I’d closed on the thing, the die was cast and you have to live with your decision, right? That’s another important lesson, I guess, to come out of this is that once you close on the property and you own it, you have to live with that decision, and if it turns out to be a good decision and it keeps appreciating or it’s the place you really want to live and you enjoy it, even if it costs more than where you were before or if it’s a rental and you’ve done your homework and it’s positive cash flow and doing well, then those are all good things, but even if you make a colossal blunder like I did, you own it, and at that point, you just have to figure out how to deal with it.
In my case, I had to keep digging into my own pocket to make up the shortfall, well, between what I’d been running for initially and what the 570 bucks a month this thing was now costing me, which was more than I had figured on because I didn’t count on the special assessments, but I just had to dig deeper in my own pocket, and then when I rented it, I had to keep digging into my own pocket to make up the difference between what I owed the bank and my assessments and what I was able to get in rent.
By the way, that’s another great lesson that I would caution anybody listening to this who’s not familiar. Landlords don’t get to set the rent. I hear all the time that, “Well, of course, owning is better than renting because if you’re renting, you’re paying all the owner’s cost plus a profit to that owner.” Well, sometimes if the guy you’re renting from, if the person you’re renting from has done their homework and done a good job, that will be true, but that’s not always true. There are a lot of people like me that get forced into renting places that back into it, where your rent is a screaming bargain compared to what it actually costs. So landlord doesn’t set the rent. The market sets the rent. If I’d been able to set the rent, I would’ve set it for $650 a month, but I don’t have that option. The market sets what the rent’s going to be.
If you’ve done your homework as an investor, well, you know what the market is going to set that rent at and what you’re considering buying, and you make sure that you buy it in such a fashion that that rent that the market is setting for you is profitable. If you do stupid things like I did, you wind up owning something that is far more expensive than what the market’s allowing it to run for.

Scott:
Now, I think it’s super valuable perspective, and I love that you’re like, “Hey, the answer to all of this is live with the decision once you’ve made it,” and really all of these factors downstream no matter how good you got of the eventually at managing that property and making the decisions that you could to optimize from there, there was just really not much you could do to change the situation. It was determined by the market and you had to live with it for as long as it took to get out from under it.

JL Collins:
Yeah, exactly. You also don’t get to decide when to get out from under it in all the cases. As I say, I couldn’t even get an agent to take the listing. That’s how hard it was to sell this thing. So I had to just suffer through it until finally the right buyer happened to walk in my door. Thankfully, the president of the association who she reached out to, he and I had stayed in touch and he knew that I was, I was going to say interested selling, desperately probably is the better word. So, yeah, I mean, it pays to keep all your doors open, I suppose, but yeah.
So once you own it, you have to live with it for better or worse, and there’s the compelling case for not doing what I did, and rather going into it with your eyes wide open and having done your due diligence and your homework before you sign on the dotted line.

Scott:
If you’d held onto it for another 10 years, what do you think would’ve happened?

JL Collins:
I don’t think it was so deep underwater that I’m not sure 10 years would’ve done it. If I’d held onto it until now, maybe it would’ve turned out okay. It depends, Scott, on whether I’m holding onto it as an investment property or as something to live in. If it had suited my living needs for a longer period of time, then it would’ve just been an expensive place to live in.

Scott:
Could you have bought another property in Chicago around that time and done much better on it if you’d been looking at it from an investment mindset?

JL Collins:
Well, not only could I, I did. That was the two flat that I bought. So I bought the two flat I want to say in ’81, a couple years later. The good news such as it is is that this was a real education. This condo was a real education. So when I decided that I was going to buy the two flat, I was a much older and wiser real estate buyer at that point. I did a whole lot more due diligence. I was a whole lot more savvy in how I approached it. That deal turned out pretty well. In fact, it turned out very well. The only mistake I made with that one is I should have held onto it a little bit longer, but again, by then I had moved out of Chicago and I was not com comfortable being a long distance landlord even though on the two flat it was cash flow positive.
In fact, if I look at it holistically once I own the two flat and I own the condo simultaneously, the two flat was positive enough that it was paying for the losses on the condo. So I didn’t have to dig into my pocket in the same way that I did before that, but of course, that also means that instead of the two flat adding money to my pocket, it was just making up for the mistake, for the massive mistake the condo represented.

Scott:
Well, what I love about that is that we started off this with the circumstances of the market and how eerily similar they are and then the disaster that you just went, that was this condo purchase, but we’re hearing that even in a tough market like that, with your savvy purchase on the two flat you were able to generate cash flow and achieve value creation over your whole period with that.

JL Collins:
Yeah, and by then, the market had cooled quite a bit, but as we talked about at the very beginning of our conversation, this was a period of very high inflation. What’s interesting about that? I don’t know. I don’t tell the two flat story in this book, but I actually bought that for no money down. I did that by getting a mortgage from the bank for, testing my memory, I think for 75% of the purchase price, and interest rates in those days, I think my mortgage was 16%-17%. Then I negotiated a deal with the seller for the other 40,000 or the other 25% or whatever it was for I want to say 7%. So I wound up with a blended interest rate, if you will, of around 13%, which, of course, sounds horrific to anybody listening today, but at the time, it was a very, very attractive interest rate. Yeah.
Now, the mistake I made on that one, by the way, is I had read this book called Nothing Down about buying real estate with nothing down, and I thought, “Well, that’s a pretty cool idea,” and I made that my goal, and I accomplished that goal, and it turned out to be pretty profitable overall, but the mistake there was that’s the wrong goal, at least in my opinion. You should never go into buying real estate, as an example, with your goal being, “I’m going to buy this with nothing down,” unless you have no money.
I had money to put down and, in fact, I could have done a better, more profitable deal by putting money down, and the goal should have been, “I want to buy this piece of real estate in the most advantageous possible way for me with the resources I have.” In my case, I had resources to put money down. I had the knowledge to do it without putting money down, and I should’ve looked at those two options, and if I’d done that, I would’ve, for a variety of reasons, I would’ve put money down, but anyway, both those options were far better than the condo.

Scott:
Yeah. Wow.

Mindy:
Well, and we’ve talked about the money that you lost. This has been a lighthearted retelling of the story, but we didn’t really get into the stress that you … This was a very stressful time, I’m assuming. It was very stressful for me when I first read the book. I was reading through them like, “This is my condo in Chicago,” and I remember just we would have these meetings and it was so stressful. You look back at it now and you’re like, “Well, that was a $10,000 problem,” but at the time, $10,000 was a lot of money. At the time, $40,000 was a lot of money. Losing $150 a month or $300 a month or $570 a month was a lot of money that you had to come out of your pocket, and you’re not thinking at the time, “Oh, well, my other property is making up for it so everything’s okay.” You’re thinking to yourself, “I have to write another darn check for $570 to the bank every single month. I could have been renting for $160.” We don’t talk about the stress and the sleeplessness and the anxiety that you’re feeling for, and this was for six years that you had this. I mean, did you ever think one time, “Yay! Hooray! Real estate’s awesome”?

JL Collins:
Well, yeah, when I sold it and before I realized-

Scott:
A manna from heaven.

JL Collins:
… and before I realized what the IRS would have to say about it. I was saying, “Yay!” The IRS took the yay away. Yeah, I’m laughing about this with great-

Scott:
I think that’s your motto.

JL Collins:
Yeah. I mean, at this point, with a distance of 40 years, I could see the humor in it and I’ve gotten a book out of it. So there is the upside, but at the time, I would not have been able to chuckle for this as we’re doing it at the time. I mean, I would not have been able to see the humor, and I don’t remember feeling stressed. I remember feeling extraordinarily aggravated.
The other reason that I bought a condo is I bought into this concept that if you buy a condo, it’s worry-free, you don’t have to mow the lawn. Well, that’s true. In the entire time I own the condo, I never once mowed the lawn. What I didn’t count on was the endless meetings with lawyers and the endless battles with YP before he fled, and then the endless conversations with the other owners trying to figure out how we were going to fix this, how we were going to finish the common areas that had been left undone, and how are we going to raise the funds for that.
So I never had to fix the plumbing or mow the lawn or shovel the snow, but there was endless work involved in owning this thing, so endless. I think, Mindy, it comes down to there was so much aggravation I didn’t feel the stress. The aggravation just overwhelmed the stress and the work. So yeah, it was an enormous amount of work and effort. Again, as I say, the good news is that was provided a tremendous education, which probably has benefited me and certainly benefited me with the next real estate purchase, but yeah, but there was lots of aggravation and probably lots of underlying stretch and certainly no laughs.

Scott:
Well, is there anything else that we should know about this experience before we adjourn here?

JL Collins:
I think we’ve covered it pretty thoroughly. I mean, I tell the story in a more coherent fashion in the book, and as they say, the numbers are there if anybody’s curious, not only is the actual numbers and the dollars of the day, but also inflation adjusted if people want to play with that, but my subtitle on it is A Cautionary Tale, and that’s what it is. This is not a book telling people don’t buy a condo or don’t buy a house or don’t invest in real estate because all those things can be good things, and I have done all of those things and have had them be good things for me as well. It’s a cautionary tale into not being impossibly naive in how you approach it, doing your homework.
Again, I would applaud you got on BiggerPockets for the educational resource you are to help people not make the kind of mistake that I made. I like to think that if BiggerPockets has been around at the time, I would’ve been at least smart enough to take a look at it and might have saved myself a whole lot of grief. On the other hand, I wouldn’t have a new book out.

Scott:
Yeah. So I definitely encourage folks to check out the book. The book is called, again, How I Lost Money In Real Estate Before It Was Fashionable, subtitle, A Cautionary Tale as you mentioned there. It’s a wonderful, fun, quick read. I think you are able to make light of the situation looking back on it. I think you learn a lot about the mistakes that can lead to enormous piling up losses in real estate. For me, for one, coming out reading the book, I felt actually better about my real estate investing and the way I approach it from reading it because it is good to hear that you can lose money from all this stuff, but feeling like, “Hey, okay. I’m a little bit more prepared than maybe Jim was going into this purchase of this condo.”

JL Collins:
“My goodness, JL, I’m not that stupid.”

Scott:
Yeah. I have these concepts around cash flow. So I think it was really helpful to get that view and it was a fun read and reinforced a lot of the core beliefs I have around really self-educating around this, knowing the numbers and running them before buying real estate.

JL Collins:
I appreciate that take, Scott, because that’s exactly how I wrote it. It’s a very short book. It’s meant to be a very entertaining, fun read. It is meant to have a serious message underlying it that here’s a classic example of lots of things that can go wrong if you’re not careful. I mean, it almost reads like fiction because so many things go wrong, but everything in it is absolutely true.
The other thing I’ll throw out is it’s filled with wonderful illustrations, and I can call them wonderful because I didn’t do them, but I found just a terrific illustrator who I think is just spot on with the illustrations that go along with the story. So I think it’s a feast for the eyes and, hopefully, it’s a fun read as it was for you. Then yeah, it’s worth, hopefully, being a cautionary tale for those who need a cautionary tale. Certainly, I would hand it to anybody before they go out and buy something.

Mindy:
Absolutely.

Scott:
A feast for the eyes of the reader, but a famine for Jim Collins.

JL Collins:
Well, I’ve recovered since, but it was nip and tuck there for a while.

Mindy:
Yeah. If you’re thinking about buying real estate, you should read this book, and if this book can scare you out of buying real estate, then choose another investment vehicle because this book is not even close to the worst thing that can happen to you in real estate.

JL Collins:
You got them mortified to hear that.

Mindy:
You didn’t even have a tenant that trashed your whole house, did you?

JL Collins:
No, and that, Mindy, is a great point because when I was investing in real estate back in the day, and especially this is before the internet, I don’t know if it’s still true because I no longer invest in real estate, but back in the day when you invest in real estate, you wound up getting to know other real estate investors because you tend to … Also occurred to me that I was the only real estate investor that I knew who didn’t have a tenant horror story, who didn’t have a story of a tenant trashing their place. I was the only one, and I knew quite a few at that point in Chicago, and suddenly, it occurred to me that it wasn’t that I was smarter than all these other people because clearly, I wasn’t, it just that my time in the barrel hadn’t come. I’d just been lucky.
In hearing their stories I thought, “I don’t want to deal with this,” and that’s why I got out of real estate investing. It actually made me money. This was a bad start to it, but overall, it made me money, but it just felt like too much work. Ultimately, with the bad tenant thing, too much risk that I just didn’t want to deal with, but that’s me. I mean, people, as you well know, people have made fortunes in real estate if you go in with your eyes wide open and having done your homework. So there you go.

Mindy:
That’s the best way to invest by being prepared and doing your homework, and what do you say, Scott? 150 to 250 hours of research before you start investing.

Scott:
I think that’s the starting point. That’s the minimum price to pay before getting into real estate investing.

Mindy:
250 to 500? Yeah.

JL Collins:
Where were you in 1979 when I needed you?

Scott:
I’d blame Josh on that.

JL Collins:
Why didn’t you call me up?

Scott:
It was a tough year for me.

Mindy:
Oh, my God! I was in second grade.

Scott:
Well, Jim, where can people find the book?

JL Collins:
Well, the easiest way to find it I suppose is on Amazon, and the easiest way to get to it on Amazon actually is to go to my blog, jlcollinsnh.com, and if you click on it, there’s a cover of How I Lost Money In Real Estate Before It Was Fashionable, and then right below that is the cover for Simple Path to Wealth. Click on either of those, it’ll take you to Amazon and you’re good to go.

Scott:
Awesome. We’ll also link to all of that at the show notes at biggerpockets.com/moneyshow285. For anybody that is interested in checking out any of these books, go to Jim’s site, go to Amazon or go to the show notes link there.

Mindy:
Jim, thank you so much for your time today. Thank you for being 1% of the guests that we have ever had on our show, and thank you for sharing your story of losing money in real estate because we don’t do that enough here. So I appreciate you taking time out of your very busy day of doing nothing all day long to talk to us.

JL Collins:
Yeah. I could be out sightseeing. Instead, I’m hanging out with you. Hey, I appreciate the invitation to come back. It’s always a pleasure to hang out with both of you in the real world, but also on the podcast. So anytime you want to have somebody on that you can laugh and mock regarding my real estate condo, I’m available.

Scott:
We will certainly do that.

Mindy:
Awesome. Okay. Thanks, Jim. Say hi to Jane for me and we’ll talk to you soon.

JL Collins:
Will do.

Scott:
Thanks, Jim.

JL Collins:
Take care. Bye-bye, guys.

Mindy:
Okay, Scott. That was JL Collins. That was a lot of fun. Honestly, when I was reading his book, that was a lot of PTSD because I went through almost the exact same scenario in the same city that JL Collins went through. I bought a condo that was supposed to be rehabbed. It wasn’t. It wasn’t rehabbed correctly. I think the guy did end up skipping town. Just a whole lot of disasters. I did not lose quite as much money as he did, but this was back in 2001 where the market was starting to climb up. I think I broke even, but I sold it after a year instead of after seven years of renting it lower, but still, all the stress, all the anxiety, all the everything, I relived it, and it didn’t dampen my spirits for real estate, obviously.
I love real estate, but one of the key takeaways that I got from that book is if this story freaks you out, absorb that freak out. Let that freak you out and realize that real estate isn’t the right investment vehicle for me at this time. You can explore it again later. Maybe down the road you’ll be in a better position to invest in real estate. Maybe the market will be in a better place for you to jump in, but if this story freaks you out, I want you to let that freak you out and take a step back and learn from it. If it doesn’t freak you out, please visit biggerpockets.com and learn, learn, learn.
What do you say, Scott? 250 to 500 hours is the starting point for where you need to be doing your investment research before you buy a property. I mean, buying a property and jumping in with both feet, I know you are trying to answer me, Scott, and I’m just on a roll. Let me keep going. Buying a property and jumping in with both feet is going to be the best education possible. Listen to Jim. He just shared this, this really great education he got, but if you can learn those same things without the pain and anxiety, that’s better. You don’t need to go to school of hard knocks when you can learn from somebody who went there.

Scott:
Yeah, we think we’re cheaper at BiggerPockets than the education that Jim or JL Collins went through here, and probably the same amount of hours at the end of the day. So I think that’s it. I think it’s that 250 to 500 hour mark is really that minimum. We mentioned 150. Getting up there and really committing the mental bandwidth to learning about this and absorbing different perspectives and hearing the horror stories, hearing the success stories and going through it I think we’ll make a huge difference in the odds of success for anybody that wants to get into this, and if you’re not willing to pay that price, maybe real estate’s not a good spent for you.
One other thing I want to point out is JL Collins got lucky in his story. When he was talking about how he had one tenant and that tenant found another tenant for him and that tenant found another tenant for him, my biggest mistake personally as a landlord was I did something very similar to that. I did a really diligent screening process for two tenants. They split up. They were a couple and she brought in a roommate, who was great, and everything went well. Then she left and I was left with the roommate. She brought in her boyfriend, right? Everything was great.
Then she left that person and I now have the boyfriend, and I’m several layers away from my screening process, and this remaining tenant, the boyfriend, several layers removed, caused a tremendous amount of problems and actually ended up getting arrested before I got the property back and was able to rerent and rehab it. So it could have been even worse from that. I really encourage you, don’t let the tenants refer or if you let the tenant refer another tenant, that’s fine, but go through the screening process and check the credit criminal and income check and do your reference check if you’re going to self-manage on that because I didn’t and I paid a price for that. So it could have been even worse for him and he could have got a bad tenant or a tenant that trashed the place. Thankfully, I did not have that problem.

Mindy:
Yes, yes. Real estate is not the right investment vehicle for everyone, and there are so many different ways to invest your money to grow and generate wealth. You don’t have to just be stuck on real estate. Even though I love real estate, I’ve had my problems, too. I’ve had co contractor problems. Oh, my goodness. That’s why my husband and I DIY everything because it’s so much easier to just learn how to roof my house and try and find a roofer or that’s actually one of the things I don’t do, but it’s way easier to learn how to do a new skill than to try and find somebody to do it for you.

Scott:
One last thing here. We would love to hear from, I think, a couple of other folks who might have invested in this time period in the late ’70s, early ’80s in real estate, and maybe had some successes and failures, what worked, what didn’t. I think there’s a lot of, to my mind, overlap between the economic environment that we talked about at the beginning of this podcast and today’s economic environment. I think it would be really valuable to hear a couple of those stories on the show.

Mindy:
Ooh. My dad bought a house. My parents bought a house up in Oregon the minute before the market crashed and they ended up owning it for 30 years because they couldn’t sell it for the longest time that I don’t remember why they ended up eventually selling it.

Scott:
Yeah. I think we’d love to hear stories from investors in particular, who have those successes or failures in that time period. I think that’ll be really valuable as we’re thinking about how to navigate the waters ahead.

Mindy:
Maybe I’ll set my dad. Maybe we can do a test recording with my dad and if it works out, great, and if not, then we won’t air it.

Scott:
Sounds great.

Mindy:
He’ll be here in a few months. Okay, cool. Well, I’ll set him up. I mean, I would have to. He’s not a techie. Okay. Scott, should we get out of here?

Scott:
Let’s do it.

Mindy:
Okay. Before we do, let’s just say, let’s use our new phrase. The IRS takes the yay away. That’s their new motto. So I have a friend named Evan who works there and I’m going to share that with him, “Hey, do you guys need a new motto?” Okay. From episode 285 of the BiggerPockets Money podcast, he is Scott Trench, and I am Mindy Jensen saying, “Give me a shout out.”

David:
This is the BiggerPockets Podcast, show 585. When you want to BRRRR, start with knowing what’s going to affect the value. The lender who’s going to be doing the refinance is going to be the one who understands how that works. So you want to talk to your representative, whether it’s a direct lender or it’s a broker like us that finds you one. Ask them, “Hey, which way should I go,” and then develop your strategy based off of what they’ve said. If you don’t like what they say, well then look for another loan officer, another lender, another whatever person that’s going to finance this, and create a different strategy.

David:
What’s going on, everyone? It’s David Greene, your host of the BiggerPockets Real Estate Podcast, here with a Seeing Greene episode. On these episodes, we get questions directly from our listener base, you, and we answer them for everybody to hear. So we have several really cool questions that come up today. We talked about financing and what type of loan would be appropriate for the right type of property. We talk about scaling. That’s one of my favorite questions that we get into today, is “How do I scale without burning out, or without making mistakes, or without taking on too much risk, or without leaving meat on the bone? Can I be going faster, and I’m not going fast enough?” We talk about if we should be raising money from people, and what point that actually becomes relevant. And then I threw in my 2 cents about the way that I raise money, and my philosophy behind the responsibility that we have when we’re borrowing people’s money that frankly doesn’t get spoken about enough.

David:
And then we talk a little bit about how real estate… Sometimes when you talk about it, it seems so simple and easy. Should it be harder? Should we be making it harder? Are we overthinking, or are we under-thinking? So we tackle a lot of the really common questions that people ask, many of them when people are getting started, but we also get into some higher-level stuff. Today’s quick tip. We want to do more live shows. So I love being able to answer video questions like this. The problem is sometimes I have to speculate as to what the person really means when they submit their question. I love it when they’re here and I can dive in deeper and find out what they’re really facing before I answer the question. So if you wouldn’t mind, go to biggerpockets.com/david, leave a video question, and in that question say, “I would be willing to be interviewed live on the podcast and get direct coaching from David and his co-host.”

David:
If you do that, my producer will reach out to you. We will let you know when the time is scheduled to do that. You could be here live. You can tell all your friends that you featured on the BiggerPockets podcast, and I’ll get to answer your question. I’ll also be very, very grateful. I’ve had people that have come to work with me because they’ve been on these shows and I’ve got to talk to them. I’ve had people that I partnered up with to do different things. A lot of relationships are built just by taking that step. So we want to hear from you. Please go to biggerpockets.com/david, submit your question, and let us know if you’d be willing to show up for a live show where we answer it more thoroughly.

David:
All right, last thing I want to say is make sure that you subscribe to this channel, that you like it, and that you’re following me on social media. I’m DavidGreene24. If you’re too shy to ask a question on the podcast, well first off, get over it. But second off, I’ll help you get over it. Send me a DM. Tell me what your question is. I want to be able to help. If you live near me in California, I definitely want to be able to meet you, because I do meetups out here. I want to get you plugged in, and I’d like to hear more about what you got going on. So submit me questions, DM me with anything that you are embarrassed to ask about in a public forum, and without further ado, let’s get on to today’s show.

Chad:
Hey, David. My name’s Chad, and I live in the upstate of South Carolina. We are trying to scale into real estate as we have been taking advantage of the tax-free capital gains that we’ve made on our primary home by moving every two years for the past several years. We tried our hand at flipping a house without living in it while we were in an apartment, and that went really well except for the tax implications from those capital gains. So we decided that wasn’t a way to build wealth or to scale into real estate for us, so now we are trying to get into it quickly. My question for you is: What is the best route for us to take going forward? And are we on the right path? We kind of have an idea based on our knowledge and understanding of real estate and investing from the BiggerPockets community. Where we are at right now is that this summer, we had purchased a property with two houses on it in the Smoky Mountains of North Carolina.

Chad:
We just finished one of the studio houses on the property and have launched it on Airbnb, and the other house we are seller financing and selling to one of our contractors there. We decided that project was too big to take on from out of state. So now that we have that one launched, we just bought our neighbor’s house and are about to launch that on Airbnb and other STR platforms in the next week or so. We decided to go into the STR route, because even though it’s somewhat risky with that endeavor, it does seem to scale faster as far as capital and cash flow there, and I thought this could be a good way to pivot into long-term and commercial real estate once we refinance and consolidate debts. So our current plan is that in the next few months, once we’ve been six months on title on the North Carolina property, we’ll be cash out refinancing that one and hopefully pulling the new equity, if not just consolidating the debt that we have.

Chad:
We used a HELOC from our primary home and a small personal loan to finish and furnish up that property, and we’ll also be getting all of our funds out of the property once the seller financing contract is complete, hopefully sometime early next year. The other home that we just purchased, we used a private money loan, and that’ll be sometime in the beginning of next year that we should be able to cash out refinance once we connect with another local lender. We’re still getting quotes on the rates and things like that for that. So that’s kind of my question, is: Are we on the right path? Because we do want to do this long-term. My W-2 kind of seems to be getting in the way, and we’re very tired at this point after renovating one property and switching right over to the next one. I’m on that lookout for another deal, but I don’t see a way to continue acquiring real estate at the end of this year until we finish consolidating those debts and hopefully have new equity to work with.

Chad:
I know that one thing that will be in the way when we do go and refinance is how much I get paid on my W-2, because the STR income won’t be counted towards our debt-to-income ratio. That’s what I’ve been told by the lenders. So using our own equity from these properties, we’re hoping to get into multifamily 10 or 12 units, or commercial property. I guess I’m a little vague with exactly specific what I’m asking, but does this sound like a good path? Are there other nuances that I don’t see that we could be acquiring other deals during this time? And as far as my own job, I am trying to pivot within my own industry of IT to increase my income to make that debt-to-income look better. And thanks for all your time, and you’ve been great to listen to on the podcast. I appreciate it.

David:
All right. Thank you, Chad. I appreciate the kind words there. Glad that you’re liking the podcast. There’s a little less beard, but there’s a little more bald. All right. So that was a little bit of a long-winded question, but I think I have an idea what you’re getting after. You’re trying to figure out… You’re saying, “How do I scale,” but then you’re also telling me what your current plan is. And I think what you’re looking for is for me to break it apart and tell you if it is sustainable, if it will work, and what you would do different, which is kind of what I do. As a consultant, I look at all the different pieces that my clients have with what they’re trying to accomplish. I run it through the weird matrix of my brain after seeing as much real estate deals as I’ve seen in the time that I’ve been doing it, and I come up with a plan that will maximize efficiency for the person according to their goals.

David:
So you’ve got several things you’re doing well, and it sounds like you’re willing to do whatever it takes to make it. So right off the bat, Chad, I think you’re going to hit your goals, which is great. So let’s talk about how we could do it the fastest way. When it comes to scaling, a lot of people ask this question: How do I scale quickly? Now, I’m going to paint a picture, or an analogy, if you will. Imagine that you’re trying to run a race, and the further you can run, the more money that you’re going to make. That’s sort of what we’re talking about here. The more properties you can buy, the further can get into growing your wealth, the more money that you’re going to make. The question to ask is: What will stop me from doing that?

David:
Now, some people lack ambition, they lack drive, or they’re afraid. Those are people that we make mindset episodes for. You’re not going to run very far in the race if you’re afraid to get started, or if you’re lazy, or if you feel like you don’t know how to run, or you’re in terrible shape. Those are people that need to learn how to analyze deals, listen to podcasts, educate themselves, because that’s what’s going to stop them from running. The goal is to get as far as you can. There’s other things that slow people down though. Other than that, maybe you’re carrying weights around. Maybe you don’t have enough energy to keep going. So what we’re going to talk about right now are the four things that I think slow most people down. Now, we are assuming that mindset is not a part of this, because from what you’re telling me, it’s not an issue for you.

David:
The four things I wrote down when I was listening to you that will slow someone down from running the race are going to be: running out of capital, that’s a finite resource, running out of time, that’s a finite resource, running out of opportunities like deals to get, that’s a finite resource, and then running out of the ability to finance, because you’re probably not going to pay cash for everything. That can be a finite resource. And you sort of touched on all of those at some point in your question. We’re going to start with capital. Most people will struggle with real estate investing because they don’t have enough money. I’m just being completely honest with you. Brandon Turner wrote The Book on Investing in Real Estate with No (and Low) Money Down. Fantastic book, lots of strategies. Do them. But I will also say those strategies work. They take more time and they are harder than if you just have a lot of money.

David:
I can run further and faster with the resources I have than someone can getting started, even with those techniques. Now, that does not mean they should not do it. I’m just saying if I’m in really good shape and I can run for four hours without getting tired, you can’t keep up with me if you’re new to running. You have to use these strategies to make it work, but you have to stop and take breaks. It’s harder for you to run. What I’m saying is don’t compare yourself to somebody who’s got a lot of capital, because they’re going to run further than you. Just let that inspire you, that someday you will have that capital and you can run that way. The two strategies that I recommend more than anything for people that are capital restricted, which is most new people, which is why I’m starting there, is house hacking and the BRRRR method.

David:
The BRRRR method is a way of buying a property, fixing it up similar to what I think you said you’re trying to do in the Smoky Mountains, and then refinancing afterwards to get your money out of the deal. That gets you your capital back. It can be reinvested. You eliminate the problem of running out of money. That’s why I wrote the BRRRR book. The second is house hacking. Now, I didn’t write the house hacking book, but I could write a book on that because I’ve helped hundreds and hundreds and hundreds of clients as well as doing this myself. It is an amazing strategy. What I tell people is you should always house hack one deal a year before you even try the BRRRR method. If you can get a primary residence loan and put 3.5% down, 5% down, you don’t need to do the BRRRR method.

David:
You don’t need to do all the work to get your capital out of the deal, because you barely put any capital into the deal. So the first thing I would say to you, Chad, is you and your wife should be house hacking one property a year. Find the best neighborhood that you can get pre-approved to afford. Find the right floor plan, get that house, split it up however you do it, whether you do a triplex, duplex, a place with a basement, an ADU, you add an ADU, you switch the floor plan. Whatever you’re doing, figure out a way to do that first. That will be the biggest thing. If you just buy one house a year like that, and then every year or maybe every two years you also do a BRRRR thing, you’ll be good. You won’t have capital restrictions.

David:
Then you’ll have enough equity like what you’re seeing in your primary residence, that you can pull it out and you can just run faster. The next thing I’ll say is time. It doesn’t sound like you’re time-restricted, but if you’re taking this new job on, that is going to become at a certain point a restriction for you. So continue to buy real estate, continue to work, like you are, to save money and to help your debt-to-income ratio so you can keep buying, but know at a certain point you’re going to need to quit that job. The next would be opportunity. Make sure you’re investing, that you have a strategy where you’re investing in an area or in an asset class that will allow your time to be fruitful. If you’re chasing after the same deals that other people are chasing after and you just can’t get anything under contract, you need a change of strategy.

David:
If you’re looking for deals that are just way too good, like there’s someone else that would buy it for much more than the price you want it for, you need a new strategy. You’re limited in your opportunity, and it doesn’t sound like that’s your problem right now. It actually sounds like you’re making some pretty good headway when it comes to finding deals. And the last is your financing, and here’s what I want to say about that. It’s good you’re getting a job to improve your debt-to-income, but you don’t have to do it that way. Companies like mine get people pre-approved based off income that the property is going to make, not the person. So you could switch right now. Now, the trade-off is you might have a slightly higher rate. It’s usually around half a percent or more to do those loans, but those are the ones that I use.

David:
I don’t use my own debt-to-income ratio, frankly, because I don’t want to have to show all of the taxes that I have, the businesses I own. My situation becomes more complicated. I don’t have a W-2 job in the sense where an employer pays me. I own businesses and pay myself out of those businesses, so I have to sort of show this really long paper trail of why I paid myself the amount I did, why I didn’t have to pay taxes because it was sheltered by real estate. It’s just a hassle, so I use loans where we take the income from the property to qualify me. And you can do that same thing. You can reach out to me, and I’m happy to look into that. If you don’t want to reach out to me, just find a lender and ask them about a loan like that so you don’t have to stay work in that job to keep buying real estate.

David:
I don’t know that these loans will be around for forever. They’re good loans. They’re 30-year, fixed rate. They’re not shady subprime-type stuff, like what we saw before, but I’m taking advantage of them while they’re here. Right now, there’s so much money that’s flowing around because we printed so much of it that lenders have a lot of it, and they need to get rid of it, and so they’re looking to make loans based off the income of the property. That’s a way that you could remove your time restrictions. So the four restrictions are capital, time, opportunity, and financing, and I believe I gave you a strategy to help with all of those. The next thing or maybe the last thing that I’ll say when it comes to the situation is we all want to sprint and get as far as we can, and that’s why I like this running analogy.

David:
Because if you’re trying to go as far as you can, you don’t necessarily start off going as fast as you can. Sometimes, trying to run as fast as you can will burn you out, and you’ll end up getting passed up in the race, or you won’t go as far as what you could have. When I go running, I start off very slow and I get warmed up, and I actually speed up as I go until I start to get tired, and then I slowly wind back down again. I think that strategy would be better for someone who wants to scale a portfolio. Don’t go buy 17 houses all at once and then try to figure out what to do. We’ve had people on this show… We’ve had them on different versions of this where they say, “Hey, I just bought six properties and I don’t have enough capital to rehab all of them. What do I do?”

David:
Well, you have a capital restriction. There’s not really a lot you can do. You’re in a bad spot. You got to sell it off, similar to what you have going on in the Smoky Mountains. That was a really good example. You’re having to sell a property to have enough capital to fix up the other one. So don’t try to go fast, but what you want to go is far. You want to do this at a pace that you can handle. Just buying a house a year in a good area puts you in a really good position for your future. BRRRRing another one after that puts you in a really good position for your future. Saving the short-term rental income that you’re making and putting that towards buying more properties puts you in a better position for the future. You’re not going to start off running as fast as you will be running in five years. The important thing is that you don’t too fast too quickly, and never make it to five years to where you can step up your game then.

Lourdes:
Hi, David. My name is [Lourdes 00:16:00]. I’m in Denver, Colorado. Today is January 10th, and my question is how to tell if an area is A, B, C, or D. And what if it’s mixed? What if you have really nice single-family homes, and around the corner, there’s some low-income duplexes? That’s it. Thank you.

David:
Hey, thanks, Lourdes. I really like this question, because we rarely ever get to go into the why of things. Most people just look at the what, but true experience and truism is gained from chasing the why. Why do we call them A, B, C, and D-level properties? Well, if you think about when we bring it up, it’s only when we’re describing a neighborhood to somebody else. I just bought a house in a B-class area. I look for houses in a C-plus area. I only want to buy A-class real estate. The letter doesn’t really matter, doesn’t make sense. That’s why we don’t have F. Why does it stop at D? It doesn’t go to F. That doesn’t make sense. Just the way it is. What we’re really communicating when we convey that is the personality of the real estate, and this is something I’ve been saying more often. Real estate has personalities.

David:
A-class properties are probably not going to cash flow when you first buy them. They might break even, but you may actually lose money on them. But over a long period of time, they’re going to go up in value a lot. The rents are going to increase a lot. You’re going to get equity probably faster than you get cash flow, and they’re going to be a joy to own. You’re not going to have a lot of problems with those properties. Those are good properties for a long-term perspective and for people that make really good money and need a place to park it, but they don’t need cash flow right off the bat. That’s the personality of that deal. A B-class property is also pretty good to own, not a joy to own, but it’s really fun to own it. You’re not getting a ton of issues.

David:
You are going to get still appreciation, but not as much as an A-class property. And you’re also going to get a little bit more cash flow, but not as much as a C-class property, but more than an A-class property. That’s kind of where I end up falling. I’m getting into some A-class stuff now. I used to not touch it very often. Now, I’d say maybe 40 to 50% of what I’m buying is A-class. Before, it would’ve been maybe 10%. But I still buy more B-class property than anything else, I would say. The personality of a C-class property is going to be heavy on cash flow, easier entry, probably a property that’s going to need some work. If you’re selling an A-class property on the market, you probably fixed it up before you sold it because you had the resources to do it.

David:
If you came to me and said, “David, help me sell my house. It’s an A-class property,” I’m going to talk to you about what we can fix up to get you top dollar, and you’re going to be able to do it because you have the money. C-Class properties, the owner might not have the capital to do that, so you’re more likely to be stepping into meat on the bone, and this is why most investors start there. It’s kind of like training wheels. You can add value to it, you’re not competing with the really wealthy people because they don’t want to own it as much, and it’s going to be stronger on cash flow than it is going to be on appreciation, which probably matters to the newer people that don’t have as much capital.

David:
D-class properties are going to be very little appreciation, if anything, compared to the other ones, a lot of headache. They’re not going to be a joy to own. Your cash flow potential is the highest, but the real benefit of a D-class property is going to be how easy it is to own it. There’s not a lot of competition to get it. You can get all these cool tricks, like seller financing and subject to. The people who own those properties are trying to get rid of them, so they’re going to play the game you want to play. You’re going to probably dictate the terms on a lot of those deals because the seller’s motivated, but they’re motivated for a reason. They don’t want to own that property. A-class property is the same owner might have it for 10 or 20 years. D-class properties tend to change hands every couple years, because people get worn out. So understanding the personality of the property will help you know where you want to get into it.

David:
But what I’m doing is I’m break down how I see A, B, C, and D-class so that instead of saying, “Is this an a A, a B, a C, or a D,” you say, “What is the personality of this? Well, this would be a great deal to get into because I wouldn’t have any competition, but man, it would be really hard to own it. There’s a lot of crime. There’s not a lot of tenants that want to live there. The school scores are low. It’s not going to go up in value.” We typically call that a D-class property, but who cares what we call it? What you need to know is how would this property work once I own it. What would it be like to operate it? And does that fit for my goals? Okay, to the second part of your question, what about neighborhoods that are both? They’re not really both, but what you described is what if you have a really nice single-family home, and then a low-income duplex that’s right next to it.

David:
It’s probably not a low-income duplex if it’s in a neighborhood right next to a nice single-family home. It’s probably just being rented to lower-income tenants. But that doesn’t mean that it’s a bad neighborhood, or it’s bad tenants, or it’s actually a problem. It just is that specific landlord might have chosen tenants that could be causing problems. Or maybe they’re not causing problems at all, they’re great, but they can’t afford to own in a neighborhood that nice, and that’s why they’re renting there. I don’t know this specific property. Now, keep in mind that’s how I’m answering this question, is I haven’t seen the house. So if this is just a haunted house, just something terrible, don’t hear me saying that you should go buy it, but what you’re describing to me is what I look for.

David:
I want to buy the duplex in the great single-family home neighborhood. It’s very rare to find that. And the reason is that most cities, when they do their zoning, they clump it up. They go, “Here’s where all the single-family homes go. Here’s where all the multifamily homes go.” And the multifamily tends to be buried in the corner, and it’s never looked at, and that’s where all the mildew grows, because it doesn’t get enough sunlight. And then you get nothing but all the tenants, and then more and more tenants start moving in there. There’s no pride of ownership. The income goes down, the neighborhood goes down. The police presence goes up, the crime goes up. That’s what you’re trying to avoid. What I like are the benefits of multifamily property, higher cash flow and less risk, mixed in with a great neighborhood of single-family homes where I’m not going to get all those issues that I described when the zoning is separating multifamily from single family.

David:
It’s better if you mix it all in together and you have a nice ratio of both. So what you described, Lourdes, would actually be what I would be pursuing. I want to find multifamily property in a neighborhood that’s B or A-class, because I’m going to have more appreciation from that property. And just imagine that it’s a duplex there, and I can rent it out and get twice as much cash flow as a regular house because it’s a duplex, or maybe three times as much because it’s a triplex. And then five years later, I want to sell it. Well, if I bought it in the section of the neighborhood that is zoned for multifamily, I’m not selling it for much. I’m going to sell it to another investor. They’re going to be looking at like it’s a D-class neighborhood, and they don’t want it. I’m stuck. But if I’m going to sell it and it’s in a nice single-family neighborhood, maybe someone buys it who wants to house hack.

David:
Maybe the David Greene team is representing a buyer, and we find that house for our client. We say, “This is the one you want to buy. You’re going to be in the best neighborhood, and you’re going to rent out the other unit to someone else to reduce your income.” Now that person’s willing to pay extra to have that property. It’s worth more to them because of the income it brings in. That’s the way that I’m looking at it. I’m actually looking for deals just like you described, so I would highly encourage you to chase after those ones with more vigor than if it was a multifamily property that was not in a single-family neighborhood.

John:
Hi, David. I appreciate your haircut. Thank you for representing. My name’s [John Mark Burely 00:23:35]. I am currently running a roofing company with my brothers. My wife and I have a barn wedding venue, and we had a two-unit rental, first purchased back when I was 18 or 19. Had the option to buy it on land contract here in Michigan. Bought that thing, had it paid off pretty quickly. Recently got news that my job… Over a year ago, a year and a half ago, my job was going away. I managed 11 apartment complexes for a company, and they were selling the whole portfolio. So plan B came on the horizon. Got my two-unit with a wholesaler. Sold that thing, took all the cash, and bought a 12-unit complex. So I have this 12-unit complex. Lose the job, take on this roofing company with my brothers.

John:
It’s going good. I want to keep building the portfolio, the rental thing. I think that’s where to be. I have the opportunity right now to make offers. They’re both off market, but I’m in touch with the owners for a 32-unit apartment complex and then a 235-unit storage unit complex. Both looked like really good deals. One of them I used to manage for the prior company, and it was out of their geographic zone, so I contacted the owner. I said, “Hey, man, you guys want to offload that?” So I’m going to be paying more per door than what we sold it to them for likely. It’s 2021, the beginning of 2022, so market’s hot right now.

John:
I’m curious. Do I try to raise money from other folks to buy these new complexes and hold onto the 12-unit? Or should I sell the 12-unit and try to milk it for everything I can, and use that cash as down payment for these bigger-sized complexes? I don’t like being over-leveraged. I don’t like owing people who I know. That’s a nerve-racking feeling. I’ve just never been in that world, so I’m not familiar with it. And I’ve heard of and seen relationships go sour over money, so I don’t like to get money between friends. So I’m curious what your counsel would be. Is this something where, “Hey, man, leverage the happy investor culture that you’re in, and use other people’s money to make these purchases and then pay them back over time and be over-leveraged”? Or sell and move on, and kind of do it the slow, steady way? So I’m curious what your thoughts are. I appreciate your feedback. Thank you.

David:
All right, John. Your hair’s looking great as well. Soon as I saw your video, I thought, “Oh, looks like I’m looking into mirror.” Let’s see if I can break down the question you’ve got here. You mentioned that you left a job as a property manager, so I’m assuming that means you are capable of managing and analyzing a property. You started a business, a roofing company, so you have some income coming in from that. And that tells me that you are a problem solver, and you don’t need someone else to lay a path out for you, so I’m going to give you advice based on those things. That’s what I can tell from listening to your video. Your question is: Should I raise money from other people to buy the bigger unit that I want to buy? And you gave two examples of self-storage or an apartment. Or should I sell what I have and use that money to buy the bigger property?

David:
And then you mentioned some of the concerns you had, some of the emotions you were feeling, like you don’t want to raise money from other people. You don’t want relationships to go bad. Let me give you my perspective on capital raising. So I do it as well. I have the website investwithdavidgreene.com. People can go there if they want. They can invest with me. I take a different approach than most people do. The average… [inaudible 00:27:27] the average, but just the more common person that I see, much more common, is they say, “Hey, if you want to invest in real estate, you can invest in this deal. I’m going to buy this apartment complex, this self-storage. Look at the prospectus, look at the proforma. If you think it looks good, you make the decision to invest in it. And if it works out, you’re expected to get this return. But if it doesn’t work out, you’re going to lose your money.”

David:
And that has gotten along pretty well, because most real estate has been going up in value. So even if they make mistakes, it’s sort of covered by all the appreciation we’ve seen. This has been a good time to be lending money. I don’t love that, because it should be the operator’s skill that determines how well the investment goes, not the market just helping them because we’re seeing so much appreciation. When I let people lend money to me, when I borrow money, I’m not doing it by saying, “Look at the deal and see if you want to invest. Lender beware. You’re doing this at your own risk,” type of a thing. I understand most people that are investing with me don’t understand how real estate works. Otherwise, they’d probably be doing it themselves.

David:
They want the benefits of real estate. They see the strength of it. They like the safety of it, but they don’t know how to do it themselves. So they’re really not invest investing in the deal, they’re investing in David. So I have mine structured to where they get paid independent of how well the deal does. If somebody lends me money, they get their interest payment, and it’s not quarterly like most syndicators do. It’s every month. It just goes right into their bank account, as if they were getting direct deposit from a bank or interest from a bank, and it doesn’t matter how the deal does. And I do it like that because I don’t think that they’re investing in the deal.

David:
I think they’re investing in me and my word, and my word matters more to me than if a deal goes bad and I go, “Hey, sorry. I lost all your money.” You’re exactly right the relationship goes poorly, because in their mind, their expectation was they were investing in you, John. They weren’t investing in that deal. They don’t know how real estate works. So if you lose their money, they’re mad at you. They were trusting you. And I think this is important to recognize. Most people investing in real estate, I don’t think you’re investing in the deal. That’s the cop out the syndicator uses to be like, “Hey, don’t blame me. You knew what you were doing,” and that’s why I just don’t do that. My word matters too much. The platform I have here on BiggerPockets matters too much. I can’t default on debt. I just wouldn’t be able to sleep at night, and people would lose trust in me, which matters more to me than whatever wealth I could build by borrowing money and doing what other syndicators do.

David:
So this is my perspective on the advice that I am going to give you. That’s why I wanted to kind of put that out there. That’s also a bit of a pet peeve of mine that I think just raising money is so easy that people are doing it fast and loose. They’re not very good at what they do, they’re not very careful, and they’ve been getting away with it. But musical chairs is going to end at some point, and all those people that put their money in real estate are going to lose it, and then they’re going to blame real estate. And I hate that. I hate when people blame real estate, rather than blame the operator who screwed up or the decision they made that was unwise. For you, I would say there’s a way we can do this where you can do both.

David:
If your gut is telling you you don’t want to raise money, it sounds like you haven’t done it before, don’t do it on your first deal. Sell your 12-unit, then go buy the storage facility or the apartment, whatever you’re going to buy. Use your own money. Put a lot down, more than you normally would. That’s going to give you quite a bit of equity in that deal. After you’ve done that and it’s been stabilized, you’ve improved the rents, you’ve made more money with it, then go raise capital and say, “Hey, I’m not raising money to buy a deal. I’m raising money for a deal that I already bought. So I can secure your money with a lien on this property in second position,” which is probably the same thing they were going to get if you used it to buy it. But you’re not making them take all the risk of what if you screw up managing and operating the property. You’ve already shown, “I’m managing and operating it well.”

David:
So it’s less risky for them to give you the money after you’ve stabilized it. Now, many people hear this and go, “I never thought of that.” It’s because most people that are borrowing money and raising money to buy real estate don’t have any of their own, and it’s because they don’t have enough experience. They can’t do what I’m describing, because they don’t have the resources to do it, because they don’t have the track record. They’re trying to learn on the person’s dime who’s giving them the money, and that’s what I don’t like. It’s better if you do it the way that I’m saying. Once you raise the money, after it’s been stabilized, you’ve effectively paid yourself back. And this may sound unconventional, but it’s not shady. It’s not shifty. There’s nothing wrong with this. People do the same thing with the BRRRR strategy.

David:
They go, “What do you mean you’re going to refinance it after you already bought it? I thought you use a loan to buy?” Well, you do, but you could also use a loan after you buy it. It’s kind of the same process. This is the same thing that I’m describing. When you raise that money on the property you’ve already bought, so it’s safer for these people, then go buy another 12-unit or comparable to what you sold with the money that you’ve raised. Now you’ve got both. You didn’t have to give anything up. You also eliminated the risk for your investors, and you forced yourself to prove that you know what you’re doing before you raised money. That’s the way that I look at problems like this. I usually put the onus on myself to take risk off of other people’s plates instead of saying, “Well, here’s the risk. Make up your own mind if you want to do it.”

David:
So I’m hoping more people will raise money the way that I’m doing it, so that there’s less bad of a reputation that gets out in the real estate investing community. We haven’t had a lot of that right now, but I promise you if you were raising money in 2005, there’s a lot of people that lost money letting people borrow it in 2005. And they blame real estate, they don’t blame the operator. So let’s not do that. Let’s keep a solid relationship with real estate. Let’s invest our money with the right operators who have experience doing it, and let’s make sure that we’re not chasing after the highest returns ever, which is also exposing us to more and more risk.

Andrew:
Hey there, David Greene. Andrew Cushman here. I don’t have a question, but I just wanted to say great job on the Seeing Greene episodes. They’re awesome. I listen to every one of them, even though most of the questions don’t apply to me, simply because you do such a good job explaining things to people that by me listening to you do it, it helps me answer questions better when I get asked similar questions. So anyway, just want to let you know you’re doing an awesome job with those episodes. They’re great, and keep it up.

David:
Well, Andrew, I don’t know what to say other than thank you. That’s very sweet of you. It actually means quite a bit, because this is a nervous and scary position to be in. I don’t know what questions are coming at me. They could be anything related to real estate. I could look like a fool. It is a little nerve-racking, so the fact that you’re saying that means quite a bit. And that just goes to show Andrew’s character. He’s such a cool guy. Andrew’s a very good friend of mine, and I would encourage you guys to follow him as well as check out some of the episodes that he and I have done together. So Andrew is my multifamily investing partner. We’ve created a system of how we underwrite, analyze deals, and then pursue them, so the LAPS funnel. How we find leads, we analyze them, we pursue them, and then we have success.

David:
And if you would like to learn more about that, check out the show that we did with Andrew featured here. All right, we’ve had some great questions so far, and I want to thank everyone for submitting them. You can submit your question at biggerpockets.com/david, because we need them so we can make awesome shows like this. I wanted to play some feedback that we had from YouTube comments so that you guys can hear what some of the people have been saying on YouTube, and I also want to encourage you to head to YouTube and leave me some comments that I can see there. My producer wanted me to let you know that we’ll be seeing Andrew Cushman on the next episode of 586. Make sure you check out 571, episode number 571 on phase one of multifamily underwriting, and then tune in for phase two, which is where we go into it deeper.

David:
So Andrew is basically my partner, like how we just heard from John and he was describing how he wants to raise money. Well, Andrew and I do the same thing. We raise money from people, we go invest it into real estate and multifamily, and we have a screening process that we use to make sure we’re not buying the wrong properties. And Andrew’s my really, really good friend, and I trust him quite a bit. And we basically break down for you all: This is what our underwriting process looks like. These are the exact steps that we do. We actually, now at this stage, leverage those steps to other people that come work for us. They started as interns, and now they’re employees of the company, and that’s how systemized we are that other people can do this work. So if they were able to learn it, you are absolutely able to learn it yourself.

David:
So make sure you check out that episode. It’s going to be 586. And before you listen to episode 586, listen to episode 571, where we get into phase one. 586 is going to be phase two. All right, next comment comes from Dave H. “You asked for comments and feedback, and here it is. This series of detailed Q&A has been some of the best content for a newbie like me. Some of the questions are exactly what I would’ve asked. Other questions from more experienced investors got me thinking about things I hadn’t considered. Keep it coming.” Well, Dave H., thank you from Dave G. I will do my best to do that. Now, if I’m being fair, while I appreciate your compliment how good the show is, the show is only as good as the questions I get asked. If people don’t ask questions or they ask lame ones, I can’t really make a good answer out of that.

David:
So I want to give the attention here to the people who have been submitting their questions. Please keep doing that. Go to biggerpockets.com/david. Submit your question there. Make it as good as you can. I really love these consulting-type questions where you say, “I’ve got this asset and I’ve got this goal, and I’ve got these things working for me and these things working against me, and I can come up with a strategy.” It’s sort of like how Brandon and I would talk about how you got to have tools in your tool belt so that when different problems come along, you know what to do. I feel like the contractor with a tool belt full of tools, and I get to show you guys which tool that I take out based on what problems are being presented to me, and then everyone gets to learn. So please keep those coming, and also thank you for the kind words, Dave.

David:
Next comment, “I would like you guys to cover getting financing in an LLC and keeping away from your personal credit for investors looking to scale, but coming with that strategy, making your personal credit and your business credit worthy to get mortgages in your LLC’s name.” Okay, this comes from New Image Properties LLC. Please, come on here and ask us a question about what you’re trying to do. I would’ve to speculate to get into this now. I’d rather be able to have you on maybe on a live show, where you could tell us what you’re thinking. Based on what you’re saying here, my understanding is you look at it like an LLC has its own credit, and then you have your own credit, but most lenders don’t see it that way. They see an LLC as an entity.

David:
But you are the manager of that LLC, and as the one making decisions for that LLC, they’re going to look at your credit. Now, if you want to get a corporation, doesn’t have to be an LLC, but a corporation and use that business to buy property, you can, but you need to usually show a track record of that corporation making real estate payments. So we can talk about that more. If you want to submit your question, I’ll get into how that works. It’s something that I do myself. So I own C corporations and S corporations, and I can buy real estate in the name of the corporation, but only when I can show a track record that those corporations have owned real estate have been making the payments. That’s sort of how you develop credit for a corporation. But it doesn’t work the same as a FICO score, which is what most of us are used to when it comes to understanding how a company looks at credit, because that’s how they do it personally.

David:
Thank you for that, though. All right. Are these questions resonating with you? Have you also thought, “Man, I wish I could avoid having to use my own credit,” or, “I want to buy more properties in the name of an LLC, because it’s safer”? Have you wondered what you should do to scale faster? Well, if you have questions that are similar, please go to the comments and tell me what you’re thinking. Leave a comment below and let me know what you need to think about, and don’t forget to subscribe to this channel. So take a quick second while you’re listening, get your finger out, stretch it a little bit. Hit the like button and hit the share button, and tell somebody about this podcast, and then subscribe to it, because we want you to get notified every time one of these Seeing Greene episodes comes out.

Pedro:
Hi David, this is Pedro. It was great meeting you at the BPCON2021. I have a question regarding the BRRRR strategy. So currently I have a house hack in Long Beach, California, and I also have single-family BRRRR rental in the Kansas City market. I’m now looking to buy a fiveplex in Kansas City as well. For the single-family BRRRR, I did the rehab in a way that would put my property in a higher set of comps so I could get a higher ARV, therefore getting more money during the cash out refi process. However, I know that as I’m getting to the fiveplex space, I’m going to be relying on commercial lending, and therefore they’re going to be looking at the net operating income. Therefore, I know that in order to get a better appraisal, I need to either increase my rental income or decrease my expenses or do a combination of both. Therefore, I wanted to get your thoughts on what’s the best way to BRRRR a property that relies on commercial lending for the refi process. Thank you, and have a great day.

David:
All right, Pedro, thank you for that. I totally remember meeting you at BPCON. I believe we spoke a couple times, and you’re one of those people that has the “Whatever it takes, I’m going to get it done” attitude. So I love that. You also brought up a great point that I want to highlight here. When you’re using the BRRRR method, what you’re really doing is starting at the end and working backwards. What you’re trying to do is make a property worth as much as you can so that you can refinance it so that you can put a renter in there. And in order to do that, you have to rehab it. And in order to have that, you have to buy it. So even though we describe BRRRR and the steps you take, you actually start with the end in mind and develop a strategy backwards from there.

David:
Now, the common way we describe BRRRR is for residential property based on comparable sales, and the fastest way to improve the value of a residential property is to improve its condition, so the rehab is typically where that happens. But you bring up a very good point. If it’s a commercial property, they may be looking at comps, but they may be looking at the NOI, the net operating income, and they may be looking at some combination of the two. So what I would say is you need to talk to your lender before you do this. If it’s us, talk to us, if it’s another lender, talk to them. But guys, everybody who’s hearing this, please hear me say this. Pedro, I love that you’re asking the question. You’re just asking it to the wrong person.

David:
All you have to do is go to the bank or the lender or the broker or whoever that’s going to refinance it and say, “David, I want to refinance my five-unit property. How can I increase the value of it?” And then we’re going to look at the different people that we’re going to broker your loan to, and we’re going to say, “Well, this one’s going to use comparable sales, and this one’s going to use net operating income. Which one of those do you have the most control over?” And you would say, “Well, it’s already pretty nice. I don’t think I can improve the condition. And there’s no comps around that are actually going to be much higher than this one, so I could probably improve the net operating income by jacking up the rents.” We’d say, “Okay. If you could get the rents up to this amount, this is how much they borrow,” and then you have your strategy.

David:
And it might work the other way, where you can’t move up rents, but there’s a lot of comparables that are priced higher because you got to at a good price. Then you know how to move forward. So I’m using this as an example for everyone. When you want to BRRRR, start with knowing what’s going to affect the value. The lender who’s going to be doing the refinance is going to be the one who understands how that works. So you want to talk to your representative, whether it’s a direct lender or it’s a broker like us that finds you one. Ask them, “Hey, which way should I go,” and then develop your strategy based off of what they’ve said. If you don’t like what they say, well then look for another loan officer, another lender, another whatever person that’s going to finance this, and create a different strategy. But someone like you, Pedro, who’s got the attitude you have, I have zero doubts you’re going to make it work. Just find the right lender, talk to them, and they’ll set you straight.

Dominic:
Hey, David. Thank you so much for taking my question. I currently do not have any rental properties and I’m looking to get my first unit, which is going to be a two to four-unit small multifamily. I want to use either a NACA loan, which Tony Robinson talked about on the recent Rookie Reply podcast, or an FHA loan. And from there, what I want to do is add value to it, kind of BRRRR, but I don’t want to take my money back out. I always want to transfer the loan from either a NACO or an FHA to a conventional, so that way I don’t have to have the owner occupancy restrictions of those loans over my head, and have a little bit more flexibility with it.

Dominic:
So I guess my question for you is this. I know what I just said, it’s simple in nature, but it’s not going to be easy. But because it seems so simple, I feel like I’m missing something. My specific question is am I off-base here? Am I missing something? And I guess my follow-up question would be how do you navigate real estate knowing that there’s a lot of simple concepts that are very powerful, even though they’re not going to be easy in practicality? How do you know that you’re still on the right track and not oversimplifying something? Hopefully that makes sense. Thank you so much, David.

David:
All right. Thank you, Dominic. I really like this question. Here’s where I want to start. Most of the strategies that you hear described on how to scale with real estate, if you really think about it, almost all of them are based on the financing of real estate. The BRRRR strategy and everything that’s involved is all about how you get your capital back out based on the fact that financing is in your benefit. If the property’s worth more, you can refinance it. You’re just capitalizing on the power of a refinance. House hacking is capitalizing on the power of a primary residence loan to buy property that will still generate income. Most strategies you hear about are based on financing. So you’re asking the right question, because you’re talking about financing.

David:
Now, what you said was “I want to use an FHA loan,” or I believe you said a NACA loan, “to get into a house, but then I want to refinance it into a different loan so that I can use that FHA loan again to buy the next property.” So let’s start with that. There’s several kinds of loans, but I just want to give a broad overview of what you’re looking at. You’ve got government loans and then you’ve got non-government loans. Government loans are typically VA, USDA, FHA, and then just conventional. And when you hear us say Fannie Mae or Freddie Mac, what we’re describing when we say that are companies that sort of ensure loans that… These companies have partnered with the government so that once they give you the loan, Fannie Mae or Freddie Mac will buy it from whoever gave it to you so that that company gets more money. They can go give another loan out. That’s how that works.

David:
And they have tighter guidelines for those loans than they do for non-government loans, but you typically get a benefit. An FHA loan is a very low down payment with the very low credit score. A VA loan available to veterans could be no down payment and no PMI. The Fannie Mae Freddie Mac loans typically have the best interest rates. That’s the benefit of those loans. But then you get into the space where you don’t qualify those anymore, and you’ve got jumbo loans, you have nonconforming loans, you have debt-service coverage ratio. You’ve got all these different types of options. And then I guess the third one could be credit unions and savings and loans institutions, typically what we call portfolio loans. So that’s banks or lending institutions that lend and keep the deal on their own books. They don’t go sell it to anyone else. So when it comes to your specific situation, you’re asking, “If it’s that simple, why isn’t it easy?”

David:
It could be easy. If you bought a house with an FHA loan, you put 3.5% down, and you wanted to refinance out of that so that you could use another FHA loan, that wouldn’t be too hard. There’s conventional loans that you could refinance into where you put 5% down. So let’s say you buy a $500,000 house, and you put down 3.5%. So that would be $17,500, and then you want to refinance into a conventional loan that needs 5% down. Well, that would be 25,000. As long as you have $25,000 of equity in that deal, plus enough to cover your closing costs, you can do that. So you walked in with 17,500. If you gain another 20 or 30,000 in the year, you would have enough at that point to refinance into a conventional loan. You could buy another house with an FHA loan. But you might not have to.

David:
FHA loans are not the only loans you can use to buy a primary residence. There are conventional loans with 5% down. Now, right now, they’re not able to used for multifamily, in most cases. Those are for single-family residentials, because the government guidelines shift a little bit, but still, you can just buy another single-family house with another 5% down loan the next year and not even have to worry about refinancing. Then the year after that, you can do the same thing again. That strategy is simple and easy. And that is why I say every single listener of this podcast, every single real estate investor, assuming they can manage a property or pay someone else to do it and have the funds to do it, should buy a primary residence every year and house hack it.

David:
You should go in for 3.5% to 5% down. You buy in the best neighborhood, the best area that you can. You live there. You rent out parts of the home to other people. There’s tons of ways to do it. You do it with a duplex and a triplex and a fourplex. You do it with a basement. You do it with an ADU. You do it with two houses on one lot. You rent out the rooms of the house. You buy the house, you put up some walls, and you make it into separate spaces. There’s lots of ways you can do that, but it is simple and it is relatively easy. It’s just not convenient to have to share your house or share your space or whatever, but there’s ways of doing it that you don’t have to share the space. I house hack, and I don’t have to share the space.

David:
I just take a portion of the property, I wall it off. I make sure it has its own bathroom and its own little kitchen area and its own bedroom and that it has a separate entrance, and I never would ever have to see those tenants. And I can do that any time I want, so I know everybody else can do it too. Everything in addition to that is what gets a little more complicated. That’s when you’re chasing after really good deals with tons of equity where there’s a big rehab. That’s where it becomes a little more complicated and not easy. But Dominic, just start with what I said. Buy a house every year and house hack it. And then in addition to that, if you want to buy out of state, if you want to do the BRRRR method, if you want to buy commercial property, you have all these options that will become known to you that you don’t have to jump into right away.

David:
Just do those in addition to the meat and potatoes that I described. And if you do it the way I’m saying, it won’t be hard. It won’t be complicated. It won’t be as risky. You’ll be paying yourself instead of a landlord. You’ll benefit in so many ways. This the best strategy. Everyone should be doing it, and everything else in my opinion should just be considered supplemental. All right, I want to thank all of the people who called in or who left a video message for me today. I appreciate you. We got some really good stuff. We got to hear from Dominic there, who had a question about “This real estate thing seems like it should be harder than a really is. Am I missing something?” We had John, who’s trying to figure out if he should raise money or if he should sell a property and buy something else.

David:
We had several other people that came in here, and they had questions that I thought were really, really good that I hope as you listen to it, you both learned something and you had your eyes opened to how you can make a strategy work. The goal of this is not to overwhelm you with information. It’s to equip you with the information that you need to take action, start buying real estate, and start building wealth. I am really, really glad I get to be the person who walks through this with you, who gets to experience this with you, and who gets to teach you, a lot of the time from my mistakes, in what I think you should do. If you’d like to reach out to me, I’m @DavidGreene24 on all social media. Send me a DM. We can talk about loans. We can talk about real estate representation. We can talk about consulting. We can talk about a lot of the other stuff that I have going on that might be able help you.

David:
And if you’re not on social media, just send me a message through BiggerPockets. I check that. I have one of my team members check that sometimes. We want to make sure that we get in touch with you, because helping you build wealth is what BiggerPockets is all about. Please consider sharing this show with anybody else that you know that’s into real estate and might have fears about it. The more that they know, the less that they will worry. And make sure you leave me a comment on YouTube, and tell me what do you think about this show and what would you like to see more of. And then lastly, I want to talk to you, so go to biggerpockets.com/david and submit your video questions so you can be on the podcast. I can help you, and all of our other listeners can benefit as well. Thank you very much for listening. If you’ve got some time, please check out another one of our videos or podcasts, and I will see you on the next one.