JF1011: A Rookie Mistake, a Slap on the Hand, and Credible Market Info Sources #FollowAlongFriday
Rookie mistakes happen, hear how Theo is learning the ropes on underwriting deals, you’ll get to hear about credible market info sources, and of course a slap on the wrist never hurt anyone…especially if it’s helpful.
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless and this is Follow Along Friday, where we talk about our entrepreneurial ventures. I am with the co-host on Fridays, Theo Hicks. Hello, Theo.
Theo Hicks: How’s it going, Joe?
Joe Fairless: It’s going well, and we’ve got an eclectic show today, all focused on real estate. We’ve got how to find the sources when looking up market data. We’re gonna talk about a mistake that Theo told me he made on a deal I believe that you’re working on – I don’t know what it is. We’re gonna be talking about some listener questions that you have, and also how we got our hands slapped for last week’s episode and how I think that was good feedback and I’m glad we did get our hands slapped for the approach we took last week, and how we’re approaching it differently this week and moving forward.
With that being said, what do you want to tackle first?
Theo Hicks: I also wanted to mention a new resource we have on the website, a book list. Do you wanna talk about that a little bit?
Joe Fairless: Yeah, sure. I get questions a lot about “What books do you recommend?” so we decided to create an exhaustive book list. It’s on JoeFairless.com, and in one of the headers there’s “Joe’s Recs” – just click that. You’ve got books for apartment investing that I’ve read, books on mindset, books on sales and negotiation and books on entrepreneurship. All of those categories are relevant to what we do, and those books, again, can be viewed at my website, and just go to “Joe’s Recs” and there’s a bunch of books there.
Theo Hicks: Perfect. So let’s jump into my mistake my made, so I can get that out of the way… It’s a very silly mistake, probably a rookie mistake, but… Right now I’m currently under contract for three four-unit properties, and I underwrote the deals originally based off of the proforma that the listing agent had sent me.
Joe Fairless: Oh…
Theo Hicks: I know. And I was sent the Schedule E and the leases after I [unintelligible [00:04:37].11] and I looked at them and I realized that what they did is they took — because [unintelligible [00:04:42].15] and the rents they were using in the proforma were the highest rents for the one-bedroom and the highest rent for the two-bedroom. So the two-bedroom that was rented out the highest, and the one-bedroom that was rented out the highest was the rent they had listed on the proforma, which I have used for my calculations.
So I looked at the leases and I was like, “Wait a minute… These rents aren’t even close to what they said they were on the proforma.” So I guess the advice would be — and this is an obvious advice, but don’t underwrite based off of the proforma, or make sure that you either look at the Schedule E or the [unintelligible [00:05:14].14] I believe…
Joe Fairless: Current rent roll.
Theo Hicks: Yeah, the Schedule E wasn’t necessarily a current rent roll or a financial statement, it was just their tax forms, so it just had how much income they had coming in through rents, plus all their expenses for a year, but it wasn’t broken out on a month-by-month basis. But yeah, a rent roll if it’s a large property, but for mine I just looked at the leases and saw that they were all lower.
Now, the plus is that all the rents that are below the highest number are all month-to-month, so I guess transitioning, I had a question for you today – I think this can apply to all real estate, but when you’re buying a large multifamily property or a small property that’s got multiple units, how do you go about raising the rents without overwhelming yourself with a bunch of vacancies or things like that.
Joe Fairless: As soon as we take over a property — by the way, we just closed on a property this past Friday; that’s another kind of cool thing.
Theo Hicks: Congrats!
Joe Fairless: Yeah, thank you. And how we do it – immediately, as soon as we close, our management team is outside the gate, we give them the okay, and then they come into the property and they immediately start renovating the vacant units. They also start working on any CapEx projects that the lender requires, but that’s a separate thing.
So we immediately renovate the vacant units, and then once we have those renovated, we’re able to start charging a premium, and start testing our hypothesis of what type of premium rents we can get for the property.
Now, if we have people living there – so in your case, you’ve got 12 units, so you probably have them all filled…
Theo Hicks: Yes.
Joe Fairless: Okay, in that case we do it on unit turns, and since all your people are month-to-month, you’re just gonna have to look in a spreadsheet and figure out what does your cashflow support in terms of frequency of doing those rent increases, knowing that you’re probably gonna have a lot of people move out, depending on how much of an increase that is.
With our properties, they tend to be on 12-month leases, so we just do it on unit turns; when your lease is up, you have the option of staying and living in a nicer apartment, or you have the option of moving out, depending on what you wanna do. If they decide to stay, we’re able to renovate the unit in 3-5 days, depending on the extent of the rehab.
But we’ve got a well-oiled machine on a couple thousand apartments. On a 12-unit, I imagine you’ll have — do you have a property management company?
Theo Hicks: No, I’m managing myself.
Joe Fairless: Okay, you’re managing yourself. But your plan is not to renovate the units, it’s just simply hold serve, and…
Theo Hicks: Yeah. So currently, the units themselves – they’re fine. Every single unit is basically the exact same. They all have the exact same counter, they all have the exact same cabinets, floors… Everything is the exact same, it’s just all the rents are different, just because of previous property management. So we’re not gonna go in there and renovate anything.
We’re kind of confused as to how to approach getting the rents to market value, because here’s our plan… Our plan is to go one unit at the time, starting with one building, and every month go to this person and say “Hey, we’re gonna raise your rents to $600 for the one-bedroom and $750 for the two-bedrooms”, and if they say that’s fine, then they can stay. If not, they move out and we’ll just clean it up and put someone in there right away.
Joe Fairless: Yeah, it’s just a numbers game. In addition to testing what response you’re getting with those rents… Because it’s an art and a science. You’re going to deal with people who will immediately move out, or you’ll deal with people who are like “Oh, I can’t pay this, but I can’t pay this. Would you be willing to do that?” and you’re just gonna have to make a judgment call.
So my recommendation would be to start with two units that are month-to-month, have that conversation with them, see if they both move out – okay… What does that do to your bottom line? Can you support that mass exodus to continue, or do you need to rent those units and then move on to the next one? That’s really all it is.
Theo Hicks: I had the idea of doing two, just because I know someone who owned a property in this area – I don’t wanna get into too much detail, but he had one unit vacant, and he marketed it at a rent higher than what I’m gonna market mine at, and his is literally around the corner. He had like ten people respond, and he was kind of choosing between three or four at the end, so I was thinking if we do that and I list the rent at the number one I get, I’ve got 12 people responding. I could technically have all 12 of those people take all the units that I have in there at the higher number, so that’s why I like the idea of doing at first, testing it and if we get a bunch of responses, either put them kind of on the backburner and say “Hey, if you [unintelligible [00:10:02].03] available for you in two months from now”, and then raise someone else’s rent and see if anybody else leaves… But that was just an idea I was toying with.
I didn’t want to have all this demand and not be able to fill it, because I am keeping tenants that are paying a little bit less.
Joe Fairless: Yeah, and… Holy cow, Theo. Proforma?
Theo Hicks: I know…
Joe Fairless: Proforma… [laughs]
Theo Hicks: I knew the agent, and I trusted him; I should have done that.
Joe Fairless: Well, we always need the current rent roll, we just go off of that. But they were off-market deals, they were hot, you had to act quickly, and the numbers still make sense, I guess.
Theo Hicks: The numbers still make sense.
Joe Fairless: They still make sense, you’ll be fine. It’s 12 units. It’s different if this was 150 units and that mistake happened, and you’re doing this on a larger scale… So it’s good to knock out the cobwebs with this one. I’m glad it still makes sense.
Theo Hicks: Yeah.
Joe Fairless: And when are you closing? July…?
Theo Hicks: 8th July. There’s some weird financing going on and I might actually only be able to close on two, and then I’ll be able to close on this third one a couple weeks later, just based off how this specific lender underwrites. I think this is something along the lines of when you are buying a property, in the process of buying it he only takes into account 75% of the income as income doing the debt-to-income ratio, but once you buy it, it’s 100%. So since we’re doing three, he said a calculation comes out where we’re going by two with our current income, versus all three. I was kind of confused on that, but in July we’re gonna be closing on these properties.
Joe Fairless: Okay. And I know a listener/friend of mine/investor sent me an e-mail to forward to you about his thoughts on your situation.
Theo Hicks: Yes.
Joe Fairless: Did you reply to him?
Theo Hicks: I did.
Joe Fairless: Okay, good.
Theo Hicks: What he said is… I mentioned on the podcast that me and my Marcella, my girlfriend, are gonna co-sign all the loans; that’s for alignment of interest, and that’s what we decided to do. He was saying that when you do that, that counts as a loan for you and a loan for me. So it’s not like it’s half a loan for her and half a loan for me (assuming you’re Marcella). So he was saying that it might make sense to put all the loans in her name, so that she’ll have these three loans in her name [unintelligible [00:12:12].10] she’d have seven loans left, and I’ll have ten full loans left.
What he was saying was that when he first started off, he was like “It doesn’t matter… We’re not gonna get 20 loans…”, but then once he got to the point where he needed 20 loans, he’s like “Man, I wish I would have done that!” So that was his recommendation, and unfortunately we’re gonna have to both put our names on both of these for this round, because we’re already in the process and it’ll take too long to get the loans through, but moving forward we’re gonna put them in our individual names. Thanks for that advice.
Joe Fairless: Good advice, thanks John. Sweet.
Theo Hicks: Okay, so now we’ve got a listener question about market data. The question wasn’t about what the factors are that you look at, but how you find trustworthy information. I guess I’ll run through the facts that we look at; correct me if I’m wrong anywhere. So we look at six different factors, and we’ve got a spreadsheet that we put all of these in. Number one, we look at unemployment – specifically the unemployment change over five years.
We look at population – specifically the population change over five years, and this is the city population that you’re investing in, but also the overall MSA population. We also look at the population age, to see who’s moving here and who’s leaving (five-year change as well). We look at job diversity; we wanna make sure that there’s not one industry that’s dominating the jobs, because obviously if that happens and if that goes away, that market’s in trouble.
Joe Fairless: The biggest discrepancy I’ve seen is 18% in Dallas-Fort Worth makes up the largest industry, which is the lowest I’ve seen, and Las Vegas was 27%-28% with hospitality. I would prefer not to be above 23% or so, and I’m arbitrarily saying 23% (it’s plus or minus). But just based on what I’ve seen across many markets, you wanna be 23% or less with any one industry. That way, if that industry starts to tank, you’ve got other industries that pick up the slack and you still have your residents employed.
Theo Hicks: Yeah. And along that line, we look at the top ten employers, as well. It’s similar to the job diversity, but it lets you know what the big employers are and you kind of compare that to where your property is and figure out who your tenant base is gonna be.
Then the last one, number six, the supply and demand. We look at the vacancy rates. So again, for all of these, we look at the actual number for the most recent year, but then we’re gonna look at the five-year change as well, and see if it’s trending up or down. And then finally, we look at the number of [unintelligible [00:14:45].02] permits that were submitted to see how many buildings are being made. So the vacancy is kind of the demand, and then the supply would be the number of units created.
Where do we get this data from? For most of this stuff, we actually just get it from the census. The census has all the information you’re ever gonna need about market data. What I like to do, and what I think is the most simple is you go to Fact Finder, and it allows you to just type in your city… It will have a column of all the different economic status, population, demographics, and it will give you everything you need [unintelligible [00:15:16].15] and you just click on what you want. If you wanted to do age and see what age is in the vacancy rate, you can do that and it’ll create data tables for you. Then you just click on the data tables and it shows you all those facts, and it easily allows you to just export it all to Excel. If you know how to use very basic Excel functions like sorting, then you should have no problem whatsoever sorting the data and fairing out what these five-year trends are.
So for everything that I’ve mentioned, we get all of it from the census.
Joe Fairless: And that’s census.gov.
Theo Hicks: Census.gov, yes. The only thing that’s not easily found in the Fact Finder – it took me some time to find what’s the 5+ permits created. It’s still on the Census website, you just have to do a little bit of extra searching. If you’re interested and wanting a direct link to that, I’ll just put a direct link to that one in the show notes for the podcast and on YouTube. That one took me a while to find.
Something else that we look at as well are the overall yearly market data that certain companies put together, and it’s just like a massive document that focuses on commercial on real estate, and it will focus on different markets, different types of commercial real estate, and it just kind of talks about what they’re expecting for the year, and comparing it to last year, what markets are hot…
That one is very interesting too, because it kind of compiles all the census data for all markets into one. If you’re just starting out and don’t necessarily know where to invest, you can go on there and look at what the top markets are.
Joe Fairless: What’s “there”?
Theo Hicks: The two that we use are irr.com. I’m not sure what “IRR” stands for, but they have a really good packet. Then we also use the Marcus & Millichap documents. These are like 100-page documents, but they have a lot of information, and whether you’re just starting out or you’re trying to find a new market, I would definitely recommend reading those, just in general. Just giving you an idea of what market data you should be looking at, what factors you should be looking at and how they calculate what markets are the best and what industries are up-and-coming and which ones are kind of going downhill, they’re talking about loan stuff… It’s very interesting, and it goes into certain details.
Joe Fairless: Cool. There you go, there’s the answer.
Theo Hicks: The last question we had was about how to find money for deals. We get that question a lot. If you go to our YouTube channel, just type in “How to raise private money for your deals.” We have like three or four videos on there. That was a question by Jeff M. [unintelligible [00:17:32].17] we’ve got some YouTube videos on there that explain that. So just type in “How to raise private money for your deals” either on YouTube, or you can go to MultifamilySyndication.com and you’ll find those there as well.
Joe Fairless: Cool. Okay, and as far as getting our hands slapped, what was her…?
Theo Hicks: [unintelligible [00:17:50].13]
Joe Fairless: [unintelligible [00:17:54].18] sent us a message after last Friday’s Follow Along Friday and she said something like… Why don’t you read it?
Theo Hicks: “A fair of this show is talking about sports…”
Joe Fairless: “Sports” was all caps I think, too…
Theo Hicks: [laughs] Yeah… And at the end there was a point, but Lord, it took forever to get there.
Joe Fairless: I hear ya. I hear ya loud and clear. We got off track… I got a little bit excited about playing basketball against Theo and losing every time and trying to beat him; we got off track. This is a no-fluff show, so we will keep it focused on real estate, and it’s always good to get constructive feedback… Because you could have worded it in a much meaner way, and I appreciate you not saying it in a meaner way; I appreciate you being constructive about it, so I hear ya.
With that being said, we’re gonna play after this. If you’ve got the score and who wins, we’re giving away a free book to whoever is the closest to the score; we’re playing to 13 and we have to win by two, so just say who’s gonna win and the total score, and you’ll get an autographed book, our volume 1 and volume 2 from us for whoever is the closest.
We had a winner this past week. Theo, what was the score?
Theo Hicks: 13-8.
Joe Fairless: Theo beat me last week 13-8. I’m getting closer and closer. I beat him in Horse, and I got smoked on the last game, 13 to…
Theo Hicks: Two!
Joe Fairless: Oh, god. So maybe I’m regressing, who knows? But I’ve got a secret weapon coming up on this week’s game.
Theo Hicks: I can’t wait!
Joe Fairless: Yeah, I have been practicing. Okay, anything else?
Theo Hicks: No. Do you have anything else you wanted to talk about?
Joe Fairless: I don’t believe I do. I hope you enjoyed the show. Best Ever listeners, have a wonderful rest of your week or weekend, and we’ll talk to you soon.
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