JF1491: Helping Investors Get The Best Financing For Optimal Returns with Doug Marshall
As a real estate professional for over 40 years now, Doug can help us learn a lot. He’s managed properties, done ground up development, and now helps borrowers get the best financing possible to optimize their returns. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Doug Marshall Real Estate Background:
- Real Estate Professional for nearly 40 years
- More than 30 years of experience financing apartments and other commercial real estate
- Author of Mastering the Art of Commercial Real Estate Investing: How to Successfully Build Wealth and Grow Passive Income from Your Rental Properties.
- Based in Portland, OR
- Say hi to him at marshallcf.com
- Best Ever Book: http://marshallcf.com/book-recommendations/
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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 the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff. With us today, Doug Marshall. How are you doing, Doug?
Doug Marshall: Hey, I’m doing really well, Joe. How about you?
Joe Fairless: I’m doing well, and I’m excited about our conversation, because Doug has been a real estate professional for nearly 40 years. He has more than 30 years of experience financing apartments and other commercial real estate. He is the author of the book “Mastering the art of commercial real estate investing. How to successfully build wealth and grow passive income from your rental properties.” Based in Portland, Oregon. With that being said, Doug, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?
Doug Marshall: Yes, I’d be happy to. As Joe has been saying, I have nearly four decades of experience in commercial real estate. I started off with a developer out of California for a number of years. He moved me to do some property management for him on class A apartments in Atlanta, Georgia, and then beginning in 1987 I permanently went over to the financing side of the business.
My entrepreneurial journey began when I started my own commercial mortgage brokerage firm back in 2003, Marshall Commercial Funding. Simply put, what I do for a living is I help real estate investors get the best possible financing for their rental properties, so they can optimize the return on their investments.
I’ve been a commercial real estate investor, both apartments and office properties since 2007.
Joe Fairless: We have so much to talk about… I am very much looking forward to our conversation. One thing that stood out to me was one of the last things you said, and that is “help investors get the best financing to optimize the return on their apartments.” Let’s talk about that… What questions should be asked in order to determine what type of financing is best to optimize the returns?
Doug Marshall: Well, that’s a good question. As a mortgage broker for the last 30+ years, I have found that most real estate investors aren’t particularly knowledgeable about the real estate calculations that are necessary to really succeed in the business. They have some knowledge of how maybe to value commercial real estate, but they generally are deficient in one or more different areas.
There’s really six different types of commercial real estate calculations besides knowing how to value real estate. You need to determine the loan amount based on the lender’s underwriting parameters, and many people don’t understand what those lending underwriting parameters are… And how do you calculate a property’s cash-on-cash return? Many people do, but surprisingly, there’s some that don’t.
How to leverage a property and how that impacts your property’s cash-on-cash return is another example. Sometimes you can over-leverage a property and actually reduce your cash-on-cash return.
And then how does loan amortization impact your investment? There’s different types of amortization methods, and surprisingly, some people don’t know what they are.
Then the minimum financial requirements lenders require of borrowers in order for them to be approved for a loan. So what I’ve done in this book that I’ve just recently completed is that I have a short ten-question quiz to find out how knowledgeable they are on these six different types of commercial real estate calculations. This gives the reader a pretty good understanding of where they stack up compared to their peers. For those questions they get wrong, I try to explain in details how these commercial real estate formulas are calculated.
Joe Fairless: I want to summarize to make sure I have them right… One is to calculate the value of the real estate, two is the loan amount based on the lender’s underwriting parameters, three is the cash-on-cash return, four is how to leverage a property and how it impacts that property’s cash-on-cash return, five is loan amortization impact on the investment, and six is minimum requirement of the… Borrowers, to be approved? Did I get that right?
Doug Marshall: That’s correct.
Joe Fairless: Okay, cool. Which one do you wanna talk about?
Doug Marshall: Well, I can talk about any one of them. I think that those are just nice guidelines to follow, and I try to explain it in detail in the book as to what needs to be done.
Joe Fairless: Okay. Let’s talk about leverage. How to leverage a property and how it impacts a property’s cash-on-cash return… And you said if it’s over-leveraged, that can hurt the cashflow. Can you elaborate?
Doug Marshall: Yes, there’s both positive and negative leverage that you can put on a property. It’s depended upon the interest rate on the loan, but also the cap rate, and they are very closely aligned. Sometimes when the interest rate is higher than the cap rate, the more leverage you put on it, the worse the cash-on-cash return, and vice-versa.
So if you have a higher cap rate property – say it’s a 5% cap rate and you have a 4% loan that you can use, then you have positive cashflow. But you have to run the numbers, you have to look at it, you have to see “Okay, at a certain loan-to-value what happens to my cash-on-cash return?” As you play with the numbers, you’ll see that as you increase the leverage, you’re gonna see whether or not it improves your cash-on-cash return… Because sometimes you have less equity that’s required as you leverage your property, and if it’s positive leverage, you’ll increase your cash-on-cash return. And just the opposite will happen if you have a negative cash-on-cash return as well, if your interest rate is higher than your cap rate.
Joe Fairless: If the interest rate is higher than the cap rate, then you would have a negative return, assuming that you operate the property similar to how it’s already been operated. But if you operate it differently, then that would change things, right?
Doug Marshall: Oh, absolutely. I’m just talking about not how you’re gonna operate the same way in both scenarios, but how you leverage it will determine your cash-on-cash return. But obviously, if you’re gonna buy a property — I was listening to one of your podcasts where… I forget the…
Joe Fairless: Theo?
Doug Marshall: He was talking about a 2% cap rate, and it doesn’t make sense to buy at 2% cap rate, unless you have the ability to have a vision for that property that will determine whether or not you can get a higher return because you know how to increase rents or lower expense, or you’re gonna improve the property’s tenant profile, whatever it might be. The vision that you have for that property will determine whether or not you should proceed.
Joe Fairless: Let’s talk about the loan amortization impact on the investment. You said there’s different types of amortization. Can you go into the most common types for commercial loans?
Doug Marshall: Well, there’s three. There’s obviously interest-only, and that’s really nice as far as optimizing your cash-on-cash return. But then you have two types of amortization methods that have different impacts, one of them being a 30/360 method, which is the traditional approach, where every month assumes a 30-day month, and then there’s the amortization where it’s called the 365 method, where — this was started about 15-20 years ago with the conduit lenders, when they saw an easy way of adding another five days’ worth of interest into the calculation for the year… So they would provide you with a better interest rate generally than you could get with a traditional loan, but it would amortize more slowly.
You just have to know over time which of those three amortization methods you want to use.
Joe Fairless: Will you elaborate a little bit more on the 30/360 and the 365? Just for someone who perhaps isn’t familiar with these types of loans, just go a little bit more high-level.
Doug Marshall: Okay. For the last 2,000 years, the traditional approach to financing was based on a 30-day month, even though some months might have as few as 28 days, and as many as 31. And it just made it easier for everyone to make that calculation. Most loans prior to, let’s say, 15-20 years ago, almost all of them were that type of amortization method. But as I said, with the actual 365 loan, things change. Instead of having 360 days, you now have 365 days; you have an extra five days of interest. So the mortgage payment would stay the same, but more would be applied to interest and less to the mortgage balance. So it slows down the amount of amortization that takes place with the actual 365 type of amortization method.
Joe Fairless: Thank you for that. With the interest-only approach, what business plan does this fit the best?
Doug Marshall: Well, I think it’s a great way to get started on a property. In the last few years especially, the lenders that I’ve gotten to, it’s not uncommon that they’ll offer two or three years or more of interest-only. The advantage of that is, if you really do take a look at your cash-on-cash return, is not quite doubled when you use an interest-only type of approach. So if it’s a little bit skinny when you buy the property as far as the cash-on-cash return, you go with an interest-only situation – all of a sudden you’re most flushed with cash; it might initially be a 4% cash-on-cash return for you. Well, if you were to go interest-only, it’d probably be close to 7% or 8%.
The advantage of that approach, Joe, is that you can make the changed necessary, especially when you have a net value added play that you’re working with. The property is maybe a little tired, it needs some renovation, and maybe you need to improve the tenant profile; it requires maybe having a little higher vacancy, because you’re moving some people out, and you’re upgrading various units, an apartment, for example… The interest-only approach still allows you to cash-flow the property.
Joe Fairless: For an investor who hears that and they’re thinking “Oh, but I wouldn’t do that, because then I’m not paying down the principle”, what are your thoughts about that thought process?
Doug Marshall: Well, that’s true, there are trade-offs between doing that… But the reality is that most investors realize that their properties are always gonna have debt on them. Very few people invest in commercial real estate apartments, office, retail expecting to eventually at some point in time to have paid off the loan. You can do that, but if you’re really trying to optimize your property’s cash-on-cash return, you’ll always have a property leveraged.
So I would not be concerned about going with the interest-only for a few years. The thing I would be concerned about though is that you have a grace period. You’ve got three years to get that property turned around. You wanna make sure that by the third year you’ve pretty much stabilized your property, rents have gone up, so that when you go back to an amortization of the loan, that your property cash-flows, so that it has sufficient cashflow that’s been generated as a result of those improvements that you’ve made over the first couple years.
Joe Fairless: Let’s go to the sixth calculation, the minimum requirement of borrowers to be approved. What’s a rule of thumb?
Doug Marshall: Well, there’s several rules of thumb for lenders. I go through it in the book, there’s actually ten different ones. I don’t have them in front of me right now, but there are ten different rules of thumb that most lenders go through when looking at a potential borrower. A couple that are most important probably is your net worth, and your net worth needs to be at least equal to the loan amount. If you’re looking for let’s say a five million dollar loan, you’d better have a five million dollar net worth.
As far as liquidity is concerned, I’ve always been surprised at how lax most lenders are on liquidity requirements. Let’s say that your mortgage payment just happens to be 20k/month; they would require a minimum of as many as nine months of mortgage payments on that particular property. So let’s say on a 20k/month payment, you would have 120k to 180k of liquid assets in your balance sheet to be at their very minimum requirement.
Joe Fairless: What are the ranges that you’ve seen for liquidity from lenders?
Doug Marshall: Well, usually it’s in that 6 to 9-month requirement. That’s what I normally see.
Joe Fairless: Okay, 6 to 9-month requirement of paying what, again?
Doug Marshall: The mortgage payments. If you have a 20k mortgage payment, you would need to have six times 20k.
Joe Fairless: As far as the net worth goes, just for clarification purposes, it’s net worth equal to the loan amount prior to closing, so the property can’t count towards your net worth. With your track record as a professional, what are some of the things that you’ve evolved in your business over the years, so that you’ve gotten better at what you do?
Doug Marshall: That’s a very good question. I think that is a critically important question. For example, first of all I’m a one-man shop, and I’m in Portland, Oregon, and I had a client that was buying an apartment in Phoenix, Arizona. I initially told him “Probably the best thing that you can do is hire someone down there to do your financing for you.” And he did that. He went down to Phoenix, he found a very reputable national brokerage house that if I told you the name you would know it, and he showed me a few weeks into it what they had offered, and I was surprised it wasn’t that competitive. I was expecting that they would know the market much better, they would have much better resources of funds available, and they really didn’t.
I said, “Let me see what I can do”, and I came up with some lending sources of my own that I’ve used traditionally, that would go down to Phoenix. But the difference between what the other mortgage brokerage firm used and myself was not so much on the actual rates and terms, though mine were slightly better, it was on the presentation. I saw what they provided, and it was like on a four-point font, and you could barely read it, and it gave no guidance as to which one they would choose, and they’d come up with eight different lending alternatives.
What I’ve been able to do is I found out exactly what the borrower was looking for, what his hot buttons were, so I was able to say “This is how much cash would be required at closing for the three alternatives that I have, this is your cash-on-cash return initially, this is what your internal rate of return will be if you choose these options.” It was like, one was spewing you with facts, and the other (myself) was providing them with the information that they really needed to be able to make a decision… So I was able to win that business, even though the national firm should have had a leg up on me for two reasons: they were local, and they had correspondent relationships with like companies that they could have gone to.
Joe Fairless: When you take a look at the real estate financing and how it’s evolved (or devolved), what are some things that are in place now from a financing standpoint that either surprise you or you would certainly take advantage of that perhaps weren’t in place before?
Doug Marshall: I will say that the financing has evolved over time, and I think at back where we were prior to the great recession – there were things that were going on at that particular point in time, even on the commercial side, but really it was the residential side where the abuses were… But on the commercial side of the business, we were in some ways way too aggressive on offering certain types of products.
In recent years, as they got out of the recession and moved forward, lenders have become a lot more conservative in their rates and terms… Even in the heyday, at the top of the real estate cycle, which we probably peaked maybe last year or maybe the year before on apartments. I’ve seen a real change in how lenders calculate what properties they wanna become involved in… But generally it’s become more conservative, and not like there’s additional advantages. Are you thinking of something else, Joe?
Joe Fairless: I’m not, no. I just wanted to hear your thoughts on it.
Doug Marshall: Okay.
Joe Fairless: Sometimes I just ask questions I have no idea which direction they’re gonna go. [laughs] You’ve got four decades, I don’t, so I figured I’d just tee it up and see where you took it. I looked on Amazon and I couldn’t find your book. Is it published?
Doug Marshall: It is not published at this particular point in time. It will be available for pre-order in June, and it becomes available — the launch date is in September for the eBook, and the paperback launch date is for December. It is being published by Morgan James Publishing.
Joe Fairless: Cool. I thought something was amiss whenever I couldn’t find it… Okay, cool. And I saw on Amazon you can pre-order and it showed the launch date December… It’s certainly a book that I’m gonna be buying, and I’ll just click the pre-order button after we get done having our conversation, so I make sure I get on that list for December.
What is your best real estate investing advice ever?
Doug Marshall: My best real estate investing advice would have to be to pull the trigger. Back in 2009, when the real estate market was in collapse, we had the opportunity to buy a property called Cedar Lane Apartments, and I had to get over the fear factor of actually doing it. Everything at that particular point in time was still in decline, it was plummeting, and actually making that decision was very difficult… Not because the property wasn’t good; the numbers showed well, and it was just getting over the fear of not following everybody else that was going on in the market… Because at that particular point in time, people were trying to sell their properties, they were trying to hunker down to some extent. Lenders weren’t lending at that time, so the best investment I’ve ever made was right at the bottom of the market… And I had to get over the fear of making the decision to go forward.
Joe Fairless: What did you buy that property for?
Doug Marshall: We bought it for $39,000 a unit, and today conservatively it’s worth about $130,000 a unit.
Joe Fairless: [laughs] Those are just stupid numbers. How much did you put into each unit?
Doug Marshall: We only put in a modest amount. It’s like probably 5k-10k/unit. It wasn’t in bad shape. We bought it at a foreclosure because the owner was taking the cashflow from that property to build a condo development that went sideways on him, and he lost the property. It was a little bit tired, but it wasn’t in bad condition.
Joe Fairless: How many units?
Doug Marshall: It was 56.
Joe Fairless: Got it, so you bought it for around 2,7 million, and now – I’m gonna enjoy doing this math… 130k times 56… 7,2 million.
Doug Marshall: Yup.
Joe Fairless: That’s a decent chunk in nine years.
Doug Marshall: Yeah, I wish all of them went like that though.
Joe Fairless: Oh, they’re not all like that? I can’t believe that. [laughs] Well, we’ll get into the opposite end of that here in the lightning round. Are you ready for the Best Ever Lightning Round?
Doug Marshall: I am.
Joe Fairless: Alright, let’s do it. First, a quick word from our Best Ever partners.
Joe Fairless: Best ever book you’ve read?
Doug Marshall: Well, the problem with that is that I love to read books, and I have over 200 listed on my recommended reading list on my website, and I would suggest that your Best Ever listeners go to my website and see what those books are… But right now, the book that I’m really fascinated with is called “Building a Story Brand” by Donald Miller.
Joe Fairless: And that’s not even on your website, for the recommended list; I’ve just searched for it.
Doug Marshall: Yeah, I’m in the process of reading it right now.
Joe Fairless: That’s awesome. Yeah, I enjoy how you structure this recommended reading list, and I see you’ve got Robert Greene, one of my favorite authors on here… I’m just kind of scrolling through.
Doug Marshall: The other thing I would tell you is that if you take a look there in the far right column, the little icon that looks like a book…
Joe Fairless: Summary.
Doug Marshall: It’s a summary, and I have about 40 books that I’ve summarized over the years… So if your listeners are not really into reading, they can click on this PDF and read a 8-10 page summary of the book, and find out if they like the topic. If they do, they can then buy the book.
Joe Fairless: That’s incredible.
Doug Marshall: So you have about 40 (almost 50 now) books that I find worthy enough to summarize.
Joe Fairless: What’s a mistake you’ve made on a transaction?
Doug Marshall: Well, I like to talk about my property that I’ve bought a couple years earlier than the Cedar Lane apartments, which was the grand slam… And I wanna let you in on a little secret, if you don’t know this one already – not every commercial real estate property that I’ve ever invested in turned out to be a home run… Now that I’ve got that confession off my chest, maybe some of your listeners can relate.
In the summer of 2007, which turned out to be about the absolute peak of the real estate market, I along with a like-minded group of investors purchased a 32-unit apartment located in a small town… And at the time it seemed like it would be a good investment. It had large unit sizes, and it was one-story buildings. It was located in a nice quiet little town, and it had the potential down the road to convert to condos. I was thinking to myself, “What could go wrong?”
Well, it turned out that a lot of things could go wrong, most of which could not have been predicted by the most seasoned of real estate investors. A couple of years ago we sold this property… And we didn’t too badly; we got a 7% internal rate of return on that investment, so it wasn’t like we lost money, but we owned it for almost 10 years… And there’s four things that I’ve found out from this property. 1) Market timing is everything; the old adage, make your money on an investment when you purchase it, not when you sell it, is very true. This investment had very little chance to perform well because we simply paid too much for it. And if we had purchased the property a couple years earlier, with a much less inflated price, we probably would have performed well.
Another lesson was that there’s a reason why properties in small markets have higher cap rates. When the economy went bust in 2008, unemployment soared, the vacancy rates rose and rent flattened or declined because of the concessions – as bad as this was in the large metropolitan areas, it was far worse in small towns, which had higher vacancy rates and struggled with more significant renting concessions.
When the commercial real estate market turned in the large cities, it was still another year or two before the small town where this property was located began to see occupancy rates rise, and you started to see rents increase again. So that’s a couple of things.
The other two things I learned from this apartment is never underestimate the cost of deferred maintenance. This was truly a value-added play and we thought we had plenty of money necessary to get these capital improvements done, and in reality we weren’t even close. The property kind of limped along because we could not put in all the capital improvements we wanted to, and we had to do it over time.
And finally, a truism that I’ve learned over the years, and I bet you’ve probably learned it as well – you need to pay close attention to your on-site manager. The old adage is you get what you inspect, not what you expect, and it’s very true. During the years that we owned this property, we had three different on-site managers, and they always started off well, but their performance was highly correlated to how well you monitored them. If you monitored them well, then things went well; if you didn’t, it went downhill.
So those are the four lessons I learned from my loser property that I purchased in 2007.
Joe Fairless: Great stuff. I wanna make sure I captured the second one – I got 1, 3 and 4… What was the second one about cap rates? What was your takeaway?
Doug Marshall: There’s a reason why cap rates are higher in small markets.
Joe Fairless: Oh, yeah. Okay.
Doug Marshall: The reality is a lot of people, especially in the last couple of years, have been chasing cap rates. “Well, I can’t buy anything in this nice metropolitan area. I’m gonna go to the small little community where the cap rates are higher.” Yeah, they are higher there, and there’s a reason for it… And really, when the economy turns, you’re gonna find out just why you shouldn’t have been in that particular small little town.
Joe Fairless: What’s the best ever way you like to give back?
Doug Marshall: Well, I have a couple of different ministries I’m involved in. I have a ministry called The Jesus Table – we provide meal and free conversations to anyone who wants to come, every Tuesday night. We’ve been doing that for about 7-8 years now.
The second one is a non-profit that’s called Fairhaven Recovery Homes. It’s a non-profit that provides a structured environment with housing for alcoholics and for drug addicts that wanna turn their lives around.
Joe Fairless: How can the Best Ever listeners get in touch with you?
Doug Marshall: They can get in touch with me by going to my website. If they go to marshallcf.com/bestever, they will see the pre-order page for my book.
Joe Fairless: Cool. Well, I’ll just go there and pre-order it through your website. Thank you so much, Doug, for being on the show. Lots of knowledge and helpful, practical tips, from how to leverage a property, how leverage affects a property’s cash-on-cash return, we talked about the interest is higher than the cap rate, it would be negative, but not factoring in the business plan, and certainly the business plan will have a great influence on that, depending on what it is.
Then also loan amortization impacting the investment. One, the interest-only approach, and then the two types of amortization – the 30/360 and the 365, and you educated us on the differences between those two… And why people would do interest-only loans on value-add deals over for a short term, as well as the minimum requirements of borrowers – the net worth equal to the loan amount, and then also liquidity between 6 to 9 month requirement of monthly mortgage payments… Plus, congrats on your 2009 deal, and congrats on the 32-unit deal that didn’t go so well and you still got a 7% IRR, and you bought at a terrible time; that’s pretty good. Plus, you got lessons learned that you’re applying towards future stuff.
Thanks for being on the show. I hope you have a Best Ever day, and we’ll talk to you soon.
Doug Marshall: Thank you, Joe. I appreciate it.