JF2368: The Case For Multifamily Real Estate in 2021 | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will be making a case for multifamily real estate as an asset class. This episode builds on previous episodes of the Actively Passive podcast that covered various industry reports and showcased in-depth information about the multifamily market.

This time, Theo and Travis are explaining why multifamily real estate is a great choice for passive investment in 2021. And while there are many nuances for each market and specific deals, some common indicators show how profitable and secure the multifamily asset class investments can currently be.

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening!

Click here for more info on groundbreaker.co

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JF2361: The Importance Of Having An Exit Strategy At The Start | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will discuss the importance of thinking about the exit strategy before entering a deal. In a way, this is not the topic that gets covered often since most investors are not thinking ahead far enough. However, selling the asset is a vital part of the investment process.

Travis gives an example of how something that looks like a great buy at first can turn out to be a lemon if nobody wants to take it off your hands. And just because a property is at a great acquisition point, it doesn’t mean that you should jump into the deal.

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening!

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners and welcome to another edition of the Actively Passive Investing Show. As always, I am your co-host, Theo Hicks, with Travis Watts. Travis, how are you doing today?

Travis Watts: Hey, Theo. Hey, everybody. Happy to be here.

Theo Hicks: Thanks for joining us. Thanks for tuning in, everyone. Today, we’re going to be talking about how to plan for the end. Very ominous, but we’re talking about the exit strategy. A lot of real estate podcasts and content are really focused on the upfront – finding deals, finding GPS from a passive investor perspective, analyzing the deal, understanding the team, and then how to fund the deal, how to get the ongoing evaluations and recaps… But there’s not a lot of focus on the end of the game, what happens at the end of the business plan.

A very common truism in real estate is that you make money on the buy, but in reality, they’re saying is that when you buy it, whatever the price that you buy that is going to impact the amount of money you make at the exit. So really, what we’re talking about is the exit. So what we wanted to do today was go over some of our thoughts based off of a blog post that someone on our team wrote… Our thoughts on how to understand the exit strategy, why it’s important, the different types of an exit strategies, the pros and cons of each… Because if you do make the most money at the exit, that’s probably the most important thing to actually know. And since people don’t talk about it a lot, Travis thought it’d be a good idea to talk about it today. With that said, Travis, do you want to, as usual, introduce in more detail why we’re covering this topic and give some background from your perspective as a passive investor, maybe when you realized that the exit strategy was actually one of the most important aspects of passive investing?

Travis Watts: Absolutely, Theo. I was skimming through joefairless.com the other day, and I just came across this mere coincidence… I just had one of those light bulb, epiphany moments… Being that I’m the director of investor relations, and I talk to investors all the time, I got to thinking of the questions I get asked all the time, and this is certainly not one of them… And I thought, why is that? Everyone’s so concerned with what’s the year one projection, and the cap rate, and the purchase price, and all these things, and analysis paralysis upfront… But what about your ability to sell the asset in general?

I just thought of this just now as you were doing your intro… I remember when I first got started, I was maybe a year into real estate, it was like 2010 or something. I went to this conference and they had an opener, someone that came up before the main act, which was about fix and flips and stuff… And they were trying to sell this tax lien investing software platform or something like that. And I got duped, I bought it. It was a couple grand. It was free information I could have found online. But the funny thing was, I got into this platform they were selling and I started searching for things, and a lot of this stuff was more or less swampland. I’m thinking, “Yeah, it’s cheap. You might be able to acquire this land. It’s very inexpensive. How cool is that? But who wants swampland? Who are you going to sell that to?” So you really could get yourself screwed in something like that, and it was a little bit scary. I did a little bit of a step back, thinking about the bigger picture there and the exit.

When it comes to value add deals – this is why I really want to bring up this topic today. Value add deals, for those that may not be familiar – we talked about this on our last episode, but it’s a strategy where you’re buying a pre-existing asset that’s got some problems of whatever type, you’re going in and fixing those issues, and you’re raising the rents over time. I’m simplifying the strategy, but basically, if I had to put a percentage to it, roughly 50% of your return is coming from cash flow and collected rents as you hold this asset. The other half comes from the equity upside, which is the forced appreciation when you go to sell. So really what we’re talking about is your exit strategy could be 50% of the equation, yet nobody’s talking about this. So I thought we have to bring this up on the show.

I’ll share one more story. I’m in a lot of investor meetup groups and there was this one in particular that I was at… It was kind of this newer syndicator, and he’s up there presenting to the group, and he says, “I tried to chase these 100 unit properties, give or take; anything from 75 units to maybe one and a quarter, somewhere in this sweet spot.” He said “Because I’m above the threshold of a lot of mom and pop operators”, which is true “and I’m below the radar of the institutional buyers.” And I got to thinking, “Then who are you going to sell to?” You’re really limiting your potential and who’s going to buy this asset. Maybe another syndicator, maybe they’re looking for bigger deals, too. So it’s great from the acquisition standpoint, but it might end up biting him later when he goes to sell, and maybe he doesn’t hit the returns, because there’s just not a big buying pool for it. So anyway, it’s certainly something to think about, certainly something to ask a general partner if you’re going to be like me, a limited partner, as to what is your exit game plan? Your strategy? Who have you sold to in the past? You may be able to answer that question yourself, which we’ll get into later. But that’s kind of why we’re covering it. I’ll turn it over to you, Theo, if you’ve got any thoughts so far on that.

Theo Hicks: Yes. I think one important thing to realize as a passive investor, what we’re saying is true – if you’re investing in a deal where value is being forced up, then you’re going your make money via cash flow. That depends on what type of investing you’re doing. Last week or seven episodes before this one, we talked about the four different types of investments. Some of them are more focused on cash flow, and less on the upside. On the other end, it’s development where it’s all upside, no cash flow, and then value-add falls in between there. So if you’re looking at a deal — obviously, when you’re investing you want to make money. So for the value of the property to increase, the value of your investment to increase, so understanding how that calculation is done is important.

There are two metrics that are used to calculate the value of the property. It’s going to be the market cap rate; that’ll be based off of recent sales of similar apartment communities. Then there’s going to be the net operating income. Its net operating income, divided by the market cap rate, equals the value of the property. So those are the two metrics that can be changed in order to increase the value of the property. So when you are investing in a deal, the goal, obviously, is to increase the value, so you want to know which one of those two are they banking on? Are they banking on the cap rates in [unintelligible [00:09:49].01] the lower it gets, the higher the value is… So are they banking on the cap rate going down and they’re just going to keep the net operating income the same or just have it go up with inflation? Do they plan on making the market cap rate the exact same, and increasing the NOI? Or is it going to be a combination of each?

So that’s why on the one hand, the sales comps are going to be important when they’re buying. Ideally, they’re buying below market rates, because when they do that, then that’s just going to be free equity. If the market cap rate is 5% and they’re buying it at 6%, then they have free equity of 1%, based off of the NOI, for free. That’s obviously one thing that’s important. If they buy it at the market rate, that’s fine. But being the highest price, buying a deal at three cap and a five cap market – probably not the best idea; but at or above is better.

And then what’s even more important, which is rarely talked about, is the exit cap rate, because that’s what’s going to determine the value of the property at the exit. So how are they determining the exit cap rate – some call it the reversion cap rate – is very, very important. That’s one of the most important questions you want to know, that’s probably hidden or not thought about. So there are lots of approaches. Some sponsors will just set it equal to what it is today, and some of them will assume that’s going to go lower.

The best approach is to actually assume the market is going to be worse at exit than at buy. So if they buy it and the market cap rate is at 5%, and they plan on selling in five years, the best practice is 0.1% or 100 basis points every year of the hold. So they’ll assume an exit cap rate of 5.5%. That way if the market is the same, then point 5% free equity. If the market gets better and the cap rates go down, then even better. But if the market does worse at sale – maybe a recession happens, something happens that changes a market cap rates in the area – then the return projections are going to be met depending on how far up the cap rate went.

But as Travis said, it is something that is super important and maybe not thought about… Not like hidden knowledge, but it’s something that you wouldn’t really think about; asking about an exit cap rate or reversion cap rate seems like it’s not that big of a deal, but when you’re talking about millions of dollars or hundreds of thousands of dollars in NOI, a 0.1% difference in the cap rate is going to change the value of that property by a lot. So just some of the things to keep in mind. Ultimately, the question here is, are they banking on NOI, cap rate, or both? If they’re banking the cap rate, what evidence do they have to support that this cap rate is going to go where they say it’s going to go, if they’re assuming it’s going to get better?

Travis Watts: Yeah, that’s a great point. All great points. But let’s talk about the hidden knowledge thing that you brought up. I was watching a webinar… I look at a lot of deals, for anyone who’s not aware; I look at a ton of deals. And I was on this crowdfunding platform, because someone asked me a question about it, and I was checking it out… I’m watching this webinar presentation on this deal; it was out in Florida. Everything looks great; projections look great, cash flow looks great, the exit looks great… I’m thinking “Wow, this seems like a pretty solid deal.” Well, the thing they left out was the reversion cap rate. No one talked about it in the presentation, no one asked about it in the Q&A… So I circled back with that sponsor afterwards and I said, “I only have one question, because I didn’t hear it. Maybe I missed it. But what’s your projected exit cap?” They were buying at five cap, basically, and they were projecting a four cap on exit.

Theo Hicks: Oh, no…

Travis Watts: I thought, ” Man, right out, I’m done.” There’s no way. I wouldn’t touch that thing. To your point, if they were buying at a five cap, the answer I was looking for was 5.5, maybe six; some conservative approach, assuming that the market had softened. Then those projected returns I’m looking at would then become a lot more conservative. But instead, they were taking a very aggressive approach, to try to make that deal look good. So this needs to be part of your criteria, anybody listening who’s a limited partner, like I am. I’m such a big advocate for self-awareness, writing down your goals, your criteria on these deals… That has to be one, is to look at cap rates. That’s my little rant on that.

But at the end of the day, Theo, and everybody, all of what we’re talking about, it’s a balancing act of risk. What we’re really talking about is what’s the risk. So you have asset classes, property ties, business plans, leverage, the time horizon… But really, at the end of the day, you’re trying to answer two questions. Is it likely that I’m going to make money? How much money? And am I okay with those projected returns? But more importantly, the feasibility of that. So I’m always trying to stack up when I’m listening to presentations or when I’m on calls with general partners… What I’m trying to figure out is, “Okay, I understand what you’re telling me. I understand that you’re saying it’s going to be this kind of percentage, this kind of return this kind of whatever. But what do I have to go by to give me certainty around that?” That’s why track record and experience are so important. How many times have you done this? Is this your typical business plan and business model? Is this your typical hold period? Typical underwriting structure? All these kinds of things. I like to know about the good, bad, and ugly of past performance. Do you have deals struggling right now? Have you lost money? Have you had capital calls as a company? I could go on and on. All I’m really talking about though is assessing the risk in all of this. So those would be my thoughts on that. I’ll turn it back to you, Theo.

Theo Hicks: Exactly. Assessing the risk and then what you’re comfortable with. As Travis mentioned, there’s a lot of different types of syndications you can invest in, with different types of exit strategies, and there isn’t really one that’s objectively better than the other, always, at all times. It just comes down to what your goals are. Sometimes there are syndicators who will buy a property, and they don’t really have an end date. They’re going to sell at some point, but they don’t really have a set number of years when they’re going to sell the property. It might just be they buy a core asset that’s already fully completed, and they might just hold it for a while. So if your goal is to have a very low-risk investment and make a return, and you’re not necessarily worried about making a large chunk of capital at an exit, then that might be a good strategy for you.

Another long-term hold strategy would be they might do a value-add play, but then rather than selling once they’ve completed the value-add, they might refinance, or do a supplemental loan, and then refinance. That way you might get, maybe not as much money back as you’ve gotten if they would have sold it, but you’ll still get a sizable return, assuming that the GP gives the LPs refinance proceeds. But then they’ll keep holding on to the deal and you’ll keep making cash flow. The cash flow might be the same, it might go down, it might go up, depending on how big the refinance was, and things like that. Other ones might plan to fully reposition and sell after three to five years. When that happens, you get all your money back, plus 50% or so profits. Again, everything depends. These numbers aren’t an exact science.

Then you’ve got a development deal, where there’s no cash flow at all, and then they exit after two or three years, or maybe they refinance and they hold… So there are all these different exit strategies, so you want to kind of ask yourself, what do you want? Do you want to double your money in five years and then get it all back? Do you want to just make a cash flow, and then that’s it? So understanding what the exit is, is going to determine which type of syndication you invest in… Because if you want that equity upside, but you also want to get the equity, you don’t want to sit there and be bigger, then you’re going to want to invest in a deal where they’re going to fix it up, force that value up, and then sell and get you your money back. You’re not going to want to invest in a core turnkey asset that is going to cash flow.

Travis Watts: Exactly. Another one that just came to mind too is a REIT roll-up. Sometimes these syndicators, they’re buying portfolio deals, which means maybe two or three properties, and they’re putting them in one small portfolio, and then they have lots of these portfolios. Then they’re going to find a REIT, maybe a pre-existing, real estate investment trust, or maybe a newly formed REIT, who’s going to acquire all of those properties in one big package. I’m using the term REIT roll-up. Maybe it’s a jargon term in the industry, but basically, you’re wrapping up all of your assets and selling them all off either to Wall Street, or it could be a private REIT. But that’s another exit strategy. But here’s how I look at it… There are really four common exits; I’m not saying this is all-inclusive here, but you could sell, like I just said, to a real estate investment trust, to a REIT, publicly traded or private. That’s one thing. You could sell to institutions, so pension funds, insurance companies, etc. That’s institutional capital, in layman’s terms. Again, not all-inclusive. Syndicator groups, and then individuals, and/or family office, things like that. It just kind of depends.

Let’s talk about that. Institutions and REITs, typically… Again, I have to use a generalization here, and that’s the disclaimer… But typically, they’re investing for cash flow and for yield, and newer properties, or recently renovated properties. I would say they’re mostly in the A class and the B to B plus categories of assets. They’re not in the business, usually, of value-add and doing lots of heavy turnaround and repositioning. They don’t want to buy assets that have leaking roofs and HVACs going out and under-market rents. They just want a turnkey asset; they want to place their capital, and they want to have virtually no worries for 5, 10, 15 years, whatever their business plan is. Now when you’re talking about syndicators and individual buyers – again, as a generalization – they’re typically looking in the B and the C class space for what these institutions are basically offloading… Because now they have problems, they need work, the rents are unable to be pushed anymore, because it’s an older asset that hasn’t really been kept up. Maybe it’s got outdated amenities… All these kinds of things. So typically, they’re looking to go in with a value-add play, and renovate, and bring things back up to the market level, and then sell back oftentimes to REITs and institutional capital and things like that. It’s just different business plans.

To your point, Theo. There isn’t a right and a wrongm and a lot of people, they prefer core assets where they’re looking for just that natural inflation, if you will, to kind of lift the values over time. They’re not looking for that forced appreciation in the deal. So those are the four exits, in my opinion, that are most common. Those are my thoughts on that. If you have any final thoughts, Theo?

Theo Hicks: Yeah. I think we went over a lot of information here. [unintelligible [00:20:46].05] condense it down… So just as a passive investor, what questions do you want to have answered based off of the exit strategy? So the first question, arguably the most important question about the exit strategy is, what is that exit cap rate assumption? What is that reversion cap rate assumption that will determine how conservative or aggressive they are being? And again, the best practice is to have an exit cap rate that is higher than the current cap rate. How higher that is, it depends, but it shouldn’t be lower than. Travis gave the story of the 4% exit cap rate, 5% in-place cap rate – probably not the best idea.

Then the other question based off what Travis just talked about is who do you typically sell to on the back end? Or who do you expect to buy this property on the back end? And then based off of what Travis said, was their answer aligned to what Travis just talked about? So are they planning on buying a B or C asset and doing a value-add play, fully renovating it and then eventually selling it? Then they should say that they plan on selling it to an institution, or if it’s like a fund, a REIT. But if they are going to buy a B property and just kind of hold it and not do anything, and then claim they’re going to sell it to an institution – well, that’s probably not going to happen.

I think those are the two most important questions – what’s the exit cap rate, and their justification for how they came up with that? And then two, who’s your typical buyer? Who do you expect to sell to on the back end?

Travis Watts: Yep. Those are great points. That’s a great way to phrase it, too – who is your typical or ideal buyer in this situation? What type of individual, or institution, or what have you. Because the answer, quite frankly, is that nobody knows. Five years down the road who’s going to buy this deal? I don’t know. Nobody knows. But the point is, you’re looking for competence. You’re looking for “Well, we’ve thought this through”, let’s put it that way. “In the past, we’ve sold to three institutional buyers and one syndicator.” Well, that kind of answers your question there. To your point, Theo, you just want to make sure all this stuff aligns with what you’re wanting. Does that help you accomplish your goals? Are they being realistic with their business plan and approach? That’s it.

Theo Hicks: The competence thing is huge [unintelligible [00:22:55].14] trap them or trick them… But these are important things to think about, and you can kind of gauge the sophistication of the GP by asking them some of these questions that they probably aren’t asked a lot. If they don’t really have an answer… They can say, “I don’t know, I can figure that out for you, and get back to you.” But if they start making things up or sound like they don’t know what they’re talking about, that could save you. Something as simple as that could save you from potentially losing your capital.

Travis, going back to your example, which was perfect – if you didn’t know to ask that question because it wasn’t presented to you, you would have invested in a deal with the return projections based off of a very aggressive cap rate assumption. You’re just asking that question, and they’re getting their honest answer, which we’re assuming the markets going to get way better when they sell, or them saying, “Well, I never thought about that,” or whatever. It just kind of gives you an idea of who you’re working with here. So is there anything else you want to mention, Travis, before we wrap up?

Travis Watts: No, I think we hit it. So for anybody listening, feel free to reach out to us with any additional questions or leave a comment. We’re happy to answer those.

Theo Hicks: Yes, any questions? Just email me at theo@joefairless.com. We’re also doing a new shorter segment called 60 Second Question. So you submit your Actively Passive Investing questions. You can email those to me at theo@joefairless.com. If you’re listening to this on YouTube, you can also leave it in the comments section. Completely up to you. Just leave your name and your question, and we will read the question and we will answer it in 60 seconds or less. 60 Second Question, email theo@joefairless.com, and we post those on our YouTube channel. So as always, Travis, thank you for joining me today. Best Ever listeners, as always, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

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JF2354: 5 Risk Profiles In Multifamily Real Estate | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will be sharing a list of 5 risk profiles in real estate. And while these risk profiles are the same for any real estate, the hosts will be focusing specifically on multifamily properties.

The list ranges from A-list properties located in the country’s top markets that are considered to be cash flow properties to buildings that are considered to be high-risk investments.

And while it’s important to invest within your risk tolerance, having the property be flagged as “high risk” may not mean that it’s a bad investment. Theo and Travis share their thoughts on what can make a risky investment attractive to a limited partner.

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening! 

Click here for more info on groundbreaker.co

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JF2347: Pros and Cons of Passively Investing in a Fund vs Individual Deals | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will be talking about being a passive investor in fund deals and individual deals. They’ll be discussing them from a factual point of view. Hopefully, this detailed comparison will help you figure out which deals are right for you and your real estate business. 

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners and welcome to another episode of The Actively Passive Investing Show. As always, I’m your host Theo Hicks, as well with Travis Watts. Travis, how are you doing?

Travis Watts: Hey, Theo. Hey, everybody. Happy to be here.

Theo Hicks: Yeah, thanks again for joining us. And Best Ever listeners, thanks for tuning in. Today, we’re going to be talking about investing in real estate, individual deals versus funds. So as a passive investor and you’re working with a sponsor, is it better to invest in a single deal one at a time, or to invest in a fund? So to learn more about what investing in a fund actually looks like, versus a deal, logistically, we have a blog post on the website you can check out, called Passively Investing in Apartments, Fund, or Individual Deals, where we talk about the different types of funds and things like that. But today we’re going to focus more on the pros and the cons of investing in a fund, versus individual deals. So before we jump into those, Travis, anything you want to mention?

Travis Watts: Well, Theo, I think this is a very relevant topic. I’m asked this all the time. I probably would have had a different take on this five or six years ago. My perspective has even changed throughout the years. It’s something I’m asked all the time. You see a lot of these more maturing companies in the syndication space, a lot of them are going towards the fund structure just because they have the reputation, the connections, the deal flow, the ability to raise more capital… So it’s definitely worth checking into and asking yourself the question whether it’s right for you. We’ll try to hold back on opinions, at least until the end… But this is more of a factual pros and cons conversation.

Theo Hicks: Perfect. So let’s jump into the first pro, or con, or advantage, or difference between the two, and that would be the time commitment. So here we’re talking exclusively upfront. So when you’re investing in a fund, you invest your money, and then that fund will be used to purchase more than just one property… Whereas when you’re obviously investing in individual deals, you’re investing in one property at a time. So if you were to invest in, say, ten deals — or let’s use five deals, you can invest in one fund and invest in five deals without, having to continuously qualify multiple deals, qualify multiple sponsors, search around for deal flow, hope for deal flow. You’re going to say, “Okay, this sponsor is a fund, they’re going buy five deals. I’m going to invest in this fund.” And depending on how it’s structured it might be a one-time investment that goes into all five deals. Each deal comes in, you invest an additional amount of money to increase your investment. But overall, it’s more of a, “Hey, here’s a sponsor. He’s doing the fund. I’m going to invest.” As opposed to, “Oh, here’s the sponsor. Here’s one deal. I’m going to invest now. Oh, here’s another sponsor, I’m going to invest in their deal. And this deal, and this deal…” And having to do all that due diligence, which is not the same level of due diligence as a sponsor is doing, but still, it’s a bunch of [unintelligible [00:06:05].13] you need to read. So it’s going to be some ongoing time commitments as well, which we’ll hear about in a second or later on in this episode. But I think that’s one of the major advantages of the fund, is that from your perspective, it’s a lot less of a time commitment to invest in the same number of deals.

Travis Watts: Absolutely. Great points. I think what I want to cover first is the element of diversification. One of my favorite topics, one of the biggest reasons I became a full-time LP investor – and I’ll share with you a quick story of why that is. A couple of things happened in my life in my 20s. One was, I had this overly ambitious goal that I bought the single-family home that I was living in as an owner-occupied residence, and I wanted to pay it off. It was a pretty good deal, so I had a pretty low basis in this property, and I thought, “Man, I’m just going to go hard with this.” And I was hell-bent on just paying that thing off.

So when I finally did that and accomplished that, I had my little moment of celebration, and then two days later, I thought, “What if a tornado hits this house? What if a flood happens? What if this thing starts having foundation problems?” It was a 1932 house, it was very old, out in Denver. And I thought, “I don’t want to have this much equity tied up in one thing.” And I got to thinking about the opportunity cost of having that much capital in one place that I couldn’t otherwise go invest. So long story short, I went out and I got a HELOC, a home equity line of credit, I ended up just doing investments instead. And I essentially just remortgaged the house. So diversification played a big role in that regard.

The other thing was, for those that know my background, I had a lot of single-family rentals out in Colorado, and I had a lot of equity in each one, as that market was driving up rapidly at that point from 2010, 11, 12, 13, 14 etc. And I just got uncomfortable with having that much equity in one location in a 30-mile radius, all in the same asset type. So that led me to discover what the syndication stuff was all about, and the ability to diversify, not only your capital, where you’re putting 25k here and 50k there, and this kind of thing, but in different regions, different demographics, different sectors, different sponsorship groups. So it sits well with me. That doesn’t make it right for everyone. Not everyone is of the mindset of valuing diversification, and rightfully so. Some folks have made multi-millions just focusing on one little niche and putting all their money there. So that’s just my take on it.

So the first topic here within diversification would be, as I mentioned, your capital diversification. The ability to spread out your risk in terms of your dollars and putting them in different deals. The way I look at funds in the syndication space versus individual deals is – I guess you could draw a parallel to index fund investing in the stock market, where you’re buying the index where you have a bunch of stocks in it, versus picking your own stocks. And for anyone that’s really read through statistics, very few people are successful at picking their own stocks and outperforming the overall market sector. So that’s kind of how I look at this, too. And I mentioned earlier that if you’d asked me about six years ago about funds versus individual deals, I probably would have said I prefer individual deals, because I want to choose which one I want to put money into. But in my experience, some are winners and some are losers. I didn’t always pick the best deals. When a sponsor has five deals a year to choose from and I choose one or two, sometimes you get a home run and sometimes you get half the return you were expecting. So a fund allows more of a blend there.

But here’s another thought too, in terms of a minimum investment. Anyone who’s been an investor in the private placement sector knows that a common minimum investment could be 50,000, it might be 100,000. And you’re talking about one deal. So if you go do 10 deals, you might be having to put up a million dollars just to get in the 10 deals that way. In a fund, the minimums often are the same; it might be 50k, it might be 100k, but there might be 10 deals within that fund. So you can spread your risk with a lot less dollars. If you do the math there, you might be putting $10,000 into 10 deals, for example. So it’s just another way to spread risk. It really comes down to you, how much money you’re looking to put to work. If you have 10 million dollars to put the work. Yeah, different story, right? But if all you have is 100k, this might be an advantage, to you to partner in a fund, potentially.

And the last thing I’ll mention here… Well, two quick notes. Geographic diversification I alluded to; there isn’t one perfect market. And markets are changing all the time, right? Businesses are moving around, people are migrating to different places, the political scenes are changing… So it’s nice to be able to place bets on several different markets that you’re a fan of, instead of like I was years ago, all up and down the front range of Colorado, between Fort Collins and Denver. If anything politically had changed there, or they said taxes are going to double, I would have been kind of screwed, right? So it’s nice to place your bets elsewhere.

And then sector diversification. What I mean by that is, depending on the fund and depending on the sponsorship group, there are different sectors, right? So you could be in mobile home parks, you could be in self-storage, you could be in multi-family, you could be in office and retail, in all these different sectors, which is really nice too, for the same reasons that I just pointed out – things change, things evolve, and maybe one day one of those sectors looks a lot better than the other. So it’s nice to be able to diversify that way. So that’s really all I got on diversification. But that’s the meat of it for me in terms of funds, is being able to diversify.

Theo Hicks: Yup, that’s definitely one of the main advantages. And kind of going back to what you’re saying about if you have $100,000 as a minimum, and you want to invest in 10 deals. That’s a million dollars in 10 deals. And kind of going back to the time commitment thing, right? You have to find all 10 deals, and hope you pick the right ones. Whereas you can still invest a million dollars in 10 deals, it’s just now you can do it one time, and then invest $100,000 and see what comes in, increase the amount without having to find the new deal, do a bunch of due diligence. So yeah, that kind of plays into the time commitment part.

And then obviously, the reduction of risks is also huge as well, because you’re diversified, as you mentioned, across multiple deals. So if you said a sponsor has five deals, some are home runs, and if I pick the strikeout, then I’m in a bad spot. So if you invest in those same five deals, all of them in one fund, then the home runs could offset the strikeouts or will outperform the average, which is good. But it also comes down to, [unintelligible [00:13:00].11] but a potential advantage (keyword being “potential advantage”) that investing in individual deals has is the upside potential.

So if an investor has 10 deals and two of them perform really, really well, and you happen to pick that deal, then you’re going to have a higher return than if you invested in all those 10 deals in the fund, and two of them are home runs, maybe two of them were strikeouts, and the rest were average, right? Then you would get the average return. So the really good ones will average out, the really bad ones and get an average return. So again, this is kind of pretty standard though for investments. The less risk involved the less the potential upside is going to be. But again, it depends upon the fund. Because if you’re investing in a fund where you do participate in the upside on sale, then is still going to get upside. It’s just if one deal does amazing, you’re not going to have an amazing return, because it’s going to be offset by the other returns.

As Travis mentioned, it kind of depends on your level of risk. So if you only have 100 grand to invest, there’s much less risk to invest in a fund than to do hoping you’re selecting the right deal. If you got $10 million, you’re trying to double that money, then taking a portion of that and investing in individual deals might be fine.

Something else we have in this list is reporting, too. So I’m sure Travis knows this as well, but when you’re investing in five, 10, 20 deals, especially if they’re spread across multiple sponsors, you’re getting emails constantly with updates on these deals. The format obviously is different, the information included is different, when you’re getting the reporting, the financials for each sponsor might be different, for each deal might be different… Whereas when you’re investing in a fund, most of the time the sponsor is going to have just one email for however many deals are in that fund. The format is going to be the exact same every month, every quarter. The reporting is the exact same every month, every quarter. And that kind of goes back to what I was mentioning earlier about the ongoing time commitment, where you’re not having to balance 20 different emails, 20 different investor reports… It’s just one email with the performance of the fund, any extra information that the sponsor decides to include about maybe the individual deals… But it’s still going to be in one location, which is definitely going to save you a lot of time and headache.

Travis Watts: One thing I’ll add to that as well – you’re absolutely right on the emails. Hence the Actively Passive Show, right? You get in this thinking, “Oh, I’m a passive investor” and then all of a sudden, you’re reading reports and T12s all the time. And one other thing is K1’s. This is the tax form you get in a real estate partnership most of the time. And when you’re doing individual deals, you’re going to get one K1 tax form per deal. So for me, I have a ton of K1’s. And every year my CPA just looks at me and hands me a higher quote, because it’s a beast. You’ve got to keep track of all your bases, and your carry forward losses, and all this stuff. I have so many K1’s.

When you’re in a fund, depending on how it’s structured, you might just have one K1 statement, even though there may be 10 different properties inside the fund. That can be a huge time-saver and a cost-saver too. So just a side note on that.

Theo Hicks: Yeah, and kind of on that same note, the paperwork upfront as well, right? When you’re investing in a fund that’s going to buy 10 deals, 20 deals, assuming some of you are going to invest one time and then not add extra investments later, it’s just one set of paperwork, right? You fill out one PPM, you get qualified as an accredited investor one time. Usually, it might vary. I’m not an attorney, I don’t work for the SEC, but just generally speaking, the paperwork is a lot less, as opposed to having to sign and fund 20 different pieces of paperwork.

Travis Watts: Yeah, and with that also is the accreditation stuff. If the group’s doing the 506(c) stuff, you have to be third-party verified. And every 90 days those letters are expiring. So as you’re going throughout the year, it’s like a quarterly thing. “Oh, I’ve got to go get another letter of accreditation again to go do this deal.” And it’s a headache. It is active, and it does take several hours of your time. So it’s just something to think about.

Theo Hicks: And then I’m going to do the natural transition to the next thing we’ll talk about, I guess the last thing we’re gonna talk about, which is why do sponsors do funds? What are the benefits to the GPs, general partners, and managers of the fund? And one of them — I’ve just mentioned paperwork, right? And so instead of having to create an LLC for every single deal, and multiple PPMs, and all that paperwork, they can just do it one time. One PPM for the fund, and then that’s used to buy individual deals, as opposed to having them do that each time. I’m sure there’s definitely going to be paperwork for each individual deal, but it’s much less for each deal when you do it upfront for the fund.

And then something else that is a benefit to the sponsor is the fact that since it’s a fund, they have a much better understanding of the amount of capital they’re going to have to invest.

So behind the scenes, whenever the sponsors are negotiating deals, one of the things that the sellers want to know, the lenders want to know, the brokers want to know is how are you going to buy this thing? How are you going to raise the capital? So obviously, having a track record of closing on deals is important. Being able to show them that you qualify for the net worth and liquidity requirements is important; but the actual downpayment, where’s that coming from? You’re not going to have passive investors giving you money on an individual deal until it’s under contract, until they’ve reviewed the investment summary, seen the conference call… And then they’re going to send you the money. Whereas the fund, you start raising capital sometimes before you even have a deal. You might start the fund with a deal, it all depends… But you need to have commitments. So when you’re talking to brokers, lenders, sellers, you can say, “Hey, I’ve got this much money in commitments already.” All you need to do is do the capital call. Or if they funded it already… It kind of depends on how it’s structured.

Much more confidence from a seller’s perspective if the buyer is doing a fund, as opposed to having to raise capital… Because what happens if they can’t do it? What happens if something happens and investors don’t want to fund the deal anymore? Whereas with the fund, they’ve already signed the paperwork. So they might not have actually put the money in there, but they’re legally obligated to — from my understanding — to invest. And there’s also the advantage that comes from the revenue coming in to pay the people involved with the fund. So since they’re getting the money sooner, they can use the fees that they collect… Because usually there are fees collected based off of the amount of money that’s invested. These fees can be used to pay themselves, to pay the people on the team that is involved in making sure the fund is maintained.

And one last thing I want to mention, because we have talked a lot about how great the fund is and you did talk about the benefit of the individual deal for upside… Something else that’s important too is that you’re not going to be a newbie sponsor doing a fund. You need to have a track record. So funds are good for sponsors who are already established, whereas — why doesn’t everyone do a fund? Well, they can’t. When you’re just starting out, you’re not going to be able to create a 10 million dollar fund. It’s more of a grind on each deal to raise that capital. But once you’re established, once you have a track record, once you have a large database of passive investors who trust you, then you can be confident that you can hit that funding goal, so that you can buy those deals. So I think that’s key, because — that’s why every single GP isn’t doing a fund… It’s because they can’t.

Travis Watts: That’s a great point. And that’s kind of one of those observations, right? As an LP investor, you see a company that’s doing funds, or a fund, and maybe that suggests that okay, you have the reputation, the track record, the experience to pull this off… Especially if it’s fund two, three, four, five etc. I’m always trying to catch the wave with these groups, so to speak, before they get so big that they’re not taking investors anymore, they’re relying on their returning investors, or they’re going to go public, or whatever they’re going to do; take institutional capital, whatever. So I’m trying to hit that threshold where these companies are getting big enough to do a fund, but they’re not so big that they don’t really need you at this point. So that’s kind of a strategy side note.

So I think overall, I’ll bring this up one more time, because I think it’s important to draw the parallel between the mutual fund, the ETF, the index fund stock investor wanting the diversification, wanting to participate in the overall returns of the market, versus the individual that says, “No, I’m going to pick my own stocks. I know best, and whatever.” And rightfully so, maybe. And that’s kind of what this comes down to is who are you as an individual, and what is your risk tolerance? If you’re looking for only choosing the home runs because you think you can identify that, then individual deals make a lot of sense in that regard, as you pointed out.

And a lot of people too, by the way, a lot of people investing in syndications are just busy professionals. We’ve mentioned this over and over – the doctor, the dentist, the lawyer, attorney, pro athlete, entrepreneur. They’re busy. So if you don’t want to take up 12 months of your time working with all these operators and trying to cherry-pick the best deals that you can find in all of this, if you just want to say, “Look, here’s 100k, you go do the work for me, and update me monthly, or whatever”, then funds can also make a lot of sense; as you pointed out, the time commitment element to it.

And another great thing you pointed out Theo, is that maybe a hybrid of the two strategies makes sense. Maybe there’s that one, two, or three deals that are out there that you think “Oh, man, that just seems so great. I want to be part of that deal.” But then, generally speaking, I’ll just invest in various funds, maybe in different sectors as well. So you’re participating in a lot of different ways.

So think of those parallels… I think there’s a lot of advantages to funds. The more we go through this real estate cycle that we’re in now, the more we’re in COVID, with all the unknowns, the more I personally like the idea of a fund structure myself. But that doesn’t mean that that’s right for everybody. That’s just my take. And as you know, at this point, I really value diversifying. So that’s my biggest takeaway.

And one last thing I didn’t mention earlier about markets, just real quick, is that markets – they’re changing all the time. Right now you’re seeing Tesla, and Oracle, and HP – they’re leaving California, they’re moving to Texas. Everyone seems to be moving to Texas. Well, that’s great right now and for the foreseeable future. But what about in 20 years? What if in Texas they say, “Well, we’ve never really had a state income tax, but now we are going to have one and it’s going to be 10%.” A lot of people are going to be exiting Texas. So one thing to kind of drive that point home, one thing I always look at is the lifecycle of the business plan. And five years to me is kind of a sweet spot. It’s much easier to predict what may happen in a particular market over the next five years than it is to go into a deal indefinitely, where you might be holding it for 20 years. Who knows what the world looks like in 20 years. So something else that’s part of your own criteria that I always talk about – know your criteria, know your risk tolerance. But in a nutshell, that’s kind of my take on funds versus individual deals.

Theo Hicks: I highly recommend checking out that blog post we have at joefairless.com, Passive Investing in Apartment Fund or Individual Deals, because there are different types of funds. And the funds can be structured in any number of ways. So it’s important to understand not only the high-level overall, what are the differences between individual deals and funds, but getting more detail on what are the differences between the different types of funds, right? The evergreen funds versus the closed-ended funds. We go in that in that blog post. We kept it high-level here. If you want to go into more details, check out that blog post we have at joefairless.com.

And then we also at the end give a breakdown of the funds and individual deals to kind of try to summarize what’s ideal for you, and not what’s absolutely universally better, but based off of what your risk tolerance is, where you’re at in your investment career, what’s the better investment for you. And I also liked how you said, “Or you just do both.” You can just diversify across — there’s diversification in funds, but it also diversification between funds, between funds, and individual deals… So there are multiple ways to get diversification, so I’m glad you added that.

So that’s what we have today for funds versus individual deals. Travis, anything else you want to mention before we close out the show?

Travis Watts: No, I think we hit it pretty good.

Theo Hicks: One thing I want to mention… Travis and I are going to start doing a new 60-segment that we’re going to post to the Actively Passive Investing Show on YouTube. And we’re going to answer your questions. So if you’ve got any questions about what we talked about today, what we’ve talked about in the past, or anything related to passively investing in apartment syndications, the best way would be to email me, theo@joefairless.com or in the comment section of however you’re listening to this. Submit those questions and we will read your name aloud on the show and we will answer that question for you.

Travis Watts: Alright, very good. Thanks, Theo. Thank you, everybody.

Theo Hicks: Yeah, so everyone, thanks for tuning in, as always. Travis, it’s always great to get your wisdom on these topics. Best Ever listeners, have a Best Ever day and we’ll talk to you tomorrow.

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JF2340: Top 10 Markets To Buy Multifamily in 2021 | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis are talking about the current Top 10 markets for investment in multifamily property. This list is based on the annual “Emerging Trends in Real Estate” report prepared by PwC and Urban Land Institute. Travis and Theo also highlight additional takeaways from the report. This information will be helpful for both passive and active investors looking to expand their portfolio in 2021.

https://joefairless.com/top-10-markets-to-buy-multifamily-in-2021/

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow.

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners and welcome to another edition of the Actively Passive Investing Show. As always, I am your co-host, along with Travis Watts. Travis, how are you doing today?

Travis Watts: Theo, doing great. Thrilled to be here.

Theo Hicks: Yeah, thanks for joining me, as always. And we’re going to talk about markets today. So we’re going to talk about, as you can see by the title, we’re going to talk about a blog post that we wrote called the Top 10 Markets To Buy Multifamily In In 2021. And if you’re watching this on YouTube, we’ve got Vanna White over there giving us a presentation of a beautiful map, the infographic we have that highlights those top 10 markets.

So this is going to be based off of a PwC and Urban Land Institute report. We’ll have a link to that in the blog post we’re referencing and also in the show notes of this episode. And we’re going to highlight some of the other takeaways from this report today. So before we dive into that, Travis, do you have anything else you want to say about why what we’re going to talk about is relevant to someone who’s a passive investor?

Travis Watts: Yeah. I think this topic is relevant to active and passive investors. It is titled Top 10 Multifamily Markets, but real estate markets are real estate markets, right? No matter what asset type you’re in, or whether you’re active or passive, it all goes hand in hand. And as we talked about a couple of episodes ago, a lot of these episodes that we do, especially this year in 2021, come from questions that I get asked frequently by investors when I’m on calls week after week as part of my investor relations role. Which market should I be looking at? Which reports are good? Which ones are bad? That’s why we’re showing you guys this; it’s a very popular and common topic that I think everyone can benefit from.

Theo Hicks: Yeah. So in that blog post – and if you’re watching this on YouTube, which we highly recommend – Travis has an image behind him that shows the top 10 markets. We’re not necessarily going to list those out today in full. As I mentioned, this is a very long report. We’re going to go into some of the takeaways from this report. And obviously, this has been a show focus on passive investing, and we’re going to talk about why each of these takeaways are relevant to you as a passive investor. So Travis, you could start off by talking about some of the issues that were highlighted in this report.

Travis Watts: Yeah. And one thing before I get rolling here… As you pointed out, Theo, this is like a hundred-page report, again.

Theo Hicks: A big one.

Travis Watts: PwC and the Urban Land Institute, it’s kind of a combination of the two. Very, very much in-depth, in detail. We could literally talk for hours on this report. We’re just going to skim it, hit some high-level topics and things to think about. Check out the blog post, because there’s a link to the actual PDF that I’m referencing, and I’ll point out what pages I’m on too if you want to kind of follow along and if that blog post is something that you want to take a look at.

So to your point, let’s get started. So what these are, are the issues that could potentially arise this year, and then how much importance is weighted on those particular issues. So I’m on pages four and five of this report. And I’ll just kind of start from the top; I’m not going to go over all of them, there’s 10 in every category. But as far as economic and financial issues that could potentially have an impact on multifamily and real estate in general, at the very top is job and income growth. As we all know, we’re in the midst of COVID, everyone’s concern is jobs and unemployment. And you get into these deals as an investor, and you’re looking at these projections of ‘We’re going to be raising rents $200 a door per month over a few years”, well, it’s really dependent on your renters and the fact that they have a job, number one, and then number two, that their income can support those rent hikes. So you’re trying to kind of read between the lines, and we need an economy that’s stabilized to support that. It’s a one to five scale, if you’re not following along, on the chart. So they ranked that as number five, meaning the most important.

And I’ll scale quickly to the bottom. They’ve got inflation and currency strength as still very important in the top 10, but the least of the top 10 of importance. There’s a lot of talk with all this money printing that we’re doing, with the Fed coming out with this proposed $2 trillion stimulus package possibly around the corner… My gosh, it’s crazy. So you’ll see a lot of headlines about inflation, and are we going to see it, and is it going to go into hyperinflation, or are we going to collapse the value of the US dollar? I personally would rank those a little higher on the list myself. That’s a concern to me. But they’ve got them there at the bottom, so take it as you will. Those are the economic and financial potential issues.

Moving on to social and political at the top of the list of most importance. They’ve got epidemics and pandemics in a category; obviously, in the midst of COVID. That makes a lot of sense. That’s still a concern of most people, especially this year. The political landscape – as Theo and I pointed out several episodes ago on the proposed Biden tax plan… If you haven’t checked out that episode, I would. It’s getting more outdated by the day, so stay up with the news. But the political landscape – we just had the inauguration, but now what Biden’s essentially proposed is to repeal the Trump tax reform that was set forth in 2017, which was the Tax Cuts and Jobs Act of 2017. And it’s not a political statement, whether you’re pro Biden or Trump, it’s just that that particular policy was really to the advantage of real estate investors. So if that gets repealed, that’s obviously of most importance.

At the bottom of this list on social and political is terrorism and rising education costs. So obviously, terrorism is hard to predict and determine. That’s kind of an unknown factor that’s always there. And then rising education costs – yeah, obviously, of importance, but may not affect the majority of our tenants and our renters. So it’s up there, but at the bottom of the list.

Last but not least, real estate and development. This is more about new construction in multi-family. The top two being the labor costs and the cost of materials being of utmost importance. At the bottom of the list being the risk of extreme weather, which is global warming and climate change and things like this, and environmental sustainability requirements. A lot of talk about this Green New Deal, and everyone’s going solar, and electric cars… Well, what if some policies come forth that says, “All multifamily units have to be solar by 2030” or something crazy like that. It could happen; perhaps unlikely, but who knows? So that’s why it’s at the bottom of the list, but it could happen as we go into this new change of hands here under the Biden administration.

So I’ll cut it there; take a look on page four and five of the report if you have it. There’s a lot more detail, I just highlighted and skimmed that. But those are some of the issues that could potentially have factors here in 2021.

Theo Hicks: And the key to keep in mind here is that these are based off of surveys of people who are real estate investors. So they’re asking them how do they think these things are going to affect real estate in particular. So these aren’t what they think high-level, but just specifically to real estate, right? And these are based off of surveys. So yeah, all of these different things we’re going to be talking about, you can see how these active real estate professionals replied. So they are people who are actually doing it, and what they think is going to happen based off of their experience and their research.

The next thing that we’re going to talk about is going to be the statistics for working from home. So don’t need to spend much time here; it’s pretty obvious that a lot more people are working from home now. So the question is, as it relates to real estate, is this going to continue? Or is this going to end? And when it does end, is it going to go back to normal, or are more people going to work from home? And so the question that was asked was, in the future, more companies will choose to allow employees to work remotely, at least part of the time. Do you agree, strongly agree, or disagree? The majority of people strongly agree, and then another 42% agree. So basically, every single person either agrees or strongly agrees that this trend of working from home is going to continue in the future. So as a passive investor, that’s obviously going to impact the locations where multi-family is going to be in demand, which I’ll talk about in just a second… But also the type of multifamily that’s going to be in demand. If people are working from home, they’re going to want a different type of experience than if they’re not working from home.

So we actually have a blog post on our website about the top amenities for multi-family for 2020 or 2021 as it relates to COVID. We kind of go through, okay, if people continue to work from home, what types of things are going to be in demand? What size of units? What are the opportunities in the units? What type of amenities at the property are going to be in demand? So definitely check that out. And then the second thing is going to be the locations that are in demand, right? So U-Haul has a really good report…  We actually have a blog post that posted — it’ll be live when this goes live; it’s called 10 States With The Most Net Migration in 2020. So U-Haul tracks all their one-way trips to see where people are renting vehicles and going one-way, with the assumption that they did it to move to that location. So they rank the markets with the greatest positive net migration, and then the markets that have the most people leaving them.

So the South, in general — there are obviously exceptions, but the South, in general, are full of in-migration markets. You’ve got Texas, Florida, Georgia, the Carolinas, and Tennessee. And then you’ve also got some of the mountain areas, so Idaho, Utah, and Arizona. Whereas you’ve got the coasts, specifically the West Coast is in general, as well as the Northeast, people are moving out of those places. So this report is just based off of the states. But in addition to this, you’ve got to keep in mind that within each of these states it doesn’t mean that every single investment you see in Florida and Texas is going to be great. Or every single market in Texas and Florida is going to be great. Again, because of this move, which Travis is going to talk about here in a second, there has been a large movement out of the large urban areas to suburban and even rural areas, which is kind of what Travis will be talking about next. So a natural transition.

Travis Watts: Yeah, that’s a great point, Theo. Actually, I probably should have brought that up at the beginning of this. Just because we’re showing you this map, just because PwC and the Urban Land Institute have come out with this data and this particular survey, there’s going to be differing opinions, whether you tune into CBRE, Marcus & Millichap, CoStar… There are different data sources out there, there are different economists, there are different opinions. Just because you live in Ada, Oklahoma, it doesn’t mean you shouldn’t do a deal there. If your neighbor is short selling their home or there’s a foreclosure in your town, maybe that’s a good opportunity for you. So it’s not to suggest these are the only markets to look at. And again, it’s titled Top 10 Multi-family Markets, but it’s just real estate in general, right? We’re really talking about migration trends, which is what we talk about a lot on this show.

So to your point Theo, my topic here is the age migration and what’s happening. I thought this was really interesting. I’m on page 10 of the report, anybody following along… And what they’re looking at is the forecast from 2020 to 2030. So they’re looking at a full decade of all different age groups and what’s likely going to happen as a progression here. So start out with folks in their 20s – this demographic is shrinking in size, number one, and these groups tend to live a more urban lifestyle. So obviously your studios, your one-bedrooms, your downtown stuff, the city life. Keep in mind, as they point out, this is a shrinking group. So urban will be shrinking, basically, is what they’re saying.

So groups in the family formation years, maybe your latter half of the millennials, folks in their 30s, and maybe up to age 40 – I don’t know exactly where the cutoff is there… But these groups are tending to look for a more suburban lifestyle. And this is a growing group. So this is going to be a big migration here that’s happening to support the suburban lifestyle.

The next one over is empty nesters. So parents where their kids have gone off to school and kind of moved [unintelligible [00:15:39].29] from the house. They’re actually – this was a surprise to me – looking at going more urban. But again, this is a group that is shrinking in size. So it’s not going to be a huge migration here. But that one kind of surprised me, that empty nesters are looking for a more urban setting and lifestyle.

And last but not least, as we all know, the retirement age groups are going to surge. We all know about the silver tsunami. I hope that’s not offensive to anybody. But they’re looking for more of the suburban lifestyle, which kind of surprises me in a sense… But yet, I really think about reality, and folks in my family and just my own parents, and that’s true. They really like the suburban lifestyle, at least in my bubble of the world. So I guess, overall, in general, to your point, Theo, it’s looking like suburban is likely going to take a wind here for the next 10 years as far as the forecast goes, as far as this source of data suggests, and the urban perhaps could be shrinking in popularity. So that’s that on page 10 of the report.

Theo Hicks: Yeah. And it is definitely tied to the working from home statistics too, right? Because most of the people that live in the city live there because it’s so hard to get to work. For example, my wife works in a big company and a lot of people that live in the city have moved out to their parents or moved back home out of the country because they don’t need to be downtown. And so if you don’t need to be downtown and it’s cheaper to live further out in the suburbs… It’s cheaper, it’s safer, you get more space… So all these things are definitely connected.

I remember reading an article right when COVID started, about how many people left New York City for the suburbs and also places like Connecticut, and stuff. It was a crazy amount of people. In addition to people have been leaving these urban areas for a while now, and so it has only been expedited. So again, the point here is that if you’re looking at deals in the large urban areas, take a look at what the explanation is for why they’re doing it. Are they getting a really, really good deal? Or are they claiming that making predictions about “Oh, well, this is not going to last forever. Eventually, they’ll come back.” Sure, maybe that’s the case. But again, there’s additional risk when it comes to that.

So the next thing which I think is really fascinating is going to be about the debt and equity underwriting standards. So as a passive investor, most likely you’re not going to have a highly custom multi-tab Excel underwriting calculator where you pull the P&Ls, and you make all these predictions yourself, underwrite the deal, right? You’re gonna be relying a lot on the information that’s provided by the sponsor who did their own underwriting.

Now, obviously, it’s important to trust that person. We’ve talked about that before, how to qualify the GP. But another really good way to gauge how aggressive or conservative their underwriting is is how banks and then these large equity firms are also underwriting deals. So when we talk about debt, we’re talking about Fannie and Freddie Mac, their traditional fancy banks, commercial banks, insurance companies, debt funds, things like that. When it comes to equity, we’re talking about, obviously, private investors, but these big public equity REITs, hedge funds, private REITs, pension funds, things like that.

So how are they underwriting deals right now, compared to previous years? There’s actually a huge difference. So this is 2021 data, and they asked them – so for debt and equity, how do you expect the underwriting standards to be? And the options were less rigorous, or remain the same as the previous year, or more rigorous. And so historically, since 2014, basically most people said it would remain the same, especially from 2017 and on. A very small percentage of people said that it would be less rigorous or more rigorous. But bring us  to 2021 and 73% of the respondents think that the debt underwriting standards are going to get more rigorous. The previous high was 47% in 2017, and then last year was 34%. So double, basically. And it’s the same trend for equity – 67% said that the underwriting standards are getting more rigorous, and again, the previous high was in 2017, at 34%.  I’m assuming that’s because that was after the election, but still double what has been every year since 2014, with this graph.

So if you’re coming across deals that are underwriting the exact same as they did in the past few years, then that’s something to think about. That is definitely a red flag. And Travis kind of already mentioned this – the rent growth assumptions, we’re talking about just the revenue growth assumptions in general, maybe how quickly they’re going to accomplish these value-add renovations or the renovations they’re doing… Essentially, anything that’s changing from how it’s currently being operated to how it’s going to be operated after them should be very conservative, and not be super aggressive.

Travis Watts: Yup. 100%. This next section really piggybacks off of that, which is great. This is the one I was actually most excited to share with folks, because I would say probably – let me put it in top three category of questions that I get asked by investors always… Is it the right time to start investing in multifamily or continue investing in multifamily? Something to this nature. So I think this kind of sums it up. And this is a great graph I’m going to be sharing with people, because this is a great data to have, as far as a survey goes.

So what this is, is the availability of capital for real estate, 2020 versus 2021. So there are two categories – there’s lending, so getting financing for your deals, and then there’s the equity, which is people wanting to buy and own equity in this real estate. So on the lending, to your point Theo, about more rigorous underwriting and lending… So naturally, there’s a slight pullback; it’s not a major shift, but there is a slight negative impact on lending from non-bank financial institutions, government-sponsored enterprises, debt funds, insurance companies, REITs, banks, collateralized mortgage-backed securities, all that good stuff, has a slight pullback. So a little more conservative approach. But this is the part that really paints the picture. There’s a massive increase in demand from publicly-traded REITs, from private local investors like myself, private equity, hedge funds, pension funds, REITs, foreign investors… Actually, foreign investors has a slight pullback. But everything else has a large margin of more demand through 2021. And I think that really says a lot.

And here are my final thoughts on this, as a conclusion to wrap that up. I’ve talked about this before, maybe on this show, maybe on other podcasts, but right now there is a huge demand for yield. We’re not finding yield, cash flow, and interest and dividends in bonds, and CDs, and money markets, and treasuries. So both Main Street investors and Wall Street are needing and wanting yield. And the biggest margin here is REITs that are increasing exposure here. Obviously real estate investment trust. But this is huge. I hear this all the time about “Well, what do you think about cap rates?” Or “I don’t know about buying something out in Texas at a five cap. That seems crazy.” Well, think about it like this, if an institution’s coming in to buy that asset, and they’re going to pay all cash, they’re not even going to use lending or debt, they’re still getting a five cap, a 5% yield off that property. Well, how much risk are they really taking with no debt and no leverage, compared to bonds and other things that are paying 2% or 1%? So that’s still a very healthy yield for an institution to have by using no leverage and no debt.

So I still think if you’re in the space, this is again, part of my personal criteria that I’ll share. But I like investing as a limited partner in these syndications, in the unit size of 200 to 600 units. To me, that’s kind of a good sweet spot. Because as we go to the exit, we’re often going to exit to institutional capital, who’s needing this type of yield. We could also sell to another syndication group, we could also sell to wealthy individuals, family offices, stuff like that. But it gives us a lot of exit potential strategies to use.

So at the end of the day, I think the demand is for yield, and I think that people have seen through this pandemic, that B and C class value-add products have really held up. Yes, it’s been impacted, I’m not trying to sugarcoat it, but it’s not been to the effect of office, retail, other asset types in real estate. So that’s my final thought on it. And I know we’re getting short on time.

Theo Hicks: Yeah. We actually have the Best Ever conference coming up in about a month, and the first webinar they did, I think it was somewhere along the lines of should you buy or should you sell in 2021, and one of the speakers was a tax expert. And, as we mentioned before, about the impacts of the new tax plan, I kind of really like what she said, and it kind of goes along the line of what you’re talking about. It’s like, look, [unintelligible [00:24:37].20] he taxes, sure, it might impact other industries more than others, but it’s going to be an across the board thing, right? It’s going to affect everything, more or less equally.

The same thing with the pandemic, or any kind [unintelligible [00:24:48].27] in the economy, it’s going to affect things more or less equally. So when you’re thinking about whether to invest or not, or what to invest in, you can’t really compare it to the yields that you were getting five years ago, or these massive IRRs and cash and cash returns. It’s more of like, what are your options right now? What’s your best option in investing right now? You have to do something with your money, so what are you going to do with it? Are you going to keep it in your savings account? Or are you going to invest it in something? And if you invest it in something, what are you going to invest it in that has the least risk with the highest returns? Which are more important to you?

So that’s why all these equity sources are so interested in real estate; it’s not necessarily because they’re going to make the most money they never made before, its’ because this is the best option right now. So that’s what I thought about when you were talking about yields. It’s not the best yield ever, but if the best yield of the options right now.

Travis Watts: Yup, a hundred percent. Times change. Before the 2008, 2009 collapse, you could have bought US bonds at 6%, relatively taking no risk. So that would be a hell of an option today, if you could…

Theo Hicks: Exactly.

Travis Watts: But instead, you’re getting half a percent or something, or one percent. So to your point, you’ve gotta go with the current environment. And a lot of folks hang on to the old ideals of things, and where that phrase was hot in multifamily, you have, “Double your money in five years.” Well, perhaps it’s still possible in some aspects, but maybe don’t count on that in today’s environment. But yes, it’s put a lot of pressure, this low yield environment we’re in with interest rates, and everything else – it put a lot of pressure on the stock market, which is why we’ve seen these huge crazy rallies in the midst of a pandemic. And then also onto real estate. So just like you said, you’ve got to make the choice for you. Where are you going to park your money? Clip a 0% coupon in the bank, or go into some kind of asset with a moderate yield?

Theo Hicks: Exactly. All right Travis. Well, thanks again for joining us. I really enjoy these conversations and getting your perspective on these things. You’re deep in the trenches every day looking at this information. And Best Ever listeners, as always, we appreciate you for tuning in.

As we mentioned in the beginning, this is going to be based off of the blog post called Top 10 markets To Buy Multifamily In In 2020, so check that out to actually get the top 10 markets. We also have a link to this 100 plus page report. But if you just want to read the report yourself, we’ll have that in the show notes as well.

So again, thank you for joining me, Travis. Best Ever listeners, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

Website disclaimer

This website, including the podcasts and other content herein, are made available by Joesta PF LLC solely for informational purposes. The information, statements, comments, views and opinions expressed in this website do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. Neither Joe Fairless nor Joesta PF LLC are providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice in or by virtue of this website. The information, statements, comments, views and opinions provided in this website are general in nature, and such information, statements, comments, views and opinions are not intended to be and should not be construed as the provision of investment advice by Joe Fairless or Joesta PF LLC to that listener or generally, and do not result in any listener being considered a client or customer of Joe Fairless or Joesta PF LLC.

The information, statements, comments, views, and opinions expressed or provided in this website (including by speakers who are not officers, employees, or agents of Joe Fairless or Joesta PF LLC) are not necessarily those of Joe Fairless or Joesta PF LLC, and may not be current. Neither Joe Fairless nor Joesta PF LLC make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this website, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Neither Joe Fairless nor Joesta PF LLC undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views or opinions set forth in this podcast.

No part of this podcast may, without Joesta PF LLC’s prior written consent, be reproduced, redistributed, published, copied or duplicated in any form, by any means.

Joe Fairless serves as director of investor relations with Ashcroft Capital, a real estate investment firm. Ashcroft Capital is not affiliated with Joesta PF LLC or this website, and is not responsible for any of the content herein.

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The views and opinions expressed in this podcast are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. For more information, go to www.bestevershow.com.

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JF2333: How Much Do You Need To Have Invested In Order To Achieve A Retirement Goal | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Travis will be sharing an infographic that will help you understand how much you need to invest in order to achieve your retirement goal. Obviously, everyone has a different number in mind, but this information will help you simplify the calculations. Travis uses $100,000 a year as a goal since that is one of the most common numbers people tend to name when asked about retirement.

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Travis Watts: Hello and welcome Best Ever listeners. I am your host, Travis Watts, on the Actively Passive Show here today. Theo Hicks is unable to join us for this particular episode. He’s on a personal day; he is well and good, he will be back next week with us. But today, since it’s only me, I promise I will do a fun, entertaining, straight and to the point, shorter episode than what we usually do, so hopefully there’s a lot of value in this for you.

And today’s topic comes from a question that I have been asked for years and years and years by prospective investors, by friends, family, colleagues, you name it… I used to ask the same question myself, for many years. The question is, “How much do I need to have invested to achieve my outcome of X, Y, and Z?”, whether that’s your retirement goal, whether that’s your early retirement goal, whether it’s just a goal for whatever it is, right?  Everybody’s going to be different. And ironically, what’s so funny about this is what I hear all the time, is “I would love to have $10,000 a month in passive income.” “I would love to have $100,000 a year in passive income.” It’s like we all have the same goals circulating in our heads. I don’t know where that comes from.

But today, I just want to show you an infographic that I have created for you that can help simplify this for you. I’m not a financial planner, I’m not a financial advisor, I’m not licensed in these capacities, so please seek licensed professional advice when you’re actually going to do your investing. This episode is for educational purposes, to help enlighten you to the possibilities out there, what they mean, how they work… So, without further adieu, I will just pull up this infographic, and I will say this, for anybody who’s listening on audio… First of all, I think these get released first on audio, and then they go to YouTube on video. So it may not even be available right now on video, but if you’re watching on video, pretty straightforward, here it is. If you’re listening on audio, I will do my very best to walk you through what this infographic is all about. Sorry, let me just minimize this real quick. And there we go. Perfect.

Alright, so here’s the infographic. How much do I need to invest to receive $100,000 a year from cash flow? Two things I want to point out, right off the top; why $100,000 a year? Well, just the most common thing that I hear when people ask me this question or bring this topic up about their goals. Use your own numbers, right? Maybe it’s 80, maybe it’s 300; you plug in your own formula.

Cash flow. Why cash flow? I’m using the word cash flow as a general definition to describe yield, like dividends, or interest, or cash flow from real estate, you name it. I’m putting that all under the umbrella of cash flow, because this is the Actively Passive Show, and we are primarily real estate focused, so I use the real estate term. No other meaning but that.

So here is the infographic. I’m going to walk you through it first, again, for those that can’t see it, and then we’re going to dive into each of these categories, and what types of investments might fall into these particular categories to help you identify what makes the most sense for you. Or you can work with your advisors too to figure that out.

So the first one is, if you had a 2% annualized return – talking about yield, dividends, interest, cash flow – then you would need $5 million invested to get an outcome of $100,000 per year. Now, obviously, that’s going to be a conservative approach. We’ll get into it in a minute of what would fall into that category, but just so you know, I’m using a scale from two to 10%, because it’s where most people are going to land. Yes, it’s possible to get less than 2%, as it is more than 10%.

4% – it would take two and a half million invested; obviously, that’d be half, so 2.5 to get 100 grand a year. 6% would be 1.675, so almost one in three-quarters of a million invested. 8% would be 1.25 million, just over… And 10% year as a return would mean 1 million invested with that type of return, to get $100,000 per year.

So let’s dive into each category and I’ll share with you some things that come to mind. I’m not going to name any specific investments, or stock names, or real estate operators. I’m just going to give you categories. And again, highly opinionated, but hey, it’s based on the research, too. So 2% would be, let’s call it, government bonds, treasuries, interest from the bank… These things, they ebb and flow, right? But this is a more conservative approach. Maybe appropriate, possibly, for older folks or someone with lots and lots of equity to put to work. This is just more of a conservative aspect of the portfolio.

In the 4% range, you bump up to annuities, which is a very common retirement product that a lot of people buy into. Life insurance policies are very closely tied to that, whether we’re talking whole life, or things like that, where they have a — I don’t know if they use the word guarantee, but they kind of have a baseline return of sorts. It’s usually around 4% the last time I looked into them, which wasn’t that long ago. And CDs, possibly; you’d have to find a very high yield CD, and maybe a longer-term CD. It just depends on the bank and interest rate environment.

6% – we bump up into some types of real estate, possibly. It could be high-end, luxury real estate, it might be a conservative year one underwriting approach due to COVID, or trying to turn around the properties, so maybe have a little bit lower yield in the beginning. It could be corporate bonds, public companies, even private companies raising capital, that kind of stuff… Dividend stocks, blue-chip dividend stocks sometimes are in this range. Again, I’m not going to name specifics, but if you go look up some blue-chip dividend players online, you’ll find what I’m talking about.

8% – this is what comes to mind when I hear 8%. First and foremost, real estate. I don’t care if we’re talking about single-family, multi-family, whatever. In 2015, those that know my story, I switched from investing in single-family homes into passively investing in multi-family syndications. And for me at that time, I made what I call the 8% rule, which is just a personal thing… But I thought conservatively speaking, I could clip an 8% annualized cash flow coupon from these types of deals. Some are going to do better, some may do worse, so I’m going to kind of take the average or eight and live off the income, which we’ll get to in a few minutes. So that’s the first thing, it’s real estate, in any form.

REITs – real estate investment trusts are usually publically-traded; they could be private, but they’re just basically a real estate investment fund that has to distribute, I don’t know if it’s 90% or 90% plus of their earnings to investors. So it’s usually a higher yield, compared to like the blue-chip companies I mentioned in the 6% category. Notes, diversified pools of notes; I’m in a couple of funds like that. Tax liens might fit into this category; again, that could be higher or lower depending on the state, the rules, and the outcome.

10% – first thing that comes to mind there is hard money lending. So someone’s going to borrow your money for doing a fix and flip, or a construction project, or whatever, but they only need your money for, let’s call it six months. So they’re willing to pay a 10% annualized yield, because they know it’s not going to be a 30-year type situation, right?

Or even a 10 year, it’s going to be very short-term. So that’s hard money lending; you might get in those yields, possibly higher, possibly lower.

Professional real estate investments, specifically private placements that I mentioned – a lot of these could be in the 10% cash flow yield range; again it just depends on the deal, the operator, when you’re listening to this episode… There are so many factors, but I’m trying to give you some general categories to think about. So it gets a little more professional, starting at 10%, talking about specifically yield, and then going higher above and beyond that.

So that’s two through 10%. The point of this infographic is just simply, again, educational purposes to get your mind thinking, to think “What’s my risk tolerance? What makes sense to me, and what do I know and best understand? Where am I at? In my 30s, 40s, 50s, 60s?” And maybe this is just the beginning of you starting to plan your retirement. Or maybe you’re in retirement, thinking “I’ve got this 401k with a million bucks in it. What do I do now?”

This might be something to think about. So that’s really what I have for you today. I know that was a little bit high level, but hopefully, it was also impactful and educational for you. Again, we’ll have Theo Hicks back next week, my co-host. But for now, I appreciate you guys tuning in. Thank you so much, have a Best Ever day. Thank you, guys. We’ll see you next time.

Website disclaimer

This website, including the podcasts and other content herein, are made available by Joesta PF LLC solely for informational purposes. The information, statements, comments, views and opinions expressed in this website do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. Neither Joe Fairless nor Joesta PF LLC are providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice in or by virtue of this website. The information, statements, comments, views and opinions provided in this website are general in nature, and such information, statements, comments, views and opinions are not intended to be and should not be construed as the provision of investment advice by Joe Fairless or Joesta PF LLC to that listener or generally, and do not result in any listener being considered a client or customer of Joe Fairless or Joesta PF LLC.

The information, statements, comments, views, and opinions expressed or provided in this website (including by speakers who are not officers, employees, or agents of Joe Fairless or Joesta PF LLC) are not necessarily those of Joe Fairless or Joesta PF LLC, and may not be current. Neither Joe Fairless nor Joesta PF LLC make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this website, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Neither Joe Fairless nor Joesta PF LLC undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views or opinions set forth in this podcast.

No part of this podcast may, without Joesta PF LLC’s prior written consent, be reproduced, redistributed, published, copied or duplicated in any form, by any means.

Joe Fairless serves as director of investor relations with Ashcroft Capital, a real estate investment firm. Ashcroft Capital is not affiliated with Joesta PF LLC or this website, and is not responsible for any of the content herein.

Oral Disclaimer

The views and opinions expressed in this podcast are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. For more information, go to www.bestevershow.com.

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JF2326: Highlights From 401(k)aos by Andy Tanner | Actively Passive Investing Show With Theo Hicks & Travis Watts

 

 

Today Theo and Travis will be sharing their opinion of the 401(k)aos book written by Andy Tanner, as well as their personal experience with 401k retirement investments.

For Travis, this book was one of the defining moments that helped him determine what kind of investor he’d like to be. Travis shares five bullet points made by Andy Tanner in the book and his personal takeaways.

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners, and welcome to another edition of the Actively Passive Investing Show. I am Theo Hicks and as always, I am back with Travis Watts.

Travis, how are you doing?

Travis Watts: Theo, really excited to be back. We took a few weeks off, so I’m really excited about this topic and good to be here.

Theo Hicks: Yeah, so this is Travis and I’s first time recording in the new year, even though this will air a little bit later… But yeah, it’s great to be back, and we’ve got a fun topic today about the 401(k)aos. It is actually a book written by Andy Tanner; it’s a play on words – a 401(k) is an investment vehicle that is probably one of the most well-known investment vehicles, at least for people who’ve worked in corporate jobs before, because it’s kind of constantly getting pushed down your throat to do the 401(k) plan.

And I remember back when I was working in the corporate world, everyone invested in the 401(k), right? It was the best thing ever. It was free money, right? All these different things that I’m sure Andy talks about in his book. But Travis read the book, has some highlights he wants to go over today. Of course before we get into that, Travis or me are not tax professionals, we are not financial advisors. This is all just our opinions on our experiences with 401(k)’s, and obviously Travis reading this book. So this is just strictly for educational purposes, but I’m really excited to talk about it.

So Travis, do you want to jump into the takeaways or going to kind of go over maybe the background of the book, why you picked this topic and kind of what we usually do to start the show?

Travis Watts: Yeah, a couple of reasons I really wanted to highlight this book – we’ve done other books of Tom Wheelwright and Kiyosaki books and whatnot… But really, these are the books that stood out to me early on as kind of those foundational books that helped me decide what path to go down as an investor. And I think that, to your point, the 401(k) is widely known in the US, and a lot of folks that work for companies have 401(k)’s, and I think that it’s a worthy conversation to be had. I’m not the professional myself, but do check out this book if you want to dive deeper into it.

My intention here is to give everyone kind of the spark notes so to speak, just the high level of a couple things to think about. That way, maybe you don’t get too far along the path before you decide that maybe this isn’t an account that I really want to have, or what’s the best strategy to use this type of account in my portfolio. Again, not being a financial advisor, but a couple relevant points.

I read this book early in my 20s, and at the time I had a 401(k), but I had a pretty low balance. I had a Roth, a traditional, I had all these retirement accounts. This goes beyond the 401(k), this book; it helps explain how these things came to be, why they’re in existence, how the tax code works in relation to them… And the more I researched and read, the more I just started deciding that, “I don’t want to make these types of accounts part of my personal strategy.” I’ll go into that a little bit later.

And what prompted me to make this episode more than anything is thinking back years ago – I was with my wife, we were at one of her work conferences; I’d just read the book, and of course, I like to give her the rundown after everything I read, though she probably doesn’t care about most of it… So she had told a co-worker, I guess, that I had read this book, and this lady walks up to me, who I hadn’t met, and she goes, “Hey, your wife says, you know a lot about 401(k)’s,” and she said, “My husband and I, we max out our 401(k)’s,” and she goes, “What’s wrong with doing that?” And she was like, calling me out, and I thought, “Oh my god.”

And long story short, we didn’t really have a conversation over it, because I didn’t want to take that standpoint of trying to defend myself or something… But later, I thought I could have added value to her though by just sharing a few things objectively; not saying you should or shouldn’t do something, just saying, “This is what I researched and learned, and that’s why I feel the way that I do.”

So that’s what this episode is; that was kind of a long intro. So what I want to do, Theo, is do what I believe to be the five main takeaways from the book that Andy’s trying to get across to folks, and then I’ll give you kind of my personal takeaways and where that lead.

Theo Hicks: Yeah. Perfect. Start with those five major takeaways from the book.

Travis Watts: Okay, cool. So the bullet points that I made – I had to go back and kind of refresh myself last week, but it’s that first and foremost, a 401(k) builds net worth, it doesn’t build cash flow. So if you’re interested in the whole basis of our podcast, the Actively Passive Show, we talk all the time about passive income and cash flow and real estate. Well, if that’s kind of your niche and your thing, this is certainly not an account that’s going to help you with that. This is treated almost like a savings account; you’re going to dump money in it, cash, and then when you’re in your 60s, you’re going to pull that cash out, whatever you’ve made over the years. So that’s what it is. I think these things came out in the late 70s, and initially, these were intended to be just one supplemental account in the big picture of having the average American retire. This was not to say, “Here is the retirement account”, like a lot of people treat it today. “Oh, my 401(k) will bail me out one day when I’m in retirement.” Not at all. You’re supposed to basically have your pension, Social Security, Roth IRAs, traditional IRAs, brokerage accounts, personal investments and a 401(k). This was just one little tiny piece of the puzzle. The tragedy and the chaos of it that Andy points out is that we’ve made this the centralized vehicle for retirement, and in most cases, statistically, it’s just not going to be enough for the average person to retire on. So that’s number one.

Number two is that mutual funds, which is notoriously what’s in a 401(k) as far as an investment option, is not going to protect you against a systematic decline in the market. When you read the headlines and the S&P and the Dow Jones are down 5%, really good chance that your 401(k) is down roughly 5% too, right? Because it’s all just tied into the same Wall Street system. So there’s not a lot of downside protection like you would have in a brokerage account, where you could do a stop loss or something like that, and if things start declining, you’re out. Can’t do that in a 401(k). So it’s a bit riskier in that sense.

Number three is that 401(k)’s really, at the end of the day, if you read the research on why these were even created in the late 70s, it was to help fund Wall Street. It was because Wall Street wanted more of a prop up obviously, right? They wanted more fees, obviously, right? So this was a way to get virtually a ton of Americans, I would probably say, the majority (I don’t know the real numbers) to participate in the stock market. It would be your choice, but it’s not that you really want to be investing in the stock market privately, but you’re kind of forced to every time you get a paycheck, you’re contributing to Wall Street. So that was really the main purpose, just to recognize what this was. It wasn’t so much about Americans individually benefiting, it was about Wall Street benefiting.

Number four – this is just a foundational Rich Dad philosophy, but investing should be a life skill. And I’ve always believed that philosophy anyway; there’s your professional education, and college, and high school, and degrees and all this, and that’s great… But also, everybody should take little emphasis on learning the investing world to a point, just so that you are aware of what this stuff is and how it works and how the taxes work.

Number five that Andy makes is that 401(k)s create an artificial demand on the stock market. So as you’re looking at these historic graphs and the stock market, you hear it said all the time, “The market always recovers, it always goes up.” Well, yeah, because you’ve got all these people contributing every two weeks through their paycheck, sometimes more frequently, into the market. So that creates – I don’t want to call it a bubble, but artificial demand on the markets is the way that he coins it.

So I’ll stop there for Andy’s takeaways, what I believe them to be. He doesn’t lay them out exactly like that, that was just after reading the book. Any thoughts, Theo, on that?

Theo Hicks: Yeah, just really what I’d like to add based on what you said, as I understand all the things. Two things; number two, you talked about the lack of protection against systemic risk. I remember I went to college at the beginning of the crash of 2008, and I got out, and then I got my first job and I made some friends who had started working maybe a little bit before 2008 or something; I can’t remember exactly what it was. I just remember that they’d gone all-in with the 401(k), right? They put as much as they possibly could, they got the employee match, and it went up, it did really well. And the crash happened and they heard their 401(k) got cut in half, and it took them 5+ years for it to even go back to what it was before the crash even happened.

I remember the same thing for the underlying mutual funds. I remember when the crash happened, the college fund my parents were saving up for us for 18 years got cut in half overnight. And I think a few years ago, my sister’s finally got back to what it was pre-2008. So when you were talking about that, it kind of brought up those memories.

And then number three, when you were talking about the lump sums of cash for institutions, it reminds me of that TV show “Billions”. Have you seen that show “Billions” before?

Travis Watts: I have not. No.

Theo Hicks: It follows this guy in Wall Street who has this big hedge fund. And one of the plotlines is, he’s trying to get a police pension fund, because he wants to have all that cash and make all those massive fees off of handling all that cash. And so that’s what came to mind when you talked about the conception of the 401(k). And I didn’t know exactly why they started it, but kind of what you said totally makes sense.

Travis Watts: Yeah, one of the guys that actually helped make this thing possible and launch it initially has since, in recent news, I think in the last 5-10 years, come out to say basically the same thing Andy Tanner is saying, “This has become chaos. This was not what we intended for this to be. This is not supposed to be your one retirement account.”

And as you know, Theo and anybody listening, pensions have virtually gone away at this point, and Social Security is taking hits, so you’re likely going to get less in the future than past recipients. And too many people are just relying on the 401(k) as the only other substitute here, and that’s a very scary thing.

One other point, to your story, Theo, about your friend who said his 401(k) went down 50% – think about this; you’ve got a 401(k), it goes down 50%, so now what do you have to earn on the 401(k) to get it back to where it was? 100%. That’s just nuts; that’s a mind trip to me. You actually have to double your money just to get back to where you were, just because you lost 50%. So it’s just kind of a weird thought process.

But anyway, I’ll go into my three takeaways back when, that made me decide to pursue other options, including real estate and making my own retirement account, so to speak.

So number one was, as many of you know, the 401(k) is intended for you to use in your 60s and 70s and beyond. So if you’re the type of individual that wants to retire early, or use cash flow or investments to help you out in life now or in the near future – obviously not a good account, right? Because you’re going to be penalized 10% penalty if you pull out the money early, on top of not a very advantaged tax situation, which I’ll go into I guess now.

Think of it this way – as I mentioned earlier, most of your investment options in a 401(k) are going to be mutual funds.  So if I go to a brokerage firm, like a Fidelity Investments, Charles Schwab, Janus, whatever, and I buy a mutual fund in a non-retirement brokerage account, and I buy today, it’s 10 bucks a share, it goes up to 12. I sell it more than a year later, I have a long term capital gain, and that has a tax advantage to it. For most people, you’re going to pay a 15% tax on that, and it gets capped. For really high-income earners, you might pay 20% and it’s capped. And for low-income earners, you might pay 0%, according to our current tax plan. Not a CPA, not a tax professional, just pointing out from a high level, that’s how it works.

So if I made that same investment, that same mutual fund, virtually speaking – usually institutional class and individual class or whatever, but same thing, S&P index or whatever – in my 401(k) and I held it more than one year and I sell it, same game, same increase, and then I pull out those gains, assuming I’m over 59 ½, I’ll pay up to 37% in tax if I’m a high-income earner, with a proposal outright now from the Biden folks that it could go up to where it was before, which is 39.6%.

So essentially, the takeaway here for anyone that lost me in that conversation is, why would you want to pay double the tax on the same investment you could make privately? Essentially, you’re just paying more in taxes. And to that point, the 401(k), when you pull out the money – it’s not until you pull out the money, but whenever that comes, you’re paying ordinary earned income tax rates. So you’re taking something that otherwise would have a tax advantage, and you’re eliminating it and saying, “No, I’d rather pay the highest taxes on that.”

So Andy asked the question, he said, “When you retire, do you intend to make more income than what you make now, or less income?” And that’s a fair question, because people are going to have different responses to that. But for me personally, it was, “I hope I’m making more money as an investor” right? You’re compounding and you’re making more investments, and so if that’s true, then why do you want to take a tax advantage today, defer the taxes, to pay higher taxes in the future? Why would you want to do that? So that was one of those foundational things. That was number two of my three takeaways.

And the last thing is this – quite simply, anyone who’s got a 401(k) knows this – very much a lack of investment options. I think the MarketWatch put out an article recently about the average 401(k) plan in America has 12 investment options… Twelve. Compared to, again, a brokerage account, where you have 1000s of options. And then outside brokerage accounts, 1000s more of options; you can invest in private companies, and like you and I invest in real estate privately… We have so many things we can put our money in, not 12 options.

So it’s just simply that — when I used to work for a brokerage firm… It didn’t last very long, but I used to do that. This was one of the primary reasons why I left the firm, is because they try to teach everybody – or they do teach everybody – that we’ve got A, B, C, D, E, F, G mutual funds, and those should be right for everybody in one capacity or another. If you’re old, it’s this one. If you’re young, it’s that one. And it just didn’t make sense to me. I thought, “No, there’s so much more to it than just that.”

So those were my three takeaways. I was fortunate to read that book early, and not have a lot in my 401(k). So I paid the penalty and I just got out of it. I started opening my own LLCs and trust and whatnot, and I just did my own private thing, and brokerage accounts as well. So with that, any thoughts, Theo?

Theo Hicks: What you said about the taxes is — when I found that out, I was instantly turned off from the idea of the 401(k). I was like, “This doesn’t make any sense.” I didn’t [unintelligible [00:18:36].07] point of it at that point. The way you presented it, it was really nice, about how you just take that money that you would have put in the 401(k) and invest in basically the exact same thing, and pay half the taxes.

And I think another question you mentioned – the one question was, do you expect to make more money or less money when you retire? Another question that I thought about is, do I think taxes are going to be higher now or when I retire? Again, who knows? But it seems like they’re trending higher; and we can look at like back in the day taxes were like 70%, 80%, or something crazy like that; like, how 30% is kind of low historically. They’re probably going to go up, so why would I forego the most likely lower tax rate now, pull all my money out and do whatever I want to with it, as opposed to having it be used before taxes for these investments? And I pull it out and it’s taxed at 70% in 20-30 years from now. When you think about the taxes, that’s probably the biggest thing.

And I remember all the different packets they gave me for the 401(k), and the corporate world never talked about any of that stuff. They just talked about how great it was, the historical increases of the underlying funds, and something we’re going to talk about here in a second, which is the employee match, and things like that… But never talked about, “Hey, if the stock market crashes, you’re kind of screwed.”

Travis Watts: Yeah, the whole tax situation right now is very parallel to the conversation around interest rates, right? We’ve seen crazy interest rates in the 70s and 80s, same as taxes back then, and now we’re pretty near zero. So it’s kind of like taking a bet on that. What do you think’s going to happen in the future? We could go negative interest rates, I guess, but we’re not going to go negative tax rates, where the government’s paying us. So yeah, something to definitely plan for and think about.

And to your point, I don’t want to make this whole episode seem like we’re bashing 401(k)’s; I’m sure a lot of people are thinking this in their head, if they haven’t already put a comment on here, but what about the match? Isn’t it free money? Isn’t that a great idea? Again, I’m not giving anybody advice, but I’ll tell you this – if and when I was working for a corporation that offered me a 401(k) and they offered a good match; 4%, 5%, 6% or 7%, meaning I put in 100 bucks, they put in 100 bucks, I would always contribute up to the match. When you start going beyond that, that’s a whole different conversation about taxes and risks, and what-if’s, and this and that and the other… But I personally always did the match; my wife still has a 401(k), she does the match, but she stops right there, and she fully intends on taking this 401(k) out when she leaves her employer.

So again, everybody’s different on that. But it is, I guess, you could say, free money; just take it or leave it. They’re either going to give it to you or you’re going to forfeit it; it’s like 100% return on investment without really taking any risk, because you put in 100, they give you 100. That’s a pretty good investment.

So they’re not all bad. I don’t want to paint the picture that way. But that’s definitely a way to look at it, we’ll say. And as they were originally intended, this could be a diversification strategy. There is some asset protection to a point inside of a 401(k), you do have that company match option… This could just be one of your assets, basically; think of it that way. That’s just one investment that I have. The average millionaire has 7+ income streams. It’s not really an income stream, but it’s an asset that you could turn into an income stream in retirement. So that’s the way I would look at that.

And man, I just couldn’t agree more with Andy Tanner that investing needs to be a life skill. You don’t have to be an expert in all this; you don’t even have to read his book, but you just need to understand from a macro level, the tax code, the history of some of this stuff, the pros and the cons of these different accounts, because it really is a tragedy when folks finally get it, but they’re in their 50s or what have you, and it’s, “Ah, shoulda/coulda/woulda”, and “I wish I never would have done that. I should have done (whatever it is) whole life insurance when I was 18” and all these things. It’s better to try to get on the ball early, get to understand how these work so you’re not in that situation, trying to live off a menial social security and a 401(k) that’s not really going to bail you out for more than 10 years or something like that. So those are my closing thoughts on it. Anything else you’ve got, Theo?

Theo Hicks: Yeah, there’s one other benefit that we didn’t talk about – the fact that you are able to, at least last time I looked into 401(k), which was a while ago, but I’d imagine it still exists, is their ability to take a loan against your 401(k). I can’t remember exactly what the interest rate is; maybe it’s like 5% or something. And you obviously had to pay it back. I’m not even exactly sure what the requirements are and what that money is used for. I don’t know if you can just take it out and go on vacation or something, I don’t know what it is. The same buddy whose 401(k) halved, I think he took the maximum loan at the time, which was $50,000, to invest in real estate. So obviously, you need to figure out what the requirements are for paying that back. But it kind of reminds me of like the whole life insurance strategy where you can take a loan against it, use that money to maybe do like a BRRRR strategy, or a shorter-term passive investment strategy. And once you get that money back, hopefully, like doubled or increased by 50%, you put the original 50K back in there and then you use the profit plus another $50,000 loan, and keep repeating that process over and over again. That’s a way to leverage the money that’s in there, but it still doesn’t take away everything else we talked about, about the 401(k). But you are able to take a loan against it.

Travis Watts: Yeah, great point, Theo. Every 401(k) plan is going to be slightly different, so interest rates might vary. Some people may not have the ability to take the loan out, others may. Sometimes it’s 50% of your vested balance, sometimes it’s 100%… So check with your employer HR your plan, if you have one.

But I think just from a high level, the takeaway here is that – is it right for you to have a 401(k)? Is it right to max out your 401(k)? Is it maybe the right strategy just to do the match on your 401(k)? These kinds of things. And ultimately, I think it could be a good diversification strategy as I pointed out earlier, if nothing else, if you have the option to do it. If your employer is not going to match you and circumstances are different, you’re not going to stick with that job very long, maybe it’s not the right thing for you.

But anyway, those are some of the things. The book is 401(k)aos, Andy Tanner. It’s a good read if you want to dig a little deeper into it.

Theo Hicks: Perfect. I guess one more maybe closing thought for me that I thought of is that – it’s kind of one of those things where it’s like if you already have your 401(k) or you’ve been maxing it out, it’s not the end of the world. But the question you need to ask yourself is, now that you have this information, what’s the next step? So if you’re a high schooler or you’re in college and you haven’t started working yet and you plan on maybe doing a corporate gig, but you also want to invest on the side, you’re going to be presented with information on a 401(k), and you’re going to have to ask yourself, “Is this something I want to start doing?” If you already have a 401(k), then ask yourself, “Do I want to continually invest the same amount of money in that 401(k)? Do I want to stop and maybe start taking loans out against it? Or do I want to pull that money out, take the penalty and then apply that to something else?”

So as Travis said, I guess the idea wasn’t just to completely bash on 401(k)’s. The idea is to present information on the 401(k), and you decide what to do moving forward… Not to say, “Hey, you’ve invested in a 401(k). That’s a horrible idea.” It’s like, “No, here’s information.” This might be a great idea for you, but most likely if you’re listening to this and you’re an investor, it’s probably not. This is more for people who aren’t investing, and it’s better than doing nothing. But the main point is that, “Okay, I have this information. Now what am I going to do?” as opposed to maybe thinking back  “Over the past 20 years I’ve invested my 401(k) – was that wrong, was that bad?” That’s over. Now, what are you going to do?

I’m really glad we got to talk about 401(k)’s today. That’s definitely an interesting topic, and I definitely learned something from this, specifically about why the 401(k) started. I always wondered, I was like—another thing I want to know is, why do the companies match? Why do they give you free money? I’d be curious to know what’s behind that.

But anyway, Travis, as always, thanks for joining me today. Best Ever listeners, as always, thank you for listening, happy belated New Year, and we’ll talk to you next week.

Travis Watts: Thanks, Theo. Thanks, everybody. Take care.

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JF2319: 10 Time Freedom Questions For 2021 | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will be answering 10 questions about time freedom. Everyone wants to have more time and freedom to spend it however they like; that’s why most people get into investing, active or passive, to begin with.

When asked to list their biggest regrets about life, most people in retirement homes state lack of time spent with friends and family, as well as not going after their dreams and aspirations. With the help of 10 questions, Theo and Travis hope to give you ideas on how to go after the life you want in 2021. No more waiting for retirement!

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners, and welcome to another edition of the Actively Passive Investing Show. I am Theo Hicks. As always, Travis Watts. Travis, how are you doing today?

Travis Watts: Theo, doing great! Happy new year! Happy holidays!

Theo Hicks: Yeah, happy new year to you as well. I think this will air a couple of days before new year’s or after new year’s, but regardless, the theme of today’s episode is going to be the new year’s. It’s a tradition for most people to set new year’s resolutions… So since this is the Actively Passive Investing Show, and something we focus on here a lot for our passive investors is the idea of time freedom, Travis and I thought it would be a good idea to do something similar to what we did a few months ago, in the episode where we went through a list of questions from Tim Ferriss’ book Tribe of Mentors. Travis and I are gonna alternatively answer those questions ourselves.

Today we create a list of time freedom themed questions for 2021. In a sense, it’s a list of New Year’s resolutions, with the purpose of having more time freedom. Travis, I know you wanna talk a little bit more about time freedom and our show before we jump into answering these questions.

Travis Watts: Sure. I just thought this would be a really good way to close out the year to the theme of our Actively Passive Show. This show is obviously for active and passive investors, and I thought we all want to get to this point in our lives sooner or later, where we’re hands off and we have this time freedom; we have the ability to retire, spend time with family, travel, whatever it is we’re passionate about… So I thought maybe these ten questions can give our listeners a few things to think about if you’re gonna set some new year’s resolution goals, instead of just saying “I’m gonna work out for 20 minutes a day all year long”, and all the traditional stuff. “I’m gonna lose 30 pounds.” Maybe it’s something to think about now, how are you gonna start creating this time freedom in your life.

I’ll be brief with this story. I know I’ve shared this before on your show, but it’s just such an impactful story, the story of the nurse  Bronnie Ware, 2009, working in a terminally ill patient care unit; kind of like a hospice, folks living out their final days in life… And Bronnie surveying basically her patients; just being friendly, and talking… She came across a lot of folks who would tell her, essentially, their life regrets. “I wish I would have done this, and I wish I hadn’t done that…” She decided that that was impactful, so she made a huge blog out of this, ‘The  Top Regrets of the Dying’, that later became a book. Now she’s a speaker on and on… But the thing I wanna point out about that story is that the top two regrets are “I never pursued my dreams and aspirations” and “I didn’t spend enough time with my friends and family.”

So knowing those are top of mind to folks at the end of life as we know it, I just felt time freedom makes a lot of sense to talk about. And maybe instead of thinking about how you’re gonna get there, what you’re gonna do with your time when you’re 60, 70, 80, 90, maybe we start thinking about it now, and we start planning for that, and hopefully, we can get there a whole lot sooner, and not have those same regrets.

So that’s the back-story behind the ten questions, and that’s really why I pieced it together that way.

Theo Hicks: Perfect. Well, let’s jump into these questions. I think the last time I went first and you went second, so let’s reverse the order this time. I’m gonna ask you the question first, and then you can ask me the question second. Best Ever listeners who are listening, maybe keep out a pen and pencil, or on your computer or on your phone, and you can type up these ten questions as well, and answer them to see — I enjoyed this exercise, and it helped me reflect on this year, and then also helped me come up with some things I can start doing in the next year. So I think it’d be helpful to you listening to do the same thing.

First question is “What time waster are you willing to let go of in 2021?”

Travis Watts: This is a great question, because to the point of time freedom, we want to free up our time, we don’t want to squander our time… And life is so short, as we all know. So for me – gosh, I could probably think of 20 different things here that are potential time wasters. The one I thought of though – I’m such a big advocate for self-education, and reading, and books, and things like this, and just self-learning… However, there’s a caveat to that that I’ve spoke about before, and that’s I went way too hard, too fast, hardcore in 2015, when I just read a ton of books, and it was almost analysis paralysis. Your brain can’t do all of that. So you need to really be choosy with what you’re gonna read and what you’re gonna study, and what mentors you’re gonna put in your life, and what information you’re gonna tune into.

To that point, I am grateful that I am invited to so many different Facebook real estate groups, and LinkedIn groups, and real estate meetup groups… I’m in more groups than I even know about, and that becomes a problem, because you start spreading yourself too thin; we’ve got our podcast, I speak with investors, I do a lot of things actively, and trying to keep up with all these different groups online. It’s just something I really need to cut back on. I need to find the one or two groups that I have the biggest impact on to help people, and just focus my time there, and not try to be in 30 or 40 different real estate meetup groups.

So for me, it’s really going through that in early 2021 and just cutting back on unfortunately being part of too many things.

Theo Hicks: Yeah, you said you’re grateful for that being a problem. Mine is I’m reading too much and I’m doing too much real estate stuff. Mine’s a little bit different. For me, I was reflecting on 2020, and I would say that the positive side for me – I have cut out a lot of time-wasters. I think I’ve mentioned this before, but I’d play video games all the time, I’d watch TV shows until 2-3 in the morning… And then kind of similar to maybe what you were talking about with reading the books, I used to consume educational content on YouTube. But then you  go down the YouTube rabbit hole where you’re video after video after video, and you’re spending hours and hours doing it, and at that point you’re hearing the same information over and over again… And are you really applying it to your life? So I have been able to minimize most of those in 2020.

The other big one that saves a lot of time is social media, because you go through that same kind of rabbit hole idea; everyone knows that – you scroll, and you scroll, and you scroll, and you can’t stop… In 2021, the one thing I want to eliminate for good would be going on Amazon Prime and watching TV shows and movies. I’ve gotta minimize it, because again, I stay pretty late to watch them. I’ve minimized it to the point now where it’s manageable, but I would like to eliminate that entirely in 2021.

Travis Watts: Yup, I’m with you man. I’ve subscribed to YouTube Premium, and Amazon Prime, and sometimes that’s a bad thing. There’s all this free content, and it’s like “Should I even be paying attention to this content?”

Theo Hicks: Exactly.

Travis Watts: That’s a great one.

Theo Hicks: Question number two, Travis – if you had one more hour during the day, what would you do with it?”

Travis Watts: Wow… That’s another tough one, because again, I could have ten answers to that. But ultimately, I think what I would do is I would read more. And I know that that maybe sounds hypocritical to my last answer, but if you’re being very choosy with what you’re reading and it really has a direct purpose, I would love to squeeze in one additional hour per day. Unfortunately, that usually gets put to the back-burner, and then of course things come up, and dinner, and a call, and then you’re in bed. So for me it’s reading.

Theo Hicks: For me, I would wanna work out for that hour. So if my hour is 25 hours a day and I had an extra hour at like noon, let’s say, instead of going from noon  to 13, or something, I’d work out during that hour… Because that’s something that’s really difficult to squeeze in every day.

There’s some other question we have later on that also hits on this, but I like this question because it’s — okay, the first question was “What’s one time-waster I wanna get rid of?” So if that one thing you’re doing is taking up an hour of your time per day, then question number two can be what you use to fill that slot. Maybe at first it could be 15 minutes of the new thing, and then 45 minutes of the old thing, and then ultimately getting it shorter and shorter till it’s maybe 45 minutes the new things, 15 minutes the old thing, and then the full hour is used on the new thing, and not the old thing.

Okay, question number three. This is a fun one… What have you been procrastinating on that you would like to complete in 2021?

Travis Watts: You know, really, I’m not that big of a procrastinator, thank goodness. That’s never been part of my life. But, that being said, of course, everybody procrastinates on something, and I guess playing off of your last answer, for me I guess that is the gym. I’m way more into working out my mind than working out my body… Which isn’t always a great thing. So I let something suffer to enhance something else… And we’ve talked about this before, I think, on the celery juice episode… You were talking so much more about the physical workouts, and I was talking about just doing like one diet change… [laughs] But still leaving out the physical part.

So for me, that’s the gym, I guess. If I procrastinate anything, it’s that.

Theo Hicks: One thing that I’m trying to do on this note – and I came up with this a few weeks ago, because my wife always asks me to do these menial tasks around the house… And I always say “Oh, I’ll do it tomorrow. Oh, I’ll do it this weekend”, and it never gets done, and the stack of empty Amazon boxes gets higher and higher in the front room, and the garage is still dirty… So one thing that I’ve tried to do – within reason, obviously – is whenever she tells me to do something, I just do it; I drop everything I’m doing and I just do it in that moment. Because if I don’t, I’ll procrastinate and I won’t do it.

One example of this would be our garage. We’ve got a bunch of big boxes in our garage, we’ve got furniture in our garage, and cobwebs, mud and dirt in our garage, and it seems like it might be something super-simple, but whenever I go in there to drive anywhere, I see it and I think about it, and it stresses me out and I feel guilty about it. And I know one person that some people listening to this show might have heard of before… I know Joe went and saw him speak, which is Jordan Peterson… And one of his rules is “Clean your room.” It’s a very simple thing, and the whole concept is that your external environment is a reflection of your internal environment… So if your office and your room is a mess, then your mind is probably also a complete mess. So if you start by cleaning your room, you can reduce that anxiety and stress that comes from just stuff being scattered everywhere. So I get that from the garage big time.

But then on a larger scale, boxes or other things that need to be picked up from the store, things that I know I procrastinate on all the time – just doing them immediately, or saying “I’ll do them by the end of the day.” I’ve been doing this for a few weeks, and it definitely helps. I don’t think about all that stuff I haven’t done as much.

Travis Watts: That’s a great one, I love it.

Theo Hicks: Okay. Number four – what is your favorite thing to do, and how can you make more time to do it?

Travis Watts: So I’ve talked about this a ton, but my wife and I – we love to travel. And unfortunately, 2020, Covid – it is what it is; we like international travel, but haven’t been able to do a whole lot of that. We snuck in Belize earlier this year, so we’re grateful for that… But the whole reason — well, I shouldn’t say the whole reason. A big reason why I chose a passive approach to real estate eventually is because of this; because I didn’t like having so much active real estate that held me down to a particular area, geographic location… I always had to attend a closing, or turn a unit, or deal with something… So that’s kind of how we have made more time to travel, is by investing in real estate private placements, and things like that.

Additionally, even though it’s an older book, I love Tim Ferriss’ 4-Hour Workweek, because it gives you a lot of great ideas on how to automate your life in a very digital way. So I utilize things like the Calendly link, and Zoom calls, and things like this to speak with investors or anyone wanting to reach out… And you can do that from anywhere. I love that.

In some ways, 2020 has been a blessing in that sense, in that we’ve all been forced to work from home, and haven’t had these old-school face-to-face events to attend… And it’s helped me get more creative on my outreach with people. So again, we could be traveling, and everything’s done digitally in my world. So yeah, that’s what I love, and that’s how we do it.

Theo Hicks: Perfect. Mine is very simple – my favorite thing to do right now is read. And how to make more time to do it – some of my ideas was 1) waking up a little bit earlier in the morning, which is something I talk about in the next question, when we’ll be talking about morning routines… But the other one – and I’m pretty sure I’ve said this before, but reading is something that I enjoy doing while I’m doing it… But when I think about doing it sometimes, I’m just like, “Oh, I’ll do it tomorrow”, and I’ll put it off again; going back to procrastination. Or I didn’t finish my reading for the day, and it’s ten o’clock at night, and I’m  tired… I’ll just go to bed, and I’ll stack it to tomorrow. And then the next thing you know it’s a week and I’ve got all this reading to do.

So one thing that’s helped me was to recognize some of those time-wasters I used to do late in to the night… And then I tell myself “Well, okay, if I could do that”, which was really no positive benefit whatsoever past the immediate gratification, as opposed to doing this thing that I enjoy doing, and that does have a positive impact further than the immediate moment, then I could do that. I could stay as late as I need to to get that done, because I used to waste all this time staying up till three in the morning, doing something that was completely meaningless.

So the what is reading, the how is waking up earlier, and then reminding myself all that time, all those late nights I spent doing things that were completely useless.

Travis Watts: Perfect.

Theo Hicks: Okay, number five – I’m looking forward to hearing your answer on this one… So how can you redesign your mornings? Or best morning routine ideas for 2021.

Travis Watts: Playing off of your last response there, waking up earlier is so underestimated how much you can accomplish. It really doesn’t matter, in my opinion, what you do with the time, as long as that’s productive. You might meditate, you might do your emails, you might work out, it might give you just extra time to make a healthier meal, instead of running out the door and grabbing something on the go, or whatever it is you do… I think that’s key.

Now, when I say “Wake up earlier”, there’s extreme cases of this. Dwayne Johnson, The Rock – he wakes up at like 3 in the morning to get all this stuff done; I don’t know about that. If your body can handle that consistently, maybe. But for me, I look at “When do I have to wake up?” If I have a call at 9 AM, I have to be up at the very latest at [8:30]. But I don’t like to push it, because then I’m running around, I’m trying to get stuff done and I’m frantic when I’m on the call. So I’ll set my alarm for 7. That gives me plenty of time to wake up, to stretch, to check emails, to make sure I’m up with the news and what’s happening… And that’s the approach I like – not to feel rushed. So generally speaking, wake up early.

Theo Hicks: Yeah, I have the same answer, actually. Attempting to slowly, not make it dramatic, waking up at 7 instead of waking up at 3 o’clock… But slowly pushing it back.

One of the things that helps me is whenever you’re forced to get up early for, say, your traveling; you have a 7 AM flight. You get up at 4: 30 in the morning to get to the airport at 5, to get there on time… And then think about how you’re doing all this stuff that you usually don’t do; going through the time change, I’m constantly talking to people all day long when I’m usually in my office, just writing or whatever… And then obviously I get tired; but then night comes, and I go to bed at 10 o’clock, or whatever, I usually go to bed. And I survived, I didn’t die, I didn’t hurt anyone, nothing bad happened; I was totally fine.

So as you mentioned, maybe that early is not sustainable, but if you can see that as possible to do, then when you wake up and your alarm goes off at 6 AM and you wanna hit that snooze button for another 15 minutes or half an hour, try to bring up something at a time in your past where everything ended up fine; you might be a little tired… Have a coffee, it’ll be okay. So that’s one thing to help – maybe wake up early.

And then two things I do in the morning to make sure I get my morning routine done is 1) I try not to open my email at all until I’ve got my routine done… Because you get sucked into that. I guess anything that can potentially suck you in and take away time from completing that routine, I try not to do.

Another thing too is once I’m done with my entire routine, the first thing I do is I open my email and then I set my agenda for the day. So I say “Okay, here are all the tasks I need to  complete by the end of the day.” So those are some of my best morning routine ideas.

Number six, how can you add 15 minutes of gratitude to each day?

Travis Watts: This is kind of derived from Tony Robbins. We’ve talked a lot about Tony Robbins, and my wife and I have attended a lot of his seminars, programs, audiobooks, all that kind of stuff. But this simple thing, if you take nothing else from any work he’s ever done – it’s probably the most impactful. And for anyone that knows what I’m talking about, when you go to a Tony Robbins event, he walks you through a 15-minute gratitude exercise. And what’s interesting is he starts by saying “Think of something that bothers you, or upsets you, or a problem in your life, or something that you feel is bringing you down, or angers you…” So you start that way. And to your point, of flipping out of bed, opening up the news and reading a bunch of negativity… Same concept – all of a sudden, your mind starts going “What the hell is going on?!”

So this gratitude exercise puts you in a different mindset first thing in the morning, is what I’ve found is best… And you start to get perspective; you start to realize what’s really important… Like we talked about, Bronnie Ware, and life in general, and it’s almost like you’re looking down from a bird’s eye perspective.

So what’s most important is love and connection and family, and that you’re healthy, and happy; we live in a modern world today, we have all these conveniences… So you start getting in this mindset, being grateful for what you have… Then you can transition, throughout the day, into the news and the negativity, and surprisingly, it just diminishes the magnitude of that negativity. And that to me is the biggest thing right there, and why I still do this every day.

So really, that’s kind of why, and that’s how; it’s simple. You can write it down, you can just think about it, you can meditate on it, you can get Tony Robbins to walk you through it, whatever works for you. But it’s just putting yourself in a mindset of the greater perspective, basically.

Theo Hicks: Yeah. And then for me just to add to that – as you said, you find it best to do it in the morning. Again, this is something that — I’m really bad at this. [unintelligible [00:21:17].17] really bad at, and this is one of them… And one of the things that I struggled with, in a sense, is that I’ll do it in the morning, and the goal would be to set the foundation, so that you filter everything that you see throughout the day through that perspective, to kind of remind yourself every  morning… And then I forget, right away; I’m in the world and I completely forget. So one thing that I try to do, that’s helpful for me, is express gratitude, however you wanna do that. Obviously, at night, but then also transitioning from one activity to another.

So in the morning, you sit in your office, you open a book, and you’re grateful for the fact that you have the book, and that there’s paper that can be printed on… Back in the day they had to handwrite everything, and people couldn’t even read… And then once I’m done with that, you get up and you make your coffee, you’re grateful for the coffee and the people who picked the beans and ground the coffee for me, and transported it over to America, and then put it in the bag… I get to go to the coffee shop, I drive my car there to pick it up…

So just doing that — and of course, I forget all the time. I probably do it maybe 2-3 times a day, but over time, just like everything, you kind of gradually pick up momentum, you begin to remember it more and more and more, until the goal would be your entire day you’re doing this. At least that’s my goal. And then making sure that, in the beginning, if you do want to attempt to do this and you only do it once per day, at the end of the day don’t beat yourself up and feel bad and be mad at yourself because you weren’t grateful for every transition that you did throughout the day, because that’s not gonna happen. It might be zero times.

But I think the foundations you mentioned in the beginning of the day is great, and then I’d add at the end, and then as many times in the middle as possible.

Travis Watts: Yup, love it.

Theo Hicks: Okay, number seven – how can you redesign your evenings to bring more rest to your night? So on the flip side of the morning routines, evening routines, so that you get rest.

Travis Watts: I’ll give a real short one to this; I know we’re running out of time here, but… Simply put – to me anyway  – it’s about unwinding your mind. The worst thing I could do to reverse-engineer this is to read a financial book, or to start working on my personal finance stuff, because then my mind gets going. “I could do this… And what about that? etc.” And then I can’t sleep.

So it’s like, no phone, no internet, no computer, at least 30 minutes before bed; ideally, longer. Setting an alarm early, so I don’t have to think about it last-minute, and just unwinding, relaxing, possibly meditating (I do that sometimes) and not engaging in anything that’s gonna make my mind start running… And really, that’s it.

Theo Hicks: Yeah, I cannot agree more with that last part. I’ll unwind with something that’s not very demanding, that’s gonna get me laying in bed, staring at the ceiling, thinking. It doesn’t have to be fiction; it could still be non-fiction, maybe more biographical, but not very engaging.

And then something else, too – smaller meals at dinner, so not completely stuffing my face until my stomach hurts, and I’m laying in bed, sick… Everyone knows that feeling. So smaller meals at dinner, so that I’m not feeling bad in bed.

We’ve got a few more minutes, and we’ve three questions left. If it’s okay with you, I’d love to skip to the last one and talk about how can you give back more in 2021. Then if we have more time, maybe we can go back to question number nine about what we would do with more passive income. So how can you give back more in 2021?

Travis Watts: That’s a great question, and I’ve always thought of this kind of thing anytime I’ve ever heard the words “give back” as a child and growing up – I always thought about money; how are you gonna give, where do you donate money, all these things. And really, it doesn’t have to be about that. Actually, it was Joe Fairless that kind of opened my mind even more to this concept, that you have to have enough of something, kind of an overflow of something, to be able to adequately give back that same thing. So if you have a lot of money, you have money to give back. If you don’t have any money, you can’t give money. For me, it’s time.

I was  able to free up a bunch of time to the types of investing I do, and a change of lifestyle and work that I choose to work on… And now that I have that abundance of time, I give back my time. I do that weekly, I do that daily, to people – mostly through my calendar link, where I set up 15-minute calls, with both investors and just anybody in the real estate space that wants to connect… And I give that back. So to me, I will continue that. I’ve done it all year this year, and for the last several years, and in 2021 – same focus.

Theo Hicks: That’s a great point… Because you’ve gotta think about this. This is one reason why we stress – at least on the active side; I know Travis does this as well, the concept of having a thought leadership platform. Obviously, there’s benefits if a person has a thought leadership platform, but at the same time, Travis is writing these blog posts of all this knowledge that he’s gained over at least the past five years, since he’s started investing. All the different mistakes that he made, all the lessons that he learned… He writes that up in a blog post and then he gives the information away for free.

On our blog, we’ve got — I don’t even know how many blog posts we have now. We have hundreds of blog posts about actively investing, about passively investing, about lifestyle, you name it; anything related to business or real estate. So by trying to focus on the podcast, interviewing people, you’re helping them and their business, getting their name out there…

Obviously, there’s financial things that I do as well, but to keep on the concept of time freedom, doing this podcast and helping people have more time… And one thing that Joe talks about — I’m not sure he still has this on the website or not; I think he does, but… If you read his bio, it talks about what his mission is, what his vision is, and why he does what he does… And he does active syndications, so that people can passively invest, they can achieve financial freedom, they can achieve time freedom, so that they have more time to spend on things… And when they have more time to spend on things, they’ll ultimately do more good, and so there’ll be more good done in the world as a result of him helping people achieve those goals. I always thought that was very interesting, and applying that to what you’re doing.

If you’re not giving away tens of thousands of dollars every single year, or every single day, or whatever – that’s okay, as long as you’re focused on the time. So it’s kind of balancing both of those.

Travis Watts: Yup, couldn’t agree more.

Theo Hicks: I’m gonna quickly, at the end here, go through these questions in a list, so that people listening can write them down, and then we’ll wrap up.

So number one was “What time waster are you willing to let go of?” Number two is “If you had one more hour during the day, what would you do with it?” Three, “What have you been procrastinating on that you would like to complete?” Four, “What is your favorite thing to do, and how can you make more time to do it?” Five, “How can you redesign your mornings?” Six, “How can you add 15 minutes of gratitude to each day?” Seven, “How can you redesign your evenings to bring more rest to your nights?” Eight – this is one we skipped – “Do you set goals, and how?” Nine – which we skipped – if you had $20,000 in passive income a month, what is one thing you would do?” And then the last one, number ten, is “How can you give back more in 2021?”

Travis, anything else you want to leave us with before we wrap up?

Travis Watts: No, but I really do encourage everybody listening to write those down, and to make note of them, and really start planning and thinking through — I’m big into  envisioning your future; so the ones that we skipped, like the $20,000 a month, that exercise is just to get your mind thinking in that direction, so that you can set your goals, so that you can reverse engineer and get there.

Theo Hicks: Perfect. Alright, Travis, thanks again for joining us today. Best Ever listeners, as always, thank you for listening. Have a best ever day, and we’ll talk to you tomorrow.

Travis Watts: Happy holidays, happy new year! Thanks for tuning in.

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JF2312: Simple But Not Easy | The Right Investing Mindset | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis discuss the importance of having the right investing mindset and the danger of paralysis by analysis. Travis and Theo reflect on what they would have done differently at the beginning of their career if they had a chance for a do-over. Many new investors waste a lot of time and energy overcomplicating things or doing them manually, not realizing that they should have been automated and simplified months ago. 

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners, and welcome back to another edition of the Actively Passive Investing Show. As always, I’m your host, and I am again with Travis Watts. Travis, how are you doing?

Travis Watts: Theo, doing great. Happy to be here, as always.

Theo Hicks: Yeah, me too. Today we’re gonna talk about another one of Travis’ blogs, entitled “Simple, but not easy. The Investing mindset.” And talk about really how to simplify things, and essentially not waste time while you’re investing. That’s gonna be the main theme of the conversation today. As always, I’ll let Travis kick it off by explaining why it is he wrote this blog post, where this idea came from.

Travis Watts: Sure. It seems to be a trend right now. Maybe it’s just me, but as I go through different blogs, and topics, and shows, I keep seeing this theme of starting over again, or what advice would you have given yourself years ago, and if  you had to do it all over again, what would you do differently – all that kind of stuff, which is really what prompted this post. So I  got to thinking — alright, I got started in 2009 in terms of real estate investing, and these are just some things I really wish I had known; it would have changed a lot of different strategies, and trajectories, so to speak…

For those that don’t know, basically, here’s the bullet points to my first six years in real estate – really complicated, really complex; it was a constant “Learn, learn, learn, learn, try something, realize you don’t like it, start over from scratch,  learn, learn, learn, learn, try something and fail, start over from scratch…” And I made it very complex; I tried to go too hard, too fast, basically. I wasted a lot of time, I wasted a lot of energy… I almost gave up a couple times, quite frankly, just in frustration… So it was six years of hassle. So what this blog is really about is to hopefully give some perspective, some mindset, which is kind of the title here… It’s simple, but not easy –  it’s an investor mindset that’s really helped me overcome these hurdles.

And the analogy that I thought of – I’ll share this and then I’ll turn it back to you real quick… It’s like, if I was tasked to dig a ditch – well, it’s kind of like I just jumped right in and started using a rock; I started digging with a rock, and then I learned, say, a month later, “Oh, there’s such a thing as a hand trowel. Well, that’s a lot easier. Then I did that for a while. Then I thought “Wait a second… There’s something called a shovel. That makes it a whole lot easier.” Then someone finally said, “Look, man, there’s something called a backhoe, and that’ll really cut the learning curve for you.” That’s kind of how I see it in an analogy form; that was my real estate experience up through multifamily. So I guess I’ll turn it back to you, with that said. Any thoughts to that? Has there been something in your life that’s similar, where you jumped in and did a lot of things perhaps wrong, or in an inefficient way, and learned later “Hey, it’s a lot easier if I just did this”?

Theo Hicks: Yeah, I think I have a really solid example. When I first started investing, I jumped right in. I heard about it from a friend and had a property under contract within 2-3 days. That property itself was fine, so the lesson isn’t necessarily from that; but once I was done, I caught that real estate bug and I was obsessed… And I remember — I was living in Cincinnati at the time, and the plan was to start doing off-market direct mail campaigns. So I went to the auditor site, and — again, I didn’t know anything. I had never read any books, I was just like “I need to make a list.” So I start going onto the auditor site every weekend on Saturdays, and I’d spend hours in the coffee shop, in the Excel document, going parcel by parcel, street by street, manually entering in data into this Excel document… Address, owner, property value. I did this for — I don’t know how long…  Weeks, maybe even months. For so long. I would do other things as well, that were also a waste of time, but… That was the one that really stuck out to me.

And I remember — this is so frustrating… I remember [unintelligible [00:07:02].10] all these addresses doing this.. There were just too many; there was tens of thousands of parcels in Cincinnati. There’s gotta be an easier way to this. So I start messing around on the website and I realize that you can email them and they’ll give you a temporary, two-week login, and you can have access to the backend — I’m  not necessarily sure what you have access to, but essentially you log in, you select their tax list, you hit Download, and you download every single parcel. So what took me months and months to do in part, I could do in two seconds.

So that’s my example of a complete waste of time. And the biggest problem there, too – I was actually talking to someone about this yesterday – is that not only was I wasting my time, but I also wasted that initial zeal you get when you first get into real estate and you’re super-excited, and you have so much energy… And instead of directing that energy towards something productive, I directed it towards something which was a complete waste of time.

Travis Watts: The classic example of that analysis paralysis to a point, and then also — that just reminded me of one of the first jobs I ever had, which was a call center job… Again, just to use the example of “Simple, but not easy…” Simple task – we need to track the attendance of all the employees. Pretty simple, right? It makes sense. Yeah, but it wasn’t easy. They had no software to do it. So one of my first jobs was to manually, to your point — like, I had all these spreadsheets, and these real-time analyzers, and I’m constantly having to move stuff around all day long, like a manual labor person, trying to track in real-time the attendance, and who’s late, and who’s a no-call/no-show… It was like, “What a joke…!” [laughs]

Theo Hicks: I totally understand… And as you said, analysis paralysis is the perfect example of that. You’re just constantly underwriting deals, and you don’t know why you’re doing it, you don’t know what the end goal is going to be, you’re not even at the point where you can even do a deal… And there’s so many examples of this.

So now that we’ve kind of given both of our examples, do you wanna go into what’s the right way to do this, what’s the right mindset to have when you’re approaching these types of things, whether it be regarding your job, or personal life, or more importantly, passive investing?

Travis Watts: Yeah. I see this all the time too on Bigger Pockets; I’m a fairly active member on that platform. And there’s a lot of confusion, quite frankly, especially for folks getting started, which again, is kind of what this blog was all about. So what I mean is there’s a lot of complexity in the modern world, as you well know. There’s so much marketing, and so many different programs, so many different points of view; in one scroll of Instagram, or Facebook or something, you’re gonna see Bitcoin trading courses, flipping houses, buy and hold; “No, forget about buy and hold. Do the short-term stuff.” “Oh, never do short-term stuff because of taxes. Do this.” And it can be very overwhelming. Without a doubt – I point this out in the blog – you’re always gonna come across people who have extreme points of view, on anything. So the question is then how do you sort that out? How do you not fall for the trap of getting caught in analysis paralysis, so to speak?

So I love this – this is like a 2,000-year-old quote by Marcus Aurelius, which we talked about on stoicism and real estate… He says “Everything we hear is an opinion, not a fact, and everything we see is a perspective, but not the truth.” And I love that, because it makes you kind of zoom out a little bit and just think — because sometimes people are very persuasive, very salesy, and you can just get drawn right into that, that it’s a definite truth; it’s just an opinion, and it’s just one approach. So that’s one thing, from a high level, from the mindset of an investor that can help a lot.

To simplify that, just avoid extreme points of view. If somebody comes out and says “Look, avoid real estate at all costs. It doesn’t work. It’s the worst asset class.” Well, that’s way too extreme. There are endless examples of millionaires and billionaires who are in real estate. So it does work. It works for some…

And then on the flipside, if someone comes out and says “Look, real estate is the only thing to be in. There’s no other asset class. Forget about everything in the world except real estate.” Well, there’s probably not a ton of truth to that either. Maybe it’s a balance of a multitude of things that you invest in, and real estate being just one aspect of that.

So I love this about Robert Kiyosaki – we talk about him all the time; author of Rich Dad, Poor Dad and The Rich Dad company… Listening to Robert speak in modern times — I don’t know when he came out with this (maybe 2019 or something through today) he always talked about the tree sides to a coin; most people obviously think two sides, heads or tails. Well, there’s the edge. And I love this concept. Because if you can learn as an investor to view things from the perspective of standing on the edge of a coin – that allows you to peer over both sides. To listen to the guy saying “Real estate is the only thing in the world to be in”, and to listen to the guy or gal saying “You should avoid real estate at all costs”, and then you can make an opinion yourself based on the facts of looking at both sides and making a decision… I think that’s critical.

He obviously does  a much better job at explaining this concept, but hopefully that makes sense just from a high-level, that you have to be able to see both sides of the coin. You have to be able to hold opposing thoughts in your mind to be able to make a decision there.

I’ll pause there just for a minute. Do you have any thoughts on that? Have you heard of that before, or does anything come to mind?

Theo Hicks: Yeah, I think I’ve heard the coin idea before, but I really like what you said. I say this all the time, it is the truth; I talk to people all the time on the podcast, I interview people every week, and every time I talk to someone, they’re doing something different. They’re investing in a different type of asset class, they’re implementing a different strategy – and again, this is just in real estate – and they’ve all reaped some level of success. So you can be successful in any asset class as a passive investor or as an active investor. The possibility is there. The thing that makes one person successful and someone else not successful kind of comes down to a lot of things, but it kind of just comes down to the strategies and the tactics, and as you said, doing the simple things that work.

That brings us to the other thing you’re talking about, which is the coin analogy… Because again, it’s not like the person who says “Real estate is the only thing to invest in”, or someone that says “Never invest in real estate”  – it’s not like every single thing that they say is going to be that extreme, or something that you want to ignore; there could be something good that you can get from what they’re talking about. So you don’t want to be someone that is of the mindset of “Real estate is the only thing to invest in”, so someone who says that you shouldn’t invest in real estate, I’m not going to listen to anything that they say; everything that they say is wrong… Right? No, you can’t look at it that way. You have to realize that you’re gonna be able to find something valuable in really anyone you talk with. Even something really small, or something huge. So you don’t need to automatically just discount someone just because they’re like that.

But at the same time, on the other end, it seems that the people that are like that, that are those extremes – they’re very attractive to people, because “I wanna be on that team.” And again, I’m trying to avoid that, and saying okay, I can think that real estate is good, I can maybe only invest in real estate, and even think that I should only invest in real estate, but at the same time still realize that this person who’s investing maybe in something else might have some technology or software or some mindset tactic, or maybe something in their personal life that could help you to be a better real estate investor.

So I think that’s totally true… And what’s nice about some of the things we talk about on this show is that they obviously apply to passive investing, but if you think about it deeper, it applies to a lot more than just your business or real estate. You can apply this to fitness, or your personal life, or relationships, or really whatever. So that’s what I had to say about that.

Travis Watts: Yeah, it’s perfect. And totally, with the title of our show, “The actively passive show”, most of what we’re talking about on all these episodes are the active components to being a passive investor. When we talk about passive investing, what we’re not talking about is just “I’m gonna throw a bunch of money in a 401K, not look at it, not think about it, not really understand it, and just hope for the best… Because I’m passive. I’m hands-off.” It’s being the educated, intelligent, actively pursuing passive investing.

So to your point, this can apply to passive investing, active investing, anything in life really… But these are the active components that I feel are most important for people to pick up on. So let’s dissect it a little bit further – simple, but  not easy. If you have a goal – and let’s use a simple goal; I’ve put this in the blog… “I want to build wealth.” Period. That’s my goal. It’s not a very good goal, because it’s not very definable, but if that’s my goal… So here’s the thing – it’s easy, right? It’s easy in the sense that “Well, make money, spend less than you earn, and invest the difference.” There’s your formula.

It’s the same thing with “I wanna lose weight. That’s my goal.” Well, pretty easy, right? Diet, exercise. End of the story right there. But it’s not that simple, because “How do I make money? What do I invest in? How much do I need to save?” There’s a lot of other components to that, and that’s kind of to our theme. So consistency and self-education is the next segment of the blog that I talk about, because there’s other elements that are necessary to reaching your goals.

We talk a ton about self-education on our show, we talk about reading, and podcasts, and books, and finding mentors, and keeping up with industry-related news… That’s seld-education; it’s being a student of your own life, and it doesn’t’ stop when you get your college degree or your high school degree. It continues on. That’s something that you just have to implement to be successful long-term.

The consistency – this one’s kind of interesting, because we don’t really talk about this a whole lot… But I hear all the time by talking to investors of all types and sorts and ages, I like to ask people about their goals… And one I hear all the time on the passive investing front is “Well, I wanna have -” and they’ll just drop a number. “I wanna have $10,000/month passive income. That’s my goal.” Okay, fine. Fair enough. But here’s the thing. Too many folks try to get there too quickly, kind of like I did. Everyone, of course, would love to get rich quick, except – here’s how you should probably look at that. If your goal is $10,000/month passive income and you’re sitting here today at 0, learn how to make $100/month in passive income. How do you do that?

Let’s use a simple number example… So if you put $15,000 to work passively in any kind of deal – I’m not specifying anything in particular; any kind of real estate, or a real estate investment trust (REIT), high-dividend-paying stock, whatever. Let’s say you get an 8% annualized return. So $15,000 at 8% a year is $100/month in passive income. There’s goal number one. You’ve gotta take this in steps; learn how to do that, master that process. Understand the philosophy, and why you’re doing it, and all of that. Then you step up to the next level. “Okay, I’ve made $100/month. How do I make $1,000/month?” And you’re continuing learning the same process; it gets quicker, and quicker, and quicker. And then you step up from $1,000/month passive income to $10,000/month passive income. Believe it or not,  even though that seems like a big jump, it actually gets easier and easier to do this stuff. But the trick is staying consistent. Self-education combined with consistency.

The famous quote I use all the time on podcasts is Tony Robbins’ famous quote that most people overestimate what they can achieve in one year, but they underestimate what they can achieve in a decade. So you have to set realistic timeframes for things.

Again, back to weight loss – everyone wants to lose 50 pounds in one month, but hold on a second; what if you just said 50 pounds over 18 months? That’s a lot more reasonable and achievable. So just be patient, take your time with it. Any thoughts on that?

Theo Hicks: Yes, I’ve got three things I wanna say to that. The last thing you said, the Tony Robbins quote about you can accomplish  more in a decade than you could thing – something that I remember Joe and I talked about back when we used to do Follow Along Fridays is this idea that I think is very helpful, and if you can do this, you’ll accomplish everything we’re talking about… If you can just make this one tweak to your mindset, which is when you’re doing things every single day and taking action, think in terms of decades as opposed to weeks, or months, or years. I’m not saying don’t set weekly goals, or have an agenda for the day, or to set yearly goals; what I’m saying is that whenever you’re doing something, for example as you mentioned, working on getting $100/month in passive income, or whatever it happens to be, attempt to convince yourself that you’re not going to realize the fruits of these things for 10 years, or 15 years. So if after a year nothing happens, you’re not at $100 or you’re not at $1,000 or you’re not  at $10,000, then you’re not gonna freak out and just stop. You can say “Okay, well, I’ve told myself I’m not gonna accomplish this for 10 years”, or whatever.

I know that it could possibly make you not really do anything and take action and be slow, but it’s for people who have a hard time with that patience and really want to get there faster and faster and faster; it’s just not gonna happen, and even if it does, it’s not gonna work out, because the perfect example would be you win the lottery and then you lose it all. You need to have a mindset built up slowly over time to handle that much weight, in a sense.

So a way to tactically do this is the same thing we’ve talked about, which is the concept of 50/50 goals, which we have a blog post on and a couple podcast episodes on. Really quickly – whenever you’re setting a goal, whether it be a yearly goal or a monthly goal or whatever, 50% of the success is based off of actually achieving whatever that number is. So if the goal is to make $100 in passive income in the next six months, then half of that goal would be getting $100 in passive income. The other half of that goal would be learning some new skill, some new tactic, finding some new software… Something that you can take away from that process that will help you achieve something similar in the future. Maybe you’ve found a really good blog that analyzes high-dividend stocks, or something; maybe you don’t have the money to invest, but now you know “Okay, I’m gonna go to this website to get information.”

And then the third thing I wanted to say is something that I learned recently; you talked about being consistent, self-educating… What happens if you tell yourself “Well, I don’t have time to do any of this stuff”? One thing that helped me was looking back — you can go as far back as you want, but think back to maybe when you were in college, whenever you weren’t investing, and you wasted a lot of time, and tell yourself how you had no issue spending five hours watching Netflix in a row, or staying up until 3 o’clock in the morning playing video games, which is completely unproductive work. But then when it comes to that end of the night, “I’m tired, I don’t wanna read/I don’t wanna do something” and I make an excuse and I go to bed, why didn’t I make that same excuse when I was doing something stupid back in the day? So if you could spend a couple of hours watching  a movie, or like me – I’d spend way more than multiple hours playing video games at night – then you can spend an hour reading about passive investing, or reading about actively investing, or reading about whatever, or starting a meetup group, or doing something that’s actually going to get you closer to your goals. That’s really helped me out.

So now at night, when a voice starts talking in my head and is like “You can just go to bed, or you can do something else” – like, no, I used to stay up till three in the morning. So if I have not accomplished what I needed to do for the day, then I’m gonna stay up and finish it, even if it’s until three in the morning… Which never happens, of course, but the idea of it is very helpful to me.

Travis Watts: Accountability. I love all three of those points. Number two, what came to mind is that — I couldn’t agree more; what we’re doing on this show, hopefully, for our listeners, is helping you build a foundation, a particular philosophy and a mindset. The foundation is key. You mentioned lottery winners who win and then lose it all; that’s such a classic example. Why? There was no financial foundation. They never took the time to learn about investing, or about personal finance, or about budgeting… So  what happens when you take an individual like that and say “Well, here’s ten million dollars in your bank”? They go and blow it. [laughs] Pro athletes, and actors and actresses – so many people that made this incredible amount of money; we’ve talked about this before, about billionaire frugality, and all this… All these examples – the Mike Tysons that make 300 million dollars and go broke, and the Johnny Depps that make even more than that and go broke, and the pro athletes, endless examples…

You have to build a foundation, and this is why so many successful, high net worth individuals, when they’re asked “What happens if you lose everything and start over?”, which is the theme of this blog, “Well, I’ll be back in ten years, don’t worry about it.” Why? They have a foundation; they know what to do. They’ve just gotta put themselves back in the game, and then re-grind and rebuild the connections and the team; they already know about investing, and ROI, and risk tolerance, and all this. So it’s so important…

My closing thought here is to ignore the overnight success stories that we all hear in the media. This thought that you’re gonna be the next Mark Zuckerberg, that you’re just gonna hone down in your dorm room and create a new software and sell it and become a billionaire… Yeah, sure, it happens; statistically though, it’s not gonna happen to you. [laughs] That’s the thing. Not to be a Debbie Downer or a big discourager, but don’t bank on that as your ultimate success plan. At least maybe have a backup plan if that doesn’t work out, and learn a little bit about investing along the way.

That classic saying, “Shoot for the moon and even if you don’t land there, you’re in the stars”, or whatever… At least your along the journey… That’s my closing thoughts on this.

Theo Hicks: Yeah, I don’t have anything to add. I think this was a very helpful episode. Most people, if you’re at the point where you can passively invest, you may know a lot of these things already… But still, as you said earlier, you might learn something new. That’s all I have.

Travis, again, thanks for writing this blog post and coming on here today and dissecting it and going into more detail with me on it.

As always, Best Ever listeners, thank you for listening. We’ll be back next week. Until then, have a Best Ever day. We’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

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JF2305: How To Prepare For Economic Recession | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will share information about economic recessions and how to avoid the negative impact they often cause. Since the Articles of Confederation signing, there have been 47 recessions in the USA. And while there are ways to lessen the blow, there is no way to prevent recessions from happening altogether.

Travis applies the philosophy of stoicism to real estate, offering to focus on what we can control. Theo shares three main real estate laws that help investors stay afloat no matter what happens with the economy.

Click here for more info on groundbreaker.co

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners, and welcome back to another edition of the Actively Passive Investing Show. I’m Theo Hicks and as always, we’ll be speaking with Travis watts.

Travis, how are you doing today?

Travis Watts: Theo, doing great. Happy to be here. Thanks, everyone for tuning in.

Theo Hicks: Absolutely. Thanks for tuning in as well and thank you for joining me, Travis. Looking forward to our conversation today. We’re going to talk about recessions. So this will be based off of a blog post that Travis wrote, entitled 47 Recessions and Counting – Are you Prepared? So we’re going to, as always, talk about why Travis wrote this blog post and then dive into the body of the blog post and go over it in some detail, and I’ll get my thoughts on it as well. So Travis, why did you write this blog post?

Travis Watts: Most of the time, I would say, when I write a blog post, it’s because I read a snippet or a headline or I learned some new fact that just kind of blew my mind, and that was the case with this one. I had learned that we’ve had 47 recessions in the United States since the Articles of Confederation. I thought, “Oh my God.” To me, that’s shocking. I don’t know. Because it seems like every few years, when we have a recession, everyone’s so caught off guard and it’s so unbelievable, and nobody can believe this is happening… And to look back at just a short history from 1800s, 1900s and today, it’s like, “Hey, this stuff happens about every 10 years.”

So it was interesting to do just a quick study on the subject. We used to have recessions in the United States about every three or four years. So imagine that; you can hardly get a breather. By the time you recover, it’s happening again. So in 1913, the Federal Reserve was implemented, they started experimenting with, “Can we stop recessions from happening?”

And now today, we know about the easing of money and the printing of money, things like this. But the fact is, yeah, we can lessen the blow here and there, but we cannot prevent cycles from happening, and recessions and depressions and all that kind of stuff. So they do happen.

The good news is, if you want to look at the silver lining, they’re now about every 10 years; that’s not an exact science, obviously. We’re about 12 years in right now from the great recession of 2008. So not 10, but close enough. Sometimes they’re eight, which would be like the Dot-com crash of 2000 and then 2008, Great Recession, there’s an eight year example. So the fact is, we have to expect this stuff to happen.

So what it made me think of actually was the episode that we did not too long ago, a few episodes back, of stoicism, the ancient philosophy. And the core of that I won’t ruin it if any of the listeners haven’t seen that episode, but the core of Stoicism is to focus on the things that you can control, and to basically, not forget about, but put out of your center circle the things that you can’t control, which would be the Federal Reserve, are they going to print money? Are they going to switch interest rates? What’s the government going to do? What’s the stock market going to do? These things  are largely out of our control. So forget about them and focus on your behavior, your portfolio, your investments, things that are directly in your control. So that was kind of my general takeaway. And for anyone that hasn’t seen that episode, it’s called Stoicism and Real Estate – How To Be A Stoic Investor; again, a few episodes ago. So that was kind of the long-winded backstory of why I wrote it. Any thoughts before I go rambling on?

Theo Hicks: Yeah, I couldn’t agree more with what you talked about when it comes to relating this to our episode on stoicism, and making sure you focus on what you can control, and always thinking about how well what I’m doing be impacted by a recession. So that’s why I talked about this and probably literally, a million times, the Three Immutable Laws of Real Estate Investing, which is making sure you’re buying for cash flow and not appreciation is number one. Number two is about debt. So low-leveraged long-term debt; long term being twice as long as whatever your renovation period is going to be. And then the third one is making sure you have adequate cash reserves. Because if you follow that, you’re going to do really, really well when the market is doing really, really well. But when the market is not doing well, or if there’s some crazy crash, then at best, you continue to perform well. But worst-case scenario is that you’re not losing all of your money; you’re at least maintaining your money, or your cash flowing, but you don’t have to give away the asset. So that’s why I’m glad we’re going to talk about how to prepare for these types of events.

And then one other thing I quickly wanted to mention is that the Federal Reserve has a really interesting resource, it’s Federal Reserve Economic Data; I’m not sure if you’ve gone to that website or not, but they have a really cool interactive graph function where you can select different metrics, like homeownership or renter occupancy or whatever – they have hundreds of metrics – [unintelligible [00:08:00].17] interest rates, and then they’ll put it in a graph and the graph will go back, as far back as it was tracked. On the graph, it’ll have little grayed out areas for each of the recessions. So you can see how did median rents perform between recessions, during the recessions,  immediately after a recession, immediately leading up to a recession…  It can give you an idea of what to expect during a recession. You can see how it acted differently, depending on what recession it was.

And then, obviously, FRED — I think it was FRED; I can’t remember exactly who decides when the recession start, but I think it’s the Federal Reserve. So at least on that FRED website, either they or there’s a link to a really nice detailed article on how they decide when a recession has started. And then after a recession has started and it has ended, and maybe six months later — because they don’t know when recession has ended until later; it’s kind of like, they look back and say, “Okay, I think it ended here.” But  they’ll write really good articles explaining why they think the recession happened, what happened during the recession, and then why it ended, for all recessions. I don’t think going back until the 1800s, but definitely for the recent ones, for sure. So it is an interesting thing. Again, just google Federal Reserve Economic Data. The website is actually https://fred.stlouisfed.org/.

Travis Watts: That’s a great resource. I actually did not know about that. So I’m going to check that out after we’re done. But that’s really cool. Thanks for pointing that out.

So to your point of preparation – so there’s really two types of ways to prepare. We have personal preparation for a recession, and then we have financial preparation. And the fact is, most Americans, and I would say this is probably true globally, most human beings are great at the personal preparation and not so great at the financial preparation. Just kind of another reason why I wanted to write this blog post, to bring a little awareness to it.

So what I mean by that is, we back up to the Great Recession, right? 6 million people plus lost their homes, their jobs, their 401(k)’s were cut in half… But in terms of personal preparation, people seem to have a plan B or come up with that fairly quickly, right? Moving in with relatives or friends, doubling up, downsizing quickly, switching from homeownership to renting. That was a rather rapid movement that happened. And we’re always as human beings in survival mode, going to find the roof over our head and the food to put on the table – we’re going to find a way to do that. And that’s where most people’s attention seems to go in large part.

So when we think back to March 2020, this is where COVID-19 and Coronavirus really hit the financial markets. And so the first thing that we saw was the stock market plummets. I think the S&P was 30%, maybe more down by the end of March, nearly overnight. But what did people do during that time? People were rushing out to buy toilet paper, to buy canned food, to buy gasoline, to buy bottled water… That’s personal preparation. But what’s interesting about that is stocks went on sale 30%. Who rushed out to go buy stocks? Obviously a few, but definitely not the majority.

So I just found that really interesting that there’s just not enough education out there on the financial side of things, and I just found that to be really interesting. That’s the case almost every time in a recession too is, we’re all good on the personal, not so good on the financial. And any thoughts on that, Theo?

Theo Hicks: Yeah, it’s funny, first of all, how all those people ran out to get the toilet paper for the [unintelligible  [00:11:27] recession. I thought that was just a Coronavirus recession thing. So I guess that’s something —

Travis Watts: Well, they may not have been exactly toilet paper then. But it probably was paper towels and household items, I don’t know.

Theo Hicks: Yeah, I saw that and I was like, “Wow. Really?” I don’t know. But that’s interesting. I mean, the way I kind of think about this is that for the personal preparation, it’s really something that you can obviously over prepare; there’s a lot of TV shows about people about their bunkers and Doomsday stuff, making sure you have ample food. But on the personal side, at least it seems to me that once the recession hits, it’s kind of like, if you didn’t prepare, you can still survive, basically. As you mentioned, if you weren’t personally prepared, then you can go live with relatives, or instead of owning your house, you can rent, or there’s still going to be food at the grocery store…

Whereas from a financial perspective, it seems like – again, looking at it from the perspective of the Three Immutable Laws of Real Estate Investing – it really is preparing. It’s kind of like once the recession hits, from a real estate perspective, at least, correct me if I’m wrong… It’s like, well [unintelligible [00:12:30].07] going to happen from both a Three Immutable Laws of Real Estate Investing perspective, but also from maybe a mindset, or more of a — I don’t know, just how you approach things, right?

So as you mentioned, once the recession hits, having the Three Immutable Laws of Real Estate Investing in place is good, but then do you know what to do once the recession hits? Do you sell everything? Do you buy? Do you do nothing? Right? And so that’s something too that you also need to be prepared for prior to the recession hitting, so that once it actually happens — during the economic expansion, everything is sitting great, you think about, “Okay, once that recession hits, what exactly is my plan? What exactly am I going to do? Am I going to buy a bunch of properties at a massive discount? Where am I going to buy these properties from? Who am I going to go to to get these properties from?” Things like that.

And so I guess, long story short, from a personal preparation standpoint, preparing beforehand is great. But once it happens, there’s still things you can do after it actually hit. Whereas for the financial side, I think it’s kind of like the flip, where what you’ve done leading up to it is going to determine how you perform during it.

Travis Watts: 100%. What’s that saying,” Hope for the best and prepare for the worst”, more or less, is kind of the philosophy behind that. So you don’t want to be a pessimist and always call in for Doomsday, and everything’s going to be bad, and things fall apart non-stop. And a lot of gurus out there that do that make a lot of money off fear. But that’s not my approach to it. It’s just accepting what it is. “Hey, we’re in 2020 and we’re in a recession. In 2030, we might have another recession.”

So to your point, prepare ahead of time, think about — when I switched over to investing in multifamily in 2015, a large part of what gave me certainty to move forward with that asset class was case studies and looking back at previous recessions, and seeing how multifamily held up. And that data supporting my case really gave me a lot of confidence. So if nothing else, do that kind of stuff, if you’re unsure of how whatever it is you’re investing in is going to perform. If you’re all in stocks, just look at what stocks do during recessions. 2000-2008, even back to the 80s, everything else; Black Monday… And just be prepared if you’re going to be in stocks.

But to that point, by the way, I know we’ve talked about the F.I.R.E Movement quite a bit and I’m an advocate for the most part of that… And I listened to some podcasts and things like that, and it was really interesting in March to listen to people speaking out in the F.I.R.E Movement. These are folks primarily in index funds. And they’re all basically saying, “Hey, it’s easy to prepare on paper for the next recession, knowing it’s going to happen. But when it’s here and you watched your million-dollar portfolio just fall to 700 K,” it’s a different deal. It feels a lot more real. It’s really difficult to sit with that. But you got to stick the path, right? If you had been an index funds, you’re almost recovered as of today.

Theo Hicks: Exactly.

Travis Watts:  So that’s the whole lesson – don’t sell out at the bottom, no matter what you’re in. So to that point, statistically speaking, when a recession hits, the folks that tend to be hit the hardest are people with one source of income. And this was kind of a key point to my blog. So I thought about that, and I thought, as important as money is, in our system – I don’t mean the love of money, or collecting money, or getting rich… What I’m talking about is how money is required to live, to exchange for food and gas and living in shelter. So it is important. I don’t care what you say, it’s important. But I thought about that, “What if we had only one source of water, and that’s it?” And then for whatever reason, that source was shut off or was contaminated. Well, then what? We’re hosed, we’re screwed. This gets back to kind of that personal preparation, versus financial.

So we’ve learned and we know that is a possibility if we had one source of water. We have hundreds of sources of water, and rivers, and aqueducts, and rainfall and underground springs, imported bottled water, on and on and on, so that we’re diversified; we have more than one source of something that we need and rely on, right? So again, that was kind of a key component here. So why not relate that analogy or that example, to your financial portfolio?

If all you have is a W-2 job, or a 1099 job, or whatever; or just one investment, or whatever it is you live on, and that’s your only source, why not start building multiple income sources?  And by the way, I’m not just advocating for the passive income, which is something that we talk about a lot, I’m just saying different income sources; have a side business,  have a side hobby. Even if you fix and flip houses or you wholesale, that counts. If you have a primary job, and you’re doing that on the side, and you lose that job in the recession, well, hopefully you can switch over to your side hobbies and at least have some supplemental income rolling in.

So something to think about. And it’s just always shocking to me, the lack of financial diversification, so to speak. So many people with one income source. So thoughts on that, Theo.

Theo Hicks: [unintelligible [00:17:33].17] Remind me to ask you. But yeah, a lot of the people that I’ve talked to on the podcast, as well as some of the older episodes that Joe has done, the people who were investors pre-2007, it’s really kind of the same story every single time. It’s like, “I was doing this one thing, it was going great, I was a millionaire… And then, because I had all my eggs in one basket, and these eggs were all crushed by the recession, then I went back to zero and I had to start over again, and then here’s a lesson that I learned. Now, I’m making sure that I’m focusing on asset classes that are— I don’t want to say “recession-proof”, but can maintain during recessions.” So I couldn’t agree more.

And as you mentioned, it’s really just—again, from my perspective, from listening to people, it’s kind of just like making sure you’re in different asset classes that are affected differently by recessions and expansions; they are not all connected to the exact same thing.

Here’s an example. When you’re selecting a target market as an active investor, you want to take a look at job diversity and say, “Okay, what percentage of the population is in each of the industries?” and whatever the highest one is, you want to make sure that it’s at most 30% of the people are in the industry. Because if you’re in a place like Detroit back in mid-2000s, or maybe somewhere like Las Vegas, where it’s all hospitality, if something happens to that one industry, then everything in that market is going to be affected.

And so when you think of diversification – it’s market diversification, it’s asset class, it’s all these different thing, active versus passive, it’s all the different things, so that unless something completely catastrophic happens, not every single one of those businesses are going to collapse. And that’s what I thought about when you were talking about different sources of income. And I was talking to real estate investors – you’re in an industry where there’s an infinite number of paths you can take. And so make sure you’re just kind of selecting a few of them, and not just going all-in on to one forever, right? It’s good to start that way, but eventually might want to consider doing a little something different as well, just in case something were to happen to your main source of income.

Travis Watts: Lots of ways to diversify. What came to mind as you were just speaking… Great points. I’m listening to —Tony Robbins just came out with a new book a few weeks ago; it’s called The Path, and it’s about the path to financial freedom, basically. And I’m not far into this book; I’m like on chapter three, I think. But he’s sharing — I think it was one of his clients or one of his friends, and this guy had created a business, put everything in, sold it… It was like a $125 million sale, something to this point, right? Well, this guy gets a huge ego, a huge head on his shoulders, “I’m a guru and the world is my oyster“, so he takes all his profits and he puts it into this Las Vegas luxury condo development. It was like a couple different buildings, or something. And this was pre-2008.

And Tony is saying — he’s talking to him and he’s trying to talk him into a little bit of diversification, like we’re talking about. “That’s great that you’re doing that condo development; you might consider also having a little bit here, a little bit there,” just trying to help him as a friend, right? Not a financial advisor. And the guy’s like not having it. “Nope, no. This is the next big thing. You ought to buy one of these yourself, Tony, etc.” And then we know the rest, right? 2008 rolls around and Las Vegas was probably the toughest hit market out there in the United States… And the guy lost everything. He went from having more than 125 actually net worth at the time, at the pinnacle of 2008, to – I think it was like owing $50 million or something to banks, you know. he went below zero.

And Trump way back when he had the same experience, back when he was developing, and whatever it was, in the 80s. He went from mega-multimillionaire to owing millions and millions and in the hole. So that can happen. And to your point, that’s when you’re a one-trick pony.

I have an uncle, by the way, that used to flip homes, and every time he’d flip a house, he would take 100% of the profits, 100%, and he’d go into a bigger home, and a nicer home, and in a better neighborhood, right? And seriously, real story… 2008 – boom, lost it all. It’s just tough stuff.

So even if you’re going to be in real estate, primarily or exclusively, there’s still ways to diversify: mobile home parks, self-storage, multifamily, single-family, active, passive… To your point, things that you can do to be diversified. But you may still consider some stocks, bonds, mutual funds, other things on the side, or alternative assets or businesses. So with that, great points by the way.

The takeaways here in this episode are – we will have more recessions in our lifetime. Let’s just call it now every 10 years or so. Let’s try to be prepared, both personally, which is important obviously, for survival, and financially as well. So how do you do that? Diversify your income streams, again, actively or passively. Have different outlets in case one is taken away in the next recession that will happen.

If you listen to some people — I was listening to Robert Kiyosaki the other day speak on the podcast or something. He thinks we’re in 1928 today as far as right before the next great depression. That’s his new prediction. Now, notorious by the way, if you’re not familiar, for predicting these huge downfalls in the economy… Maybe he’s right, maybe he’s wrong, but pay attention, because whether we are or we’re not, we’re going to have more ups and downs and cycles moving forward.

So, again, 6 million people lost their homes, their jobs, their 401(k)’s got cut in half in the last recession. It hadn’t been that bad so far to a point with the Coronavirus recession, but you never know. Like the old saying that, “History doesn’t repeat itself, but it rhymes”, classic example right there. So that’s kind of the key takeaways.

And then again, stoicism – focus on what you can control… Your decisions, your behaviors, your preparation, your portfolio, your investment choices, what you decide to educate on,  who you decide to listen to… All these things are in your control. Can’t control the government, the Fed, the policy, the interest rates. So unfortunately, we have to just sort of let it happen and roll with the tide.

And interesting fact  we talked about – I downloaded this research study from the Dave Ramsey Foundation (or his companies) about millionaires, and the average millionaire has seven sources of income. Think about that. My nephew, who’s 19 years old – I helped him open up a brokerage account, I taught him about a real estate investment trust, high yield dividend stocks… He’s probably got four or five income sources at 19 years old, with relatively little money. But that’s not the point. It’s the concept, right? He’s going to hopefully grow that over his lifetime, and be in good shape for what’s to be expected in the future. So with that, that’s really all I got, and those are some of the takeaways from my blog.

Theo Hicks: Thank you so much, Travis. I did have one question for you. I think you can answer it really quickly, but [unintelligible [00:24:35].03] from what you do, or you think people should do, or what you’ve heard other people do, but do you have savings account? Like, completely liquid, that has a certain number of months of this cash is sitting in there? Like, is that something you do or not? I’m just curious.

Travis Watts:  Yeah, it is. And I’m happy to share that. So you’ll hear different things, like “You should have 6 months of living expenses in your bank account”, or maybe it’s 12, or maybe it’s 3. I don’t know. You hear all kinds of different things. Here’s the thing, though – I have a very diversified portfolio of investments; numerous passive income streams. And my personal perspective on that is the more passive income that you have predictably coming in in a very diversified way, the less you may need in reserves. So yeah, I still have that six to 12 months living expenses, it’s kind of an old school thing. I still loosely follow that. But at the same time, I recognize that every month, I’ve got a lot of different income sources rolling in as well. So even if I had $0 in the bank, hopefully, some of those investments, if all hell broke loose, some would still pay out and I’d have enough to pay my living expenses. I keep a very modest overhead. I recommend people do that. I am a fan of trying to reduce debt and things like that first, before going heavy into investing. But anyway, to answer your question, yes. Yes, I do.

Theo Hicks:  Perfect. And then last thing before we wrap up – because you were talking about the Tony Robbins book and the example of someone making that money and then investing it in Vegas and the crash happening – there was a really good documentary that [unintelligible [00:26:05].22] in my mind from a long time ago. I’d never heard it before and I watched it. It’s kind of like weird at first, but it’s actually really good. It’s called Queen of Versailles or something like that. Have you heard of that?

Travis Watts:  I haven’t, no.

Theo Hicks:  Basically, it’s about this couple who are trying to essentially create this billion-dollar house, or something crazy like that, based off of the house of The Queen  in Versailles. And the husband is in real estate and I think they do timeshares, or something. So they documented it and you’re supposed to be following them constructing this house, but in the middle of it, the crash happens. And so instead, it turns into this complete nightmare scenario where the husband is trying to scramble to figure out what to do with his real estate business, because it’s his one source of income, and he’d been a billionaire on it, and now it’s completely collapsing and he owes these banks all this money, all this stuff. And then at the end it’s kind of crazy, too… So I recommend if you want to see firsthand documentary person; it’s pretty short, I think an hour and 45 minutes. I don’t think I’m even pronouncing it right, but is Queen of Versailles or something like that?

Travis Watts: Yeah, I’ll check it out.

Theo Hicks: Check it out.

Travis Watts: Thanks for the recommendation. I’m into that stuff .

Theo Hicks: It’s definitely a good watch, and [unintelligible [00:27:06].24] the whole time, like, “Oh, no…” So I’d definitely check that out if you want to see what we’re talking about in a documentary. So anyways, thanks, Travis, for going over this blog posts today. Again, make sure you check out the blog post. It’s called 47 Recessions and Counting – Are You Prepared? That should be in Travis’ BiggerPockets profile, and I’d imagine it be on our blog as well by the time this airs. So Travis, again, thanks for joining me today.

Best Ever listeners, as always, thank you for listening. Have a best ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

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JF2298: How a Passive Investor Vets an Apartment Deal Part 3| Vetting The Investment Summary|Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis share their expertise on how to vet the real estate deal by reading the investment summary. They discuss the most common red flags and things to look out for before agreeing to a new deal.

This episode is part 3 of the series “How a Passive Investor Vets an Apartment Deal”, which focuses on the most commonly asked questions about real estate deals. The other parts will cover the topics of vetting the market and the team.

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners, and welcome back to another edition of the actively passive investing show. I’m your host, Theo Hicks, as well as Travis Watts. Travis, how are you doing today?

Travis Watts: Doing great, Theo. Thrilled to be here. As always.

Theo Hicks: Yup. Thanks for joining us. And we’re going to wrap up a three-part series on how to vet a syndication deal. And we’ve done part one and part two on how to vet the actual team, and then how to vet the market in part two, and in part three, we’re going to talk about how to vet an actual deal as it comes in.

I know that the overall series is called How to Vet a Syndication Deal, but obviously, the deal is just one aspect of the vetting process. So we’ve got 10 different things we want to hit on today… Travis, do you have anything to say, or do we just jump right into it?

Travis Watts: Just to point out, again, if anyone listening hasn’t heard episode one and two, tune in to those; there’ll be a little bit of overlap. But this one’s really exciting, because everyone gets excited about the deal itself. And also a lot of investors, myself included, make a lot of mistakes, in my opinion (newer investors, especially) looking too intensely at the deal first, and not enough on the team and the market. So definitely rewatch those if you haven’t, and excited to get started in the deal.

Theo Hicks: Perfect. So point one is the investment summary, and what to look at in any investment summary. Before I dive into this – I just spoke with someone earlier today, and he made a really good point that I think is very relevant to what we’re talking about today. He was saying how he has some passive investors who he’s just shocked by, because maybe he talked to them on the phone once, and he knows that they haven’t necessarily done any research on him, the company, his background… And they will invest hundreds of thousands of dollars with him. And he’s just kind of surprised that somebody would be willing to do that without doing some level of due diligence beforehand. And he’s not talking about why he thinks that is the case, but… I thought that was interesting, because I was like, “Oh, we’re actually about to talk today about how to do due diligence on a deal.” So I know he talked about it in the previous episodes that you don’t want to go too in-depth, and you’re not going to go to the level that the actual syndicator is going, but you also don’t want to just do nothing, and then look at the email, see the returns, and then just invest, right? There’s still extra research you want to do, and that starts before the deal by researching the team, and then what markets they’re investing in. And once they have a deal, it doesn’t stop there; you’re still going to do research on that specific deal. And most of the info you’re going to get is going to come from the investment summary document that they sent you, which is essentially just a presentation that the sponsor puts together that gives you all the info on the deal. And so usually, they’re fairly long… I’ve got one in front of me right now that’s 60 pages long.

So, Travis, you can correct me, but I do recommend reading through the whole document before you’re investing in the deal. The key components in the investment summary… And again, I’m not going to talk about all of this; I’ve actually done syndication school episodes where I go into a ton of detail on the investment summary. [unintelligible [00:06:24].07] a new book coming out as well on passive investing that goes into even more detail on the investment summary. But what you want to think about here is you want to not just look at their returns, but you want to look at the information, and the assumptions, and the data that they are using to come to the conclusion of these terms, right? So you’re not going to see their full underwriting model, but they should tell you what assumptions they are making in order to come to these returns. How much are they increasing rent by? And then what are the rent comps that that is based off of? And then are those actually accurate rental comps? Or are they something that’s way better than what the deal is actually going to be, and so the rent numbers are inflated? What income and expense increases are they using every single year? Are they assuming that the rents are going to increase by 10% every year because in the past five years they’ve increased by 10%? Or are they being conservative and saying, “Oh, it’s going to increase by 2% to 3%”? Those are examples of things that you want to look at.

So you’ll read it through and they should have outlined for you in the executive summaries and various summaries what assumptions they’re making, and then if you scroll down to their financial analysis section, they should have their proforma and then they should have underneath that exactly what assumptions they made for each of the line items. For example, for concessions – are they just basing them off of the T12, or are they changing them based off of something else? Are they making their expenses based off of the T12? Are they basing them off of their property management company? If something is different than the T12, why did they make that change? Those are kind of the things that you want to think about.

So there’s a lot, but the whole idea here is that you want to identify their assumptions that they’re making, and then making sure that those assumptions aren’t something that are just completely crazy and aggressive, as opposed to being conservative. So the more times you see the word “conservative” in the investment summary, the better.

Travis Watts: I couldn’t agree more. The things that I would add to that — first of all, I love this, because you’re a lot more on the active side, and speaking to a lot of active syndicators themselves. I’m more on the passive side and speaking to passive investors, so it’s great to get the two perspectives.

This is what I would say to anybody who’s active or passive to the theme of our show here – the purpose of the investment summary is to essentially paint the picture of your business plan, what you intend to do, what your assumptions are, to your point, and to answer as many questions as you possibly can, all within a summary.

To that point, I’ve got to say, I’ve seen some bad investment summaries. And what I mean is, I want to go through that, kind of some red flags and what not to do… So you were just mentioning, Theo, that you’ve got one in front of you that’s 60 pages long. That’s a great length; that tells me they’ve got enough information in that summary to pretty much answer most questions that people are going to have. What I’ve seen commonly with new operators is a six-page overview, or a 10-page overview. And what happens is, by the time I’m done looking at the last page, if I even get that far before I fold on the deal, I’m saying “Is there a preferred return?” or, to your point, the assumptions’ there; what about the average income in the area? What about the schools in the area? I have so many questions that you have to hop on a call now, and then you got to go book that and set that up. It’s just inconvenient. And you should have a call obviously with the operator to ask questions or to clarify points, but as an active syndicator yourself or GP, you want to make sure you’re trying to address any concerns and any questions that may pop up… Maybe even put an FAQ at the end of it or something, to where people theoretically should not really have any questions by the end of it.

So the other red flags I look for is either on page one or somewhere near the end, there should be always legal disclaimers. And that’s important. It’s a very litigious society; you want to know that this group is working with adequate attorneys and legal counsel, and that they’re doing things the right way; they’re not just making a PowerPoint and then trying to raise capital. That’s a bad idea.

Other things I look for are multiple points of contact; that’s part of my own criteria. I don’t like to read through a whole summary at the end, where it’s like, “Contact John Smith” and he’s the only point of contact. I understand it might be an investor relations rep, or maybe it’s just a solo GP… But what happens if there is only one point of contact in a deal, and that point of contact is not in contact, or they’re on vacation for weeks at a time? That can be very concerning to investors. So I like to store a few numbers in my phone, if I can’t get a hold of one, I’ll try the other. Just something basic to look at.

The last thing I’ll say is just professionalism goes a long way. This is something I get asked by newer GPs that are just getting started, I get asked a lot about what LPs are looking for, and that kind of stuff. I always start with professionalism. Your website, your company prospectus, these overviews that we’re talking about, make them look professional; if there are typos all over the place, and you’re missing stuff, and it’s six pages long, and it looks like your nephew made it on PowerPoint, I’m usually out like that. If I see something that looks that bad, no one’s taking the time or effort to even put any emphasis on this. I don’t want to partner with somebody like that.

So just something to keep in mind, whether you’re an LP looking at it, you’re thinking, “Gosh, they misspelled their company name.” Or you’re trying to raise capital and wondering why you’re not being very effective. Think about that. So that’s all I have on that first topic.

Theo Hicks: Yeah, I’ll just very quickly add to that. A lot of things Travis talked about are things that indicate how trustworthy this individual is, how on top of their game this individual is. And as you remember, we talked about when vetting the team, one of the main reasons why people choose to invest with someone is going to be because of trust. You look at 20 syndication deals, and the return numbers are the exact same; what’s the differentiating factor? Do I trust the team? Do I trust the person?

And then one other thing I forgot to mention was case studies. Cases are also really good to see in the investment summary, because it proves that they’ve done this before, and you can see how their projections compared to their actual numbers.

So moving on to the next point we want to talk about… So when you’re deciding to invest with a syndication deal, you want to understand what the business plan actually is, what they’re going to do. And the reason why you want to know this is because, number one, the types of returns and the risks associated with each of these is going to be different. But also, the assumptions that they make should also be a little bit different for each of these… Which we’ll talk about a little bit more later. But really, the three main categories are going to be the value add, like a new development, or a fully distressed asset class; or also the turnkey. So I guess that’s four. So depending on which one you do, the types of returns can be a little different.

Let’s just take the opposite end of the spectrum – if you’re investing with a syndicator that does turnkey deals, you’re likely not going to get a lot of upside, but you’re going to see a steady cash flow from day one that doesn’t really change. So there’s a little bit less risk in there as well, since they have less assumptions and less moving parts that deal. But also, you’re not going to make as much money. And so is that what you want? Do you want to just have a steady return? Or do you want to have a chance of doubling your equity investment? Well, if you want to double your equity investment, and [00:13:48].01] turnkey, well, it’s probably not going to happen. Whereas if they have a development deal, or a distressed deal, or a value-add deal, then yeah, that’s definitely possible. But there are also many more assumptions that go into it. It’s a little bit riskier, so you want to make sure that you’re looking at those assumptions, like what Travis is going to be talking about in a second – how much money they’re investing into each of the units? What’s the current condition of the property? Is the market conducive for that type of strategy?

So really, the twofold part is number one, is this the type of business plan I want to invest in based off of my desired returns and my risk comfort level? And then number two – okay, if that’s the business plan they’re doing, then are they setting themselves up for success with his deal in regards to the team, in regards to any assumptions that they’re making?

Travis Watts: 100%, yeah. To wrap that up in a nutshell, to me, the thing I extract from what you were just saying, is knowing your risk tolerance. So generally speaking, higher risk, higher return, right? Everybody kind of has heard that in one form or another. So what I mean is new development has a lot of risks that come with it, right? You’ve got to get permits and licensing, and you’ve got to rely on contractors, and the cost of materials, and it takes years to complete sometimes, and you have 0% occupancy for a long time… There’s a lot that can go sideways, be delayed, go wrong. So that’s risky; to me anyway, that’s how I see it.

So if I’m going to invest in a new development deal, I need to understand that I should be expecting potentially a higher return, versus buying something, to your point, turnkey, already stabilized, already occupied, already has a long track record of being rented – there’s less risk in that, because you’re essentially making money on day one. As soon as you close, there’s money rolling in the door. So you’re probably going to have a lower return because of that.

So it’s understanding where you stand in this balance, understanding what those different types are and what you’re comfortable with. So I tend to focus, for anybody who cares, on the value-add stuff, because I like the idea that one, they’re usually stabilized and occupied anyway, and there’s potentially some upside to the deal as we improve it and bring it up to market rent. So I kind of like that combination of the two; that to me lowers my risk.

So not to be too long-winded on that… What I really want to talk about though is how do you know that a deal is conservative? That’s a very common question, because everyone likes to throw out the word conservative, and who doesn’t want to hear that? But what does that mean? And what do you look for?

For example, an average value add deal – it might cost 5,000 to 10,000 per unit in a turn cost, give or take, so you want to be looking at are they within that normal range? Or are they saying they’re going to put 20,000 into a unit, or 2,000 into a unit, and perhaps they don’t have enough budget allocated to do so, and things pop up unexpectedly… So making sure they have an adequate cap-ex budget, capital expenditures.

Also, something I look at more than ever in 2020 with COVID is breakeven occupancy. That’s important, and that, for simple numbers, we’ve talked about it before on the show. But if you have a 100 unit apartment building, and a 70%, breakeven occupancy, you can have 30 tenants not renting or not paying at any given time, and you’re still able to pay your operating expenses. You may have a 0% return, but you’re not losing money. So that’s important to think about and to look at as you think about recessions, and COVID, and things like that, all the government stuff going on right now.

The other thing I look at is debt financing. So let’s say it’s a value add play, and we’re expecting to buy it, renovate it, and sell it within five years. That’s a pretty typical structure in this space. I would like to see a longer debt term. So like 10-year debt, for example, that’s either fixed or capped – you can purchase an interest rate cap – longer than the business plan. Because the last thing you want to do is have your debt come due right as you intend to sell it, and then you can’t sell it; or we’re in a big recession, and now there’s no equity in the deal, so you’re looking at a potential loss, or you need to get a supplemental loan and you can’t, or all kinds of problems can pop up. If you’re using bridge loans and short term debt, there’s a time in place for all of this, but generally speaking, I like longer debt terms than the business plan.

The other thing I look at is the entry versus exit cap rate. For buying at a five cap today, I like to see at least let’s say a five and a half cap, maybe even greater in five years. 10 basis points per year is kind of my general rule of thumb. I’d love to see more of a gap, but then you’re looking at potentially lower returns and projections. But I have seen it. There was a deal I was looking at a couple of weeks ago, buying at a five and exiting at a seven cap. That’s pretty extreme on the underwriting perspective, but it’s also extremely conservative as well.

And for those that aren’t familiar, I’ll tell you this real quick. Cap rates, just essentially, high-level stuff here – if you paid cash for a property, that’s approximately like your cash flow return, using no leverage and no debt. So five caps like a 5% annualized cash flow if you paid cash.

So what I mean by a higher cap is a projection, you don’t ever want that to actually happen. You don’t want a seven cap when you sell and you buy at a five; that means that the value is going down. But it means that they’re projecting that there might be a softening in the market. And even if that were to happen, they still project they can return these types of numbers to the investors, and that’s kind of what you’re trying to balance out.

The last thing I’ll say, and you already touched on it Theo, is rent bumps; being realistic with it. Here we are in 2020 with COVID, and maybe we’re gonna head into a recession… Who knows, right? I don’t have a crystal ball. But if you’re looking at a deal and it’s “We’re going to raise rents 10% a year for seven years straight”, you need to find out why that is, and if that’s even realistic or going to happen. What assumptions are they going on, to your point? Right now what I see a lot is almost a 0% rent growth in year number one, just because of COVID. Nobody knows, so it’s better to again, under-promise over-deliver. So that’s all I got on that.

Theo Hicks: Those are all really good points. I can’t think of anything to add when it comes to a deal being conservative. I think you hit on all the most important points, except for maybe the reserves, because they’re accounting for reserves upfront. Right now it’s a little bit different, because you’re going to have to have six to up to 18 months of principal and interest in reserves between the loans because of COVID. But even if they don’t, making sure they have some sort of upfront operating account fund to cover the unexpected.

The next thing we have on this list is the different classes of property. This kind of ties back into the business plan. So it’s kind of a quick thing you can do, but if the property is a complete disaster, lots of deferred maintenance, and they aren’t investing any money into renovations – if it’s a deed property, but it’s presented as a turnkey deal, probably not a good sign. Vice versa, if it’s that really A-class luxury property, but they claim they’re going to force appreciation by raising rents – probably not going to happen.

So it’s understanding the property type, and the business plan, and making sure they match up. It’s most likely not going to be an issue, but it’s still something that you want to confirm. And you can get a good understanding of this by just reading the executive summary, because they usually say there’s a lot of deferred maintenance, it was owned by an institutional investor… What’s at the current state of the property? Where are we at right now? And then what’s the plan to take the property to where we want it to be? And then do they have the money to get to that point? I think the next point that you’re going to talk about, which is the sensitivity analysis is something that’s even more important than understanding the class of property.

Travis Watts: Exactly. And before I jump into that, real quick, just to piggyback off what you said there about the A-class scenario… It’s funny, I had to laugh, because again, just about — maybe a month ago, I was looking at a deal that was sent to me, and it was totally an A-class property built in 2015, 2016, something like that. And their whole business model was forced appreciation; it’s like, “What do you think you’re going to do to that property to make it so great and bump the rents so much?” And it just isn’t something I would believe in. Again, back to being conservative. Their projections were like “Double your money in five years on an A-class property”. I don’t think so. But hey, everyone’s got an opinion, right?

Theo Hicks: Well, one thing I forgot to say… So what do you mean by A class, to your point there? So it’s based off of when the property was built, but it’s also based off of economic occupancy too, as well as the condition of the property, and the market too, technically. So a D class property could technically be fully occupied. But it could be in a really bad condition in a really bad market, and that’s a D class. Whereas for an A-class property, it’s usually a new construction deal, a luxury, fully rented, rents are kind of maxed out. And then obviously, B and C are something that kind of falls in between. So those are the three different factors that determine the class and property, high level.

Travis Watts: Yeah. Again, property classes are subjective, too. So that’s something you’ve got to watch for if it’s on a proforma or on an overview. Like you’re talking about, you might see them say, “Hey, this is a B plus property.” It’s a C minus. So who really knows the answer? Well, nobody, technically. But to your point, there are things you can look at – what age is it, what the occupancy… And in general, A-class is a new development, new construction, luxury, highest rents, great areas, all that good stuff, right? It’s the best of the best, the cream of the crop. B usually still has some nice amenities, a gym, a pool, a barbecue area, a dog park, these kinds of things, but it’s an older product; maybe it was built in the 80s, or the 90s, or the early 2000s. C, start dropping off all the perks right? Maybe it doesn’t have a pool, maybe it doesn’t have a gym; maybe the gym is super outdated or super small, and maybe the ceilings are real short, maybe it was built in the 50s, 60s, 70s, that kind of stuff. And D, to your point is usually no amenities or very little, and in a bad area, so to speak.

So again, higher risk, higher return. It’s nothing against a D property. If you’ve got a great team that specializes in that niche, they might be able to turn that thing around and make a lot of money. So just know where you stand on the risk scale. And again, for anyone who cares, I tend to focus on the B asset class, for the most part. I have done some Cs. Okay, to your point, stress test, and sensitivity analysis… Every group should have this data; they might call it something different. What this is, is you’re looking at their underwriting and their assumptions on the deal, and they’re stressing it, in the sense of, “Well, hey, what if interest rates spike up and they double because the Fed makes a big move? What if occupancy drops really low? What’s the breakeven occupancy, like we talked about earlier? What if cap rates shift up or down?” So what this is, is usually just a PDF or whatever, that they can send you; sometimes it’s in the overview itself, other times it’s not. I would always ask for it, any deal you’re going to invest in, just to know, more or less, the worst-case scenarios. How would your overall return, either cash flow or IRR, internal rate of return, be affected if, and then it’s like a, b, c, d, e, f, g, right? It’s all these different situations and scenarios. What if people don’t pay? What if things get worse in the economy? This is just showing you how conservative the deal is. It’s probably your best set of data to understand how conservative a deal is. So I would definitely ask for that.

So again, it’s called either a stress test or a sensitivity analysis, or something similar. If you say those terms to a GP as an LP, they’ll know what you’re talking about, and they should be able to show you something to that effect. So that’s all I’ve got on that. That’s pretty important.

Theo Hicks: Very important that you mentioned. A lot of deals I’ve been looking at lately, they’ve been including it in their investment summary a lot more lately, I think because it COVID.

Travis Watts: I agree, I’ve seen that too.

Theo Hicks: So the next thing we want to talk about – we’ve kind of already hit on this, but the operational, the interior or the exterior, and the amenities upgrades. So when you’re dealing with a value-add, or below, so the value-add or the opportunistic, distressed type of deal, and the business plan is to force appreciation, then you’re going to want to have an idea of what they’re doing to force appreciation, and then what the numbers look like in regards to that. So the different ways you can force appreciation are going to be to make physical improvements to the property, or to make operational improvements to the property. So operational improvements are things that you aren’t necessarily adding anything to the property, like physically… Technically, you might be adding like a new property management company or something, but you’re not adding anything to the property, but you’re making some sort of change to the way that property is managed or operated in order to either increase revenue or decrease the expenses. For example, it would be like billing back utilities to the residents, or maybe one of the expenses is abnormally high, like maintenance, because there’s a lot of deferred maintenance; that’s addressed upfront, and so those expenses are going down.

And then for the other upgrades – the interior, the exterior, and amenity upgrades, those are things that are actually physically done to the property. So interior would be upgrading the unit’s exterior, would be improving the outside of the property, like new roofs, parking lots, parking painting, which might not necessarily be able to calculate the exact ROI, “I put a new roof and they we’re going to raise rents by five bucks.” So that one is more on the deferred maintenance side. You’re going to see that the further down you get with opportunistic deals, and sometimes for value-add deals, it might be focusing on some things, but ideally not that many.

And then the amenities upgrades – those are where you take an existing fitness center or an existing clubhouse, and you upgrade it, make it nicer, or you add it. So for these, they should have a section in their investment summary that says what interior upgrades they plan on doing, what exteriors upgrades they plan on doing, and they’ll have a cost for that as well.

The important thing here that I want to stress is that essentially how syndicators are determining what their renovated rents are going to be is based off of these improvements they’re making to the property. So they say “Hey, right now we’re at this condition, and we’re demanding X in rent. The plan is to go in there and do this to the unit, do this to the exteriors, do this to the amenities, and then we’re going to get higher rents.” But the evidence for those higher rents is going to be other properties in the market that have the same level of upgrades.

So when you’re looking at those rent numbers, they should have a section that has the rent comp analysis – you want to make sure the properties are actually rent comps; you want to make sure that they’re not maybe putting in fake granite countertops and black appliances, and their rent comps are granite countertops and stainless steel appliances, because that’s going to demand a higher rent. So that’s one of the main things to look at.

And then secondarily would be – and I kind of already hit on this – making sure that what they’re doing from the interior and exterior perspective matches the business plan. So Travis gave the example of a turnkey, where they’re somehow going to force appreciation. So I’d say “Okay, well, what amenity upgrades are they doing?” And then looking at the rent comp and seeing if that actually matches up. If it’s a value add deal, they probably shouldn’t be spending half their budget on deferred maintenance. If it’s an opportunistic deal, then yeah, they’re going to be spending a little bit more money on these things. But then at the same time, you want to make sure that they’re not using rent comps that are in an A-class area, when their property is going to be a B or C class.

Travis Watts: Those are great thoughts. And again, a story came to mind that I want to share with everybody, because this is a really simple, practical takeaway that everybody can do. So if you’re an LP, you’re looking at a deal, you read through the business plan, you understand what they’re saying… Okay, cool. What I did just like two weeks ago, I went to apartments.com – I use that all the time – and I looked at all the comps in the area. And it’s a great site because you can just put in a ZIP code, you pull up every single apartment complex in the area, you look at all their different rents, you look at all their different amenities, all the photos, and you can now stack up and decide for yourself if this seems realistic.

And what happened with this particular deal that I was looking at – what I found out, what I discovered is their projections, what they said they were trying to achieve in rent, if they ended up achieving it, would be the highest rents in the entire market within like a 50-mile radius. I don’t like that. I don’t want to be the most expensive place out there. What I like to see more often is they’re buying a property, the rents are 300 below market today, and they’re trying to raise them 200. So they’re not trying to be the most expensive, they’re not trying to go overboard with it; under-promise, over-deliver.

And one last thing to recap everything that you’d said, the name of the game here is increase your net operating income; the primary valuation of multi-family is based off net operating income. So to your point, what Theo is talking about is you can do that two ways – you can cut expenses, so the inefficiencies on the property that currently exist, and/or you can raise the rents and the revenue, find new ways to bring in revenue outside of just traditional rents, too – premium parking, covered carports, self-storage on site, whatever it is. So at the end of the day, from a high level, that’s all we’re trying to do in the value-add space.

So what I want to touch on, which we’ve already kind of touched on, but I want to go into a little more detail, is debt financing. What I talked about earlier was having a 10-year term on a five-year business plan, that kind of stuff. The other thing is, a lot of people assume just because we’re in the environment that we’re in, the interest rates are really low, so that’s just how it is; everybody has a low interest rate. But that’s not the case. I just looked at a deal a couple of days ago. These guys had a 4.89% interest rate; I looked at another deal, very comparable, 2.89%. That’s a big variance. You need to understand why that is, who they’re using as a lender, is that short term debt, is that a bridge loan? It’s important to recognize this stuff. So right now you should be getting really great rates around the 3% range, give or take, in the environment that we’re in. So if you see something almost 5%, you need to ask yourself why that is and what type of financing they’re using.

And the last thing is a fixed rate or having a cap. I touched on this lightly before. A fixed rate would just obviously mean if you’re locking in a rate at 3%, it’s going to be 3% throughout the entire hold period of the project; it’s not going to move. That’s important, because if it does fluctuate up and down, now you need to be going back to that sensitivity analysis and stress test and figure out what that means for your overall investment.

What a lot of groups will do though is it’s like an insurance policy – they buy an interest rate cap. So if interest rates are at 3%, right now, they might buy a four and a half percent cap. So that’s the max that it’s going to go up. So you just need to know what the cap is, if they even have a cap, those kinds of things. So just questions to ask the sponsors that may or may not be in the overview, but that’s important data to know. So that’s all I’ve got on that one.

Theo Hicks: And then one other thing to add would be the refinance or supplemental loan – we always want to know if they expect to do that, and then if that’s included in the returns. It shouldn’t affect the overall annualized cash on cash that you’re going to get it earlier or at the sale… But it’s just good to know. If you look at the return, it says you’re going to get a 50% return in year two, and you go in there with the expectation that something happens and they don’t do the refinance, then you might be a little disappointed. So I think a good practice would be to not model that in and assume you’re not going to refinance. They mention this in the investment summary, “Hey, we might do refinance. We have the opportunity to do refinance. We’re not putting it in the returns.” So it’s just kind of icing on the cake there.

Travis Watts: Yup, couldn’t agree more. Sometimes that can be a form of aggressive underwriting, to say “Oh, our average cash flow projection is going to be 20%.” You’re thinking “What the heck?” Well, they’re factoring in an immediate refinance, and they’re averaging a poor cash flow with a huge, high number. But to your point, it may not even happen, and then what? You’re left with 6% cashflow. That’s not what you signed up for, so to speak. Alright, that’s all I got.

Theo Hicks: The last thing I wanted to talk about would be looking at the actual proforma. So what the proforma is – it’s going to be a line item breakdown of all of the income line items, so gross potential rents, and loss of leases, and then some of the losses, like concessions and bad debt, and vacancy, and the other income. And then below that, it’ll have all the operating expenses. So maintenance and repairs, contract services, payroll, utilities, things like that. So that’s what’s on the far column. And then next to that it should have how the current operator is performing. So they might just have a T12, or they might just have a T3. So a T12 would be the total for the previous 12 months. A T3 would be the total of the previous three months, annualized out for 12 months. And so they’ll take the last three months and basically multiplied by four.

And then next to that they should have what they expect to do each of the years. So year one, year two, year three, dot, dot, dot, until the last year they plan on selling. Now, there’s a lot of information here… So the main thing to look at is to compare the T12 and the T3 numbers to what they say they’re going to do. If you see a massive change, and there isn’t a note anywhere on why they did that, you’re going to want to understand what’s going on there. So if for example the current maintenance and repairs are $150,000 per year, and then the year one maintenance and repairs is $50,000 per year, that’s a pretty massive decrease. And if there’s not a note and explanation as to why that’s happening, well, that’s a red flag; that’s something you’re going to want to know. So kind of the same thing applies to all the different line items; just take a look at them really quickly and say, “Okay, gross potential income. How does that compare to how they did over the past 12 months? Okay. Vacancy, the same thing. Oka. Concessions, same thing.” And then now, what’s interesting is that if you’re looking at a T12, right now, it’s including all of 2020, whereas the first three months were normal operations, and then the next nine months were COVID. So if you’re looking at a deal, you want to know what that T12 is over, right? If it’s 2019 numbers, then that’s completely different than how the property is currently operating. So in that case, the T3 might be a little bit more accurate than the T12.

A T3 is going to give an indication of where the deal is at more recently. Now, the T3 could also be potentially misleading, because think about it from the seller’s perspective, right? Okay, I’m selling my deal; the higher the net operating income, which is the income minus expenses, the more money I can get. So I might do some things in order to inflate the value of the property. So the T3 might be way stronger than the T12. So that’s something that the active investors are looking at. But overall, just compare how they say the property is going to operate, and if there are any differences or major differences, there should be an explanation for that.

Travis Watts: Yup, couldn’t agree more. I know we’re going a little long on time for our typical show time, but I did want to say this last, because this is something really nobody’s talking about, that I think is extremely important, that I want to talk about… Which is the exit strategy of the type of asset that you’re buying. So I like to invest in units of, let’s say 200 to 600-unit range… The reason being, you have a lot of exit strategy potential. So you might sell to an institutional player, like a pension fund, or a REIT, or mutual fund, or something like this. You might sell to another syndication group; you might sell to an individual investor, or a family office, just a very wealthy individual or family. So you have a lot of exit strategies.

Versus if I own an eight-plex, well no institutional capital is interested in my project, no syndication group is interested in my project. So really, I’m only selling to other individual investors, therefore my buying pool is very small. So that’s important to recognize, unit count, when you’re considering this stuff. Most individual investors are buying 100 units or less, usually, much less; I’d probably say 50 or less. Syndication groups are going to be 75 units to whatever, I don’t know, 400 units; I’m just using simple numbers. Institutional capital might be 200 plus, that kind of stuff. So it’s important to understand, because even though you’re buying a good deal, what if you can’t offload it? What if you intend to sell it at a certain price, but there are just no buyers that are interested at that time? So you want to maximize your chances to achieve the business plan returns.

Now, the reason you’re not going to find that stuff in an overview or a prospectus is because you don’t want to limit your market, you can’t guess what the future holds, you don’t know who’s going to buy the property, so it’s kind of a moot point to list in there these kinds of things, not knowing who’s going to actually make the purchase. But it is important as a passive investor to recognize that, “Hey, this asset may be very appealing to institutional players out there…” Many of which, by the way, for those that may not know, a lot of their business models are turnkey, to your point earlier; they’re looking for things that are either new construction, newly built or newly renovated, even though they’re pre-existing and older units. But they don’t have deferred maintenance, they’re high in occupancy, the rents are up to the market level… They just want to sit on it. It’s a cash flow play, they’re chasing yield, right? They’re not in the business of value-add; they don’t want to get in there with construction crews and turn things around. They just want to buy something for the yield, because you’re not finding that through CDs, and money market, and bonds, and treasuries. Everybody’s chasing yield. So that’s a whole different place. Sometimes they’re even paying cash for these properties, just to get the cap rate yield. 5%, believe it or not, in today’s world is pretty lucrative to a lot of institutional players that can’t find that anywhere else.

So it’s something to think about as part of your own personal criteria, what types of deals that you invest in. That’s why I chose that unit range.

Theo Hicks: That’s a really good point, and I guess one last thing [unintelligible [00:39:45].20] but one last thing that makes a deal more attractive, especially now because interest rates are so low – so if the debt is assumable. So what assumable means is that at the sale a buyer, assuming they qualify, can assume the existing debt. So deals right now are probably not; many people probably aren’t assuming those loans. But as Travis mentioned, interest rates are historically low right now. And if, say, you’re planning to sell five years from now, and you’ve got a 10-year debt or 12-year debt at a 2.75% interest rate, and interest rates happen to go up to like 5% or 6%, and you don’t have an assumable loan, then you’re not going to be able to get as much money for that deal, or you might not be able to sell it at all. Because, again, since the debt percentage is that much higher, the people buying might not be able to get the cash flow they need to justify the purchase price.

Whereas if you can sell them the deal at that 2.75% interest rate, you’ll attract a lot more attention, [unintelligible [00:40:41].07] more money, or increase the chances of selling the actual deal. So it’s definitely not a deal-breaker, but it’s just that much more beneficial to have assumable debt, especially right now, because of how low the interest rates are.

Travis Watts: That’s a great point. It’s the same concept as buying the interest rate capped; in case interest rates go up, you’re locked in at a certain point. It’s the reverse of that – you’re locking in a low interest rate for someone else to assume. So it’s a great point, and thanks for mentioning that.

Theo Hicks: Awesome. This was the world’s longest actively passive investing show ever. But I really enjoyed it, and I think we got a lot of solid info out. So Travis, thanks for sticking with me throughout this episode. Best Ever listeners, also thank you for sticking with us. Let us know if you like this length, I’d be curious. Because it’s probably double what we usually do. But I know some people like longer episodes, where we go into more detail. So let me know at theo@joefairless.com if you enjoyed the length; or if you’re mad at us, email me too and let me know.

So Travis, thanks again for joining me today, I really appreciate it. Best Ever listeners, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

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This website, including the podcasts and other content herein, are made available by Joesta PF LLC solely for informational purposes. The information, statements, comments, views and opinions expressed in this website do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. Neither Joe Fairless nor Joesta PF LLC are providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice in or by virtue of this website. The information, statements, comments, views and opinions provided in this website are general in nature, and such information, statements, comments, views and opinions are not intended to be and should not be construed as the provision of investment advice by Joe Fairless or Joesta PF LLC to that listener or generally, and do not result in any listener being considered a client or customer of Joe Fairless or Joesta PF LLC.

The information, statements, comments, views, and opinions expressed or provided in this website (including by speakers who are not officers, employees, or agents of Joe Fairless or Joesta PF LLC) are not necessarily those of Joe Fairless or Joesta PF LLC, and may not be current. Neither Joe Fairless nor Joesta PF LLC make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this website, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Neither Joe Fairless nor Joesta PF LLC undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views or opinions set forth in this podcast.

No part of this podcast may, without Joesta PF LLC’s prior written consent, be reproduced, redistributed, published, copied or duplicated in any form, by any means.

Joe Fairless serves as director of investor relations with Ashcroft Capital, a real estate investment firm. Ashcroft Capital is not affiliated with Joesta PF LLC or this website, and is not responsible for any of the content herein.

Oral Disclaimer

The views and opinions expressed in this podcast are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. For more information, go to www.bestevershow.com.

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JF2291: How a Passive Investor Vets an Apartment Deal Part 2 | Vetting The Market | Actively Passive Investing Show with Theo Hicks & Travis Watts

Today Theo and Travis will be answering a common question about vetting the real estate market before entering a deal. Since this knowledge is shared from a limited partner perspective, the goal is to find a way to keep the market information up to date while spending less time researching it.

This episode is part 2 of the series “How a Passive Investor Vets an Apartment Deal”, focusing on the most commonly asked questions about real estate deals. The other parts will focus on vetting the team and the deal itself.

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners, and welcome back to another episode of the Actively Passive Investing Show. I’m Theo Hicks. As always, we are back with Travis Watts. Travis, how are you doing today?

Travis Watts: Theo, doing great. Happy to be here for episode two.

Theo Hicks: So, yes. As Travis said, this is part two of our first-ever actively passive investing show series on how to vet a syndication deal. And so these are the three categories of things that you want to look at before investing in a particular deal. Make sure you check out part one which was last week, or if you are listening to this in the future, seven episodes ago, and that was how to vet the team. And today we’re going to talk about how to vet the market that they are investing in.

One thing that I forgot to mention in the last episode is why these three things. And when we talk about specifically apartment syndications, the three major risk points from the perspective of all parties involved is going to be the team, the markets, and then the deal. So the syndicator should be doing things to minimize the risk of the deal failing, of the market failing, or of the team failing.

Last week we talked about questions to ask to not only evaluate and qualify the team, but also see what things are being put in place to reduce that risk point. So this next thing we’re going to want to qualify is going to be the market. So Travis, do you have anything else to say? Or do jump right into these points?

Travis Watts: I think we could jump right in. Well, one thing real quick is – I had said this on the last podcast, but I get asked these questions on nearly every podcast I’m a guest on, every investor so to speak that I speak with. It’s always something to the extent of how do you vet a team, a market, or a deal, or what pieces of criteria are you looking at, what’s most important to focus on… So that’s why we’re doing this series, just from a high level. I thought, “Hey, why haven’t we done this on our own show? We need to share this with people. It’s critically important.” So that’s all I have to say. Go ahead and kick it off.

Theo Hicks: Perfect. So the first point we’ll talk about is the role of the team for identifying the target market. So just kind of like an overall before getting into specific actual metrics, but you want to have a basic understanding of their market evaluation process. So what does this entail? Are they just googling “top markets” and then going to some blog post that some random person wrote, and then picking that top market, and like “I’m investing here”? Obviously, there’s going to be more that goes into it than that. So, what specifically are they doing? What type of research are they doing online? What metrics are they looking at? Are they actually visiting these markets in person before investing? Or at least the submarket or the neighborhood. And then during this trip, what types of things are they doing? What type of things are they looking at?

And then also, is it just the GP that’s involved in this, or are other members of the team involved as well? The property management company for example. Are they signing off on the strengths of this market? And then lastly, is it a one-time thing where they said “Oh, this market is great, and it’s always going to be great for all time. I’m never going to analyze this market ever again”? Or are they doing things to consistently reevaluate and reconfirm that it’s a good market? Basically, what’s their process for this, right? Are they every quarter looking at the metrics again and tracking those? Are they visiting the markets? Are they consistently reading the news in that market? Best practices, setting up Google alerts for that market… This is something that passive investors can do as well actually – set up a google alert for the target market, and businesses, and unemployment, and jobs, multi-family apartments. So just high level, first of all, are they analyzing the market on a consistent basis, and what does that actually look like?

Travis Watts: That’s a great plan. I want to pick up on one thing that you pointed out, I think it’s really important, and that’s the bias that a lot of folks have. Just because maybe they were born and raised in a particular market, and they’ve never moved, they’re just always going to invest in that market. And on the pro side of that, yeah, they probably know that market really well; on the con side of that it may not be the best market to be investing in at this particular time. And I see that all the time with different operators. So be aware of that and ask those questions. Great point.

And here’s the other thing – I tell every other limited partner, you do not have to be an expert in everything. That is the beauty of being a limited partner. So the way I approach this is I do the macro-level research. I look at just the big picture – how is the economy doing, the unemployment rate, the interest rates from the fed, whatever is going on from a high-level migration trends, where people are moving… That’s kind of my research. Quite honestly, you can do the macro-level research on any particular market in a matter of hours if you’re efficient, or let’s call it a matter of days if you want to take your time through it. And then you could be done potentially for six months on that particular market; you could really understand the fundamentals and what’s happening. Market’s don’t change that rapidly.

Now to that point, obviously, you need to focus on the micro-level. Now, this is what I personally defer to the sponsors; they should be the experts on the ground, so to speak, they need to know everything about this particular property, this three-mile radius, the incomes in this area, the school system ratings, the employment hubs, they need to know it all. Well, I can’t be an expert in all of that, on top of the macro. You could, but it would take all your time. And then what’s the point of being a passive investor if all you do is research non-stop? You might as well be active in the space. So that’s kind of how I approach it – focus on the macro, let the GP’s do the micro. That’s really all I have to add to that category.

Theo Hicks: That’s a great point. So on that point, we’re going to go over some of the metrics that the GP, as Travis mentioned, will know in extreme detail. And from the passive investor’s perspective, you don’t necessarily need to go every single day to the census website to look up these numbers; the point here is you have an understanding of the types of things that will impact the investment. And a lot of what you’ll see is kind of like common sense, it’s kind of obvious. And then when you’re reading through these investment summaries, you can see what is the main highlight of this market. And then you can see if there’s anything that’s left out that you might want to look up, to see if it’s left out for a specific reason because it makes the market not look as good. And so the first thing we’re going to talk about is going to be the demographics of the market.

So the first thing that we mean here is what percentage of the market are renters? As opposed to owner-occupied. Because at the end of the day – again, it’s common sense, but it’s just a supply and demand formula. So all these metrics are going to indicate whether there is a high demand for multi-family rentals in that market. And specifically, the type of multi-family rental that’s being offered, whether it be luxurious A-class, or C-class for working-class folks.

First is how many people are actually renting there? If everyone there owns homes, well there’s not going to be a large supply of renters for them to choose from, whereas opposed you want to see a renter population in that is fairly high compared to the average. I also mentioned, you want to know the actual demographics from a perspective of age. So the different generations demand different things. Millennials and Gen Z want an entirely different type of units and experience than that baby boomers want. So if it’s a heavy baby boomer area, you’re going to have a different type of product to offer.

And then I mentioned, you also want to understand the employment type. I think we might talk about this a little bit later actually, but what types of jobs are people working there, and then how much money are they making; that will indicate the type of property to offer, and the rent. So I think Travis, you might have talked about this before, or maybe it was someone else, but you don’t want to see an apartment that’s got rents that are two times the median income. This means that half their income is going to that rental. You want to see something around 35% max, ideally, 25% to 30% is a little bit better. And there’s obviously a lot of other demographic metrics you want to look at. And Travis if you could talk about the other one, which I know is important, which is going to be the population growing or not.

Travis Watts: Exactly. And one thing I’ll pick up on what you said which just flashed back in my memory – I wrote a blog, I forget how long ago it was, on BiggerPockets about rent versus own. And I got in a little debate with someone, a happy, friendly debate of course… And it was funny because they were advocating that you always, always, always should be a homeowner and never rent. It was a very black and white perspective. And by the way, they were from Indiana. The average home price is like 150k and the average rent is like $1,500. Yeah, okay. I’m pretty much with you on that. But I said “Hey, what about in San Francisco, where you’ve got a million-dollar average home price and maybe an average rent of two thousand a month or something?” I forget what the stats were. But in other words, could it perhaps make more sense to rent in that particular market? Maybe. That’s a lot bigger gap, like you said, with the average home price; so something to think about.

Back to this topic here, here’s the bottom line – is the population on that particular market growing, declining, or stagnant? Census.gov, lots of public info, look at up. Again, macro level is what I advocate, and just understand what the trend is, look back for the last five, ten years, look at historics, look at the recession. That’s one thing that’s helped me a lot, is each recession and depression and whatnot, they’re not the same, but they’re similar. So I like to look at what this particular market did in 2008, 2009, and 2010, how much it declined… And things changed. For example, Houston has come a very long way at being job diversified and industry diversified and industry diversified. It used to be, it was just pretty much oil and gas. So if oil and gas goes in the tank, that whole market is in the tank. It’s not so much the case anymore. Again markets move slowly; that’s taken decades and decades and decades to change. So again, once you do some macro-level fundamentals, you’re probably good for at least six months, maybe even twelve months. So that’s all I have to say on that.

Theo Hicks: And I think it’s a perfect transition to this next part, which is looking at the employers and then the industries in the market. So as Travis mentioned, Houston for example used to be predominantly oil and gas. So I’m not sure what the exact number was, but if half the employee population is working for oil and gas, then that’s great for real estate when oil and gas is doing really well. But then when oil and gas is not doing very well, then that’s not good for real estate, because the people don’t have jobs, if they don’t have jobs they can’t pay for real estate.

Similarly, you can look back at the most recent recession, not including the one that we’re technically in right now, Michigan would be an example, right? A lot of the population was employed in the auto industry, the auto industry tanked, therefore real estate tanked. Right now with the pandemic, the areas that are the hardest hit are the ones that have a large percent of the population in the service industries, because those are what closed down. So you want to take a look at what the population breakdown is for each industry, and ideally no industry is employing more than 25% of the population. That way, if that industry was completely wiped out 100% then you still have a large portion of the population still working, still making money, and still paying rent.

And then similarly, you often to look at the actual companies themselves, the top employers, because you also want to see the situation where a large amount of the population is working for one specific company… Because if that company were to take a hit — again, maybe it seems like Walmart is never going to go away ever, but people don’t think GM or Chrysler was ever going away either, I’m sure. So again the whole point here is to minimize risk. So to minimize the risk you don’t want to see one single company or one single industry dominating the employment population percentage.

Travis Watts: Exactly. And just took quickly recap all of that, two things; it comes down to companies relocating to a market or currently in a market, and it comes down to people currently in a market or moving into a market. That’s really all it is, it’s jobs and people. That is multi-family housing. You’ve got to have people to rent and they got to have jobs that can afford your rent, it’s really that simple. As we said before, it’s not rocket science, it’s common sense, at least to me, mostly common sense.

So what you look for are, again macro-level, look for “Oh, hey did you know that Amazon is building a brand new headquarters distribution center in Dallas Forth Worth? They’re going to bring on 2000 new jobs in this particular 10-mile radius.” It’s important to recognize that stuff.

And to your point to have diversity. It’s not just Amazon and then there is no other employment for 50 miles in either direction; you want a little health care, maybe oil and gas, and tech, and financial, all that good stuff. So check out — U-Haul stats are great. You can just get them right off their website uhaul.com, I guess that’s what it is. But they’ll show you where people are renting a truck and where they’re dropping it off, a.k.a. that’s people moving. So just check out what’s going on, macro level. And then let the GP’s fill you in on specifically what’s happening right now and that little sub-market.

Theo Hicks: Actually, go to joefairless.com and then search “U-Haul migration trends,” because we have a blog post on the most recent data.

Travis Watts: Perfect, I didn’t know that. Thanks.

Theo Hicks: Alright, so the next metric you would want to look at would be more of the supply side, but also an indicator of demand, which should be new construction and absorption rates. So new construction can indicate demand for multi-family. But not always, right? Because there could be hyper supply; but if these large massive commercial real estate companies are building a lot of property, similar to if a massive fortune 500 company is moving to the area, they likely know what they are doing. Again, not a guarantee, but it’s an indicator that there’s a demand.

A better metric that’s an actual number would be an absorption rate, so you can look up the number of new constructions on the Census website, they kind of track that every single year. And then if you could just type in “new construction”, I think there’s something that’s actually tabulated quarterly or monthly too somewhere else. But the absorption rate is also a really good indicator of demand. The absorption rate is a ratio of the number of units that have been rented to the number of available units over a certain period of time. So the higher the absorption, that means that there is less supply to keep up with demand. And a really low absorption means there’s a lot of supply. So this kind of lets you know that obviously if there’s more demand, that pushes rents up and then that’s good for investors. And so take a look at that absorption rate as well.

And as I mentioned before about hyper supply – IRR releases a yearly report that talks about the phase that all the major markets are in; they break them down to is there an expansion, and hyper supply recession or recovery. So obviously recession, hyper supply, maybe avoid those markets; expansion is good, but it might be ending soon, and the recovery phase is a good place to get in to maximize growth. Something else too,  on the flip side – if they’re not building a lot, that could also be a good thing, because that means that there’s a constraint on supply. So just because they aren’t building anything might mean that it’s hard to build in the area, which also a good thing for investors. So a lot of new construction could be good, but it also can be bad, and then no construction can also be good, but can also be bad. So I guess it kind of depends.

Travis Watts: Exactly. And there’s so much data, you guys listening, that we’re going through… Please get a book; again, I already talked about obviously your book, Theo, and Joe’s book, The Best Ever Apartment Syndication Book, a great resource. But there’s a lot of books that can go through all of this in much more detail… Because I know me back when, when I was trying to figure all those stuff out – it was overwhelming, really was overwhelming. So the best thing to do… We’re only giving you the high-level stuff to think about, so make a little bullet point to study up, and then go find a resource, or a mentor, or a program, something to help fill in the blanks for you.

The last thing I would say to that category is the unemployment rate. The national average right now give or take 7%-8% national unemployment. So when I’m looking at markets, again, macro-level as a limited partner, I’m just looking for a market that is outperforming the national average, quite frankly. So I’d love to be in a market where unemployment is 3%, 4%, or 5%, or something, not 7% or 8% as the national average.

To your point earlier, I know you mentioned Michigan being reliant on the auto industry back in the last recession, and still kind of is… Their unemployment went up, if I remember right, over or about 17% in that market during the great recession. Well, that’s a huge number. So again, that’s why job diversity is so important; industry diversity… 17% unemployment… Usually, by the way, I’m not a conspiracy theory guy, but usually it’s a little higher than what’s actually reported, so just a note, that’s a really bad thing for multi-family. So I’d like to do more study actually on what multi-family did in Detroit during those years, but… Tat’s all I’ve got to say on that topic.

Theo Hicks: Yeah, and one quick follow-up to kind of what you’re saying at the end there… Something else you might want to consider looking at – you don’t have to, but it’s just something that’s interesting is actually to look at the labor participation rate as well, because that’s what they’re basing the unemployment rate on. It’s who is actually looking for a job.

So if you look at markets… The last time I looked I’m pretty sure the labor participation rate was in the 60% range; so it’s 60% of the population that’s looking for a job or is employed, and what percentage of them are unemployed. So if you go to a market and it might have like a 1% unemployment, like “Oh, it’s the best market ever.” When you look at it and only half the population that’s there is considered part of the labor force, that’s what Travis means that the unemployment rate might not be exactly what the unemployment rate says on the census. It might be higher, because… It means there are more people  unemployed in that market than just 8%, or whatever.

Another metric, just a really quick one, is occupancy and rental rate trends. So again, pretty straight forward, but you’re going to want to see a market that has a stabilized average occupancy rate, so at least 95%, but then you’re also going to want to see it trending in the positive direction, right? You don’t want to see a market that has a year to year decline in the occupancy rate. And then similarly for the rents, you’ll want a see a rental rate that’s increasing.

On the same note, you can also find different multi-family institutions that will project out what they expect the rents to be in the future, and usually, the syndicators will include any rent forecasts in their presentation to you. But overall, you want to know the historic trends over say the past five years or past ten years for occupancy and rental rates. And then you want to see what some of these people are saying for the forecast. And they also forecast population as well, something else that you can find forecasts on. So you want to see what’s going on in the past, and then what do they think is going to happen in the future.

Travis Watts: Yup, a hundred percent. The last thing I’m going to add here, and then we’ll wrap it up, is check out the landlord-tenant laws in a particular state you’re looking to invest in; they’re not created equal. What you’re looking for, again macro-level, as a limited partner, is that the tax laws generally speaking are in favor of the landlord, which is you, it’s the owners of the real estate. Obviously, we need laws to protect both sides a hundred percent for that, right? However, there are some states… I always like to pick on California – it’s like, you can’t evict a tenant if it’s raining outside or if there’s a cloud that covers the sun. Obviously, I’m making that up. It gets so ridiculous that you’re like “Really?” You can’t even do business in the state. So pay attention to that stuff.

And additionally, I prefer investing in tax-free states, or at least tax-friendly states in general. Again, here’s a practical way to think about it from a limited partner perspective. Let’s say I invest in a syndication deal, five years later it sells, I’m looking at paying tax, long-term capital gain and state tax on a hundred thousand dollar gain, just to use simple numbers. Well, if that deal happens to be in California, I’m looking at paying them at least $13,000 in state tax upon the sale, whereas if that same deal were in Texas, and sold, I would owe nothing to the state. So there’s a direct $13,000 savings, just because I chose a state upfront that was tax-friendly. So something to think about. I mean obviously, if your preference or your bias is California, New York, New Jersey, fine. But just know that that’s going to be a factor one day down the road.

So with that, I think we covered some awesome stuff on markets. It goes much deeper, but again, everyone listening, these are just bullet points; take some notes, hopefully, open your mind a little bit and go dig a little bit deeper into it and get the facts for yourself. And that’s all, yeah.

Theo Hicks: And the last thing I would say is that we have a blog post on the website, so just go to joefairless.com, you can just type in “target market,” or if you just google “ultimate guide to evaluating a target market,” we have a very detailed blog post that goes into all the metrics we talked about today. I don’t think we talked about the landlord-tenant laws in the tax-friendly state in that blog post, but I do think we have a separate blog post about landlord-tenant laws. But everything else we’ve talked about, we go into a lot of detail on where to find this data and then what good metrics are and what bad metrics are in that blog post. So if you want to go learn more details check that out, or I’m sure there’s lots of books out there as well.

So yeah, that concludes part two on how to vet a syndication deal. We talked about the team last time in part one, the market today, and then in part three we’re going to go into detail on how to evaluate an actual live deal that is presented to you. So until then, make sure you listen to part one on the team. And Travis, again, thank you for joining us today, we really appreciate it. Best Ever listeners, thank you for joining us as well. Have a Best Ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

Website disclaimer

This website, including the podcasts and other content herein, are made available by Joesta PF LLC solely for informational purposes. The information, statements, comments, views and opinions expressed in this website do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. Neither Joe Fairless nor Joesta PF LLC are providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice in or by virtue of this website. The information, statements, comments, views and opinions provided in this website are general in nature, and such information, statements, comments, views and opinions are not intended to be and should not be construed as the provision of investment advice by Joe Fairless or Joesta PF LLC to that listener or generally, and do not result in any listener being considered a client or customer of Joe Fairless or Joesta PF LLC.

The information, statements, comments, views, and opinions expressed or provided in this website (including by speakers who are not officers, employees, or agents of Joe Fairless or Joesta PF LLC) are not necessarily those of Joe Fairless or Joesta PF LLC, and may not be current. Neither Joe Fairless nor Joesta PF LLC make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this website, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Neither Joe Fairless nor Joesta PF LLC undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views or opinions set forth in this podcast.

No part of this podcast may, without Joesta PF LLC’s prior written consent, be reproduced, redistributed, published, copied or duplicated in any form, by any means.

Joe Fairless serves as director of investor relations with Ashcroft Capital, a real estate investment firm. Ashcroft Capital is not affiliated with Joesta PF LLC or this website, and is not responsible for any of the content herein.

Oral Disclaimer

The views and opinions expressed in this podcast are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. For more information, go to www.bestevershow.com.

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JF2284: How a Passive Investor Vets an Apartment Deal Part 1| Vetting The Team | Actively Passive Investing Show with Theo Hicks & Travis Watts

Today Theo and Travis will be sharing their knowledge on how to vet the team before entering a real estate deal with them. They discuss this matter from a limited partner (LP) position. Since your real estate investment is illiquid, you need to consider the long-term implications of this business relationship. You’ll be communicating with your partners over the next 3-5-10 years, so you’re much better off finding out about who they are, what they do, and how they do it early on.

This episode is part 1 of the series “How a Passive Investor Vets an Apartment Deal”, focusing on the most commonly asked questions about real estate deals. The other parts will focus on vetting the market and the deal itself.

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners, and welcome back to another edition of the Actively Passive Investing Show. I’m here again with Travis watts.

Travis, how are you doing?

Travis Watts: Theo, I’m doing great. I love your background. Everybody tuning in on YouTube, we finally have matching backgrounds, check it out.

Theo Hicks: You have to go to YouTube once this video is aired and check out our matching backgrounds. I’ve got the green screen now, so it’s nice and bright in here, I’ve got the nice ocean background. So thank you to Travis for helping me figure that out.

Anyway, so we’re going to kick off, I guess this first-ever series that we’ve done on here. It’s really a three-part series about vetting syndication deals. Obviously, from the perspective of the passive investor. And in part one, we’re going to talk about vetting the team. So that’ll be today. And then next week, or if you’re listening to this way in the future, seven episodes later, we’re going to do part two which is going to be vetting the market, and then part three is going to be vetting the actual deal itself.

So as I mentioned, we’re starting off today with vetting the team, and so we’ve got 10 points we’re going to go through, and Travis and I are going to alternate. So do you need to jump right into the first one or do you want to say something first, Travis?

Travis Watts: The only thing I would add to that is this is coming from a limited partner perspective as you’re investing in an apartment syndication or a real estate private placement. These are the questions that I’m asked by investors every week, I’m asked on nearly every podcast I do, no matter which podcast it is; it always comes down to, how do you vet a team, a market, a deal? So I figured, why haven’t we covered this on our show? Because it’s one of the most commonly asked questions that I get. So that’s why we’re doing the episodes. That’s all I got. So go ahead and kick it off.

Theo Hicks: Perfect. And I guess one quick thing too is that we’re going to answer all these questions from the perspective of the passive investor. Travis is obviously going to take it as being an actual passive investor himself, and then the way that I’m going to answer the questions is how we teach people that want to be active syndicators to be prepared when they’re talking to passive investors; what types of things they should expect the passive investor to ask based off of the team, the market and the deal. So we obviously wrote a massive book on this, 450 pages, The Best Ever Syndication Book, so we’re going to not do a 24-hour podcast. We’re going to try to hit these high level, but for all the things we’re going to talk about today, at least for most of them, there are more in-depth blog posts or they go in more depth to it in the book.

So the first thing that we’re going to look at when vetting the team is going to be their experience and track record. So when I talk to syndicators, I tell them that you’re going to want to make sure you have relevant business experience or relevant real estate experience, or both. So the vast majority of, if not all, syndicators that are active when they got started, they weren’t just fresh out of college, they typically had some sort of experience in business or in real estate.

So to be more specific, it’s not just having a regular full-time job, where you don’t get promoted or you bounce from job to job every year. What you want to see from the business perspective is someone who got promoted multiple times, preferably to any large corporation, preferably to a director type level. And then from a real estate perspective, it doesn’t necessarily need to be multifamily, because it’s kind of like a chicken and the egg situation where if I want to do multifamily, I need multifamily experience and if I’ve never done multifamily before, so how do I do without the experience.

So they need to have some sort of real estate experience. It could be being an investor themselves. So their investments — it could be single-family homes, smaller multifamily, maybe have an apartment, maybe invest in some sort of commercial real estate… Or it could be some other form of working in the real estate industry like they were a broker selling or doing loans, maybe they worked for a property management company… But the key is, is that they have to have either strong business experience, strong real estate experience, or ideally both.

And the reason why is because they are going to have skills that they learned from that past experience and then apply to apartment syndications. This is kind of when you’re working with a beginning apartment indicator. Obviously, if they’re more experienced, then what’s more important is their actual track record. So I’m not sure, we’ll probably get into this in more details… But by the track record, do you mean have they done deals in the past that met or exceeded the return projections to their investors?

Travis Watts: Yep, 100%. Love those points, and you’re exactly right. It’s funny, both LPs and GPs in this space often actually don’t come from a real estate background. So maybe they had some single-family experience or whatever. But here’s the good thing. Real Estate Investing isn’t rocket science, right? I think we can all wrap our heads around it even from scratch as an adult in a matter of days and we can pretty much get the ins and outs of it.

I see it all the time. A GP would say something like, “I was a former Marine, so that taught me a, b, c, d, e, f, g. Now I’m syndicating deals and I’m bringing that experience and that methodology to what we do in our business plans,” that kind of stuff. Or come from an engineer background, used to do startup companies, switched gears into real estate. “I’m a numbers guy,” that kind of stuff. So great points, I won’t get too long-winded on that.

The only thing I would add, actually, on that small segment is aligning your philosophy with the actual GP. So what I do as an LP – and we’ll get into criteria later; this closely borders criteria and it is technically part of your criteria… But you need to identify what your investing philosophy is. I’m a cash flow focused real estate investor, I prefer to invest in affordable housing nationwide; not subsidy housing from the government, not like Section 8, but average rents, let’s call it $1,000 a door or $1000 a month, where a lot of Americans can benefit from this. There’s historically always been a demand for affordable housing, there continues to be an increased demand for affordable housing. So I like to be in that sector, because a lot of people can afford that rent. And if they can’t, there’s always someone else willing to come in and pay that rent in most cases. So a little less speculative there.

I like the idea of value-add, that’s part of my philosophy as well. That goes far beyond real estate; even as a child, young adult, anything — like buying a car that needs some work and then we’re going to buy it, fix it up, it’s going to be worth more now and it’s going to sustain its value longer. I like these types of concepts. So I apply that right into real estate. And I like buying something off-market at a discount, improving it, making it better and selling it for more. That’s just something that really aligns with my philosophy in life. There’s a lot of things that we all can buy, pre-owned perhaps and still get the same usage out of it than what we had before when it was new.

So I define that on paper and in my head and speak it out loud, make sure I fully understand it. And then as I’m interviewing general partners and sponsors and teams, I’m just asking them about their philosophy and what do they look for in real estate? Why do they do what they do? And the more alignment you can have, I think the better off you’ll be. It causes a lot less problems down the road, because you know, they’re generally going to be thinking along the lines that you think when recessions come or what have you, and hopefully, they’re going to make decisions in alignment with decisions you yourself would make if you were calling all the shots. So that’s all I had to say on that segment to add on.

Theo Hicks: I think a lot of things you said we’ll hit on a little bit more later on this episode, when we talk about understanding what their business plan is. But you didn’t mention something about speaking with them and making sure you understand what their investing philosophy is. That brings us to the next point, which is scheduling some sort of introductory call to actually vet them. So I’m not going to spend too much time on this. But the whole point here is that before you invest with a syndication team, it’s best if you actually speak to them first, to ask them a list of questions, which we’ll get into here in a second. And I’m sure it’s possible to invest with someone, and maybe Travis has done it before, without actually talking to them or not even meeting them in person. We’ll get into some of the questions you want to ask about the team and their background and what they’re doing, what their business plan is, with their experience with the business plan, who’s doing what… But really, at the end of the day, one of the most important factors, if not the most important factor when you’re deciding who to invest with is trust. So when you speak to them and what Travis will talk about next, meeting with them in person, you’re going to be able to, in an intuitive sense, determine if this is someone who’s trustworthy or not, by the way that you feel when you talk to them, how you feel, they are answering the question; does it seem like they’re hiding something and not being transparent? Is this someone that you like, that you enjoy speaking with? All these things – they might not seem like they’re directly related to the ROI and what the renovation timeline is and the hold period and things like that, but that’s going to go a long way, because you’re giving them your money and you are trusting them to invest that money, to preserve that money and then to ideally grow that money.

So if you don’t like them, if you don’t trust them, if they don’t seem transparent, then it’s probably not a good idea to invest with them. And really, the only way to determine that is going to be actually talking to them and asking them questions.

Travis Watts: That’s a great point. And you brought up something that’s so important, and I speak to this a lot also on podcasts, which is – you need to essentially get along with these folks. I don’t know if you go as far as saying “be friends” with them. I mean, obviously, business friends, good acquaintances, something, but… I kind of treat it that way myself. Because these investments are illiquid. When I give someone my money, it’s out and it’s gone for three years, five years, seven years, it could be 10 years. So the last thing I want to do is make a big decision like that, not get along with the people and have to be forced into communication with them for a 10 year period. That’d be a horrible thing.

So take the due diligence time to have an actual conversation, like a human interaction conversation, not just a transaction-based conversation, like, “Hi, this is Joe. What’s the cap rate? What’s the break-even occupancy? How much is the minimum? Okay, thanks, bye.” That doesn’t qualify as contacting the sponsor to me. I want to know about the sponsor, what are their hobbies and what do they do on their days off? And I just want to get to know them a little bit as a person… And there’s so much to be said about a simple gut check. It’s something this year—I’m so glad I use a Calendly link to connect with people and network, especially since COVID, that’s really kicked up.

The problem, though, has been up until this point, that it’s just a phone call. And there’s a lot that you miss in body language, in professionalism and things like that, things I wish I could portray to others, things I wish I could see upon others. Are they sleeping on their couch in their pajamas having a call with me or are they at their desk at home? I don’t know what they’re doing.

So I started implementing a Zoom link to my Calendly call, so that we can connect like this face to face and people love it. I’m telling you, 8 out of 10 people that book a call with me are choosing the Zoom option and I think that’s awesome. And it has a lot to do with COVID, and everyone’s getting more familiar with Zoom and Skype and all these online things. But hey, guys, it’s free. You live in California, your sponsor is in New York, you can either pick up your bags, put your mask on and go buy flight tickets and hotels and taxis and rental cars to go meet someone face to face, or you just hop on a Zoom call and it’s free and it takes five minutes. So you choose, but it is important.

And the last thing I’d say is additionally, if you can, if it’s reasonable, try to visit a property that they’ve actually worked on before or that they’re working on currently or the property that you’re vetting and I know we’re just talking about the team and not the deal, which we’ll get to in a later episode more about that. But these are things that I do when practical. I don’t always do it before I invest. Sometimes it’s after, which I know, sometimes may be a moot point. But it’s good to see how their teams are performing, how their property managers are performing, how they’re performing as an asset manager, ask the property managers questions about the sponsor… It’s always good to get this kind of feedback. So I’ll keep it to that and we’ll move on just for time sake.

Theo Hicks: So the next point is some top questions to ask the GP. And the way you want to think about this is that you have a whole list of questions that you’d want to have answered, and you don’t have to ask every single question when you’re talking to the GP in an intro call. You don’t have to have a list of 100 questions and go through every single one. You can do research on them beforehand, and we’ll get to that a little bit more a little bit later; it comes to their online presence. But you can go to their websites, maybe they have some sort of deck that you could look at the talks about their company, maybe you found them and that you have a live deal and they can answer a lot of questions about what types of deals they do, who they are, who their team is, and the other investment summary. But of course, there are some things that you’re going to need to ask on the call. So again, there’s a lot of questions, but I’m just going to go over the overall categories that they’re in.

So first, you’re going to ask question about who is actually involved in the deal. So this is going to include the actual point person you’re talking to… So this would be a member of the general partnership; they most likely have one or more business partners, and they split up duties. So you’re going to want to know who does what, why is Travis doing acquisitions and asset management? Why is Theo doing investor relations and capital raising? What part of their background makes them an expert, credible in that specific part of the business plan?

And you also want to ask questions about the other, what I call third-party vendors that are involved. And the most important one is going to be the property management company. So who’s a management company? How big are they? What’s their background? What’s their experience? The CPA is also kind of important, right? You want to make sure they have a CPA that specializes in, in our case, apartment syndications, so they make sure that they’re taking advantage of the tax. And Travis and I talked about this last week, we talked about Biden’s tax plan.

And then these other team members as well. But those are the most important members involved. You can also ask questions about the actual passive investors, right? Who is their longest passive investor? Is the person or people who invested in the first deal, if they have been investing for five years, whatever – is their first investor still investing? How many family and friends are investing, right? Because if they got family and friends investing, if they’ve had someone who’s invested for a long time, that indicates trustworthiness.

Travis Watts: Yep.

Theo Hicks: Next is going to be their credibility, we’ve kind of talked about that. What’s their actual track record doing, what they’re doing right now, for that specific deal? Next is going to be alignment of interest which, Travis, just as you hit on earlier about the alignment of interest in the investment philosophy… There can be an alignment of interest in other ways as well. Essentially, the more skin in the game the team members have, the better. So are they investing their own capital in the deal or other team members investing their own capital on the deal? If the deal were to suffer, will they suffer as well? This also kind of ties to an online presence, right? If they also have, for example, a really popular podcast, well if they start doing really shady things for their deals, it is not only going to impact their investing business, but it might invest their thought leadership platform, maybe they have some sort of consulting program as well. So it’s also something that promotes an alignment of interest.

Theo Hicks: Now, to the—

Travis Watts: 100—

Theo Hicks: Sorry, go ahead.

Travis Watts: Sorry. I was just saying, 100%, I agree. Go ahead. Sorry.

Theo Hicks: I’m going to be quick. So next is going to be transparency. So how transparent are they? So we kind of talked about this before, when you’re talking to them. Are they trustworthy? Does it seem like they’re hiding things? Are they willing to share financials? How often are they giving you updates on the deal? Questions like that.

And then next two are going to the business plan and the target market, so ask questions about their market and their business plan. That’s going to be part two and part three. So we’ll go over those questions there. But overall, all these things are going to give you an idea of how trustworthy they are and how probable it is that they are going to preserve and grow your capital.

Travis Watts: Great points. And I’m going to keep it brief on my extension to that, which is – don’t exclusively do this, but I know this is difficult for a lot of people, including myself, but try to ask the difficult questions. But don’t just have a phone call and ask all the difficult questions. Because that can be a huge turnoff to a GP if you’re coming in like an interrogator, just trying to get to the bottom of everything. So ask the questions Theo talked about, the general questions, the experienced questions, and slip in a few things in there like, “Hey, COVID is happening. What if our occupancy drops a lot? Have you done a stress test or something like that to see what might happen to this project?” Ask, again, about co-investment. I know you already mentioned it, “How much are you personally investing in the deal?”

Make them light and space them out. Maybe if you have 10 of those, only ask three or four on one call and give it a break for a while and turn to it. But it is important, it really is and all those questions of key person risk. What happens if you yourself pass away or so-called “get hit by a bus”. That’s a horrible thing to say. But it’s good to know. There’s not a right and wrong answer per se. It’s just that they have an answer. It’s that they’ve thought it through and that they can say, “Oh, yeah, well, here we have keyman insurance in place,” or, “Oh, we have a co-GP and they would be taking over the business model.” It’s just something, right? And it’s not, “Oh, uh… Hm, I don’t think I will get hit by a bus. I don’t see that happening.” That’d be the wrong answer, I guess. But ask the hard questions. That’s all I’ve got to say. Let’s move on.

Theo Hicks: That’s a really good point; asking, what’s the worst-case scenario and then what would happen if that happens? I never thought about that one. The worst-case scenario would be if the entire general partnership died, and then what would happen?

So the next point, this would be a quick one… It’s understanding the asset class and the business plan. So we’re going to go into a lot more detail on this. We talk about analyzing the deal in part three. But the business plan and asset class are important when evaluating the team, because if they’re doing a heavy renovation business plan and they or the team members have never done a heavy renovation business plan before, well, maybe you don’t want to have them learn on your dime, right? And then also, secondarily, the track record of the team, in making sure that all the team members ideally have done this business plan in the past.

You’ll also want to understand, as Travis mentioned earlier, your investment philosophy and investment goals, because the return structures and the types of returns that you’re going to get are going to vary based off of the business plan. So on the one hand, you’ve got something that’s completely turnkey, where it’s mostly cash flow, but not a lot of upside. On the other end is some development deal where it’s all upside and no cash flow. So if you are someone who wants steady cash flow and wants to almost guarantee that your money isn’t going to be lost, then you’re not going to invest in a development deal. And so the syndicators doing developments, then you’re probably not going to want to invest with them and then vice versa. If all you care about is doubling your money in five years or whatever, then investing a turnkey is probably not going to be the best approach.

Travis Watts: Yeah, bottom line, know your criteria. The easiest way to know your criteria is to grab a resource like Theo and Joe’s book, The Best Ever Apartment Syndication Book, as an example, read through what criteria means and what all the criteria may be, things like that, and then decide which ones are most important to you… Or reaching out to someone like me or anybody active in the space to say, “What do you look for in terms of your criteria?” I’ll share with you a few bullet points of just examples of what criteria would mean. It would mean I invest in Texas and Florida 200 to 600 units, B class assets, five-year holds, five caps or higher… I’m just spitballing stuff out there to look at; break-even occupancy at 70% or lower, projected exit cap rates that are higher than our entry cap rate. This is all just criteria; monthly distributions versus quarterly. There’s a lot out there. So you have to decide which ones are most important to you and then be asking them, “Do these match up to what I’m looking for?”

And trust me, there’s enough general partnerships out there, you will find someone that meets your criteria or at least most of it. That’s kind of an illusion, that – when I got started, I didn’t think there was many deals to be had and so I had to compromise a lot. That’s not true. There’s a lot of groups, keep looking, keep searching, keep asking people, “Hey, if this is my criteria, do you know anyone that’s doing deals like that?” I’d be happy to share that, I’m sure a lot of people would. So I’m going to cap it at that and let’s wrap it up.

Theo Hicks: Yep. So the last point here and I’ve already kind of hint on this would be their online presence. So a lot of this information that you can gather on the general partners can be found online if they have a website, for example. Now, something that we talk about a lot when we’re talking with people who want to be apartment syndicators is the importance of having some sort of a thought leadership platform like what Travis and I are doing right now. And besides what I talked about earlier, that if they’re consistently out there, putting out content, talking to other real estate professionals and they have this brand, that may or may not even be generating the money, but at least giving them a strong reputation, than if they are doing shady things on their deals, then more than just that deal is going to be threatened. So that’s one thing, the alignment of interest.

But also with the passive investors perspective, as Travis and I kind of mentioned, you’re going to talk to them before you mess their deal, maybe for like a few hours, right? So you’re going to have to use that time on the phone, maybe back and forth email, maybe some sort of webinar or conference call. That’s really going to be your main interaction with them before investing in their deal. So if they have an online presence, if they have a podcast, a YouTube channel, if they’re doing blog posts, if they have a website, if they’re being on other people’s podcasts, they have conferences, all these things, that’s a bunch of content that you’re going to use to get to know them a little bit better. Obviously, people don’t act the exact same when they’re doing interviews like they do in real life,  but if you listen to enough content, you’re going to get an idea of who that person is, that they know through talking about, if they’re trustworthy, if you like them, if you can get along with them, that you might not be able to get if it’s impossible to find them.

I can’t say specifically why, but I don’t think it’s good if you Google someone’s name. Like, if I want to invest with Travis Watts Syndications and I Google Travis Watts and there’s nothing that comes up at all, I can’t find them, that’s not a good sign.

Travis Watts: Yep, 100%. And only thing I’ll add to that is the power of referrals. Most of my deals, most of the partnerships that I’ve been involved with as an LP, started with a word of mouth referral. How? I used to go to a lot of conferences and I would ask people who they’re investing with, what their experience has been? You tend to get the same names over and over and over in a positive way and a few in a negative way. So you can learn that way.

You could get on online forums like BiggerPockets and ask questions there. Usually, that’s best to do over direct message and not a public thing. A lot of people don’t bash people publicly and rightfully so.

The other way is, I’m in a few very large real estate meetup groups, one in particular, I’ve probably done 8 deals out of that group alone, where they have presenters and stuff. And there’s a lot of people in the room who have already invested with these sponsors. So that gives some credibility there and some referrals. So something to think about. That’s the last point I’ll make. And in general, that’s really the approach. I think you hit on some awesome key points. And that’s how I vet out a team or a sponsor.

Theo Hicks: Perfect. Well, Travis, thanks again for giving us your wisdom and your thoughts on this, the passive investors’ perspective when evaluating the actual team. As I mentioned, this was a 20-25 minute podcast, there is a lot more that goes into this. So if you go to our website, https://joefairless.com/ and under the “Blog” section, we have a category for accredited investors. And a lot of the stuff we talked about, we have blog posts on them that go in more detail. Specifically, we have a blog post called How To qualify the GP, How to Qualify their Team.

So next, we’ll do part two, which is going to be the market. So that’ll be next week. So Best Ever listeners, as always, thank you for tuning in, have a best ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, everyone. Thanks, Theo.

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JF2277: Are You Speculating or Investing | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will be discussing the differences between a speculator and an investor. 

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners and welcome to the best real estate investing advice ever show. I’m Theo Hicks, and I’m back with Travis Watts for another edition of the Actively Passive Investing Show. Travis, how are you doing today?

Travis Watts: Theo, doing great as always. Happy to be here.

Theo Hicks: Yeah, thanks for joining us. And today, as you can see if you’re watching on YouTube from Travis’s background, How To Invest Like A Pro, Speculating versus Investing. I think that we have a very good topic. It’s simple but it’s very important to understand the difference between speculating when you’re investing and then actually investing.

So Travis, maybe again, as usual, tell us a bit of background to why you wrote this; because this is based on a blog post that Travis wrote. And then we will dive into the differences between speculating and investing.

Travis Watts: Yeah. To your point Theo, really it’s a basic concept; it may not even warrant a blog post. I did it as a blog post because I felt it was important enough to share this with people, and because I have so many conversations with investors, week to week, and oh my goodness… The term investing is just not created equal, especially in the real estate space. It gets thrown around loosely, but I don’t think a lot of people have a good grasp of what it even means to be an investor, so I really wanted to hone down and clarify.

If you’re listening, you probably think you understand already and maybe you do, but I want to break it down a little more in-depth, to paint some real examples of speculating versus investing. So that’s kind of why I wrote it and what we’re going to talk about.

Theo Hicks: Perfect. So Best Ever listeners, if you’re a loyal listener and have been listening for a while, you’ll know that Joe has his three unbeatable laws of real estate investing. And the first law is to buy for cash flow, not for appreciation, and the distinction made between natural appreciation and forced appreciation. So that law of real estate investing is going to apply to what we talk about today.

Travis Watts: Yup, 100%. It goes hand in hand. So lesson #1 I put in the blog is about the velocity of capital, which is something not widely talked about. And the velocity of capital is just the simple concept that your money has to continually be moving; you have to be constantly re-investing, re-allocating, doing a re-finance, having a sale, moving money around. The minute that you start taking cash and shoving it under a mattress or putting it in the safe putting it in the bank, it begins to die, not only because of inflation, but potential loss. And when you’re locking a bunch of home equity in, let’s say, a stagnant market, all that cash is just sitting there locked up and there’s nothing you can do about it in order to access it.

So you can think of it as electricity; electrical current has to constantly be moving. The second that stops moving, it starts to dissipate, erode and go away and die. That’s the same with your money, so think about it that way. So a couple of things I wanted to define upfront is what is speculation, what is investing. Let’s get some simple bullet points here. And by the way, there’s a lot of ways to invest, and I’m not advocating one is better than the other. I just want to paint a scenario and let you sit with that, to think if maybe that could apply to you. I’ve made money, Theo’s made money, a lot of people have made money in the speculation space, and in the long term approach.

So speculation is like, let’s say that you’re going to flip a house. Why is that speculation and not investing? Well, you’re speculating that the rehab budget is going to cost what it’s going to cost. You’re speculating that it’s going to take you about 3 months to turn that property over. You’re speculating it’s going to sit on the market one month after that. You’re speculating the purchase price – someone is going to be willing to pay for that. That’s a lot of speculation, and that’s why it’s not investing. You have to constantly be repeating that process and gambling in a sense; it’s an educated guess hopefully, but it’s still speculating.

Another example… I hear this a lot in The Real Estate Guys; I’m a big fan of their podcast, but they have callers that call in and they’ll say something like, “Hey, I bought this property out in California, and it has a negative cash flow, or it’s a  breakeven, it doesn’t have any cash flow to it. I’m renting it long term. But hey, it’s in California. It’s an appreciation market, right? So like in 5 years hopefully I’m going to sell it for twice what I paid for it.” Again, you’re speculating the market is just going to up up up and away forever. Look at what’s happening in California right now; that may not be the case. So there’s an element of speculation to that without having any cash flow. And a development deal, whether syndication or your own, you’re speculating the cost, and the build, and the timeframe, and the permits, and what’s it going to sell for, what it’s going to rent out… There’s a lot of speculation in that.

Of course, you don’t have to agree with me on this point, anybody is listening, but I see these things as speculative, opportunistic types of plays, and less about investing.

So let’s talk about investing. What do I mean then, who’s an investor then? Well, cash flowing-real estate, primarily… Because what are you banking on? You’re banking on the current income. You’re actually buying an income stream; you actually have tenants in there right now; you have a long history of people paying, and what the collections have been, so that’s what you’re really banking on.

So it’s still a little bit of speculation… That would be the speculation that people are going to continue renting your property over the next few years. That’s your speculation, but it’s a lot more conservative than thinking you’re going to lease-up a 400-unit building from scratch in 12 months; you may or you may not.

A dividend-paying stock. A lot of people buy stocks because they had a consistent distribution of dividends for 20 years, let’s say. So that’s an investor, you’re investing for cash flow, or same with like a bond. Most people aren’t buying bonds because they think it’s going to up in value, they’re buying it because of the yield on the bond. That example in today’s world; but historically speaking, you can get 5, 6, or 7% on bonds, that would be the case. So any thoughts before I move on, Theo, from that?

Theo Hicks: Yes. I’m glad you made that distinction at the end and said that “If you’re buying for cash flow, there’s still some small level of speculation, but it’s minor”, compared to some of the other investment strategies where most, if not all of the moving parts are based off of speculative assumptions, assuming that things will continue to go the way that they go.

It reminds me of something that we are putting in our Passive Investing Book that should be coming out in early 2021. It’s related to risk in different investments, and the possibility versus probability. So no matter what you’re investing in, there’s always a possibility that something goes wrong. There’s no investment that’s 100% guaranteed to perform exactly how you expect it to perform. So it’s possible that that won’t happen for all investments… So the question isn’t, “Is it possible to lose money?” Yeah, obviously. The question is, “What is the probability of you losing money on that investment?”

So the more assumptions that are put into this deal, the more probable it is that money will be lost. Again, it’s not always the case, but usually the more probable it is that you lose your money, the also more probable is that you’ll make a lot of money. So when it comes down to speculation versus investing, when you’re speculating, the probability of you losing money is a lot higher because of the number of assumptions that are made… As opposed to when you’re investing – sure, you’re still making money, sure, it’s still possible that you lose money, but the probability of losing money is much lower.

Travis Watts: That’s a great point, I appreciate you pointing that out. That’s 100% the case; I couldn’t agree more on that. So I point out a couple of things, I say that professional real estate investors understand two things. Number 1 is the need to continually move money into new investments, and number 2, how cash flow is used to create exponential wealth. So let’s talk a little bit about that.

I’ve put in the blog an example of a gambler… So just to paint a picture of a term that I used in the blog, called house money. So if I go to a casino, and I have a thousand dollars, and I go place a thousand-dollar bet and I ended up winning $1500… Okay, that means I now have $500 more than I started with. I still have the thousand, plus the five. So if I take the original thousand that I had first bet, that I won back essentially, and I put that in my pocket, and now I only have $500 left in my hand, now I’m playing with house money. What is my risk at this point, right? I can go around and just bet here and there a hundred bucks, a hundred bucks… I’d go to zero, but ultimately I didn’t lose anything, because I still have the $1000 I walked in the door with.

So you can play this game without being a gambler, in terms of being a cash flow real estate investor. So the example I layout in the blog is if you had, just for example, say $500,000, and you decide to spread your risk into 5 different investment, 100k, 100k, 100k, 100k, 100k. Let’s assume each of those cash flowing pieces of real estate give you a 10% annualized return. So that means at the end of the year you’re going to have $50,000 in passive income, in collections, in dividends, or interest, if you want to relate it to other assets. So here’s the thing – at the end of that year, let’s say it’s December now, and now I have $50,000 more that I started with – I can take that 50 and go make a new investment. I can go put 50 into syndication, or private placement, or some stocks, or whatever… And I’m now playing with house money; I now reduced my risk, because now I’m going to go leverage and make even more cash flow and have even more tax advantages, but not have to be worried about that $50,000. And every single year, assuming these are multi-year deals, you can do the same thing. Every year you get to take another 50. Actually, it will be a little bit higher, because you’re compounding the earnings on the new investment as well, the 6th investment.

So every year you’d play with more and more house money, to the point that you’re playing mostly with house money, so you’re therefore reducing your risk… As compared to, now let’s look at the opposite situation. I have $500,000 to invest, and I spread that into five development deals that are going to take multiple years to develop. Well, that means, A, there’s probably no cash flow in the meantime… And what happens if in three years down the road the market shifts, we go into a great, huge recession, and now our assumptions, our speculations, they’re way off. We’re never going to sell those properties for what we thought. It’s costing more in construction cost, because of bad trade deals that politically happened… So many things can happen. The city is denying different permits, who knows. It’s not leasing up, because someone built right next to us, and they’re leasing up before us, and therefore we can’t collect enough tenants… There’s a lot of things that can happen with that.

So now my principal, my initial $500,000, is at risk. I’ve had no house money in the meantime, I haven’t been able to reduce any risk, and now I’m looking at a loss of a potential principal. So just think of this idea of, again, the two things that professional investors know – continuously moving over into new investments; as cashflow is rolling in, you’re making new investments using that cash flow, and that’s how you create exponential wealth. You keep stockpiling on to the cash flow.

A big way that Robert Kiyosaki, Rich Dad Poor Dad author, invests is he calls at the infinite return. So he’ll go in, add some value to a property, do a refinance, pull a lot of that initial equity out, and go do another deal, and then add value and refinance and pull as much equity out as you can, and he’ll go and do another deal. Well, meanwhile he’s holding all of these properties, and they’re also cash flowing; so this is the exponential growth curve that he’s creating that way. So there are different methods to it… I honestly don’t prefer that method, believe it or not. I like the shorter sale points. I like to sell between 3 and 5 years, potentially, and move it into more investments myself. But hey, it doesn’t matter. Me versus anybody else. I just wanted to paint the picture of what this is all about, so that’s really what the blog is about.

Theo Hicks: Yeah. There’s a lot of people that I’ve talked to on the podcast that started off with a chunk of money… Usually, it’s not 500k, it’s a lot less than that. And they’re active investors obviously, but the same concepts apply; they use that 30 grand, and then they will — you call it the Robert Kyosaki’s strategy… Let’s call it the BRRR strategy. He’ll buy it, he’ll rehab it, he’ll rent it, he’ll refinance, and he’ll repeat it. And after that first investment, that repeat, you’re now using that same money again. So you’ve got a house, and you got your 30k back. The only difference now is that I have a house, plus I’ve got 30k to do it again. And so they continue to use the same money over and over and over again to build up a portfolio, while at the same time generating cash flow from those properties, so they can then use that house money to go ahead and continuously re-invest.

And as I mentioned in our conversation — I think it was last week when we talked about this… Because I remember I made the spreadsheet where we compared 401K versus investing… I remember I did it and I realized that with the 401K you can keep putting money in here over and over and over again, whereas in this scenario I’m putting in $50,000 or whatever it was, and then that’s it. I’m not investing again. So that way my net worth is way higher in this investing category, but the amount of money I’m inputting is also different; so the ROI is just massively different, because of the fact that, again, I don’t need to keep putting money into a 401K, I can just re-use that same capital over and over and over again while at the same time generating house money.

Travis Watts: Exactly. So the lesson is when you re-invest cash flow, you’re essentially reducing your risk at the end of the day. As you said, really at the end of the day this is a very simple concept. And I’m sure anybody who is professionally on LinkedIn, or I think Instagram – those are probably the two worst for being hit up by these Bitcoin and cryptocurrency traders who call themselves investors… It just drives me nuts. Maybe that’s where I derive those, because deep in my subconscious I’m angry. But you know, I just want to get the reality out there that that is not investing; if there’s no cash flow to it, if it’s speculating, which of course crypto is speculating… You’re not an investor. You can call yourself that, and that’s the problem though – there’s a lot of people that like to call themselves investors. So that’s my rant on it.

Theo Hicks: Bitcoin is the future, Travis. Don’t you know that? It’s the future.

Travis Watts: Well, it may be… But we have to acknowledge that it’s a speculative play, and that if we’re going to buy Bitcoin at 10,000, the hope is that it’s going to go to 20,000. That’s the hope, that’s the speculation. If we buy at 10, and we sit on it for 20 years and it goes to 5… [laughs] That’s the whole concept there.

Benjamin Graham has a great quote I’ll close with here on this concept. He says confusing speculation with investment is always a mistake. That sums it up; it couldn’t be more true.

Theo Hicks: Yeah, in our Three Immutable Laws post we talk about it, similar to the gambling scenario, that if you’re playing Blackjack or whatever, and I think maybe it’s talking about roulette… And you bet on black, and it happens to hit black 10 times in a row and you look like a genius, because you have 10 times your money. And then you put it all on black and then it lands on the green, and it’s all gone. You’re like, “Oh, what happened?” There’s no skill in roulette.

There’s still some skill to this; it’s not exactly like gambling, but it’s much closer. Speculating is much closer to gambling than what we talked about as investing. So is there anything else you want to mention before we sign off?

Travis Watts: Just one more quick concept… I’m sure a lot of people who are stock investors or have heard the term the lost decade in the stock market… It was just that had you bought in at a particular time in the last decade, 20 years ago actually, and then held stocks long term, we went from basically the peak of the market to financial collapse, and there would have been a 0% return in a full decade. Well, had you been invested in cash flowing anything, anything that provided interest, dividends or cashflow, like real estate, you at least would have had that. Over the course of a decade you could have potentially doubled your money, who knows?

So that’s the whole thing – I never want to place a bunch of capital on something, wait 15 years to find out if it’s going to pan out. To me, it gets back to the 401K thing we talked about earlier. But anyway, I could go on and on. But no, I don’t have anything else, so we’ll cut it off.

Theo Hicks: Perfect. Alright, Travis. Well, make sure to check out his blog post, How To Invest Like A Pro, Speculating versus Investing. I’m assuming it’s on BiggerPockets; it might be on joefairles.com, too. Travis, thanks again for joining me. Best Ever listeners, as always, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody. See you later.

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JF2270: Top 10 Changes for Real Estate Investors Under the Biden Tax Plan | Actively Passive Investing Show With Theo Hicks & Travis Watts

Today Theo and Travis will share their thoughts on the tax proposal that’s been recently released. And while this tax plan is only at the early stage, it’s important to consider the options early on.

Travis mentions ten main points that real estate investors need to examine. Most of them apply exclusively to high-income earners, but some touch on the very popular real estate policies such as 1031 Exchange that are true no matter what income bracket you’re in.

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners and welcome back to another edition of the actively passive investing show. I’m Theo Hicks. As always, I’ll be speaking with Travis Watts. Travis, how are you doing today?

Travis Watts: Theo. I’m doing great, as always. Thanks everyone for tuning in.

Theo Hicks: Yeah. Thank you Travis for joining us. Best Ever listeners, thank you for tuning in. Today we are going to be talking about taxes. Travis put together a really detailed blog post about Biden’s proposed tax plan. So the blog post is entitled “The top 10 changes for real estate investors under the Biden tax plan.” And so as always, Travis is going to talk about why he wrote this blog post, which I think is probably pretty obvious to the listeners, and then we are going over to each and of these 10 points and the different things you can potentially expect from this tax plan. So Travis, as always, why did you write this blog post?

Travis Watts: Great point. Well, I kind of did this actually as more of a special report, right? This kind of was on a whim, in addition to the regular blogs that I do. I just felt it’s timely, it’s important… And to our listeners being mostly real estate investors, this is something everybody should be paying attention to. As you pointed out Theo, this is a tax proposal; that does not mean this is the way that it is, it doesn’t mean everything we talk about in the show will happen. There are still a lot of steps that have to be taken to put these into effect. But I just wanted to take the Biden tax plan, which was released publicly for everyone to view. I extracted each component that was relevant to real estate investors, and just I threw it and a little report that’s easy to read; it’s just one through ten… I just want to help people out that way. So that’s kind of why I’ve put it together.

I guess what we can do is just go through these 10. I’ll announce kind of what each one is, how it works, that kind of thing, and then I’ll turn it over to you if you’ve got any thoughts or comments on it, and we’ll take it from there.

Theo Hicks: Yeah. Before we begin, another thing we’re going to talk about, if you just Google “Joe Fairless taxes”, we have a couple of blog posts that talk about taxes from the perspective of the passive investor… So things that we’re going to talk about today, like bonus depreciation and capital gains, and 1031 exchanges, and things like that. This is a half an hour show, we’re not going to be able to go and into the history on those, and what specifically they mean, and go over a bunch of examples… So for more information on that, check out those blog posts we have on our blog.

Travis Watts: Yes. Thank you for pointing that out. Additionally, Theo and I did a show recently on Tom Wheelwright’s book, Tax-Free Wealth, where we go into the reasons why a lot of real estate and business owners get the tax advantages. Why that is, how that works, what those numbers are. So that’s a great coupling with this episode here today.

Essentially, let’s just start from a high level. So Donald Trump passed the Tax and Jobs Act in 2017. This was a huge incentive for both real estate investors, investors in general, and businesses. It was basically just a lot of various tax advantages that you could take part in, okay? And that was to stimulate, obviously, the economy and the stock market and everything else.

Long story short, what’s happening right now is the Biden plan essentially wants to repeal it, in a matter of words. Not every single component, not all. And there are some added tweaks that have been put into the Biden plan, but essentially that’s being taken away. So not great news for real estate investors, but we’ll go through, and I’ll try to leave opinions out on this. I just want to go through the facts of what’s being proposed.

So let’s jump into the top 10. So the first one would be the elimination of bonus depreciation. That is something that came from the Tax Cuts and Jobs Act. So what this is in relation to real estate investors is, everything that you do as far as improvements on real estate has a lifespan, according to the IRS. When you buy a refrigerator, when you put in the plumbing and piping, cabinetry, carpet, the IRS has defined lifespans for these that you can depreciate them over time, right? So they’re going to lose their value over that lifespan. Even though that lifespan may not be exact. That’s how depreciation works.

So what bonus depreciation is  – just to use one example, landscaping improvements on a property. Meaning if we buy an apartment building, or we buy a single-family home, and we’re improving the landscaping, so we’re planting trees and bushes, and gardening  outside the front for the curb appeal, that has a lifespan of 15 years, just as an example.

So what happened prior to the Tax Cuts and Jobs Act is that you would have to take the cost of all of those improvements and write them off over a 15-year period, pro-rata, each year. That’s what you get in depreciation. This bonus depreciation allows you to take 100% of that. Let’s say we spent $10,000 in landscaping, we can write off $10,000 all in the first year of ownership on the property. So what that’s done, long story short, is when you file your taxes it can be quite incredible.

One thing, by the way, I forgot to mention before I jumped into all of this is that Theo and I, by the way, are not CPA’s or tax advisors, or licensed professionals, so please do seek licensed advice. All I’m doing here is taking what was made available publicly as far as the Biden plan and I’m just relaying components of that, how that pertains to real estate. As far as all the ins and outs, I’m no expert on this by any means, so just please note that. So, that’s number one. That would potentially be removed making the tax advantages of real estate investing a little less lucrative than what they have been.

And one more disclaimer on that point, that was to expire anyway I think in 2023 under the Trump plan. So that wasn’t going to be a forever thing. But it’s been quite nice as a full-time real estate investor to have those tax advantages, especially for the high-income earners that we work with, that are passive investors. So any thoughts on that, Theo?

Theo Hicks: I would just say that there is a distinction between the bonus depreciation and then the accelerated depreciation that comes from cost segregation. It sounds like for bonus depreciation – again, not a CPA – for cost segregation you need to bring in a specialist to do this for you. It’s kind of the same thing where rather than depreciating something over the [unintelligible [00:09:38].05] I think it’s like 27 and a half years, or something like that – it kind of accelerates that and reduces it to a shorter timeframe, but it increases the depreciation, which is one of the major reasons why people invest in real estate, because it will lower their taxable income. So this is not the same as that. So it’s not saying that you’re not going to be able to do cost segregations anymore; it’s just that this new bonus depreciation might go away.

Travis Watts: That’s correct. Thank you for distinguishing that. The cost segs are done by third parties, very frequently happening in the syndications phase, private placements, and things like that. Okay.

Number two is a possible elimination – this one shocked me – of 1031 exchanges. This is a very popular, widely used tax strategy among real estate investors. This has been in place, by the way, since 1921. And for those that may not be familiar, a 1031, just to use a simple example – I buy a single-family house for $100,000 today, I improve it, I hold it a few years, and now it’s worth $200,000, and I sell it… Well, then I would have $100,000 gain that I’d have to pay long term capital gains tax on. A 1031 would allow me to not have to pay that tax, at least not right now. And I could exchange that property, I could essentially sell it and buy something like-kind, or larger, and kick the can down the road as far as having to pay those taxes.

And where this strategy really works well for a lot of people that do this, it’s more of an estate planning strategy because if you kick the can, and kick the can, and kick the can, you’re just 1031-ing over, and over, and over, and over, and then one day you pass away when you’re 90 years old, whoever inherits that last property that you’re holding gets a step-up basis, which we’ll talk about that in another one of these bullet points, where they also don’t owe all of that back tax that you never paid. So it truly can be a tax-free strategy for a lifetime. So it’s really a huge thing. And with the possible elimination of that, that’s going to be a game-changer in real estate. Any thoughts, Theo?

Theo Hicks: Yeah, the way I would think about this is that — first of all, if you’ve been doing the 1031 for a long time, and maybe you started off with a $100,000 property and now you have a million-dollar property, maybe the business plan was to sell within the next 2 or 3 years, maybe considering/assuming this goes through – I don’t think it will be like an immediate thing, you’ll have a date, maybe consider figuring out a way to get into a property that you can, as Travis mentioned, hold on to a lot longer. So at least you can kind of kick the can down a little bit longer down the road, as opposed to waiting until this happens and then selling it, and then having to pay a ton of money in taxes.

So I think here it’s just a planning thing, where you figure out okay, how many properties do I have to 1031? Is there a way figure out how to get that into a big apartment that I can hold on to for a long time, or at least spending a little bit longer, maybe 1031 every 5 years or something, cutting the current period a little bit shorter, 1031-ing again and then holding out for the next 4 to 5 years and see what happens. That’s probably the strategy there.

Travis Watts: Very good, thanks for sharing. Alright, number three is a proposal to raise the long term capital gains tax rate on people making more than a million dollars per year. So why I point this out is long term capital gains and short term capital gains are very applicable to real estate and investing. So how this would work is we have tax-favored brackets for investors, as we talked about before in Tom Wheelwright’s book, and why that is is because we’re helping provide housing, and we’re doing what the government needs done, and these kinds of things. So anytime you’re going to invest in the United States in some capacity, long term, there’s going to be a tax advantage tied to that. So this probably won’t affect a ton of people, being that you have to earn over a million a year, but quite a few people that I speak to with in my network that it is going to affect.

So how this works right now as it stands, the top bracket for long-term capital gains tax is 20%, but there’s a caveat, there’s also something called the net investment income tax of 3.8%, which came in from the Obama presidency. So technically that would mean 23.8%. So here’s something to think about – a lot of CEO’s, as one example, are paid through stock options, and it’s because of the tax-favored treatment. So a lot of CEO’s take a lot less in a W2 salary because of all of the employment taxes and the tax brackets, and instead, they’ll get millions of dollars of shares, they’ll hold them more than a year, and as they need liquidity and money, they’ll sell off and they’ll pay essentially half the tax, sometimes even less. And that’s been the name of the game. So what this is going to do is really hurt a lot of CEO’s who notoriously make more than a million dollars per year.

And what this proposal would do is take that 23.8% top bracket rate and raise it all the way up to 43.4%, and that’s at the federal level. You still have a state income tax that’s applicable if you’re in a state, especially like in California or New York, that’s very high. So essentially it’s over 50% tax that a lot of high-income earners will be paying. So that’s kind of more or less what that is. Not going to affect a lot of us, but any high-income earners, that’s a huge change; that’s going to essentially double the taxable income for a lot of people.

Theo Hicks: I don’t think I have anything to add to that one.

Travis Watts: Okay, got you. Now, what we related to earlier about the 1031 exchange strategy where one day you pass away, someone inherits your property, they don’t know the tax either, so there is now a proposal to take away that step-up basis.

Let’s think about this, so if we have a parent or parents, that may be bought a single-family home to live in in the ’70s, they paid $50,000 and then today it’s worth $500,000, the way that would work is if they were to pass away and then grant you or I that property as the beneficiary, we would get a step-up basis, meaning that that property would be valued at $500,000, and if we were to sell it tomorrow, we wouldn’t have any taxable gain, because as we inherited it, the basis stepped up to 500 and it’s worth 500, so it’s a tax-free sale. With the elimination of that step-up basis, now we would have a taxable gain of $450,000 upon receiving that property, which is just incredibly crazy.

Theo Hicks: Yeah.

Travis Watts: I will leave my opinions out, but that’s crazy. So that’s one proposal there, which obviously – that’s another estate planning strategy. It’s something to think about. A lot of people don’t think about that because it’s about death; you’re technically not paying yourself that tax, but someone is. So you’re able to leave a lot less to other people. Any thoughts?

Theo Hicks: This is like The Price Is Right [unintelligible [00:16:46].06] The Price Is Right all the time, and I didn’t realize that if someone won a car, they have to pay taxes on that car. So they win this thing, like “Oh, I got a free car.” But then they have to pay a bunch of taxes on that car. I always thought that was funny. It’s like “Oh, I won”, but then “Oh, I can’t afford the taxes”, so now the car is gone.

Travis Watts: Yeah. You can’t even afford to get a free car.

Theo Hicks: Yeah. That’s interesting, I didn’t know that. So besides The Price Is Right tax, I don’t have anything to add to that one either.

Travis Watts: Alright. Cool. Number five, let’s talk about a little bit of good news here. So there is a proposal to re-implement a first-time homebuyer tax credit. I’m pretty interested in this one, because in 2009 I was the recipient of a program that had a first-time homebuyer tax credit. That’s how I bought my first property. So at that time it was an $8,000 tax credit. And the way that that one worked, that was to re-stimulate the housing market after the great recession, right? That was the purpose behind it. This one’s a little bit different.

Because our housing market has done so well, and it’s so strong, and it really isn’t in shambles, at least not today, we don’t need to re-stimulate the housing market today. But the problem now has become, is millennials and young home buyers can’t afford houses when they’re five hundred thousand, a million bucks in some of these bigger cities; it becomes very difficult to purchase a house. So the Biden tax plan is proposing a fifteen thousand dollar first-time homebuyer credit. And what I like about this is, unlike the one that I received, I had actually come up with all the money upfront, go to closing, do the down payment, make the deal happen. Then 8 weeks later they sent me a check for 8k. This one will be received at the closing table. So you don’t actually have to retroactively receive that back, you’re going to get it right upfront. And that makes sense, right? If affordability is the issue, well then you can’t afford it. So that’s kind of the change there. So that’s a great one, I really think highly of that particular aspect to the Biden tax plan. Any thoughts on that Theo?

Theo Hicks: Yes, so assuming a 3.5% down payment, that’s like a $420,000 house. So I think you said in the blog post it’s up from 8,000, so about double. So yeah this is… Okay, I’m just looking for an active perspective. This is great news for fix and flippers, because you’re going to have that many more end buyers on the back end, assuming that the property meets the requirement for… I’m assuming that it is through FHA requirements.

Travis Watts: That’s a great point though that you bring up. So unfortunately, with a lot of these tax proposals we don’t have all the details, because they’re not real yet, they’re not actually going into effect. So we don’t know all of the stipulations.

I was reading one article that said it could be up to 15,000, so maybe there’s going to be a caveat there. FHA, VA… There are different things; I don’t know, to be honest, and nobody knows. But to your point, it’s definitely going to help, no matter how you finance. Maybe it’s only available to owner-occupants, or maybe you can use it as an investor. I don’t know. So we’ll have to wait and see. But generally speaking, it is going to allow a lot of access to homeownership at the younger levels.

Theo Hicks: And house-hacking, too; it’s great for house hacking. You basically house-hack with $0 down. [00:19:55].15] there’s probably mentioned some requirements for the person borrowing. You know what, that’s definitely good news.

Travis Watts: Yeah. That’s great news. Number six – and this one gets really complicated, so I’m just going to keep it high level… But they’re looking to phase out the QBI, which is to qualify business income deduction. That was part of the Tax Cuts and Jobs Act as well. So basically anybody making over $400,000 per year, this is where you can basically deduct 20% of our qualified business income for tax purposes. It could apply to real estate or businesses, or real estate businesses… But that was just one additional, great, extra tax advantage for business owners and potentially real estate investors… So that may be taken away or phased out, at least for the higher income earners.

Theo Hicks: Yeah, I think it was the most recent best real estate investing advice ever conference… Or maybe it was two times ago, I can’t remember. But someone gave a presentation on QBI. You run a business and [unintelligible [00:20:49].18] it was pretty complicated. I really didn’t understand it if I’m being honest.

Travis Watts: Yeah. Anyone checking out the blog —  I’ve put a lot of hyperlinks in this blog, because these topics just go on and on and on with research. So click the hyperlink, learn what QBI means, figure it out.

Theo Hicks: There you go.

Travis Watts: Okay, number seven. Trump did something pretty interesting as far as the estate tax. He raised it to 11.18 million per individual. So if you pass away and you have basically 11 million dollars in assets individually, there’s no estate tax that’s due. And as a married couple, obviously, that doubles, so 22 million dollars. So quite high, probably historically maybe the highest ever, I don’t know. But that was a huge change.

So Biden has proposed let’s take that back down to 5 million. So now we are looking at, in a lot of cases, with accredited investors, real estate investors, that you may be thinking now about estate tax possibilities especially, obviously, older folks, hopefully, not the younger folks. But these are the things, guys – back to the stoicism stuff that we talked about a few weeks ago… But there’s so much out of your control; these are things you can never predict. When you’re  going to pass away, nobody knows. And what are the rules going to be at that time? We don’t know. But for anyone who’s an elderly real estate investor, this is definitely something to consider, that you got more than a 50% cut to the estate tax. Any thoughts on that?

Theo Hicks: No. I don’t think so.

Travis Watts: Okay. Pretty straightforward. Here’s a huge one, and one of the biggest – raising the corporate tax rate to 28%. So we had some of the highest corporate tax rates; and when I say corporate tax rate I’m talking primarily about C corporations, which are the most publicly traded companies. So we had a 35% tax on C corps before Trump came into office. He lowered that down to 21%, which was incredible. That’s a huge shift obviously, right? That’s almost 50% cut, which was a lot of the stimulation that we saw in the stock market and all that before COVID. Well, now the Biden plan is looking to bring it back to 28. So not back to where it was, not a complete repeal, but hey, we are in a recession now, a lot of companies are hurting badly, and now we are looking at raising taxes on them on top of that. So just be aware of that and figure out what it means for you in your portfolio. We’ll have to see.

Then also in addition to that, there’s going to be a minimum of 15% tax on corporations that have profits over a hundred million or higher, because one of the big problems that have been happening is US corporations headquartering in foreign countries that have a 0% tax, and so, therefore, they could make millions if not billions of dollars and pay no taxes here in the US. So that would change with at least a 15% minimum tax for US corporations. So that’s pretty big one. More in relation to the stock market, but I wanted to point that out.

Theo Hicks: Yeah. One thing that’s kind of related to this a little bit – I’m just doing a show on qualifying markets, so I guess I’m kind of getting ahead of myself here… But it’s really good just to make sure, in general, whatever market you’re investing in, that you’re keeping your finger on the pulse of companies moving in and out of that area… Because that has a huge impact on the real estate in the area. It doesn’t matter what asset class you’re in; for apartments, obviously, the more companies there the more jobs, the more jobs the more people have work, the more people have  work, the more they can pay their rent. So I’m not necessarily saying this is going to affect that either way, but just kind of a general piece of advice is to set up a Google alert. Just go to Google, it’s in the little dot, dot, dot at the top right-hand corner of the screen. One of them is alerts, and you can set up alerts; type in your city name, like Cincinnati, plus “business”. Cincinnati unemployment, Cincinnati new businesses, Cincinnati Fortune 500. That way, every day you’ll get emailed any news articles that reference businesses. So is a business leaving, is a business moving, is a business expanding? That’s not going to have an immediate impact like, “Oh, a business is coming here. Rents went up to $100.” But it’s more of something just to be aware of for the future strength of that market.

Travis Watts: Yup. Great point. I appreciate you pointing that out. The last two, 9 and 10, I only put them in because we have a lot of high-income earners that we work with in the syndications space, and this could be applicable to a lot of people. You probably heard Biden talk a lot about “No tax change for anyone making less than $400k per year.” Well, in some ways that’s true, in some cases that are not. But anyway, number 9 is raising the top federal income bracket back to 39.6%, which is what it was before. Trump had reduced that down to 37%, so not a huge difference, 2.6%. But that could affect a lot of people. So just know if you’re a high-income earner, there’s one more tax to put on top of it, and with CEOs and everybody else.

Number 10 is a Social Security tax would be kicked back in. So the way it works right now, I didn’t even know this, by the way, this was kind of interesting. But there’s the 12.4% Social Security tax that we pay on earned income when you’re a W2 wage earner. Well after you make $137,700 in a year, that tax drops off. You quit paying it. Well, what this proposal says is, “Yeah, it still drops off at $137,700, but if you’re making $400k or more, it comes back in the play again.” So anyone making $500k a year or a million a year, they’re going to be paying that tax again on the second half of their income-earning. These are just subtle things to think about but all in all, man, if you’re a high-income earner, look out.

Theo Hicks: Yeah.

Travis Watts: Look out for this tax plan. So that’s all the 10; as I said, the last two are really just applicable to high-income earners. But for the most part, these were the real estate related things that I could extract out of that plan. Any other thoughts, Theo?

Theo Hicks: Yes, just kind of what you said in the beginning… As we mentioned, we’re not CPA’s,  so we’re kind of just trying to give you the facts here, and then maybe explain a little bit about how we think this might impact real estate or businesses in general. But I think at the end of the day, as you’ve mentioned, it seems like it’s affecting high-income earners, and we are doing a real estate podcast, so this might affect a lot of you listening out there… So just make sure you’re talking to your CPA and kind of figuring out what changes you need to make to your business in order to reduce your taxable income to not be completely hit by this.

And kind of going back to the Tom Wheelwright book that we did, something he said that I really thought was interesting was he said, “I only have a few pages to talk about what to pay in taxes, and the rest is talking about how to pay less in taxes.” So the tax code is some crazy amount of pages long. So yeah, I’m just going to reiterate the advice I gave in the episode, which is that make sure whatever you’re passively investing in or actively investing in, make sure your CPA specializes in that. That way they will have knowledge of the tax code as it applies to whatever you’re doing. Maybe some of these things, there’s another part of tax code that you could use to offset that, or something. Again, I’m not a CPA, I don’t know for sure, but it couldn’t hurt to have a CPA that specializes in apartment syndications for passive investors, so that they can help you to reduce your taxes as much as possible.

Travis Watts: Exactly. And I was just… The other night, because I’m nerdy like this, I was watching a video somebody made. I think it was Graham Stephan video; I don’t know if you ever watch his content. He’s a realtor and the real estate investor out in California and now moving to Nevada… But a younger guy, millennial, advocate for investing, and real estate business, and all the stuff. Well, he made a video that was really cool about how to pay zero in taxes, legally. Again, he’s not a CPA either, but these are just planting seeds, right? These conversations topics to have with a CPA or a licensed professional. But it was really cool, he starts with just the standard deduction that we all get on our taxes, and then maxing out an HSA account, and for him, that was a 401K, and then a solo, and then a traditional, and then… He goes up to — I think it was like an $80,000 income paying zero in tax.

So again, it’s planting seeds, it’s not to say all of that is applicable to your or I. I know I wouldn’t do some of that stuff that you proposed, but your point is exactly on key, Theo. Find a competent CPA that you could take my blog post here, these top 10, and print it out and give it to your CPA and say, “Hey, how does that affect me or what strategies can we implement to where I do best in this new tax proposal scene.” So it’s stuff like that. But anyway, I’m going to cut that off, because I think we are over our time. But go check out the blog post. Thank you Theo for all of your insight on that, and that’s all I got.

Theo Hicks: Thank you, Travis. Again, that blog post is Top 10 Changes for Real Estate Investors Under the Biden Tax Plan. That is on the website, joefairless.com, under the blog tab.

So again, Travis, thank you so much for writing this blog post. It’s very detailed, it has a lot of hyperlinks in here for you as well, so you can go into more detail on what each of these different tax factors are. So Travis, again, thanks for joining me today. Best Ever listeners, as always thank you for listening. Have a Best Ever Day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody. See you later.

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