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Dave:
Hey, everyone. Welcome to On the Market. I’m your host, Dave Meyer, joined today by James, Kathy, and Henry. And today, we are going to be talking about the biggest mistakes that each of us made in 2023, at least so far. I guess we still have a couple of months to make even more and make mistakes, but at least I don’t know about you guys, I’ve got plenty of mistakes to fill out this show with.
We could have a very long episode today, but let’s just start. Before we get into each of your individual mistakes, I’d love to just know what mistakes you’re hearing about right now. Henry, I know you work with a lot of students. You coach a lot of people. Are there any common mistakes or threads that you’re hearing from about the current investing market?

Henry:
Yeah, I think one of the most common mistakes people are making right now is not factoring in enough holding costs, because the cost of money is so high, and so people are budgeting. They are budgeting for their holding costs when they’re doing the flip, but then it may end up that they have to take out loans at a higher interest rate than expected, and then holding the properties for longer than expected.
It’s much more costly now the longer you take to finish a project. And I think people aren’t being conservative enough when factoring in the holding costs.

Dave:
Well, I think that’s probably going to be a theme. That’s actually a similar thing I was going to say. But Kathy, are you seeing any common errors that you think our audience should be trying to avoid?

Kathy:
I mean, the big errors I’ve seen over the years over and over again is people for buy and hold buying properties that look really good online, look cheap. They trust the agent. They don’t get the appraisals and the inspections and get the third party people to verify that the properties in a good area and that it really will perform the way that they want it to and the way it says on paper.
So it’s basically don’t trust the pro forma, what’s on paper. You always have to find out the reality of it. So not putting in the pro forma an assumption that rents are going to continue to rise. We just don’t know that. We don’t know that prices are going to continue to rise. The property just needs to make sense right now and be able to do the pro forma if things went well, stress test it, or if rent went down, could you still handle it?

Dave:
Have you heard this advice that people are saying? It doesn’t have to cashflow in year one because rents will go up. And yeah, two years ago that made a lot of sense. But I think another common mistake is thinking that rents are necessarily going to keep going up. They could, I don’t know. But if you’re counting on that to make your deal work, that’s a little bit risky.

Kathy:
Yeah, I think I do say that kind of, so I will defend myself here.

Dave:
Okay.

Kathy:
And that is that your costs are the highest in your first year. You’ve got acquisition costs, your closing costs. So if you’re just looking at your year one pro forma, it’s not going to look very good. So just be careful of that.

Dave:
I just mean your run rate. If your run rate isn’t looking good and you’re going to be down not counting those one time costs that occur in your first year, then perhaps look elsewhere.

Kathy:
Yeah, we just don’t know. We know that we had massive rent growth, and maybe it’s just going to stabilize for a while. Some of that rent growth was, what, 20% in one year of rents going up, so we should count that as rent growth for the next five years, honestly.

Dave:
Totally, yeah, yeah. What about you, James? Any common mistakes you’re seeing?

James:
Just the abuse of debt and really setting up the deal correctly. It doesn’t matter if it’s hard money, town home financing. Any type of debt out there is substantially more expensive, which is slowing things down. What we’re seeing is people are getting a little bit of trouble. Just like Henry said, these deals take a lot longer and they haven’t adjusted their pro forma to account for those extra hold times. I mean, your typical house two years ago would sell in three days. Now it can take 30, and that debt racks up.
It costs more money. In conjunction with that, people still are going in and they’re only buying because they want to get the deal done, and then they’re not setting their exit strategies. I’m seeing some people get into trouble because they close with a development loan. They’re planning on refinancing the property rate and term, and then they didn’t really understand the commercial debt side.
And they’re having to bring a lot more money in because the loan to values have shifted so much with the debt ratio coverage, and then they’re running out of liquidity. And so I feel like people are getting their liquidity locked up and getting stuck in very high payments and it can be very disastrous.

Dave:
All right. Well, those are some good common mistakes that we’re seeing right now that everyone listening should obviously try to avoid. And after this quick break, we’re going to get into the maybe uncommon mistakes that all four of us have made this year. So we’ll be right back. James, let’s hear about your mistakes. I feel like you take a lot of big swings every year. You’re comfortable taking some risks. So does that come with making a few mistakes?

James:
Well, the first thing, one of my first mistakes I think I’ve made this year is I didn’t buy enough in the beginning of the year. The market was in this overcorrection mode for a second where we’ve seen pricing jump up since the beginning of the year, probably another 5% on a rebound, not in growth, but rebounding back.
There was some no-brainer deals where you’re looking at them and you’re like, “No matter what, this is a good buy,” But we did a pass because we had so much stuff going on. They were like, hey, this is the smarter thing to do. But really the smarter thing to do is to make a bunch of money. So it’s like buy the deal no matter what and figure it out.

Dave:
Before you go on though, James, when you didn’t buy more deals, is it because you felt like you had too much risk already out there, too much money in the market and you were uncertain about it, or you didn’t have the capacity to handle it?

James:
There’s numerous reasons why we didn’t. Part of it is every time the market changes, we feel we have to rebuild our businesses and our systems at that point, like how we’re doing our renovation plans, what kind of contractors we’re bringing in, how we’re going to issue permits, what kind of staff do we want on, and how we’re implementing the plan needs to be different today than it was two years ago because it’s a completely different market. Even though the market’s still healthy, inventory is low, it’s still different, right?
Cost of money’s way up, so it makes more sense for us to bring in more higher caliber contractors and pay them a lot more because the debt will trade off. And so what it does is we’ve been rebuilding all of our construction teams, our development team. We actually brought everybody in-house so we can keep speed going. So it’s a lot of moving chess pieces around to get you going for that next market. That was one of the pauses we did. The other pause that we did is we have a lot of stuff.
We’re building 80 town homes right now. We have $20 million in flips going, which are…They’re just bigger projects. And so we wanted to get through the inventory. But as you get through your inventory, you’re not going to make what you when you bought it 12 months ago. Your performance is not going to hit the way you thought because the market has changed. And that’s just part of real estate and investing. But the best way to offset that sometimes, if you’re a no-brainer deal, you should still buy it and figure out how to…
Rather than pass or sell it off, it’s like still figure out how to collect that revenue even if it’s a simple plan. So we could have done some very simple things and still made some pretty good money, but we took that pause. Now, the pause was good because it let us reset, but we probably left a quarter million bucks at least on the table.

Dave:
Yeah. All right, good. Thank you for explaining that. That makes sense. But obviously in retrospect, it hurts a little bit. Let’s hear about this mistake.

James:
One of the biggest mistakes that I’m dealing with right now… It’s funny because people are like, “You’re dealing with that? You do so many projects.” It just happens. We are flipping a very expensive home. We have a loan for $1.8 million on it. It’s worth four and a half million. We have a great buy on it. We went through a substantial, huge renovation where we put in about a million bucks into this property, or it’s about 800 right now. Rebuilt the whole thing. It took us about 18 months to get permits, get it built through.
Actually it took us about 20 months to get the tenants out, get the permits, and rebuild it through. We’re coming to final. And one thing that we had been talking to the city about was they’re like, “Oh, hey, when you go to get your landscaping permit, just pull clear and grade. We’ll be all good.” That’s an over the counter permit typically. So during this 18 months, we could have pulled this permit at any given time. But as you’re going, you’re buying deals, you’re moving forward, you’re working on the project, you’re focused on the house and getting it stabilized.
We’re done with the house, and we go to pull our clearing and grading permit. It turns out when we already knew there were some wetlands on the property and we have to go through a formal CIPA checklist for this landscaping plan.

Dave:
Oh no.

James:
We’ve been sitting on this deal for seven months, paying $18,000 a month as we’re waiting for approval and the house is completely done. And not only that, we don’t want to sell it because part of the huge value of this property, it’s on two and a half acres in Downtown Bellevue, which is very hard to find. So it’s very exclusive, but we can’t do anything until we get this permit. There were so many things that triggered based on that.
Even though we had been talking to the city and they said, “Everything’s going to be fine. Everything’s going to be fine. Don’t worry about it,” then they changed their mind and they can do that sometimes. So the best thing to do is just lock down your permits and your game plan immediately, and we waited too long. And as of right now, if I hit the 10-month mark, which I’m probably going to hit, that’s $180,000 that cost me. When we bought the deal, we were on an 8% loan. Rates have gone up and now we’re on an 11.5% loan.
So we’re just eating that cost. And what that comes down to is just always… Even if you think it’s not a big deal, just put the plan in motion, get it checked off, and then move on. Because we’re literally finaled on our electrical, our plumbing, our building, everything, we just can’t get a landscaping permit.

Kathy:
Unbelievable.

Henry:
That hurts. That hurts.

James:
It hurts. What a waste of money.

Dave:
Do you normally just pull all your permits right at the top? Or how do you avoid that in the future?

James:
What you should do, because we knew it was a big lot, a lot of times you don’t think to pull a clearing and grading permit, but because we were clearing out two and a half acres… And we weren’t grading the whole thing. It was because we should have looked into the code more, and I would’ve done it a little bit differently. So you need a clearing and grading permit in the specific city once you clear more than 5,000 square feet. And that’s not like with a tractor. That’s just clearing out shrubs.
And because we thought we were just removing sticker bushes but not touching the soil, it was going to all be good, which in the code it says that’s okay, unless you do more than 5,000 square feet. Well, we have an 80,000 square foot lot. And honestly, because of the 18 months, the sticker bushes kept growing. If we would’ve kept maintaining it throughout the whole project, it probably wouldn’t have been a big deal either.
But why spend money maintaining it when you’re going to rip it all out, throw 100 grand in the landscaping anyways? And so it’s just one of those things where you coulda, woulda, shoulda. It would’ve been very easy to put it into our plan. We just didn’t, and now we got to pay the piper on it.

Dave:
That hurts. Sorry to hear that, man.

Kathy:
Yeah, that’s just another day in California, right? That’s just how it works here. That’s why flipping in California terrifies me.

Dave:
You just expect a 10-month wait.

Kathy:
Yeah.

James:
But you know what? It’s my fault. It’s my fault. And you got to own your own mistakes as an investor, and that’s just the way it goes sometimes. It sucks, but the good thing is we’re going to get through the project. We’re going to sell it. We’re going to make a little bit of money or get our money back, and then we’ll go do it again.

Dave:
Well, that’s a good attitude to have, and luckily you have 180 grand to lose. In the deal, I mean. There’s so much equity in it. Not you personally. But if you could still lose 180 grand in potential profit and still even break even, it shows that you had a great buy on that deal.

James:
A great buy, but I mean, think about what you can do. You can go buy another house with 180 grand.

Henry:
You can buy a couple in Arkansas.

Dave:
Oh yeah. Let it go, man.

James:
You could be making a high interest rate loan. You could be buying a deal. What a waste of time and money. Again, sometimes the plan goes bad.

Dave:
All right. Well, thank you for sharing that one with us. Henry, what’s your biggest mistake of 2023?

Henry:
Oh man, my biggest mistake of 2023, so I just closed the deal where… This was my first flip where I lost money.

Dave:
How many flips have you done before you lost money on one?

Henry:
A couple hundred.

Dave:
Oh, okay. That’s an excellent win percentage.

Henry:
I got pretty close to losing money earlier in the year, but actually when I did the math, I made like $8. I still counted that one as positive.

Dave:
Just don’t count the rate of return on that one. You made money.

James:
As long as you’re in the green, it’s all good.

Henry:
Green is green, my man. Green is green.

Kathy:
Just lost time.

Dave:
What was your hourly rate on that deal?

Henry:
But this one, so this is a house I bought. It was in a more rural part of town, but it was on three acres. It was a good deal, man. I paid 180 for it and ARV was 350 to 375. Needed about a 70,000 to $80,000 renovation. And so I bought it thinking and understanding I had multiple exits. So a lot of things factored into what made this a mistake. It was a good deal. I bought a good deal. It wasn’t that I bought a bad deal, but it was a case of I grew too quickly.
And so during the time after I bought that, I ended up having to hire a project manager because we were buying so many deals at the time and working on so many projects. It’s not like I had this established project manager process in place. I was coming to train this guy, and he’s fantastic. He’s doing a great job. But the timing of it was just not great because the holding costs were expensive. I mean, we had owned it for four months before we even looked at what are we going to do with this thing?
Are we going to go ahead and do this renovation or are we not? Because we had so many other projects that needed to get done. So by the time we got around to figuring out what we’re going to do with this project, I just decided to go ahead and stick it on the MLS and try to whole tail it. And I tried that and I couldn’t get a bite. So the mistake with the property was the layout just seemed difficult for most investors.
So in order to make this one work, you were going to have to essentially create a hallway in the middle of what’s an existing bedroom, because you got to essentially walk through one bedroom to get to another and a bathroom to get to another. So the layout was just funky. And so if you’re going to flip that, you got to fix that. And me, that’s not a problem to me. I’ll just fix it. I’m optimistic enough to know we can go and we can fix that, but a lot of investors just didn’t have that vision.
They didn’t want to deal with that problem. And so when I stuck it on the market, it was hard for me to find somebody from an investment standpoint that wanted to solve that problem. We ended up selling it on market to an owner occupied who’s going to live in it and fix it over time, but we sold it at a pretty significant discount. Everybody else made money. My agent made money. My money lender made money. Everybody involved made money. I was the only one that didn’t make any money, but it was more of a conscious choice.
I just wanted to stop the bleeding of the high interest, sell the property, get done so I can move on to the things that I know are working and are going to generate the income that I want, plus the opportunity cost of what I can do now that I don’t have that sitting over my head ahead. I could have done the renovation myself and spent the 70 and then sold the property for a higher amount, but it would’ve took me another four or five months, maybe six with everything else I have going on.
Just doing the math of that monthly payment and I said, you know what? Let’s just go ahead, call it. I think I ended up losing about 11 grand, so it wasn’t the end of the world. Call it and move on. So everybody else made money. So it was good for everybody, just not me, but a case of growing too fast and the market conditions. And if I had it to do again, I probably still would’ve bought the property and just made sure I got to it sooner and probably just managed that one myself, because it was a great opportunity. I got too busy.

Dave:
I mean, that’s sort of what happens. I guess since this is the first one you lost money on, this might not apply, but when you do the volume of deals that you and James both do, do you give yourself an allowance knowing I’m going to take a lot of swings this year, and if I miss on two of them, it’s okay. Do you think that way, or does it really hurt? I guess I’ll ask you, James, since you’ve lost probably money on more than just one deal.

James:
Definitely more than one deal. I’m a 2008 get your butt kicked investor. I always have that kind of little bit… I call them battle scars. That you’re just like you kind of remember that things can go wrong really quickly. I always tell people, if you buy 10 deals and you’re really good at this, you’re most likely going to lose money on two of them. Three if you’re going to get pretty average, or maybe be duds. Two are going to go a little bit better than average and you’re going to hit a couple two.
Two are going to crush, and that’s if you’re good at it. And that’s just the law of statistic. I mean, that’s just statistical averages. It’s going to happen. You’re in a high risk environment. It’s going to go great, it’s going to go bad, and you want to blend it together.

Dave:
Well, Henry, I appreciate for your first loss. You’ve got a pretty good attitude about it.

James:
Your batting average is pretty good, Henry.

Dave:
Yeah, yeah, you’d be in the hall of fame.

Henry:
I mean, the expectation is you’re going to lose some, right? I don’t expect to never lose money. I’m really fortunate that it hasn’t happened before. I’m fortunate that even though I lost money, nobody else did. My investors got paid. Everybody got paid, and that makes me feel good. I’m okay losing some money. I don’t want to have anybody else ever have to lose money because of a deal I’m doing.
And so we didn’t have to do this. All in all it’s like a win for me because now I’ve moved on and I’m making money on other deals. But it wasn’t fun having to bring a check to closing on a deal I’m selling. That wasn’t a good feeling.

Dave:
Yeah, that’s probably a weird feeling.

James:
I got to give Henry some props on this because I was actually, turns out, I was the lender on this deal.

Kathy:
And you made money.

James:
I made money. That’s why I love private money lending. It’s less work. But at the same time, as a borrower or an operator, I didn’t even hear about this. Henry borrowed the money. He had to step to the plate, do what he needed to do, move on. That’s a good operator. So hats off to you, Henry, because I never even heard about this.

Henry:
Thank you. I need you to give me more money, so that’s why I didn’t want…

Dave:
Pretend you didn’t hear any of this, James.

Henry:
But in all seriousness, that’s a phenomenal… I tell my students this all the time. I’m like, if you’re going to borrow money, guys, you got to make your investors whole no matter what. No matter what. You’re going to have to bite some bullets sometimes if you get yourself into a sticky situation. But if you want to grow in this business, man, you got to make your investors whole, period, point-blank. That is the most important part. You eat last, man. That’s just always how it’s going to be as an operator.

Dave:
Absolutely. Well, Kathy, as someone who raises a lot of money from investors, what is your biggest mistake in 2023?

Kathy:
Well, in 2023, it’s been a good year. Like James, I would say my biggest mistake was not raising more money for our single family rental fund, it’s coming to an end, and buying more because it has been phenomenal. We just have not had competition. We’re the only people at the table so often. The only one the wholesalers call and our deals have been phenomenal.

Dave:
That’s great.

Kathy:
That’s the positive side. But the issues that I’m dealing with in 2023 come from decisions I made a decade ago when I didn’t know the things that I know today and the reason why I love to teach and share so that other people don’t make these mistakes. Back then, I was, like Henry was saying, growing too fast, had too many opportunities, too much money being thrown at me.
And I would get excited about cool things. And one of the projects that came to me, things like a wine village, something that a lender doesn’t know what that is. Basically it was just commercial property where wineries would lease from you and have tasting rooms and so forth because they only need a small space.

Dave:
I mean, a wine village sounds pretty cool.

Kathy:
It’s very cool, and it’s in California. And it’s in a part of California that doesn’t have this. It was outside of Napa, on the way to Shasta. All of it looked great. The pro forma looked great, but what we discovered is that lenders didn’t understand it well enough, so we had trouble getting the financing. So the big lesson… Okay, that’s one, but I learned that years ago. But this year the thing I learned is that in some of these syndications, the way I would structure it, and I know the way that other people structure it, is different layers of lender.
And we’ve been talking about lending. Some will be a bank loan, some might be private equity, some might be where you have a syndication. You have an LLC and you bring in one kind of investor who’s on the equity side, and then you can bring in another investor that gets a lower rate because they’re coming in as a lender. And that tends to be you get paid first as a lender. So I would structure these because a lot of people investing in their IRAs… I’m going to get a little technical here, but it’s important for people to understand this.
If you invest in your IRA, you take your IRA money and you invest in somebody’s syndication, somebody’s apartment deal or a wine village, and you are equity, meaning you’re a part owner of it, you get what’s left after everybody else gets paid. Well, in your IRA, it’s considered investing in a business. It was an operational business. If you’re building homes and selling them, that’s an operational business versus an apartment that’s more passive. You get UBIT, unrelated business income tax, within your IRA, and that could be like 50%.
So that’s a big shock, but it doesn’t happen if you’re passive. So I would bring investors into a deal that was… They could come in as a lender, but then they’ll also be equity investors. Well, if the deal goes bad, and I have one from 10 years ago that did, which a lot of people say, “No one can lose money in real estate over the past decade,” but you know what? You can when you invest in things that are different and weird and shiny objects and so forth. So in this LLC, we had lenders and equity investors.
Now what I’m learning is if there’s losses and you can’t pay everybody back and you can’t pay the full amount of the loan, the equity investors pay loan forgiveness tax. In addition to losing their money, they pay tax on the loan forgiveness, the part of the loan they didn’t pay. So here I’ve got two groups of investors. It’s just complicated. So again, before you ever do any syndication, always make sure you’ve spoken to your CPA and they truly understand the position that you’re in and what the tax consequences would be.
But I’m concerned that a lot of people in these multifamily deals where there was like 10% equity and then there was like 10% that was a bridge loan and then the bank loan, well, those equity investors, if there’s losses, they’re also paying debt forgiveness on the part of the loan they didn’t pay. So I think there’s going to be a lot of investors out there shocked that not only did they lose their money, but now they pay tax. Hopefully the losses offset.
But if the loan is massive, and I didn’t do any of these multifamily deals, I’m just saying for those who did, if they leveraged up to 90%, which again I would never do on multi. My mentor was like, don’t leverage over 60%. He was conservative, but that’s why I didn’t do any deals. Going to 90%, let’s say… You’ve seen some of these deals that have gone bad where 20% is lost. Now those equity investors pay. They’re paying taxes on top of losing their money.

Dave:
It’s just kicking someone while they’re down. That’s just rude.

Kathy:
I don’t get it, but the IRS looks like it. Well, you took this money to do this deal. So if you’re not having to pay that money back, that’s income. That’s how they see it. I hope that wasn’t way over complicated.

Dave:
No.

Henry:
You explained that well.

Dave:
That sounds terrible, but I’m still focused… Can we go to the wine village? Does this exist?

Kathy:
So we never could get the financing on it, so no. We’re just trying to sell it now is land with all the entitlements. And if anybody out there wants a wine village, it’s ready to be built. We just couldn’t get the financing. It’s a cool project.

Dave:
I want to visit a wine village. I’m not sure I want to build one.

Kathy:
There’s some really good ones. We were modeling it after some in Washington, actually. I don’t know. James, do you know of any wine villages because there’s been successful ones in Washington State?

James:
Are they in Yakima probably or Chelan?

Kathy:
Isn’t there a wine area of Washington? I think it’s there.

James:
Yeah, Yakima has gotten pretty nice wineries now down there, but I don’t do wine. I don’t even drink.

Henry:
You need a rockstar village.

James:
You repurpose it to a rockstar village.

Kathy:
A rockstar village. These ones in Washington are killing it because you’re just leasing a tiny little space. Because they’re not making the wine there, they’re just tasting it. They make their wine elsewhere. But all these wonderful wineries that are hidden out in the hills, nobody’s going to go visit.
The wineries could come and have little tasting rooms in areas where there are people and they’ll pay a lot because then it’s direct to consumer versus having… They pay like 50% to go through a wholesaler. They were willing to pay a lot more to rent the space. So the numbers looked fantastic. Just you have to build it to make it work.

James:
It sounds like a cool concept.

Kathy:
It’s permitted. Anybody got money, let’s build it.

Dave:
Well, for my biggest mistake, I guess my biggest investing mistake for this year, because there have been plenty of other ones, is probably something that everyone here identifies with, but it was not firing someone as soon as I should and just waiting too long, even though I knew I had to, but I was being lazy about it. And it’s going to cost me a whole lot of money. I have a short-term rental. Most of the deals I buy now are passive. So I still operate a couple of deals in Colorado, and I have this short-term rental that I hired a full service property manager for when I moved to Europe.
And they’ve just been bad since the beginning. And every couple of months, you probably get this, you get on them, they start doing well for a couple months, and then it slacks off again. And it goes up again and it goes off again. And I just waited for so long. And finally it got to the point where we were getting really bad reviews. There were some issues with the property that really needed physical rebuilding, and so we figured that. I came to the conclusion that I just finally had to pull the bandaid off, but it was right at the beginning of the summer in Colorado, which is the busiest season.
And so I lost all of my bookings for June, July, and August, which was probably 10 or 15 grand. And then I also lost all of my reviews, which when you think about all the money you lose from losing 50 or 60 good reviews, all the lost bookings for the last year. So if I had just done it in a smart way, Colorado where the short-term rental is, there’s like a mud season, I could have just done it from March to May and it would’ve been completely fine. But I was lazy about it and now I’m licking my wounds a little bit.
So that one hurts. And I think probably relatable to everyone, because whether it’s a property manager or a contractor, sometimes you just delay that inevitable, uncomfortable situation that you know you got to get yourself through.

Kathy:
Hire slowly, fire quickly.

Henry:
It’s easier said than done, man.

Kathy:
Yeah, it is.

Dave:
I know. Living so far away, I didn’t really want to figure it out, to be honest. I just wanted them to do a good job and they didn’t. But it’s okay. Like you said, you get a lot of good years. Sometimes you miss for a little bit. But as long as you’re trending upward over time, it’s good.

James:
That’s interesting to me. So when you hire a short-term rental property management company and it’s your property, they own the reviews technically?

Dave:
They did on this one, yeah. The new one I’ve figured out a way to not do it, but I did not realize how they had structured it the first time around. So that really sucked.

James:
It’s like kind of golden handcuffs because you don’t want to leave it.

Henry:
That’s terrible.

Dave:
Yeah, exactly. Exactly.

Kathy:
Yeah, that’s interesting because when I hired a property manager for my first out of state short-term rental, I thought they were going to handle it all and they said, “No, no, no. It should still be under your name and your Airbnb.” And I ended up firing them before we even started because they were terrible.

Dave:
Really?

Kathy:
Yeah, yeah. When they’re not answering your messages right away at the beginning of a relationship, this is problematic. And then I was so glad that I got… Oh, that’s why you’re supposed to keep it in your own account for this reason, but I didn’t know it at the time. It was just luck.

Dave:
Yeah, it’s an important lesson. And now I’m offering discounts to people I know or giving it away just so I can get some reviews. So if anyone wants to go to ski in Colorado, hit me up on Instagram. I got a very nice house. You could go visit this winter, or we can all go. You guys want to go?

James:
I will happily go check out your pad.

Kathy:
Yeah, let’s have a reunion.

Dave:
There’s no one there.

Kathy:
We’ll just trash it.

Dave:
Honestly, it’s like a 16 person house in a party town, so it gets some wear and tear for sure.

Kathy:
Perfect.

Dave:
It wouldn’t be the first time I’ve trashed it, at least. That’s for sure.

James:
Well, I’ll be in Vail for Thanksgiving, so I think we should all just go to your place for Thanksgiving dinner and have an OTM Thanksgiving proper. Henry, you cook the turkey and let’s just go.

Dave:
I’m going to be on my honeymoon. I’m going to be on my honeymoon Thanksgiving.

Kathy:
Well, we’ll just join you there then.

Dave:
You guys can go. Yeah, You guys want to come to Thailand?

Henry:
Oh, I would love to go to Thailand.

Kathy:
Where are you going?

Dave:
We’re going to Cambodia and Thailand.

Henry:
So jealous.

Dave:
I’m very excited.

Kathy:
Yeah.

Dave:
It’s going to be very nice. But you guys can have the house. You can cook your turkey there.

Kathy:
Henry’s cooking.

Dave:
All right, well, thank you all so much for sharing your mistakes. I think this is an important part of real estate investing that I think we do a decent job sharing our mistakes on this show. We’re probably going to do some more of this because today was our mistakes with investing, but we’re going to have to come clean about some of our predictions for 2023 at some point too. There will be some admissions of mistakes definitely I think on all of our parts. I know I have a couple that are haunting me, so stay tuned for that.

Kathy:
It’s not the end of the year yet.

Dave:
Yes, that’s true. We will see what happens, but we will also have a reckoning before the end of the year for that as well. If you want to learn more about our wonderful hosts here, James, if anyone wants to talk to you about losing 180 grand, where should they do that?

James:
Best way to figure out how to lose money is go to my Instagram at [crosstalk 00:32:10] jamesdavid.com. I got lots of stories for you.

Dave:
All right, Kathy, what about you?

Kathy:
At RealWealth.com is our company, and then Kathy Fettke on Instagram.

Dave:
All right. Henry?

Henry:
Yeah, you can catch me at my website, seeyouattheclosingtable.com, or Instagram. I’m @thehenrywashington.

Dave:
All right. And if you want to find me, you can do that on Instagram @TheDataDeli. Thank you all so much for listening. We’ll see you next time. On The Market was created by me, Dave Meyer and Caitlin Bennett. The show is produced by Caitlin Bennett, with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.

David:
This is the BiggerPockets Podcast, 837.

Kevin:
My real estate point of view is if I buy a place for 500K and I’m into it for 5 with fix up, I want $100,000 of equity. That’s my goal. Which percentage wise is 20%. So now if I look at investing a million dollars, I want $200,000. I’m actually not the biggest fan of caring about so much what the rent is and the rent cashflow percentages. I want that equity because that’s tax-free money. I hate paying taxes. I paid enough taxes and I’m tired of it.

David:
What’s going on, everyone? It’s David Greene, you host of the BiggerPockets Real Estate Podcast, the biggest, the best, the baddest real estate podcast in the world every week bringing you the how-tos, the stories, and the current events that you need to make good decisions in today’s market. And in today’s show, even though I’m recording this from BiggerPockets’ conference in Orlando, I’m going to be with Meet Kevin of YouTube, Kevin Paffrath. We are in LA at his place, and we’re going to be taking questions from you, our listener base, and we have a great show for you. Kevin and I get into a lot of interesting topics from the greater economy to individual specific deals, a little bit of everything today. And most importantly, we cover a lot of people who should not be buying deals. Not every single situation is something where you should pull the trigger. We have several today where we say, “Hey, you should not buy this deal. You should not partner with this person. This is a bad idea.” You’re thinking about it the wrong way, and here’s why.
Very excited to bring this show to you. But before we get into it, today’s quick tip is simple. Get your tickets for BiggerPockets Conference 2024 now. Many people are trying to get into this one in Orlando, but unfortunately tickets were sold out and the best hotel rooms were taken. If you would like to meet me and other BiggerPockets talent as well as a lot of other jazzed up real estate investors, go to biggerpockets.com/events and get your ticket now. All right, get ready for a great show.
The first question will come from the forums. This is from Don K. in the Woodlands, Texas. Don says, “I target 12% on my passive real estate investments. 20% or more for active real estate investments without taking excessive risks at a maximum leverage of 50%. What is your target for return on investment annual on your passive real estate investments? On your investments, which require a more active participation, how do you calculate that and has it changed as years go by?”

Kevin:
Wow.

David:
So Kevin, target ROI, what do you shoot for?

Kevin:
It’s really interesting. I am not a percentage guy, which is crazy because I’m like Mr. Finance, especially with stocks, and we’ll talk percentages there and growth rates. But when it comes to real estate, I have a really different way of looking at real estate. My real estate point of view is, if I buy a place for 500K and I’m into it for 5 with fix up, I want $100,000 of equity. That’s my goal, which percentage wise is 20%. So now if I look at investing a million dollars, I want $200,000. I’m actually not the biggest fan of caring about so much what the rent is and the rent cashflow percentages. I want that equity because that’s tax-free money. I hate paying taxes. I’ve paid enough taxes and I’m tired of it. So that’s my point of view.
I will say, when I hear these numbers, the question was phrased as this is someone’s target, and then they say, without risk, it doesn’t sound like reasonable. Especially if this is cashflow, it doesn’t sound reasonable. If you got maybe this is a flipper and it’s in an appreciating market, maybe that’s realistic then. But otherwise, I think if we’re talking cashflow here, I think it’s a little loony.

David:
You’re making a really good point. Also to highlight, when you speak with more experienced investors, successful people like yourselves, it’s not that cashflow doesn’t matter, but the conversation trends away from cashflow.

Kevin:
Oh, quickly, yes.

David:
Right?

Kevin:
Yeah.

David:
When you’re new, this is all that people talk about. It’s all they think about. I have a book that’s going to be coming out soon about the 10 ways you make money in real estate, and the natural cashflow is one of them. Well, that’s the only one we all hear about. There’s different reasons why that may be. My gut tends to believe it’s because the influencers, the gurus, the people that want you to take their course, they have to sell you on cashflow because cashflow is how you get out of your job, it’s how you get a girlfriend, it’s how you make your dog like you, it’s how you get on the yacht with the hot chicks. All the things that have nothing to do with the reasons you should be pursuing financial independence are related on cashflow, right? So it becomes this magical carrot that everybody wants to chase. Now, what you’re talking about with equity, great point, not taxed. What’s your take on how you buy properties that aren’t going to cashflow without losing them?

Kevin:
Right. Well, so this is very risky, and I want to finish off also on just one of the last things you said. I think that’s so interesting because you’re right. It’s this idea of selling this goal of financial freedom. I think as soon as people start getting dividends, like in stocks, which I think are a complete ripoff, you shouldn’t touch dividends unless you’re retired, and then cashflow and real estate, the problem is people then take that cashflow but then they spend it on going to the mall or going on a vacation or whatever. And so now you’re paying taxes and you’re not even building your wealth because you’re just blowing it. It’s so stupid. So I wanted to add that part.

David:
That’s a good point.

Kevin:
So-

David:
When you don’t spend equity, it’s hard.

Kevin:
It’s hard. That’s the point. The harder it is to spend your investments, the less likely you are to do it. Harvard did a study. They said if you have cash in a savings account, you are nearly 100% likely to spend it. If you have cash in an investment account, a brokerage account, you are nearly 100% likely not to spend it because it’s psychologically punishing, “Oh, I’m going to rob from my investment to go spend money.” Whereas if there’s a dividend or a rental income coming and it’s going right into your checking account, you spend it. Now, I’m going to have to ask you to repeat your question.

David:
No, no. The question would be, let’s say that we have someone here in this, they’re like, “That makes sense. My take is equity is easier to build in cashflow. It’s very hard to control cashflow itself.” You are dependent on what market rents are and expenses are going to be what they are. You can’t just eliminate expenses. But equity, you do have some control over. You can improve a property, you decide what you pay for it, you pick the market you buy in. You have an easier ability to build wealth when it’s through equity. The downside is, how do you make these payments? So what’s your advice for someone who says, “Yeah, I can understand the wisdom of this, but I don’t want to lose the property”?

Kevin:
Right. So when I bought my first house, we realize the payment was going to be about $1,950, PITI, plus we figured there’ll probably be some things that break or whatever. So add another couple hundred bucks. That was around 2,150 bucks, and we went into that barely making 2,100 bucks. We did not make enough money to comfortably make that, but we’re like, “But it’s a great deal.”
So we were in a situation where I was just starting my real estate career so I wasn’t making money. It took me 11 months to close my first real estate deal. That’s 11 months of no income when you’re making these payments. So it’s really scary, and I would never recommend that to anyone. The reason I did it with my wife is we looked and we said, “Look, worst case scenario, we could rent this place out for $2,500. Next worst case scenario, we could move roommates in. It was a three bedroom, two bath. We’ll be in one. We’ll rent out the two other rooms for 600, 700 bucks a piece. That’ll help offset a lot of the payment, the traditional house hacking.”
So we created these little hedges, we’ll rent it all out if we need to. We’ll rent out the rooms if we need to. We’ll go move back in with mom and dad if we need to, whatever. And I realize not everybody’s as lucky to be able to say, “Oh, we get to be able to have a fallback of moving back in with mom and dad.” But I also realized when you have nothing, it’s really hard to lose. So I was willing to take that risk with my wife. We’re like, “Well, worst case scenario, we’re going back to zero.” We’re like, “We already are at zero.”

David:
Good point.

Kevin:
So now, if somebody has already… If they’re looking at interest rates today and they’re 7, 8%, unfortunately I see people doing this, and this really scares me, as people are saying, “Well, I’m betting that rates are going to come down.” So somebody sent me a message, they’re like, “Hey, I want to buy this duplex and the payments going to be $4,500 was the payment in Florida.” I’m like, “Okay, well what’s the rental income?”
“Oh, 2,500.” I’m like, “This is a terrible idea.” It’s a negative 2,000 guaranteed. With it, 100% rented out, and you have to pay for yourself to live somewhere else. So then the next question is, “Well, what is your capacity to float basically a negative almost…” It’s 24,000, but add in maintenance and other stuff. “What’s your capacity of float?” $30,000 of additional investment every year? “How much money are you making?” Well, so this is where we have to consider individual suitability. If you’re making 5 million a year, who cares, right? Sure, okay. Maybe you think you got a great deal, you really wanted that property, whatever. But if you’re making an average income 50, 60, 70, 100K, hell no. That’s stupid. So I think that’s number one, is what’s your income. And your goal, I’m pretty sure you talk about pretty regularly in your book, which is increase your income, right?

David:
That’s exactly right.

Kevin:
Yeah. So if your income’s low, increase your income first. Focus on that. How could you provide more value to society? Realistically, you’ll probably make more money focusing first on making more money. Anyway, different topic. So for most people, I think big negative cash flows are a very bad idea. If you’re negative 100 bucks or 200 bucks, you ask yourself, “Well, can I float another 1,200 bucks a year or 2,400 bucks a year?” Well, most people can.

David:
Right.

Kevin:
So that’s my line, is what’s your ability to float that as an additional investment? And is that an investment worth throwing more money at? If it is, maybe 100 bucks a month makes sense.

David:
Would you give up $100,000 of equity so you don’t lose 100 bucks a month? Does that sound smart?

Kevin:
No. No, no, no, no. So my thing is I would rather lose 100 bucks a month and have 100K of equity because it’s going to take me 10 years. Or no, it’ll take me like 80 years, you know?

David:
Yes. That’s exactly right. The cashflow method takes a lot longer to build up that wealth, but the downside is you can lose it. So what I hear you saying is focus on ways to manage finances outside of that individual asset.

Kevin:
100%.

David:
The stronger of a financial position you’re in, the less you have to worry about the return on the cashflow and the more you can get into the spaces where big wealth is made and you’re not taxed.

Kevin:
Well, consider the principal paydown as well. If you’re negative 100 bucks, your principal paydown is probably 400 to 700 bucks a month. Well, that’s literally money you’re putting into that forced savings account you can’t spend. So you’re technically not really negative. You’re technically positive.

David:
That’s in this book that’s going to come out after Pillars. That’s the argument I make, is that real estate makes you money in so many ways, but when you only focus on cashflow, you stop paying attention to the money you’re saving in taxes through depreciation and the principle pay down that’s happening and the amortization schedule that favors you the longer you own it and the equity and the rents that go up every year if you buy in the right area, that there’s a chess aspect to real estate investing and when you’re just trying to play checkers, you’re just looking at cashflow. So I think that’s a great answer.

Kevin:
Yeah, it’s incredible because I think that’s the problem though, is people discover us on social media, but the mainstream idea on social media is cashflow. And so then you get the… Let me put it this way, what tweet’s going to go viral? A tweet where you break down, “Hey, if you buy a house, you get these tax benefits principle pay down. You get all these long-term, 10 different ways to make money.”

David:
[inaudible 00:11:29].

Kevin:
Right? Is that going to go viral? Of course not. How about, “Why would you buy stocks or real estate if you could make 5% on a money market fund?” Well, those tweets do a lot better because it’s simple and it appeals to everyone, like, “Yeah. Real estate sucks. I’ll get it in a money market.” Well, how long is that money market going to offer you? 5%. What wealth are you going to actually build?

David:
Great point. So when you’re getting your information from free sources like the internet, expect that you’re not going to be getting the most accurate information. You’re going to be getting the most sensationalized, which is why they’re listening to us because they’re going to get real talk.

Kevin:
And I’m not anti Elon, but it’s one of the reasons I’m so frustrated with platforms like Twitter, is they incentivize how do you get somebody to stop scrolling and interact with your post. Well, the way you do that is with something sensational. Whereas don’t get me wrong, I feel like the sensational title guy on YouTube, but the point is, when you get in the video, you’re now listening to a 20-minute video or whatever it is on real perspective, which you’re not getting in a ten-second tweet that you’re committing.

David:
All right, Don K, hope that helped. Our next question comes from Jaron W. in Indianapolis. Jaron says, “Every one of our single family rentals have trapped capital. They’re all BRRRRs. I believe that’s a fancy way of saying equity. I’ve never heard of trapped capital. That’s interesting.” I think that means he left money in the BRRRR. He didn’t get it 100% of it out. “It’s nearly impossible to not trap capital if you’re buying and holding rentals right now. It’s a good problem, I suppose, but it’s nearly impossible to grow a portfolio without finding more cash. As an experienced investor, what advice can you give to younger people tackling this issue? Should I leverage more? Should I partner up? Should I stop trying and sit on the sideline?” So Jaron here has the issue of he’s doing some BRRRRs and he didn’t get all of his money out and he’s just run out of capital, but he wants to scale a portfolio. Common problem. What do you say?

Kevin:
Well, first of all, look, everybody’s got a different strategy. I hear partners and I think, “No thanks.” I have seen so many partnerships destroy families, friendships, relationships out of stupid things like what color the doorknob should be. It’s absolutely insane. And so if you’re going to ever do partners, you got to have somebody who’s making the decisions and somebody who’s not. If you’re going to have a partnership, please have that relationship established. I have found that I like control. As a result, I have found I don’t work well with partners. I can work myself making decisions with a team of people who are [inaudible 00:13:56]-

David:
Executing your decisions.

Kevin:
Yeah, my decisions and my formula. But yeah, anyway, so I hear partners, I shut down. Stop trying, I think, is the wrong answer. I think you should be trying in a different way. Leverage is, I hear risk.
So my thinking is, what can the individual do to increase their other sources of income to make sure that you can keep investing> this idea of trap capital makes it sound like it’s bad. That’s how you build wealth, is you don’t need to be leveraged to the hilt. I remember just over this last decade post the financial crisis, seeing my properties over time, they get to leverage ratios that would start at 75% on refinance and then all of a sudden they’re at 65%, then they’re at 59%, and I’m like, “Oh, I can pull money out of this.” But what I always told myself is I’m going to leave those there on purpose as little piggy banks, because one day something’s going to hit the fan in markets and then I’m going to go break those piggy banks. I’m going to take the hammer and I’m going to break the piggy bank and then the cash will be there when I need it, rather than always trying to be perfectly leveraged.
And I suspect Mr. Trap Capital, I think it’s Mr. Trap Capital, is a spreadsheet kind of person, and they’re looking and going, “Oh, There’s 20K left in there. I don’t know. Now my ROI is slightly less. If I had that 20K, my ROI would be slightly higher.” Usually, folks who get so in the weeds of spreadsheets don’t succeed long in real estate. I don’t know. That’s just my impression.

David:
Because the spreadsheets are an idealized version of how you want the world to work. Then you get into the business and it doesn’t work the way you’re thinking.

Kevin:
Real estate’s a people business, not a spreadsheet business.

David:
I really like your points there, especially the part about you should be making money outside of real estate. That does not get talked about in our space. It’s one of the reasons that I wrote Pillars of Wealth, is because I was frankly tired of people coming to me and saying, “David, I have no money, no credit, no job, no skills, nothing to offer the world, and I really want to invest in real estate. Can you show me how to do it?” And I’m like, “Look, if that’s where you are in life, we need to have a conversation about how you get money, credit, skills, value, not how you go invest in an asset that can hurt you if you don’t have sufficient capital to weather a storm.”

Kevin:
Bingo.

David:
So let’s say you’ve got a little brother and he comes to you, you love this little brother, and he goes, “Kevin, I keep getting fired from my jobs because my boss wants to be there at 9:00 AM and I like to sleep in. I can’t get a girlfriend because I’m 80 lbs. overweight and I don’t make eye contact with people. I have no confidence. Can you help me get a job that I make a lot of money, but I don’t have to wake up early and can you help me find a girlfriend that doesn’t care that I’m 80 lbs. overweight and have no confidence?” Would you tell him, “Oh yeah, there’s this crypto thing”? Right? “There’s this NFT where you can make all this money and you don’t have to change anything.” Or would you say, “Look, I love you little brother. We need to get you on a treadmill. We need to build up your confidence by doing some hard things in life, or you need to get out of bed earlier”?
What is the answer? Do we give them an easier route or do we say that the problem starts with improving what they’re doing?

Kevin:
I think we have to remember that we’re in a world that rewards capitalism and capitalists. So you have to become a capitalist. And so then we look and say, “Okay, we’ll watch what successful people do and copy them.” What do capitalists do? As much as that word can be negative to people who just want stimulus checks every day, that word comes across as negative when we want to sleep in. But the reality is what do successful people do? Well, they work hard. They work long hours, they wake up early or they have routines, they have systems, they have value that they can provide.
And so sometimes that means if we’re starting at zero, we go, “Okay, well fine. I want to become more like a capitalist. Where do I start?” Well, how many licenses do you have? They’re not that hard to get. Licenses, surprisingly, have very few requisites. Go become a real estate agent, become a lender. Just by going through those tests, you’ll learn so much about… And look, don’t get me wrong, we forget most of the stuff that we study for these tests anyway, but it gets you in the mindset of thinking, “Oh, there’s 10% here that actually really applies to the business of lending or real estate or finance and you learn.” Now when you sit down with somebody at an open house as a realtor and somebody says, “Well, how do I run this amortization or a discounted cashflow or how do I do whatever?”, you know because you’ve actually trained yourself. If you don’t have a skillset and a way to provide value, you won’t make it.
So the beauty though is there are plenty of people who don’t provide value, which as soon as you figure out how to, you can succeed. And there are plenty of ways to do it, whether it’s in finance or real estate. That’s the whole reason the BRRRR method exists, which is buy a place that’s a fixer upper and renovate it. The reason that’s not arbitrage to zero is because it’s hard. You need people skills. You need to be able to work with contractors. You need accounting skills, money management skills. The way you get it is by working in business. And so working really hard and getting underpaid for many years while you build experience will help you in the future be able to work less and be overpaid.

David:
That’s great. It’s investing in yourself. When you hit the ceiling that you can’t get where you want to go, that’s a good thing because it makes you reanalyze what you’re doing. So Jaron, you’re trying to make money through one pillar, which is investing, and that’s great. This is why you need to incorporate other pillars like other ways to make more money just like what Kevin said. All of a sudden these problems go away when you’re not trying to just do it all through real estate investing.
All right. Our next question comes from Albert Knoe out of Boston. “I need a sanity check here if what I am thinking makes sense.” I like how we started this off. “I own two triplex properties, one of which I’m trying to BRRRR. I’m a buy and hold investor and in this for the long game, which means I have to break even for a few years while I still get appreciation, tax benefits and raising rents, then I’m willing to make that sacrifice. A lot of investors I know are pushing me towards cashflow and leaving the current deal as is until interest rates get better, but this of course cuts me off from the repeat and BRRRR.” Here’s the details. So Albert Knoe has a BRRRR here that’s 100% leveraged and is breaking even. Is this a bad investment or is this a good investment?

Kevin:
Yeah, it’s incredible. We’re just looking at the details and we’re like, “Wow.” At first I’m like, “Oh my gosh, he’s 100% leverage because he funded his down payment from a HELOC.” And then we’re looking at it going, “He’s going to be massively negative cashflow.” And then we’re like, “Wait a minute, he’s breaking even, 100% leverage?” Look, we have this rule of thumb, it’s called the buying window. The buying window is deemed to be open when you could borrow 100% and break even or have cashflow. That’s what he has here. I think one of his comments was, “Well, I’m only going to break even for a short period of time and everybody’s pushing me to sell it.” Why? This seems great. It blows my mind. I mean, I think if interest rates go higher, maybe there’ll be some risk, but he’s even got cashflow on top of that. It was like a thousand bucks or whatever. I don’t see an issue here. It looks like he’s got $300,000 of equity. He got a great deal and he’s got extra capacity to be able to make the payments.
The only way I would sell this is if I just got injured in a car accident and I couldn’t work anymore and I was screwed basically. But other than that, if you’re capable of capable of functioning in society, providing value and making money, why? Tell your friends to shut up and go invest in real estate. How much real estate do they own?

David:
Yeah, presumably it’s in a good appreciating market because he bought it for 815,000. That’s not a cheap market.

Kevin:
Right. And a price for what? 1.1 or something?

David:
Yeah.

Kevin:
Yeah. Well, but to triplex, so 300K a door-ish, a little less. Yeah. I mean, look, it’s a great asset. I don’t know why sell it here. I don’t see this friend’s argument at all.

David:
There you go. So moral of the story is cashflow is a thing to look at. It’s not the only thing to look at. This guy basically paid 815,000 and appraised at 1.1. He’s walking into close to $300,000 of equity. How much money do you have to make at a job to keep 300,000 after being taxed, right? 400,000, $450,000. That is a good investment and it’s probably going to get better. But you made a great point. It only works if you have income coming in from other sources to float you during the period of time that you’re waiting for the rent to appreciate and cashflow to grow.

Kevin:
Exactly.

David:
All right, we hope you’re enjoying this shared conversation so far. Thank you everyone for submitting the questions that you did. Please make sure that you like, comment, and subscribe to this channel as well as checking out Meet Kevin on YouTube who came in for backup with me today. At this segment of the show, we like to go back and review comments that you have left on previous shows. So let’s see what some of you said. The first from Julian Kovard8345. Oh, I recognize Julian. “It feels so good to hear this adversity story at the end. I just recently closed on a townhome that was a five and a half month transaction. Sometimes I feel as if I’m the only one going through all the BS. Glad to know that there’s someone else out there who had to struggle as well.” This comes from episode 357, so if you want to know what Julian is referring to, go check out podcast episode 357.
From Donya Salem. “David: when you get a deal, you’re literally getting a problem. You’re getting someone else’s problem.” Oh, this is me. She’s quoting me right here. David says, “When you get a deal, you’re literally getting a problem. You’re getting someone else’s problem. Damn, that’s a nugget of knowledge.”
And then Fine Art on Fire said, “Isn’t it though? That’s wisdom really.” Well, thank you guys for that. Definitely appreciate it. This comes from people that are trying to find a great real estate deal that cash flows and as equity and is in a great neighborhood and is easy. Those things are never going to exist in the same deal.
Jamal Adams says, “Volume over perfection. Fine leads, run comps, make offers. I had to refocus on this concept when I got in a rut.” Good comment there.
From Technically Human GX, “This is the real estate version of when Charlamagne Tha God came onto the Joe Rogan experience.” Definitely check out episode 357 if you want to see what Technically Human GX is referring to there.
And from podcast episode 822, Street King says, “I don’t leave comments often, but you and Brandon have helped change my life. I’ve been interested in real estate investing for some time. I read a few books by Brandon and yourself and finally took the leap and purchased a property in February. It was exciting and nerve wracking at the same time, but had been so much fun with a lot of learning on the way. With your words and knowledge I receive from the BiggerPockets podcast, I feel I have the knowledge I need to be successful. I am thankful for this episode and the info on building equity. I can’t wait to purchase my next property and continue to build my portfolio. Thanks for all you guys do.”
And our last comment from Keith Manseneli. “Wow, I listened to as many of these as I can, but with so many investors in different situations, they don’t necessarily apply to us at this moment. Almost all of the QAs in this episode were directly relevant to us right now. Thank you for all your answers and breaking each subject down for us to understand. Thank you, David, and to all of you on the BiggerPockets Podcast show.” Thank you for that.
As always, we love and appreciate everyone’s engagement, so please remember to like, comment, and subscribe on our YouTube. And if you would like to be featured on the show, go to biggerpockets.com/david. We would’ve had this link set up sooner. We just couldn’t think of a name for it, finally got that figured out. You can submit your video or your written question to be answered on the Seeing Greene episode.
All right, jumping back into this, Kevin, our next question comes from Hayden McBride in Asheville, North Carolina. Hayden is new to investing and saves a good portion of their income. In about a year, they will be moving to Wilmington. “I currently work as a housekeeper for a company that manages short-term and midterm rentals. I think this is a different perspective than most people who come into the real estate business and could potentially be beneficial. I see what types of homes are rented out more often and are more desirable depending on size, type, location, amenities and many other aspects. My question is, do you think that a background in the hands-on work of the upkeeping of rental properties gives me any sort of advantage for getting started in the real estate business, either investing in real estate or in being an agent?”

Kevin:
Oh my gosh, absolutely. I mean, if I had a list of people who were like, “Hey, I want to apply to work with your startup house hack,” and they gave me that background of like, “Hey, I basically am a property manager and I’m doing all these,” I’d be like, “Please, apple.” This is great. I think sometimes people don’t even realize the advantages that they have. They need somebody else to tell them like, “Go do it. You’re good. You’re good.” You got to have that self-confidence. This background, amazing. This is what you need for real estate. You got to have real estate property management background, and you’re either going to get it by learning it yourself when you do it and you don’t have it. Or if you go in, so much easier. And I was listening to some of these comments like, that you’re taking someone else’s problem, the five and a half month transaction, yeah, totally normal. That’s why there’s so much money to be made. If you’re able to solve these problems, you can make a lot of money.

David:
It’s the barrier to entry. People run away from it and they need to be running to it.

Kevin:
Yep.

David:
All right. Next question from Boris Slutsky. “I’m currently looking for private money investors who can help me to fund a portion of the entire down payment.” That’s funny, a portion of the entire down payment. “Portion of the down payment for my next property, and I have a few people who said they might be interested in being debt partners in the deal. My question is, how do I provide a proof of funds for the lender or to the listing agent to even get pre-approved for the loan or to get the deal under contract? Is there a way of using my investor’s financial statement, showing the funds available, plus a broad letter of intent stating that they have general interest in investing with me or something like that?”

Kevin:
I mean, look, as a real estate broker who’s dealt with nonsense offers for 10 years, I wouldn’t touch this with a 10-foot pole. So what they really need to do is cash in the bank, baby. If you’ve got debt partners, then maybe make an agreement that, “Hey, there’s no interest for the first month, or we’ll add that to the back or whatever,” but get that money funded. If somebody is interested in providing debt, you got nothing. If somebody provided you capital and it’s in your bank account and they’re now out of the picture, well now you have the capital. Now you can actually put it to work. But my next concern on that is if you’re asking, “How do I now get pre-approved?”, well now it gets even harder because lenders look for debts if they’re going to count this debt against you, because it sounds like you haven’t gone through the pre-approval process already-

David:
They’re going to source those funds for sure.

Kevin:
They’re going to source this unless you leave them sitting there without making payments on them. But then really you’re not disclosing this debt to the lenders, which is defrauding the lenders anyway. Really, it sounds like somebody got an idea and they’re way ahead of themselves. How about we go back to step one in real estate, qualify, demonstrate, close. Oh, step one, qualify. Call a lender. “Hey, hey, mortgage loan originator.” You literally go to Yelp, type of mortgage loan originator. I used to be an MLO. “Hey, here’s my situation. Here’s how much money I make. What can I qualify for? What do you need from me? Oh, okay, tax returns, W-2s. Here we go.” And if their follow-up is, “Oh, well, I don’t have a job,” well then that’s really where your first step is, is get a job, right?
People are always like, “Oh my gosh, it’s an investing channel, Kevin. How could you say get a job?” That’s like an insult. I’m like, “Well, the easiest way to actually build your investments is have a job.” In fact, there are a lot of people who didn’t like their job and then they got into investing and they realized, “Wow…” I used to be a law enforcement explorer. There were cops that were like, “I hate this. I can’t wait to retire.” And then they get into real estate investing and they’re like, “Now I love it because I take my W-2 with overtime.” Some of these officers, staff or whatever who were ranking, they’re making over 100K. They’re like, “I now milk the fact that I have a W-2, I qualify for real estate all day long.” It’s great. You’re self-employed and you have income. It’s a pain in the butt to get qualified.
But anyway, so the structure of this person’s question somewhat implies to me that they don’t have a job, they haven’t been qualified and they don’t know what they’re talking about, which when those three things come together, I also get really nervous about them wanting to take on debt because I think they’re going to mismanage this.

David:
And it only gets explained in our space as a positive thing. Take on debt, make real estate, make a bunch of money because you only hear about the deals that work. Nobody goes on these podcasts and says that, “I did that and it was a complete disaster.” We did an episode with Luke Carl and he talked about how he worked his W-2, saved his money, invested. That’s the same way that I got started, literally as a cop working crazy over time buying properties. I said we need to rename the W-2, which has a bad connotation and start calling it the down payment generator.

Kevin:
Oh, that’s a great idea. Absolutely.

David:
Yeah. How do you get better at your job so you can make more money so that you can buy more real estate? And I know that this sounds different than what people get used to hearing, but really if you showed up at the gym and said, “I want to start lifting weights, I want to get stronger,” you would quickly realize it’s not just about lifting weights. “I’m going to have to eat different. I’m going to have to sleep different. I have to learn the form.” There’s a whole thing that goes into this. You guys were training martial arts, right? The person comes in, they go to training, you realize, “Oh, I need to improve my cardio. I need to improve these areas of life.” Anytime you want to be successful at something that you start, you quickly realize where you’re deficient, and that’s okay. You just make improvements in those areas. And I don’t think real estate investing is any different.
So Boris, if you’re having a hard time coming up with the down payment money for the house, what if you just use an FHA loan and you house hack and then in a year you go do it again and you turn what you bought into a rental property. You don’t have to borrow money from people and put this complex Rubik’s cube together of how you can get a house or a lender. Just use a primary residence loan.

Kevin:
Yeah, it’s funny. I wrote that down and didn’t mention it. So thank you for saying that because you’re so right. It’s like just borrow from the bank. And if you can’t qualify for an FHA loan, maybe you shouldn’t be in the deal anyway. But I mean, that’s how I got my first property, is 3.5% down. And then the bank will even finance the renovation for you. Now, that takes patience and it’s kind of hard. I don’t really recommend it because it’s a pain in the butt.

David:
The 203(k) [inaudible 00:31:30], yeah.

Kevin:
The 203(k)s, yeah, that’s exactly what we did. And they gave us 50K, but then we borrowed from a second later because it’s so hard to get the draws on those 203(k)s. So we borrowed from another source, used their money to do the reno-

David:
And then replenished it with the 203(k) [inaudible 00:31:45].

Kevin:
Exactly. Yeah, yeah, yeah, because it’s such a pain in the butt, the process otherwise. But anyway, the point is, you only need 3.5%. You know what? On 500K, we’re talking about under 20K.

David:
There you go. All right. Next question is from Wesley Abercrombie. “Hey David, I love your content. I saw you post a video on Instagram about how the BRRRR model doesn’t make sense for every home. Instead, sometimes a flip could make more sense depending on the profits. What would you say that the profit margin is where you decide to flip the house? 50K? 70K? Or do you use a different metric?

Kevin:
I hate flipping. I think there are so many expenses involved in flipping. Flipping makes great sense in an appreciating market because you have less risk. In fact, the appreciation can sometimes offset your selling fees, but that’s just being in an appreciating market.
In this sort of environment that we’re in, flipping, I think, has a lot of risk. There’s a reason a lot of the institutional flippers, the Open Doors, the Zillow, Zillow got out completely, Redfin got out completely, and Open Doors slowed down dramatically, there’s a reason they’re slowing down with flipping. So is there a metric for when it makes sense to flip? I mean, boy, I think if it makes sense to flip, it probably makes sense to BRRRR, unless it was a very expensive property. For example, you go buy a $1.5 million house, it’s harder to justify buying and holding because the rents often don’t catch up. The rents makes a lot more sense between usually that 300K to 800K range. Start going over a million, at least in most markets I see, the rents… I mean your cap rates are like 1.9%. It’s like, what’s the point? Again, you have the equity, you could BRRRR it out, but still, I’d rather have a bunch of 600K homes than keep those.
So I suppose if I walked into a smoking hot, I can make 300K by flipping this on one and a half, would I do it? Sure, I’d rather have the smaller rentals anyway. But generally, that wouldn’t be my goal. So hopefully that answers that question.

David:
That does help. I can simplify this for you, Wesley. You created equity through this fixer upper, which was good. At least that’s the goal. The question is, “Do I get the equity out via a cashout refinance and keep the house, or do I get the equity out via selling it to someone else and get their money?” Like Kevin mentioned, if you’re going to sell to somebody else, you’re going to have some inefficiencies where you’re going to pay closing costs, you’re going to pay realtor fees, you may have to make some repairs on the property. It’s not the most efficient way to get that equity out. Then you’re going to go pay a bunch of taxes on the profit. If you refinance, pretty much you just have the closing cost of the loan as those are the only inefficiencies you’re going to have.
When I’m looking at the situation, I ask myself a couple questions. The first is, is this an area that I want to keep the house? If this is a really bad location and it’s going to be nothing but headaches for you, flip it. Let somebody else buy it as their primary residence. They’ll be happy with that location. Don’t try to rent to tenants in a place that’s going to cause you headache or isn’t going to go up in value.
The next is, is their cashflow? If you’re going to be bleeding 3 grand a month on this property and you’re not in a strong enough financial position to take that on, sell it to someone else, take the money, go invest it in real estate where it is going to cashflow. If you are getting cashflow, in most cases, it makes most sense to keep it as a BRRRR. And then you not only benefit from the equity that you created in the process, you benefit from the future equity that you will get as the property appreciates. But it’s not a hard and fast rule. You can’t put this into a calculator. You have to actually look at all of these dynamics holistically and then decide, “Is this an asset I want to hold and how can I keep my inefficiencies lower?”

Kevin:
That was great added perspective. I think you’re so right. I mean, “Is it even where I want to own real estate?” That is such an underutilized statement or even question, because if you don’t feel comfortable doing a Craigslist transaction there at nine o’clock at night, do you really want to be renting there? Do you really want to be an owner there? I don’t know. Some people do. I mean, there’s a firefighter, he’s a course member of mine. He’s like, “Kevin, the cashflows out here are like 7, 8%.” I’m like, “Well, where are you?” And it’s like Atlantic City and it’s like 30% poverty rate. He’s like, “I deal with all this,” but he’s like, “But the reason I get all the deals is because I know street by street where to buy” because he’s a firefighter so he’s dealing with… He’s on the streets every day. Well, the days he’s working. So again, competitive advantage.

David:
Yeah. And what if there’s no tenants in that area?

Kevin:
Yeah. Well, that’s also true.

David:
If there’s no one to rent to, then it doesn’t make sense to keep it, right?

Kevin:
Also true, that liquidity of renting folks forget. See, the two things you want in real estate are liquidity of sale and liquidity of renting. If you need to sell it fast, can you? If you need to rent it fast, can you? And sometimes folks get into rural horse property in the Midwest and it’s 30 minutes away from the next gas station. It’s like, “Well, how long is it going to take you to find a tenant for that?” If it’s going to take six months to find a tenant, I don’t want that. It’s going to take years to sell it.

David:
Good point. Or maybe in that market, there’s a lot of people that want to buy, but there’s not a lot of tenants that are going to be there. So if you flip it, you can get money out. And if you keep it, it’s going to be sitting vacant for six months. Those are the things you got to look at. It’s not as simple as if I put it in a calculator, the Excel spreadsheet’s going to give me the answer. It can help you with the decision making. It cannot be the thing that makes the decision.

Kevin:
If you need to analyze a deal on a spreadsheet, you should not buy the deal. That’s generally my rule of thumb. If I can’t napkin math or even mental math the deal out, then A, I don’t know enough about the area because I should know the area enough to instantly see a listing and a list price and go, “That’s going to be a great deal. I know how much to spend on it. I know what it’s going to run for because you already have that market knowledge.” If you’re sitting on a spreadsheet, maybe you don’t even have that market knowledge yet. And the second question is, is it so tight that you really have to create this idealistic spreadsheet scenario? If that’s what you have to go through, probably not as great of a deal.

David:
Interesting perspective. So you’re saying sometimes people use spreadsheets to justify a bad deal because the numbers make it look better than it is?

Kevin:
Of course. Spreadsheets are designed to be complicated. Spreadsheets are designed so that when you present it to somebody, you have a little highlighter over the bottom line that’s like, “This is the ROI. It’s going to be 10% cash on cash return every year.” But then you get into the realities. And the realities are, “Oh, you’re dealing with evictions every three months on different units and you’re dealing…” Spreadsheets don’t account for that. And you change these little variables like, “Oh, the market rents are $2,500.” So what do people do in spreadsheets? “Well, I’m going to get $2,700.” And then they realize like, “Oh, at $2,700, I’m getting professional tenants,” basically people who you’re going to have to evict all the time, watch Pacific Heights, as opposed to if you ran the math at slightly under market rent. Market rent’s 2,500, you’re at 2,450. Now you’re getting high quality tenants over 700 credit scores. No headache. Now, the numbers don’t make sense on the spreadsheet, right? If you have to go to the spreadsheet and trick yourself into it, you’re probably-

David:
Yeah, it’s tempting to play that spreadsheet magic, move things around.

Kevin:
It’s what it is. It’s magic, and then it’s a farce.

David:
All right. Our last question here comes from Dan Kelly in Charleston, South Carolina. Dan has some relatives and investors that want to partner buying a short-term rental in the Mount Pleasant area of Charleston. And Dan doesn’t have a ton of money himself, so they’re looking at how to put this deal together where Dan would be the boots on the ground and would handle the day-to-day responsibilities for his contribution while his partners would be providing the capital, and he says, “Do you have any recommendations for how the investors in a project like this could organize ourselves in regard to financials, physical contributions to the properties and the management of the rental?”

Kevin:
Yeah, don’t do it. This sounds literally like cancer, like… Okay, I shouldn’t make that comparison because that’s insensitive. People have cancer. But this sounds miserable. Literally miserable. First of all, this is not the time, in my opinion, to be getting into the short-term market. I think the short-term rental market, at least what I’ve seen in my experience flying around the country analyzing these markets, is short-term was great during COVID because there was a lack of people providing short-term rentals.
Now, there is a surplus of people providing short-term rentals in a time where we’re going through economic difficulties. And hotels have done a really good job at catching up at providing the amenities that were missing previously. COVID’s not an issue as much anymore. Regulation on short-term rentals has gotten extreme. Just last Sunday, I was in Vegas, went through a property, I’m like, “Why are they selling this?” They’re like, “Oh, it’s short-term rentals. It’s a short-term rental. We should show you 12 month cashflows for 2022,” they wanted to show, and I’m like, “How about 2023?” They’re like, “Well, the rules changed and the numbers aren’t as good [inaudible 00:39:55]-

David:
Isn’t that funny? Isn’t that the real estate version of catfishing?

Kevin:
It’s a scam, man.

David:
Here’s a picture of me eight years ago when I was at my best.

Kevin:
Yes. It’s a scam. So first of all, I cringe when he said short-term rental. It sounds like a horrible idea right now. There will be an opportunity again. I wouldn’t be surprised if we go through some kind of little short-term rental reset or little bubble pop or whatever it is. So that made me cringe.
Then I heard partners and then I wanted to vomit, but that’s me personally. We already talked about that earlier. I’m not a big fan of that. Then I heard, “I don’t have a ton of money,” and then I’m like, “Oh my gosh. It’s literally checking off a bingo card of what not to do in real estate,” literally. So you’re telling me you want to get into short-term rentals when we’re possibly peak short-term rentals behind us already. You want partners when you’ve never done real estate before. It doesn’t sound like you have experience. You don’t have the money. You’re trying to set up like, “Well, how do I…” What he wants to hear from you, by the way, is, “So you’re going to set up an LLC and then you’re going to have a contract between all of you and you’re going to do 30% of the work and you’re going to track all your hours, and then you’re going to do 25% of it.” it ain’t going to happen. Don’t do it. This is a terrible idea.

David:
I got to say I agree with you here. This is risk stacking, okay? Haven’t bought real estate before, haven’t invested in short-term rentals, don’t know the market that good, bringing in partners which we always tend to look at the positive of a partner and we always forget about the negatives because they’re probably not super experienced either if they’re considering letting this person who doesn’t do this pick out the property and manage the whole thing, lack of experience, lack of capital. This is a situation where if it worked out, you would’ve gotten lucky, right?

Kevin:
Yes. And it’s important to remember too that most of the folks who were really making money with short-term rentals, the net income they were making was basically just their salary. I see this all the time. People are like, “Oh, my Airbnb business brings in $3 million” and they’re like, “Okay, well that’s gross.” So now let’s take off principal interest, taxes, insurance, cleaning, all the Airbnb… Take off everything. And now all of a sudden you’re down to like 200K, which don’t get me wrong, that’s great. But now, oh wait, you’re working 80 hours a week because you’re basically working two jobs, managing the rentals. So when we actually generally look at people’s financial breakdowns of how much they’re really netting, they’re netting enough to pay themselves a salary. It’s a job.

David:
Yeah. And often a lower paying job than they would get if they took a normal job, right?

Kevin:
Yes.

David:
That’s a great thing to highlight because when it gets shown on TikTok or Instagram, what they say is, “My 25% ROI on this deal.” We go, “I can’t get a 25% ROI anywhere I want to go do it.” And then you say, “Well, we’re assuming that’s with zero work.” If I got 25% in the stock market, I didn’t do anything. That’s 60 hours a week of working that maybe comes out to a $9 an hour wage. This was a terrible idea, unless you got a ton of equity in the deal or something like that. But that is a great point that you highlight. It is very misleading. And I think that Dan here is probably hearing these great stories of short-term rentals and maybe getting sold a bill of goods.

Kevin:
But you know how I doubled my income between 2010 and 2011? I went from making $5,000 a year to $10,000 a year, okay?

David:
Yeah. It’s a great TikTok video how I doubled my income. I was doing this, yeah.

Kevin:
Exactly. I went from working part-time at Hollister to having a full-time job at Jamba Juice, okay? The numbers and these percentages, because you talked about this 25% ROI, it’s so easy to mislead people.

David:
All right, Dan, our advice is maybe don’t jump into this deal with a bunch of inexperienced partners. If you are really serious about investing in real estate, again, house hack. Look at buying a house in a great neighborhood that you can rent out the rooms or maybe you even short-term rental parts of the house. Get yourself some experience with a 5% down loan where you can gain what you don’t have without using other people’s money and getting yourself in a big, nasty, messy partnership. Earn the right to buy those houses later. And then you might not even need the partners because you might’ve made your own money. So that was the last of our questions, Kevin. Thank you for tag teaming this Seeing Greene with me. Anything you want to say before we get out of here?

Kevin:
Hey, I’d like to pitch. We’ve got a startup. It’s actually called House Hack. It’s a little different from the traditional form of house hack, but go to househack.com. You can learn all about it. Make sure to read the offering circular. The SEC will get mad at me if I don’t say it. There are risks involved with investing in startups or fundraising. One-to-one valuation, read about it at the website. And read the offering circular. But that’s it. Otherwise, I’ve got a channel, Meet Kevin on YouTube. And thank you. This has been a blast. I love these questions. See, I sit down and I’m like, “What kind of videos should I make today?” And I bias towards like, “What’s the latest going on with Congress or the Fed?” But these are the real questions where people have these burning desires like some of these scenarios we went through and they need somebody to tell them, “You have a competitive advantage here. Do it.”
“You should not do that. Do this instead.” So this is a great format. Thank you.

David:
Thanks, man. That’s how we do on Seeing Greene. If you would like to be featured on an episode, submit your question at biggerpockets.com/david. And if you’d like to know more about me, you could follow me @davidgreene24 on Instagram or your favorite social media, or check out davidgreene24.com. All right. If you’ve got a minute, check out another BiggerPockets video. If not, I will see you on the next episode. This is David Greene for Kevin House Hack Paffrath signing off. Thank you.

Since 2021, Stockholm and London-based VC fund Oxx has been highlighting the work of young open-source software ventures that have the potential to become investor-friendly sustainable businesses. When it comes to marketing and growth potential, open-source businesses offer some very real advantages over peers working in similar segments. The problem is that in the early stages at least, they don’t offer up the kind of metrics that venture capitalists are looking for. Oxx’s research sets out to put that right.

As Oxx partner Bob Thomas sees it, open-source software ventures often start out as a result of frustration on the part of their founders. For instance, they encounter a problem that existing software tools don’t seem to address or solve. So, they create a tool and – in true open-source tradition – they invite other developers to contribute their own expertise. Those contributions might manifest in the shape of improvements or customizations for specific use cases or company systems. “They are oft

So what you get – at least in a best-case scenario – is a community of enthusiastic users and developers. The kind of community that will become ambassadors and advocates for the software tool in question. And as the software is commercialized, this community provides a platform for rapid growth.

“You might start by giving the tool away free,” says Thomas. “But as you commercialize you have two advantages. “The first is a community of developers who work with you to build new features, so you can develop the tool at low cost. And the second advantage is distribution.”

Thomas cites the example of an open-source database tool with 1,000 users. If the provider then builds a commercial addition to the tool, there is an existing well of potential buyers.

Under The Radar

The potential problem is that while open-source software providers may well have a community of loyal users, what they don’t tend to possess is a set of commercial KPIs of that kind that will whet the appetites of VC investors. In many cases, the traditional signifiers of commercial potential are not in place.

All of which brings us back to Oxx’s research. The company has designed its own metrics in a bid to identify the rising stars of the open-source sector.

Thomas outlines the problem and the solution. “A lot of open source developers put their tools on Github,” he says, referring to the platform that connects developers with users. “On Github you see a lot of stars,” says Thomas. “The problem is that the star rating doesn’t really tell you very much about the developers.”

Product/Community Fit

Oxx assesses commercial potential by looking at the number of contributors. Put simply, if a project attracts between 50 and 100 contributors, it’s a good sign. There is, Thomas says, a strong correlation between the number of developers attracted to the tool and its longer-term commercial potential. The underlying reason is that this particular metric indicates a good product/community fit.

That sounds good in theory, but what about the real world? Well, Oxx has used its metrics to compile an annual list of rising stars. Members of its cohorts have enjoyed success in going on to attract venture capital.

Raising Capital

Oxx identified 37 rising stars between 2021 and 2022. Of the 21 companies included in the first year cohort, 81 percent have raised more than $5 million from VCs and the collective total is around $1 billion. Fast forward a year and companies in the 2022 list have thus far raised $500 million in total. Across the two years, five of the listed companies are set to become unicorns.

This year, Oxx has identified 18 companies and based on its metrics, it expects to see a similar investment trajectory.

Thomas stresses that the purpose here is not to find prospects for Oxx. As he explains, the fund tends to invest at the scaleup rather than the startup stage. What the research does do is highlight the potential for open-source software in the business-to-business market.

For European companies, the B2B software market for specialist tools is global from day one, Thomas says. Using platforms such as Github businesses can attract users without necessarily having to invest face-to-face selling. As with product-led marketing, the open-source developer can grow by word of mouth.

So is open source a marketing silver bullet? Well, it’s probably not as straightforward as that. Moving from the stage where software is given away free to the point where it is paid for can be challenging. And then there is the IP question. What will third party contributors think when the product they’ve devoted their own time to for no reward is commercialized. Thomas says open source businesses should clearly define the terms on which third parties contribute at the earliest stage.

“But this needn’t be complex. Contractual templates are widely available. On Github they are a dropdown,” he says.

Perhaps, Oxx’s research shouldn’t come as a surprise. Founder newsletter Failory recently published a list of the top 15 open source unicorns with companies with valuations ranging from more than $4 billion to $1 billion. Clearly, open-source businesses can thrive. Oxx is aiming to make the potential winners more easily identifiable.

Ashley:
This is Real Estate Rookie, episode 334.

Tony:
I guess we can just go pros and cons for allowing someone to arbitrage your unit. You ideally could potentially charge slightly higher than market rents. If you’ve got a bigger multifamily property, you could lease out multiple units at one time to one person. The third benefit, and this is counterintuitive, they’ll probably end up being your best tenants, because they’re going to handle a lot of the minor maintenance issues on their own if they’re a good host, because they’re going to want to make sure that it’s ready for that guest.

Ashley:
My name is Ashley Kehr, and I’m here with my co-host Tony J. Robinson.

Tony:
And welcome to the Real Estate Rookie Podcast, where every week, twice a week, we bring you the inspiration, motivation, and stories you need to hear to kickstart your investing journey. And today, we’re back with another rookie reply, answering questions from you, our rookie audience. And look, if you would like your question featured in one of our episodes, head over to biggerpockets.com/reply, and we just might choose your question for one of our shows. But today, we got a long list of stuff that we’re going over. We talk a little bit about rental arbitrage at the end of the show. What is it? When is it beneficial for the landlord and for the person doing arbitrage? We talk a little bit about how to structure partnerships, and if you guys haven’t yet, head over to biggerpockets.com/partnerships to pick up mine and Ashley’s book about partnerships where we cover on how to structure a partnership, what to look out for, mistakes that rookies make when they’re doing that kind of thing.

Ashley:
And if you have checked out our book and given it a read, we would love to hear from you if you could leave us a review at biggerpockets.com or if you ordered it on Amazon or Barnes and Noble, if you could leave a review there, too. Well, you guys, we have run out of reviews. That means we need you to leave a review, an honest rating and review of the podcast, so that we can feature you. And please share any lessons you’ve learned, any wins you have had from this podcast, listening to these amazing guests, and we would love to give you a shout-out. But before we get into today’s show, Tony, I need to have a little boring banter with you. So by the time this airs, you’ll be holding a little baby girl in your arms, so just fill us in real quick: what’s going on in the Robinson household to prepare for baby?

Tony:
That’s a good question. Sarah’s pretty proactive, so she’s been prepping leading up to this. We cleaned out the garage last month to make room for all the stuff that we were going to get for the baby shower. We had a closet downstairs, the closet you have underneath your stairs, it was just a junk place. Now it’s all the baby stuff. We just finished the nursery, I think last weekend, so we’re pretty much ready. I think the only thing that’s missing right now is diapers. For whatever reason, we didn’t get any diapers at the baby shower, so we got to get diapers and wipes. But everything else, we’ve got. We’ve got literally everything that we need, so we’re just waiting right now for baby girl to get here.

Ashley:
It’s funny because when I came to visit you guys in August, in the morning, I got up and made myself breakfast and I went, I don’t know where anything is in your kitchen, so I’m just going through random cupboards and I opened up this big cabinet and it’s just a piece of paper that says baby stuff, just like the whole cabinet is saved for baby stuff.

Tony:
And now it’s filled up. We got stuff in there now. We got a lot of cool little trinkets and stuff, and one of the ones that was pretty cool is that it’s like a Keurig, but for baby formula, so you just fill up the reservoir with water, and then there’s a big thing at the top for the powder, and then it’s literally wifi enabled, so say that we wake up in the middle of the night, we need to make a bottle, you hit a little button on the app, it mixes everything and gets it to the perfect temperature for the baby. We got a lot of cool little gadgets like that.

Ashley:
That is cool.

Tony:
Because I had my son, he’ll be 16 shortly, so that was almost two decades ago that we had him, and so much has changed.

Ashley:
Did they even have Keurigs then?

Tony:
They didn’t even have Keurigs. It has been cool to go on that journey, but we’re excited. We’re super excited.

Ashley:
Well, thank you for sharing that with us. Everybody I’m sure is excited for a little podcast baby to come and make an appearance sometime on the show. Okay, let’s get into our rookie reply questions on this amazing Saturday. By the time this airs, I’ll actually be spending every Saturday at peewee football games, but Tony, maybe it will be beautiful for you, and California probably be cold and windy and rainy at football games, but I hope everyone is having an amazing Saturday so far.

Tony:
Yeah, there’s also a good chance that I might be holding a brand new baby girl in my arm, so we’ll see, depending on how close. Actually, no, I’ll definitely be, because this is coming out the end of October, so baby Robinson will be here by then for sure.

Ashley:
Yes, I’m so excited. I can’t wait. Okay, so our first question is from Steven Cobb. “Hey everyone, I’m about to try to make an offer on the house, but the property is on market, so I’m talking with the agent. When I make the offer, is there any official document that I need to submit, or do I just give them the price I want to offer?” Great question, Steven. And there are differences between submitting an offer to somebody on market and off market. On market is when the property is listed on the MLS, and there is a real estate agent that is handling the transaction. Tony, you can tell me if you read it differently, but I’m thinking that he went to the agent that is listing the property?

Tony:
Mm-hmm.

Ashley:
That he doesn’t have his own agent, which is completely fine. A lot of agents who will do that, it’s considered being a dual agent where they will represent you and the seller. In this circumstance, or if you go and get your own agent, there is no official document that you actually need to present or make up. The agent will do the whole contract for you. And that is one reason I love using a real estate agent, is because they do all of the paperwork for you, and you don’t have to. Tony, you want to go through a list of things that when you’re talking to your agent, I’m talking to my agent, what are some of the things we have to tell them when we’re making an offer? It’s not just the price you want to offer, there’s other things that go into the offer that needs to be considered.
What your agent would tell you this, or any agent will say, “This is the additional information I need,” but just so you’re prepared that you can have it. The first thing is what name do you want the contract in? Are you putting in your personal name? Are you going to put the property in an LLC? You can also put an LLC or a name and do and/or assigned to. This way, you have the ability to change the contract before you actually close on the property. When I purchase a property, I always put them into the same development company.
And then I’m like, “Okay, here’s my business partners, which one’s going to be a great fit? Okay, great, it’s going to be Joe this time for this property. I’m going to put it into our LLC that we have.” And then, by the time it’s ready to close on the property, we make the change to the contract that it’s maker. But this is also how wholesalers can do it too, where they can assign the contract to somebody else. That’s the first thing. Start writing a list down you guys. The first thing is the name. The contract is going to go in. Tony, what would be your second thing?

Tony:
Yeah, I think the second thing, and the one that’s always important for me is your due diligence period. And due diligence is your opportunity as the buyer to really open up the hood of this property, go under the hood for this property, and make sure that as it appears on the outside is how it appears on the inside as well. This is when you’re doing your general property inspection, maybe you’re doing a septic inspection, maybe you’re scoping the sewer lines, you’re having electrical bids created and plumbing bids created. But basically, this is where you really get to sharpen the pencil on all of your initial expenses that you projected associated with that property. And the due diligence period is important because typically during your due diligence, if you find something of concern, say that maybe you assumed that the roof is in good condition, but after the inspection was completed and having a roofing contractor go out, turns out the entire roof needs to be replaced.
That’s a relatively big expense. So you can then go back to the cellar during your due diligence and say, “Hey, I would like to get a reduction of $5,000 to help cover the cost of getting this roof repaired or replaced.” And then you and the seller can negotiate. If the seller says no, as long as you cancel your purchase agreement during your due diligence phase, you typically can get your earnest money deposit refunded back to you. If you were to try and cancel outside of your due diligence period, and maybe there weren’t some other contingencies, you might lose that EMD. I like to typically focus on the due diligence period. A shorter due diligence, it’s typically more, I think, attractive to a seller than a longer due diligence. And I’d say for most of our properties right now, especially if it’s a flip or something we’re going up, 14 days of due diligence is pretty typical for us, but that’d be the second one for me, Ashley, is due diligence.

Ashley:
Okay, well, that was the wrong answer because we were still on the first page of the contract and you skipped to the second page of the contract. The correct answer for the second thing was the address, so the address you want to put on the contract, and this is where your property taxes would be sent to. This is the address the county will have on record as far as the mailing address for this LLC and for the property where you’ll get your property taxes. And then to tag along with that is the email address, because most agents use electronic signature, so they’ll need your email where they can send the final contract to get signed by you electronically.
Then moving to page two, definitely agree, the due diligence, super important. Are you going to have that inspection period? For how long do you need to have that due diligence? Then the next thing would be your purchase price. How much are you going to pay for the property? And then to coincide with that as to how you are paying for the property. Are you going to be paying cash? Are you going to be getting a bank loan? Is it going to be an FHA loan? The loan type you are getting is important in the offer, too, because that will definitely play into someone’s consideration for your offer.
FHA loans are harder to get in a sense, because there’s more hoops to jump through. You have to do an FHA loan inspection, which is separate from your inspection that you’re getting during your due diligence period compared to a conventional loan where the loan company, the mortgage company, isn’t doing any of their own inspection. If you’re looking at two offers, yours with the FHA loan seems a little more risky because what if we go this far and then they say, “No, sorry, FHA loan, we actually won’t cover this property. It doesn’t meet our inspection criteria.” Then the contract falls out, and now these people have to start all over. The next thing after the due diligence would be what your price is and how you’re going to pay for it, and then that ties into a contingency. You can put a contingency in there that if you do not get bank financing and you don’t get your bank commitment letter by x date, then you can actually back out of the contract.

Tony:
There’s tons of different contingencies you can add to your purchase agreement, Steven. I think the piece that’s important is that you don’t want to overdo it. You really just want to try and focus on the contingencies that are most important to you, so yeah, the due diligence, the financing contingency is a big one. We’re doing stuff, we just signed a purchase agreement on a hotel, and one of the things that we had was the environmental study. And actually I learned this from you, Ashley, like, hey, we want to make sure that this thing passes a phase one environmental. And part of our due diligence, but we called it out separately, so there’s tons of things that you can include from a contingency standpoint. But just know the more you have, the less attractive your offer gets. But we talked price, we talked owner information, we talked due diligence and contingencies. I’m trying to think if there’s anything else that I typically include in a purchase agreement. Anything that you’d add that we haven’t chatted on yet?

Ashley:
The only thing I would add is a closing date, that we’ll close in 30 days, so that would be the last thing that I would add. What I usually do is I write out an email to the agent, or I send this in a text sometimes, too, and I will literally just list out this information: name, address, email, inspection, due diligence period, price, how you’re paying, and then closing date, or how many days until closing. It’s just an itemized list I go through and I’ll fill out that out and send it right over, and that’s usually enough information to have all that filled out. And then if there’s any other contingencies you want in there, too. For example, maybe you’re selling your primary residence or another investment property, and saying you’re only going to be able to close on this property if your other property sells, too.

Tony:
The closing date is super important. I was actually trying to look at the last flip that we bought earlier this year. But yeah, typically, a shorter closing window is more attractive to a seller than a longer closing window. Like Ashley said, 30 days is a pretty common escrow period on a single family or small multifamily type residence. Longer escrow periods typically if you’re going into bigger commercial properties. But what we will do on a lot of our flips is we’ll go no financing contingency, because we’re typically raising private money or we’ve already got the money raised in a lot of scenarios, and then we’ll do a 21-day closing.
We’ll have 14 days to get our inspections and our due diligence completed. Then it’s just another seven days to finish off all the paperwork with our private moneylenders, and typically, we’re able to close within three weeks. For us, we’ve got a pretty strong offer because there’s a tighter window, no financing contingency, no other crazy contingencies as well, and it allows our offers to stand out. And I’m pretty sure on this deal, we weren’t the highest offer, but they liked our terms a little bit better than some of the other offers they got.

Ashley:
Yeah, I think that’s a great point. All these other contingencies and terms that you’re putting into your contract can actually make a difference more than price. And that’s why if you have the chance to find out why that person is selling their property can actually help you tailor your offer to that. Okay, so our next question is from Carrie Adams. “Any recommendations on how to structure a partnership for long-term buy and hold?” Cue Tony.

Tony:
I don’t have my book.

Ashley:
You don’t have your book?

Tony:
Where’s my book? I put it up here.

Ashley:
Hold on. I got one.

Tony:
All right, so Ashley’s so excited right now that she just ran into her microphone.

Ashley:
I just spun around and hit my own head.

Tony:
All right, you do the honors today, Ash. I’ll hold the book up, but you do the audience.

Ashley:
Okay, well, I wheeled over to get my book in my chair, so I got mine too. But anytime we hear the word partnership, we are your go-to people, because we wrote the book Real Estate Partnerships. You can find it on the BiggerPockets bookstore. You can go to biggerpockets.com/partnerships, and if you use the code Ashley or Tony, you can actually get a little discount, too. Now that I’m all frazzled from running to my desk, in this question it says, “I have great credit, and my potential partner has more cashflow.” So they’re both bringing value into the partnership. As in cashflow, this is meaning they have actual capital, they have cash to put into the property. They’re willing to go half on the down payment, but the mortgage would be in my name. Tony, I think this is the perfect question for you, because this sounds very similar to how you set up your joint venture agreements.

Tony:
I’s a great question, Carrie, and I think there’s a little bit more to unpack here because I would want to know outside of just how were you structuring the purchase, because what you’ve defined in your question is the purchase, is who’s going to carry the mortgage, which is an important question, and how are we going to cover the down payment and closing costs, which is another important question. But what I would ask next is, how are you going to divide the responsibilities of actually owning and managing this real estate investment? Is one of you going to be the person that’s going to handle everything, while the other person is more of a silent partner? Are you going to split responsibilities down the middle? Is one person going to do 70%, the other person going to do 80%? I think the long-term management of this investment is a critically important thing to consider as you’re putting the initial structure together.
Because assuming all things being equal, how you have it set up right now, one person’s bringing the capital, one person’s bringing the mortgage, that’s a pretty equal thing here, right? Because the ability to get approved for a loan is incredibly important. Better rates, maybe a lower down payment percentage, but you still need the capital to actually close on that deal. But say that you, Carrie, were the person that was going to manage everything, and this other person was literally just bringing the capital, it might make more sense for you to actually have more ownership in the property, because you’re getting the mortgage and you’re doing the management, or maybe you charge the property management fee. There’s a lot of different levers here, but it’s hard to really give a super concrete answer without knowing what the asset management’s going to look like. What are your thoughts, Ash?

Ashley:
Yeah, I would say one thing in here is I think that Carrie should get more equity than the other person is because she’s taking on the debt and she’s giving half the down payment. She’s giving up more for this property, she’s increasing her debt to income ratio, and she’s putting in cash. I would take that, and whatever you’re working out the percentage to be that I think Carrie has more value in this partnership, because she is taking on the debt and giving half of the down payment. Now, if that were to change and flip-flop, and maybe the one person was putting in cash and then just the whole down payment amount, and then for Carrie to get the debt in their name. There’s definitely different variables, but I also think, too, is what is the outcome of this partnership? And I think one thing to be very cautious of when you are structuring this is do what Doni does in his joint venture agreements: do a five-year exit strategy.
In five years, you’re evaluating if you want to keep the property, or if one person wants to sell, you sell it. Having those exit strategies in place, very key when setting up your structure for this. And I think a joint venture agreement is the way to go, because if you are going to… Or you could do an LLC on this, you’ll just have to go and get the financing in the LLC, which then you wouldn’t be bringing as much of a value to the partnership, because the debt would actually be in the LLCs name and not in your name, and the interest rate and the terms wouldn’t be as great, either.

Tony:
But there’s so many different ways to structure it, Carrie. I think what’s most important is that the two of you sit down and really identify, we’ve got the acquisition piece hammered out, but what does the long-term management of this buy and hold look like? Who’s going to be playing what roles? And then do your best to assign either equity, or fixed hourly payments, or percentage of the revenue as a management fee for those duties and responsibilities of actually managing the property? I think it’s a common mistake that a lot of rookies make is that they overvalue the acquisition side, and they undervalue the long-term asset management. The acquisition, it’s a one-time event, right? You’re going to buy the property one time. But the asset management, that goes on for as long as the two of you own that property together, which could be a year, could be five years, could be 30 years, could be forever. You just want to make sure that you’re keeping that in perspective as you structure this partnership.

Ashley:
Okay. The next question is about hard money loans versus construction loans by Rhett Miller. He wants to know, “What are the best ones to use for a BRRRR: a hard money loan or a construction loan? Pros, cons. I’m looking at two lenders and one suggested a construction loan. I was just wondering what your thoughts were. Thanks in advance.” Okay, so the only construction loan I’ve used is actually to build my primary residence, so that was just ground up construction. Have you used a construction loan, Tony?

Tony:
Yeah, I have. I’ve used it twice for some of the properties that I had in Louisiana, my first few long-term rentals out there. But I think it might even be beneficial just from my own understanding to at least break down some of the differences here. Hard money versus construction loan: typically a hard money lender is a company of business that specializes in funding rehab projects for real estate investors. And usually you’ll see higher interest rates than a usual investment property loan. Additionally, there’s points like additional fees you have to pay upfront to use that debt as well. But a hard money lender’s bread and butter customer is the real estate investor.
At least for the construction loans that I’ve used and the ones that I’ve seen, you can get those from a more traditional bank. I got both of mine from a local credit union in the market that I was investing in. Even big banks like Bank of America has a construction loan. Typically, those are going to be for your primary residences, but you can get a construction loan from a local bank or credit union, not just a hard money lender.
I’ll explain how my construction loan worked, and I’ve actually never used hard money because I’ve always gone the private money route, but I’ll explain how the construction loan worked. The way that this specific credit union had it set up, I had to go out and find a property. Once I found the property, they would do… Basically, I would submit my identified scope of work. Say “Hey, here’s the work that I plan to do on this property.” They would then take that scope of work along with the current condition of the property, and they would basically do a future appraisal where they would say, “Hey, based on the scope of work and the current condition of the property, here’s what we think this property will appraise for after your work is done.” And as long as I was below a certain percentage, I think it had to be like 72% of the after repair value, they would lend me all the money for the construction and the purchase.
Basically, I had a one-year construction loan with them. It was an interest only loan, it was a great loan product. I think at the time interest rates were at a little over three, maybe, and I was paying 6% on the construction loan, so it was pretty good. Cheaper than if I would’ve gone out and gotten hard money at that time. I had a 12-month interest only construction loan. And what was great about the loan was that I was only being billed on the amount that I had drawn at the time. I bought the property for whatever, 70,000 bucks. Initially, it was only 6% on that 70,000. And then as my construction bill got larger, then the loan itself, the balance that I was being charged on got larger as well.
And then at the end of that 12 months, I was able to refinance with that bank into permanent long-term fixed debt. I went from the 6% construction loan down to, I don’t know, a 4% investment loan. That was a process for the construction loan. It’s all in house. They handle both the short-term debt and the long-term refinance, pretty much all under the same roof.

Ashley:
For this one, I think my answer at least would be using hard money versus the construction loan, just because in my experience with hard money, there is a lot less oversight compared to the construction loan. The construction loan, when actually I had to have a licensed contractor who was actually approved and verified by them, by the bank, where with hard money, they didn’t ask who was doing the work or anything like that. Not that I wouldn’t use somebody who wasn’t doing a good job. I think different hoops like that, the hard money was easier than doing the construction loan as far as having those hoops, and having so much information verified, and things like that. And for the draws with the hard money, it was a lot easier process to get the draws than it was for the construction loan, too.

Tony:
I guess the inverse of that, I actually found it super helpful, Ash, because I had this construction loan on my very first investment property ever, and I found a ton of value in actually having the bank send a representative to the rehab before they released a draw, because I was getting this confirmation. I was in California, the property was in Louisiana, several thousand miles away. I had my property manager, I’d already contracted the property manager, they would go and walk the property for me. I was FaceTiming with the GC once a week, he was giving me a walk through the property. But then I also had the representative from the credit union who would walk the construction to make sure that, okay, there’s progress being made before they release the draw. It was this security blanket for me to make sure that the rehab was moving the right way.
And then even on the acquisition side, I had this bank who knew the market way better than I did give me their estimate of the ARV. And so, I was super confident moving forward with it, because not only did my initial analysis make sense, not only did my realtor’s suggestion make sense, but then the bank who knows and has lended on tons of properties in that market, they also had this ARV that made a ton of sense. I think for a first time investor for a lot of our rookies, even though there are a few more hoops to jump through, it really can be a good set of training wheels on that first big rehab that you’re doing.

Ashley:
Yeah, that’s a great point as far as the training wheels, is someone holding your hand along the process, where with hard money, there definitely wasn’t that for me, at all. But that’s a great point. The one thing that I will challenge you on, I guess, with that is I did this YouTube video years ago with a hard money lender, and I said the same thing. “Wow, you send inspectors out? That’s actually really great. It’s like that second set of eyes on the property, somebody else who maybe has more construction knowledge.” And he looks at me and he goes, he’s like, “You know you’re paying a lot of money for those inspections, right? Those are baked into your loan fees. It’s not a free service.”
And he said, “If that is really why you want to do this type of loan product is for the inspections,” he said, “it is way cheaper to actually go and hire a third party inspector to come out and to actually do inspections like that for you, too.” I always think about that and how that was interesting. And sometimes you look at some type of service or product and you think like, oh wow, I love it because of this feature. Try to think more outside of the box, and if that’s the only feature you really need and why you’re finding value in this thing, is find a way to make that work for you without having to buy the whole process or system.

Tony:
Totally agree with that. I think I was in a unique position because this was a truly small credit union that had just a few branches in and around that local area, so it wasn’t expensive debt by any means. Like I said, I think there were no points. I didn’t pay any points upfront. The interest rate I’m pretty sure was 6%, and this was back in 2019, which was pretty good, so it seemed like a good one for me. I will say that the one downside was that I couldn’t use it to flip a home. I could only use it to BRRRR. And they made that very clear to me, like, “Hey, you can’t sell this property once the construction’s done. You have to refinance into permanent debt with us.” And then I think I had to hold it for at least like a year or something like that before I could sell it, so it was only for BRRRRing.

Ashley:
That’s actually another great point as the pros and cons versus hard money and a construction loan is what their refinance terms are. Especially when you’re doing a BRRRR like the question asked, the hard money lender that I had used on two BRRRRs, you had to refinance with them, but you had to have at least three properties you were going to refinance at a time, and they would only do almost a portfolio loan to refinance. I ended up pulling my properties off, and there was a 1% fee to actually not refinance with them.
And then also when I’ve done it with the bank, it was my primary residence or whatever, but we had to refinance with them once the construction loan was done. But I think really comparing what the refinance terms are, so not only the terms of the rehab process and that initial hard money and the construction loan, but also what happens when you refinance? Are you charged fees because you’re refinancing with someone else? What is the interest rate going to be? Can you lock in a rate? All those different things, look at that end scenario to the actual refinance piece, too. Okay, our next question is from Arbin Pale: “How much notice do you give to tenants that you’re not renewing the lease?” Tony, what’s your-

Tony:
I give them 24 hours notice. “You guys are leaving tomorrow at 10:00 AM, and if you don’t, I’m calling the sheriffs.”

Ashley:
This depends on your rental landlord laws in your state. I mentioned this actually our last rookie reply, we did episode three of 31 a couple of times, avail.co, or you go to your local housing authority website, or you Google your state and then tenant landlord laws. And usually, there’s some kind of handbook or guide available to you, free or really low-cost landlord classes you can take. Highly, highly recommend taking them. In New York state, you have to give notice depending on how long the person has lived at the property. If they’ve lived there for less than a year, they’re on a year lease and they have to live there over a year, you have to give 30 days’ notice that you’re not renewing their lease, or that you are renewing their lease. And if there’s a rent increase, it has to be that amount.
If it’s two years or less they’ve lived there, then it’s 60 days. And then anything over that is 90 days’ notice. Having to juggle this if you have multiple tenants, keeping track is very important as to how long they live there, as to when you actually have to do their lease renewal. Highly recommend setting some notification five days before that 30, 60, or 90 days, giving your time to write up their new lease agreement, their lease renewal, or that notice to let them know that you’ll not be renewing their lease. Check your state laws as to what that requirement is. I think the more notice you can give, the better. You just want to make sure that if you’re not renewing their lease, that they don’t retaliate by not paying rent for the next three months.

Tony:
I was going to ask that too, Ash. Say that you do issue a non-renewal notice, and let me just take a step back. So again, that property management company that I worked at for a very brief period of time, they also had it very clearly laid out inside of the original lease agreement what would constitute a non-renewal. For example, if you got X number of documented noise complaints that could lead to a non-renewal. If you had X number of late rent payments, that could lead to a non-renewal. So some things are super clear, where it’s like, hey, when your lease is up, you already knew that you weren’t going to get renewed. But say that it’s something maybe more severe where you’re issuing that notice. Have you ever had a tenant trash the place because they were angry, or just leave in the middle of the night? Or are most understanding, and they leave peacefully?

Ashley:
I actually can only think of one tenant that I’ve done a non-renewal with. And maybe when my properties were with the third party property management company, they did and they took care of things, so I was oblivious as to if someone was given a non-renewal or not. But before that, even when I property managed, I can’t think of anyone offhand unless it was like we said, we gave them their notice to cure or quit because they weren’t paying rent, for non-payment.
But as far as anything else, we did have one resident recently where right when we took over, her lease was up, we gave proper notice that we weren’t renewing it because of all the complaints. An old property management company had emailed us every time there was the issue, so we had record of it. It was issues with her dogs. And then she also was late all the time, and so we did a non-renewal with her. And she did try to say that she wanted to stay and things like that, and we just stuck to our guns, and she ended up moving out, and she actually moved in with somebody else at the apartment complex for a little bit. We heard from the neighbors or whatever, but apparently she’s found somewhere else now. But I can’t really think of any other times that we’ve done non-renewals for somebody.
Okay. Our last question today is from Chris Latt. And Tony, it is a question for you. “Airbnb arbitrage from the landlord’s perspective: what are the major disadvantages of this? I just listed my primary residence for rent, and I’ve already gotten inquiries about potential tenants that want to short-term rental the home when they are traveling, or they want to short-term rental a portion of the house. I added a private entrance to the master bedroom of my current house.” In this scenario, we have Chris who has somebody inquiring to be his long-term rental in the property, but while they’re traveling, going on vacation, doing whatever, they want to turn part of the house into a short-term rental to supplement what they’re not paying so they can go and travel. Tony, what is your take on this?

Tony:
Yeah, as the landlord, I guess we can just go pros and cons for allowing someone to arbitrage your unit. The pros are that you ideally could potentially charge slightly higher than market rents. If market rent is whatever, 1300 bucks, maybe you could charge this person, do an arbitrage, 1500. And it’s not uncommon, I think, to see that. The second benefit, and this is more so if you’ve got multifamily, but I know you’re talking single family, Chris, but I’ll talk to our multifamily folks as well. We took on our first arbitrage units from a buddy of mine that has a 12-unit apartment complex, and we took on not one, not two, but three of his units. He had three vacant units, he only had to go to one person, and I was able to lease all three of them from him.
If you’ve got maybe a bigger multifamily property, you could lease out multiple units at one time to one person. And I only signed one lease for all three, so all three are managed under one lease, so there’s less management, less overhead, et cetera, for that landlord. The third benefit, and this is counterintuitive, but the third benefit is that they’ll probably end up being your best tenants, because they’re going to handle a lot of the minor maintenance issues on their own. Because as a short-term rental host, if I’ve got the window between 10:00 AM when one guest checks out and 4:00 PM when the next guest checks in, if there’s a leaky toilet, or a handle gets broken, or something is wrong, I’m not going to wait on the landlord to come. I’m just going to fix it myself to make sure it’s ready for that next guest. A lot of those minor maintenance issues go away when you’re allowing someone to sublease if they’re a good host, because they’re going to want to make sure that it’s ready for that guest.
Those are some of the benefits. The disadvantages are potentially, you could have short-term rental guests that maybe bug your other residents. If you’ve got a single family house, it could be your neighbors. If you’ve got a multifamily, it could be the other folks that are inside of those units. But Chris, yours is a single-family home, so maybe you’ve got a little bit of space between your neighbors and your home, so it’s not as big of an issue. But if you’ve got people upstairs and downstairs, it becomes, I think, a bit of a harder thing to manage. And the other disadvantage is that God forbid, but you could have someone that there was a rager or something, and maybe they caused some extensive damage to the property, but I’d say that’s probably more of a rare occurrence than people actually understand. Honestly, I think there’s more pros than cons. But Ash, you’re the actual long-term landlord lady here, so what are your thoughts on this piece?

Ashley:
And I also arbitrage two apartments that I rent from somebody else. I’ll say, first of all, the first thing that came to mind is my short-term rental units, one of them, I was just trying to think, it’s been 2018 or 2019 I’ve had it, and that apartment to this day is nicer than people who have lived in an apartment at that same apartment complex for only a year. One huge benefit is it’s constantly being cleaned, and it’s always maintained and nice. That was the first thing I thought of is if these people are going to be renting it out as a short-term rental, they will most likely keep the house and the property very nice and clean, because they will want those five star reviews. They’ll want to get as much money as they can. That was my first thought as to that it may actually work out in your favor, and it’s not going to be a long-term tenant that’s just going to trash the place or not clean it and not take care of it because they’re going to be renting it out.
Another thing is, too, is that you’ll be able to look up the listing, and you’ll be able to read the reviews as to if they are taking care of the place, or if people are commenting and saying that the place is disgusting and blah, blah, blah, don’t stay here. The next thing, too, is I would check with your insurance agent as to how this would work for your insurance. Tony has short-term rental insurance on his properties. I have landlord insurance on my properties for my long-term rentals, so talk to your insurance agent and see how this would come into play. Do you need to have your long-term tenants get short-term rental coverage, so that way if somebody does throw a rager and do all this damage, or things happen to the property, that it’s actually your long-term tenants that are responsible to cover through their insurance all of the damages that were done at the property, and it’s not even anything to do with you?
And that actually would give me more peace of mind knowing that the long-term tenants have the insurance in place, so it’s them paying any deductible, and it’s their insurance premium increasing because they have a claim, and not you having a claim on your own homeowner’s insurance. Everything you touched on was great. Those are the only two things that I would add.

Tony:
Yeah, for the arbitrage units that we’re doing, we also have our own insurance in place as well, just to try and protect everyone. But yeah, honestly, I think it could be a win-win for you as the landlord, and for the folks that are renting it from you.

Ashley:
Well, thank you guys so much for listening this week. I’m Ashley at Wealth from Rentals, and he’s Tony at Tony J. Robinson. If you have a question, you can submit it at biggerpockets.com/reply, and you can also check out our new book, Real Estate Partnerships, at biggerpockets.com/partnerships. Thank you, and we will see you back here on Wednesday.

Doug Bauer, Tri Pointe Homes CEO, joins ‘The Exchange’ to discuss demand in homebuilding, how the industry is positioning itself for new home builders, and more.

By Meeta Vengapally

The other day, I went to the grocery store and bought a sweet red pepper for seven dollars. Through my sticker shock, I reasoned with myself that it had to be done. Peppers are incredibly healthy, I use them in many dishes, and I wasn’t going to let my children live on French fries alone.

What kept me in the produce aisle agonizing over this decision is the same for all of us—vegetables shouldn’t cost so much, and neither should everything else. Standing there in dismay, I looked around at the other shoppers and realized that we were all in the same boat. Our world is currently pretty crazy, so I asked myself, how do we create sanity in an upside-down world? More importantly, how do we—and our businesses—prosper?

Overcoming disillusionment in our personal and professional lives

It’s no surprise that inflation, crime, and poor mental health all go hand-in-hand. We’re human. Everyone is doing their best and we’re at the point where people must go to desperate lengths just to survive. America is one of the most affluent countries in the world, but the wheels seem to have come off the tracks. People are struggling and it feels as though moral fortitude has been lost.

We live in an increasingly marginalized, politicized, hateful world, and what causes all of this is deep-seated fear—fear in both our personal and professional lives. But this disillusionment can either bring us down or lift us up together. Considering the problems we face, we can choose inaction or innovation. Many businesses are struggling through this time but those that are rising above are choosing to seek new solutions. In truth, what’s happening in the world can make us all better and stronger with the right mindset. Here’s how.

1. Understand that you’re not alone

My personal key to thriving despite disillusionment and worry is focusing on the knowledge that if I’m fearing something, countless others are as well. When mental health issues spring up, well, someone else has that to contend with, too. My terrifying grocery bill to feed my family gives me the same heart palpitations that it gives others. If I’m struggling with leadership decisions, you better believe that countless leaders are as well.

Although we can’t control our current world, we can take a moment in the produce aisle to realize that we’re not alone in this. The pandemic, protests, and serious crime on the rise—none of this is under our control. More than ever, it’s time for us to focus on what we can control: what we do for ourselves and how we relate to family, team members, and our customers or followers.

2. Lead from the heart

I’m an Instagram influencer and I’ve been questioning that term lately. How do we influence? What impact do we have? These questions are more important than ever because we can rise above the negativity through the decisions we make in life and business. “Influencing from the heart” may not be a widely discussed leadership tactic, but as business owners, content producers, and entrepreneurs, we absolutely must lead from the heart and foster our creative spirits in the face of challenges.

Our customers, team members, and even those we pass on the street want to be seen. The best way to do this is in a heartfelt way. Businesses that are thriving right now understand this key principle. The world has changed and they’ve changed with it. There’s the old adage about the customer always being right. My take on that in our modern climate is the customer is always right about needing that heartfelt, human touch. We all need it in this time of disillusionment.

More from AllBusiness.com:

3. Rise above the “I’m okay” fallacy

“I’m okay” is one of the biggest cop-outs. Even as a leader or small business owner, sometimes you’re not okay! Admitting this is an expression of your humanity and contributes to the health of everyone around you. Our society is geared toward looking the part: strong, resilient, and fashionable. I think these qualities are excellent, but we gain more strength and resiliency when we admit to the moments that we feel weak.

This is particularly important in business and most don’t realize it. If a team member is feeling unwell or suffering in some way, their resilience grows when leaders let them know that it’s okay to not be okay. When we give each other strength during difficult times, we all rise above and become more resilient. If your business or sales are “not okay,” the same principle applies. Being honest about what’s going on opens the door to what needs to be done. Ignoring it creates the opposite effect.

4. Step back from the chaos

When I step back from this maddening world, I ask myself, “What do I say to my kids?” The answer came to me with that red pepper in my hand:

Look around. Everyone is struggling. People who break into shops are struggling (but that doesn’t mean they should do it). Those suffering from depression and anxiety are struggling, and those trying to make ends meet are struggling.

Entrepreneurs and leaders often feel the need to push ahead. People depend on us and success is the main goal. However, the modern superhero needs to step back and assess. There are so many new variables in our world. Responding out of fear isn’t the right choice. In a crisis situation, of course, you need to think on your feet, but if you are dealing with circumstances where you can take more time, then do so. Giving yourself that moment will help you soar above and gain perspective.

Thriving despite disillusionment

The entrepreneurial spirit teaches us to be strong, confident, and resourceful. Our current topsy-turvy world is teaching us to be something bigger: both vulnerable and strong in our communication with one another. We see what we see. When it comes to the news, we’re fed what we’re fed. More than ever before, our interactions are complex, challenging, and immensely important.

Being disillusioned in America feels a bit like a pandemic hangover, but there’s a greater lesson that has come from it. People don’t feel okay sometimes. Perhaps you don’t feel okay. Maybe your business is hurt. But it is important to know that not being okay is okay. This greater understanding and acknowledgment is vital for your family, your entrepreneurial spirit, and yourself.

Take a break from the world and focus on what you have to give. It’s the most important life and career decision you can make.

About the Author

Meeta Vengapally, a trailblazer in the startup tech world and a social media personality, is the Founder and CEO at Garnysh and a sought-after influencer. Meeta has a portfolio of orchestrating over 1000 brand partnerships and serving as a spokesperson for top-tier companies. She balances her entrepreneurial achievements with being a dedicated momager to her two talented teen actors, Winston and Sitara Vengapally. Stay connected with Meeta on Instagram, read her Forbes profiles showcasing her expertise in the startup world and on social media, and explore her articles on AllBusiness.com.

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Dave:
Hey, everyone. Welcome to On The Market. This is Dave, your host. Today, we are going to be joined by one of the OG data and market media people in this entire industry. His name is Clayton Collins. He is the CEO of HousingWire Media. If you’re not familiar with HousingWire, they’re one of the biggest housing market media companies in the industry. They don’t focus really on investors like we do here at BiggerPockets. They focus on the broader marketplace, so mortgage lenders, real estate agents, a lot of those types of things. But Clayton and his team, they have been acquiring data companies actually over the last couple of years, and so they have some of the most cutting-edge data of any of the sources out there.
So, today, I’m having Clayton on to talk to him about some recent changes that we’ve been seeing in the market. So, inventory, as you all know, is a really big issue this year, and they have some of the most up-to-date information about that, so I’m eager to talk to him about if there’s a shift going on as we go into the winter because I’m starting to feel one or sense one, and I’m curious to see what he’s seeing. We’re also going to talk about Clayton’s predictions for mortgage rates, and I know this is something people really want to know, so I’m going to talk to Clayton and get his opinion about where mortgage rates are going to go and why.
I know we all like to prognosticate, but there are some really important macroeconomic trends and technicalities that go on behind the scenes that Clayton knows a lot about and is going to help share with us today. So that’s what we got for you today. It’s going to be an awesome show. It’s a lot of fun. Clayton is really great at explaining some really important topics in the housing market. So we’re going to bring him on in just a minute here. But first, we’re going to take a quick break.
Clayton Collins, welcome to On The Market. Thanks for being here.

Clayton:
Dave, it’s my pleasure. Thrilled to be your guest today.

Dave:
Well, yeah, this is going to be a lot of fun. For people who don’t yet listen to the HousingWire Podcast, can you tell us a little bit about yourself and your work at HousingWire?

Clayton:
Yeah, happy to. So I’m the CEO at HW Media where I have the pleasure of leading our HousingWire team. At HousingWire, we’re focused on providing housing professionals from real estate brokerage, and agents to loan originators, and mortgage capital markets leaders, loan servicers with the full picture of the housing economy. So we have a team of editors and reporters that cover everything that happens in housing from housing market and interest rate news to the movement of people, and companies, and M&A, and innovation. Everything that happens in housing.
I came into this venture, and I’ll tell you more about my background, Dave, more as a banker type, but somehow I got sucked into hosting a podcast. Now, I’m the host of the Housing News Podcast. So, each week, I interview different executives in the housing industry from mortgage bank CEOs to economists about what’s happening in their world. We keep it like a board level conversation and talk about some of the tougher topics that they don’t always get to talk about, and I try to pull out some of that juicy knowledge in this really fun format that I think you and I have both grown to love.

Dave:
Oh, for sure. Yeah, and it’s a great show. I do listen often, and you do get excellent guests, so I definitely recommend it.

Clayton:
I appreciate it.

Dave:
One of the other things you didn’t even touch on, and I’ve been following HousingWire for many years, is that recently, you acquired Altos Research, and we have had their founder, Mike Simonsen, on the show. He and I are friendly as well. Now, you guys are tracking some of the most up-to-date housing market data, honestly, there is that I see. Can you just tell us a little bit more about what you all are looking at?

Clayton:
Yeah. So, Dave, I appreciate you asking about that. Altos is an important part of that phrase I use, “The full picture.” So we believe that business news and business content is on a constant evolutionary cycle that’s leaning more and more toward data-enriched content, and research, and proprietary information, and narrative-driven journalism and storytelling is an incredibly important part of a data-rich ecosystem. It’s how professionals consume information. But we know for us to achieve what we want to achieve at HousingWire by being the full picture, we need experts like Mike and data like we get from Altos to really color that picture.
Altos tracks 100% of active listings in the country. So we like to think of Altos as the most real-time source of data for what’s happening in the active real estate market. So we’re watching every active listing, every price change, every pending, all the data that drives market intelligence, and our users, which are primarily real estate agents, title professionals, and loan originators, use that information to better inform their home buyers, and sellers, and referral partners.
So we take all this active market data, and decipher it down, and cleanse it, and make it understandable so professionals at the local level can be the expert in their market and know exactly what’s happening in their zip code, or their city, or their neighborhood. We have some really cool visualizations of data and the health of the market we call Market Action Index, and we bring all these tools directly to the professionals that are working with home buyers and sellers every day, and make it easy for them to understand what’s happening in housing.

Dave:
Yeah. Great. I mean, I totally agree with the value proposition. It’s the whole idea behind the show as well, that we need more narrative data-driven information in today’s world, and you guys are doing a great job at it. Just for anyone listening, you can check it out. A lot of it is just available on HousingWire. You can go check it out right there, but tell us, Clayton. What are you seeing right now because inventory has really been the story of the year? It’s the word of the year in real estate, I guess, but things are starting to look a little different as we’re heading into Q4. What are you seeing?

Clayton:
Yeah. I mean, it’s been an incredibly… I don’t want to use the trite term of challenging market. It’s been a complicated market, Dave. So, over the last year and a half, we’ve seen interest rates, mortgage interest rates grow at a faster pace than we’ve seen at nearly any time in history, and we’re at a point right now where interest rates are at 20-year highs, and that creates some really challenging dynamics in the market. In most environments where interest rates expand this quickly and reach multi-decade highs, you’d start to see some serious pain in the underlying asset, and you’d start to see home prices decline. But there’s this other dynamic, and it’s that word that you just mentioned, “inventory,” that’s made this challenging market more so of a complicated or complex market.
So, depending on the research you follow and the analysts that you trust, there’s a view that we’ve been underbuilding in the US for at least 13 years, and household formation has far outpaced new inventory coming to market. So we have this demographic push of first-time home buyers and people that are forming households that are creating demand in the US housing economy, and we just haven’t kept up. That undersupply has created an inventory constraint, and despite the pressure with mortgage interest rates, we’ve seen home prices hold up. In most markets, home price appreciation has continued, and it creates this really unhealthy dynamic where first-time home buyers, repeat buyers all face affordability challenges finding the home that they want, and it creates a pretty funky scenario in the residential housing ecosystem.

Dave:
Yeah. Definitely. I mean, I think we’re all getting used to this low inventory situation.

Clayton:
Yeah.

Dave:
Do you see anything in your data or just in your own opinion that would increase supply? We talk a lot on the show about demand because that seems more variable, but I’m having a hard time. I’ve been asking a lot of guests this. Do you think anything will change the supply picture through the end of this year maybe into 2024?

Clayton:
Do you want me to hunt for silver linings or-

Dave:
Sure. Do whatever you want to do.

Clayton:
No. I think the reality is I do not see a dynamic that changes the inventory or supply situation drastically in the foreseeable future. I think we’re looking forward at a multi-year, potentially multi-decade market where we operate in a lower inventory, lower supply, supply-constrained market. Now, we know coming out of COVID in a market that moved incredibly quickly to the upside in terms of volume, and then now this interest rate increase that year-over-year metrics are hard to track, and there’s going to be noise in every measure where we’re looking at month-over-month, year-over-year even normalizing for COVID. There’s a lot of noise in year-over-year metrics.
So, today, as we sit in fall of 2023, we’re watching the Altos Research data, and we’re seeing that inventory today is still 5% lower than inventory of last year despite the fact that we’ve been watching inventory increase each week for the last several months. So we start to see this trend where more inventory is coming available, and that’s coming available because days on market is extending. So homes are not moving as quickly as interest rates approach this 7.5%, 8% range. So homes are sitting longer, so inventory is building. Now, the easy headline there, the housing bear, the bubble boy persona, our analyst, Logan Mohtashami, would-

Dave:
Yeah, we’re big fans of Logan.

Clayton:
Yeah.

Dave:
I love Logan. His terminology is hilarious.

Clayton:
Yeah. He’s a genius when it comes to colorful terminology. Some of the players in this housing ecosystem that we operate in. So, the bubble boy mentality. It’d be like, “Oh gosh, we’re looking at multi-months where every single week, inventory is climbing. This is a problem brewing.” But we’re still sitting at a place with 5% fewer homes than last year, and I’m not armed with the data as we come into this conversation, Dave, but we’re significantly lower than we were at almost every point pre-COVID in terms of what normal housing inventory levels look like.

Dave:
Oh, yeah.

Clayton:
So I’m going to warn you right now. Someone is going to write a headline and saying like, “Inventory is climbing. Home prices are getting slashed. We’re heading into a bubble, a turbulent market. It’s all going to blow up.” Our data does not show that. We show that we are climbing, but we’re climbing back toward a slightly healthier place, slightly healthier, but we are still in a savagely unhealthy housing market, and that unhealthiness is fueled by low inventory and affordability challenges that are complicated by mortgage rates and home prices.

Dave:
Yeah. I think it’s super important for people to pay attention to not just the percent change, but the absolute numbers when they’re looking at some of this data because there is something… As we’ve gone over on this show a little bit is that there’s something called the base effect. When you’re comparing this year to an anomalous year like last year, then data looks a little bit crazy. But if you zoom out a little bit and look over 5 years or 10 years, you can see that historically, inventory was much higher than it was even today even though it has started to increase.
Now, this is a good segue to one of the things I wanted to ask you because in certain markets, we are starting to see inventory approach or even exceed pre-pandemic levels. These are some of the COVID boom towns like Boise and Austin, I think Vegas and Reno, or those profile, but some of those markets have actually steady… been okay over the last few months even though they were previously in a correction. Do you see any change in demand or any downward pressure on prices in those markets?

Clayton:
Yeah. So we published some research based off of data from CoreLogic on some of the markets that are most likely to see a price decline, Dave. What we’re seeing in that data is that there’s different drivers in all of those markets. So there’s markets, like in Ohio and Pennsylvania, that are being driven by lack of population growth and lack of job growth, and then there’s markets in Florida or as we think back to the phrases of the last crisis, the Sand States just saw rapid appreciation in prices, and it’s more so of a normalization than a… but a normalization that will still sit significantly higher than the base rate of pre-COVID.
So there’s different drivers on what we’re seeing in each market. I think we saw a lot of exuberance and over-ask offers in certain markets that were really popular during COVID, particularly in states that had a better lifestyle, more lax enforcement of some of the COVID restrictions, no state income taxes, the things that attracted people over the last couple years. Some of those states are going to see a slowdown in home price appreciation, and certain markets may even see some declines in prices, but I think it’s very much… It’s hard to quantify those as bubble markets or crisis areas. It’s just a volatile pricing ecosystem that saw a fast run-up and is trying to find the equilibrium point.

Dave:
Yeah. It’s weird because it feels like there was this correction, at least a modest correction on a national scale. It was more pronounced in these types of markets. About a year ago in Q4 of 2022, maybe into Q1, and then things got better at least from a price perspective if you’re someone who wants high prices. I think certain investors of our investors don’t want high prices.

Clayton:
No.

Dave:
Now, it feels like… and things got better, and I think a lot of people are starting to think, “All right. We found a bottom.” To your point, there’s this pricing exercise that’s going on like, “What is real? What was COVID exuberance or this massive change in migratory patterns?” But now, it feels like we’re going… To me at least, it feels like we’re going back into the pricing exercise because rates just won’t slow down, and now we’re accepting… I feel like in the last two or three months, there’s finally market-wide acceptance that the Fed is not bluffing and that they are going to keep rates higher for longer, and we need to all deal with this. Now, there’s going to be this second pricing exercise that goes on.

Clayton:
Let’s not even call it a pricing exercise. Let’s call it the way markets are supposed to operate.

Dave:
That’s true. Yeah. That’s literally a market.

Clayton:
When cost to capital goes up, there’s pressure on asset prices.

Dave:
Yeah.

Clayton:
So we primarily look at the housing economy through the lens of the residential homeowner, and I know the BiggerPockets audience inclines much more toward the investor category. So it’s a different lens, and there’s a little bit of different analysis that goes into the right time to buy or sell when you’re looking for a roof over your head or an asset that produces yield. But the secret on the investor side is understanding the national headlines and that over the last 12 months, on a national level, we still saw close to 4% national home price appreciation. Over the next 12 months, we expect 3% to 3.4% home price appreciation, but where are the deviations from that?
The article that you spotlighted and asked me about, where home prices are supposed to fall, that volatility, I think, is where opportunity will be found, and this interest rate environment definitely puts pressure on pricing standards. I think that does create an opportunity for home buyers and investors alike. I’m not sure we’re going to… We’re not going to preach the “marry the house, date the rate” thesis, but you do have to think about winter market environments, when it’s a good time to buy winter market environments, when it’s a good time to hold, and high cost of capital markets often create downward pressure on asset prices which is something I’m paying attention to.

Dave:
Yeah, yeah. Absolutely. That’s a very good point, and I’m curious. You said what? 3% to 4% growth over the next 12 months, is that right?

Clayton:
Yeah. I mean, we’re talking about this, the CoreLogic home price article, so I’m hinging on their estimates.

Dave:
Okay.

Clayton:
There are some pretty wide estimates. I mean, we still have investment banks that are forecasting negative home price appreciation, but most of the housing economists that are watching are looking at that 3% to 4% range on a national level.

Dave:
I’m curious. It must all be on rate declines, right? I guess I just don’t see how prices keep going up personally, unless rates fall, so they must, and there’s a good chance rates do fall next year. I’m just saying that must be why.

Clayton:
Great qualifier there, Dave. I think every housing economist that I’m following is forecasting lower rates by the end of 2024. Now, wishful thinking, optimism, fact. I don’t know.

Dave:
We don’t know.

Clayton:
I think long-term interest rate forecasting is a fool’s game, and there’s no win there.

Dave:
It’s so hard. Yeah. Yeah. Just when we were starting to settle in the mid-sixes, everyone was starting to get comfortable with it, then bond yields just started going crazy in the last month. It’s like no one even really knows. Yeah, we’ve had good jobs data, but no one really even fully understands why bonds have just run up. There’s this huge sell-off going on right now.

Clayton:
I mean, a big reason why mortgage bonds are… the spread is so wide is the Fed is not buying.

Dave:
Yeah.

Clayton:
We have a long-term… Look back at the last decade, spread between the 10-year and 30-year fixed rate mortgages was 130, 140 basis points. We’re sitting at 300 right now, and that is because of the Federal Reserve. The Federal Reserve is not just controlling interest rates, they’re also controlling the throttle on buying mortgage-backed securities, and that’s creating incredible pressure in the capital market’s ecosystem which arguably is more impactful on the price that consumers and investors are paying for debt than even some of the interest rate moves.
So the Federal Reserve is having a big impact on spreads right now, and that’s something that can be fixed. If we start to see a normalization of mortgage-backed security buy-in, the bond market starts to operate as it should, and banks and the Federal Reserve start coming back into the market and buying mortgage-backed securities, we’re going to see a massive change in the 30-year fixed rate mortgage for the better. But right now, you want to know who’s buying mortgage-backed securities? Nobody.

Dave:
Yeah. Exactly.

Clayton:
That is a dead market, and that’s creating a really big spread.

Dave:
Yeah. So just so everyone understands what we’re talking about here. If you’re not familiar, mortgage-backed security is basically when people bundle a bunch of different mortgages, and they’re sold on markets to investors. For much of the last, whatever, 15 years or so, one of the biggest buyers of mortgage-backed securities has been the Federal Reserve. As part of their effort to do “quantitative tightening” to reduce the monetary supply, they are reducing the amount of bonds that… or excuse me, of MBS, mortgage-backed securities that they are buying.
One of the major drivers of mortgage rates, as Clayton just alluded to, is the spread between the 10-year yield and mortgage rates. Normally, like you said, it’s about 1.5% or 150 basis points. Now, it’s about double that, and the spread is due to a lot of different complicated things, but one of the main things is demand for mortgage-backed securities. That is a major driver of the spread, and as demand goes down, prices for these mortgage-backed securities go down, and that sends yields and interest rates up. So hopefully that makes sense, but I totally agree with you, Clayton, that that is a very complicating factor in this entire scenario and maybe one of the reasons for optimisms that rates will come down because mortgage rates could come down without the federal funds rate falling.

Clayton:
What happens if mortgage rates start to come down? Demand on MBS will, we anticipate, will pick up. So, at the same time, as rates coming down, the spread will narrow, and rates will come down even faster. So one of the reasons the spread is so wide right now is because who wants to buy a tranche of mortgage-backed securities at a 7.5% or 8% rate? Those loans are going to get refied so fast, so investors need to get paid off quickly. So they’re demanding a really… There’s pricing pressure on the mortgage-backed security portfolio because the loans are going to get refied the second we see a change in interest rates. So the owners of those mortgage-backed securities need to get paid fast. In the first year or two, they need to make their margin on the security, and that’s one of the other reasons why there’s a lot of pressure on the spread between the 10-year and tranches of 30-year fixed rate mortgages. So there’s a potential for this market to move really fast in the other direction.

Dave:
Interesting. Yeah.

Clayton:
But we just haven’t found that precipice point where there’s willing buyers in the market. If the Fed is not buying, banks aren’t buying, and we sit at this stalwart standoff right now where nobody is buying mortgage-backed securities, consumers don’t want to buy houses at 8% rates, yet there’s still an inventory crisis, so home prices hold high. It’s interesting.

Dave:
Yeah, it definitely is interesting, and I’m glad you brought that up because I think for some people, it’s illogical that you wouldn’t want a 7% mortgage rate because as a bank, you would think higher mortgage rates equals higher profit. But as you clearly stated, Clayton, that these loans are not going to be held for a long-term. At least that’s the overwhelming belief, is that rates will come down eventually, and that everyone with a 7% or 8% mortgage is going to refi into a 5% or 6% mortgage, or whatever it comes down to.
Then, a lot of residential mortgages don’t have prepayment penalties or anything like this, and so that the only way that a bank makes money is by charging a higher interest rate upfront, which is exactly what they’re doing. So this is getting a little technical, but it really matters because everyone wants to know where mortgage rates are going, and a lot of people just look at the Fed and they’re like, “Oh, the Fed is doing this. The Fed is doing that.” That does impact things, but there is this whole other bond market, MBS market that is playing a huge, huge role in mortgage rates right now. So hopefully this helps everyone learn a little bit about it.

Clayton:
Prepayment is an important topic. So mortgages are one of the only securities out there that do not have any type of prepayment penalty. It’s a unique part of our US housing economy. So if you’re a bond trader or a fixed income investor, and you can get yield from corporate debt that has prepayment penalties and will have longer duration, that’s a much better investment right now than the 30-year fixed rate mortgage that we know is going to get refied, and MBS holders are going to get taken out. So it’s a complex factor there, but perhaps a better place to spend time than pontificating about where rates will go, it’s like what happens when rates move?
Dave, one of the things that we’re thinking about… Concerned, thinking, optimistic. It’s a weird concentric circle right now, but if rates do move downward at a significant rate, that will be the precipice for more inventory coming to market because home buyers are home sellers. So as soon as the homeowner starts to feel confident and that move-up decision or relocation decision, that repeat buyer is going to come back in the game, that will create more inventory because they’ll sell their prior home, which is a good thing. It lubricates the market and creates volume for the industry, but what it’s also likely to do is put some wind in the sails of home price appreciation again. So if we see interest rates make a significant move beneath seven into the sixes, and God forbid, back into the fives, I think we’re going to see home price appreciations shoot back to the teens, and we’re going to be back in a precarious situation where we’re talking about affordability issues again.

Dave:
Wow.

Clayton:
This time, driven by the price of the asset, not so much the cost of the capital.

Dave:
Interesting. Wow. Do you think there is an inflection point there where it would get that high in appreciation in terms of rates?

Clayton:
There is an inflection point there.

Dave:
Yeah. I mean, I’ve seen some data from a John Burns real estate or research and consulting, and Zillow say it’s about 5.5% I think is the spot.

Clayton:
I think that’s too low. I think the market is a full-on frenzy at 5.5%.

Dave:
I do, too. That makes sense.

Clayton:
I think we have a very functional housing economy at 6%. If we dip back to the fives, I think we are in frenzy land.

Dave:
We’re in trouble. Yeah.

Clayton:
We keep talking about these first-time home buyers. First-time home buyers are not anchored or hinged to 3% loans because they didn’t get them. They might’ve heard about it, but they’re not like me who has a two handle on their mortgage, and it’s never going to go anywhere.

Dave:
Yeah. They weren’t getting underwritten, and they saw what their monthly payment would have been.

Clayton:
Yeah. So they’ll be a little bit disjointed. Their nose will be a little bit out of whack, but they’ve never had access to that cost of capital. I hope they don’t ever again because we know what happens with… 3% cost of debt means that we are in a world war with a national pandemic and some really bad stuff happening in our global society.

Dave:
Right. Yes.

Clayton:
I mean, I don’t want to forecast for that or bet for that because it’s not a good thing.

Dave:
Yeah. You and be both. Yeah. It’s interesting though because… I wonder though. The big question to me is what you just brought up, and I’m glad you did, is that in traditional times, you see this scenario where when there’s softness in the housing market, inventory goes up. This is clearly not what’s going on in this market, and so your assumption, which I assume too, is that the reverse is going to be true, that when rates fall, the supply and new listings at least will start to increase. If it happens proportionately or not I think is a really big question. If we’re going to start to see maybe more demand or maybe more supply, or how much supply comes online is still just such a big question. I could see exactly what you’re talking about, or I could see, in some ways, demand just coming back online without as much proportionate supply, which would lead to this sort of frenzy you’re talking about as well.

Clayton:
Yeah.

Dave:
So I think it’s a big thing to watch if and when rates do come down.

Clayton:
If we’re going to connect the whole picture and we see this environment where inventory starts coming back and interest rates are palatable, then we start to see an environment where the interconnectivity between the ownership market and the rental market starts to get more attention. So I think we’re in a point right now where for first-time home buyers, homeownership has become inaccessible due to asset price and cost of capital. So potential first-time home buyers are choosing to continue as tenants and continue renting.

Dave:
Yeah.

Clayton:
In the last week, we’ve seen headlines in the Wall Street Journal, we’ve seen narratives from the National Association of Realtors about potential first-time home buyers extending their leases. I think there’s even some YOLO-type headlines in the Wall Street Journal about people saying, “I took that house down payment and went to Europe and just chose to travel.” So there are some people… Now, we all know how some of those article sources are developed. It’s not always representative of the whole population, but there’s a narrative that some folks who had homeownership in their sites are just backburnering that, and they continue on renting, and go on and live their happy life. But that title turned at a certain inventory level, on a certain interest rate level where those renters decide, “Hey, homeownership is now back in my option pool, and I’m going to make that jump.”
So, ultimately, it all comes back to demographics, and we have a very strong demographic wave of 20-somethings and early 30-somethings that are either forming households today or form households in the near future, and it doesn’t matter what happens in the financial markets, the interest rate markets. We do not have housing supply to meet the demand of current demographics. So those people are either going to own or they’re going to rent. There’s going to be demand on either side, and there’s going to be movement between the two, and that’s going to be driven by interest rates.

Dave:
Yeah. That’s going to be very interesting for us, for our audience in particular because I think it points to the idea that their rents could start growing again, too. We saw this crazy rent growth, and it’s really flattened out. But if this scenario that you’re describing does unfold, it would point to further demand for rentals, and I could definitely see that happening. There’s definitely a logical path where that could happen.

Clayton:
The crazy thing with the rent market is it’s a lot more feasible to change the volume of rental inventory faster than it is the volume of ownership inventory. So multifamily developers have been able to bring a lot of inventory to market really quickly at a pace that home builders cannot. So the rental market has more control of their own future than I think the homeownership market does for better and for worse.

Dave:
That’s interesting. Yeah.

Clayton:
Overbuilding can happen fast, and inventory problems can be created or solved. I would defer to you, Dave, on where you think we are in that cycle.

Dave:
Multifamily is not looking great, I mean, from an oversupply perspective like we’re seeing… I think in Q3 of 2023, we’re going to see by far the highest delivery of units ever at a point where it’s already starting to soften, and it looks like we’re going to have above-average deliveries for… I don’t have the data in front of me, but I think we have above-average deliveries, and that just means new units coming online for at least another year. So I think this is going to create a very interesting situation for multifamily where rents are already getting soft, cap rates are rising, there’s an influx of supply. It’s why I think on our show we’ve been saying that multifamily values were going to drop quite a bit, and I still think that’s true, but probably a conversation for a whole other podcast.

Clayton:
Yeah, it’s a complicated ecosystem, and multifamily capital is important. I think that some of the same banks who have been supporting multifamily developers and operators both at development and lines of credit are going to start filling some of the… They have exposure to the office market as well, and there’s going to be some pressure on access to debt and access to credit lines, and starting to see that pop up in the ecosystem already.

Dave:
Definitely. It, honestly, unfolded a little slower than I was expecting, but I think that will be a major story in 2024.

Clayton:
So we’re not going to convert all the office buildings to apartments, right? Are we doing that?

Dave:
I wish. I mean, they keep talking about it, but from everything I look at, it just says it’s not really as feasible or as easy as people want it to be. So it would be nice. But before I go, Clayton, we’re talking about stories for 2024 with your media business here. Are there any other stories in 2024 you’re looking forward to or think are going to be particularly interesting?

Clayton:
Yeah. I mean, I think housing is interesting from media perspective because it’s a sector that goes through rapid change, and our mission and vision is to provide the full picture to housing professionals. I think as a media and data business, we’re more important than ever in a period of change. So I’m excited to support our audience and support our users as we go through a volatile market. It’s sad and disappointing that we’ve seen a lot of really qualified and really successful professionals exit the industry with volume down in real estate and mortgage. We’re going through a wave right now where there’s a pretty notable reduction in force, in the number of people that are part of this industry.

Dave:
Yeah, staff.

Clayton:
It’s sad and painful to watch, but it’s also a really important inflection point in residential real estate. We’re watching volumes come down, but we’re also watching change at the national level. Some pretty headline lawsuits happening around real estate agent and broker commissions. Depending on the outcome of those, and there are some pretty varying viewpoints there, it could be a precipice for major change in the way that homes are bought and sold, and potentially could open the door to a very strong innovation wave.

Dave:
I like the sound of an innovation wave. I’m not hoping for anyone to lose their shirt, but hopefully, it’s an innovation wave that raises all ships.

Clayton:
Yeah. No. Innovation waves. There’s winners and losers, but ultimately, this industry is built to support the homeowner, and the changes that we’re seeing in market right now, as painful as they may be, do seem to point to a more efficient and economical solution toward homeownership. That’s going to come with technology. It’s going to come with faster and more free access to data, and knowledge, and information, but hopefully, it creates a faster-moving, more easily accessible housing economy that’s great for homeowners, and then ultimately, still is a very fruitful place to do business for lenders, real estate professionals, and then folks like you and I who operate in the ecosystem.

Dave:
All right. Great. Well, I trust you all will be covering this closely. If anyone wants to follow Clayton and his team’s work at HousingWire, you can find them at housingwire.com. Clayton, thank you so much for joining us. We appreciate it.

Clayton:
Dave, it’s my pleasure. Thank you.

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