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. 

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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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JF2325: 20 Markets to Buy Multifamily in 2021| Syndication School with Theo Hicks

 

In today’s Syndication School episode, Theo Hick discusses the best 20 markets to buy multifamily properties. He also shares the 3 rules that will keep your investments safe and sound no matter the current state of the economy. As long as you’re buying right, your deals will be well-maintained even during the time of economic uncertainty.

Theo based his list of 20 trending markets on the annual report put together by PWC and the Urban Land Institute. Over 3000 real estate professionals have been interviewed in order to put together an in-depth report.

To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit 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 Syndication School series, a free resource focused on the how-to’s of apartment syndication. Although this will be released in about mid-January, this is my first time recording in the new year, so happy new year’s, happy 2021, and thank you for tuning in.

Today we’re going to pick up right where we left off in 2020 by talking about the how-tos have apartment syndications. Make sure you go and check out some of the older syndication school episodes that we released in 2020, and also in 2019, and maybe even 2018. I’m not sure how long I’ve been doing this for now, but lots of valuable information, as well as lots of valuable free resources to download. These are PowerPoint presentations, how-to guides, Excel template calculators, things that will help you along your apartment syndication journey.

Being the new year, I thought it’d be great to kick it off with an episode that talks about some of the markets to look into 2021. So 2020 has been a pretty crazy year. We talked about the impacts of COVID19 in real estate in general, and some of the projected changes. We did talk about some of the information on particular markets, but today I want to go through a list of some of the top markets to buy multifamily in in 2021.

Now, one of the things that we talked about a lot on Syndication School are these three immutable laws of real estate investing. And the entire concept behind these three laws, which as a refresher, are 1) buy for cash flow, not appreciation, 2) secure long term debt, and 3) to have adequate cash reserves. Now, the idea behind all these rules is that no matter what the condition of the overall real estate market is, you’re still able to maintain your existing portfolio, and then based off of the three rules, being involved with buying allows you to buy new deals. And so follow these rules all the time; you can buy deals during a recession, which we’re technically in right now, and the deals you bought prior to the recession we’ll at least maintain and not be completely destroyed during a recession. And again, when you think about these three laws, the whole point is that you can still buy real estate, you can still buy multi-family, you can still invest during these downturns, during these periods of uncertainty, as long as you’re buying right.

And what I’m going to talk about today is evidence of that point, that you can continue to buy during recessions, downturns, whatever you want to call it right now; we’ll call economic uncertainty. Periods of economic uncertainty. So this is based off of a very lengthy report, that’s over 100 pages long; I highly recommend reviewing it, and I’ll link to it in the show notes of this episode. It’s called The 2021 Emerging Trends in Real Estate. This is an annual report put together by PWC and the Urban Land Institute.

I really like this idea… They essentially interview a bunch of real estate professionals, and then the ones that they don’t interview, they’ll send surveys to. And they do this for over nearly 3,000 individuals. So they say that they interview 1,350 individuals, and then they surveyed another 1,600 individuals. These are people who own commercial real estate, or develop commercial real estate, work for some sort of advisory firm… They are passive investors in commercial real estate, they’re like investment managers, advisors, banks, lenders, homebuilders, land developers, REIT companies… It’s incredibly a broad spectrum of commercial real estate. And they ask them a bunch of questions on what they think is kind of going on, and then based off of the 3,000 or so responses they get, they put together this really detailed report. They also obviously pull data from the Bureau of Economic Analysis, US Department of Commerce, some of the big commercial real estate reporting firms out there, and they put together a really nice report.

And the one thing I wanted to focus on today, as I mentioned in the beginning, are what are some of the markets that we should be looking at in 2021? More specifically, what they did is they asked all of the respondents to let them know, “Okay, so based off of all these major metropolitan statistical areas, MSAs, would you recommend that people either A, buy, B, hold, or C, sell their properties?” And so for all the markets, they compiled all these responses. So out of 100, what percentage said that you should buy real estate in this market? What percentage said “Well, you shouldn’t buy. If you have an existing property, you should probably hold and not sell.” And then “No, if you hold property, you need to sell and get out of this market.”

So these are the markets that all these different active real estate professionals think and recommend that people buy in in 2021. So I’m going to go over those today. This is specifically for multi-family. They have a breakdown of the same survey for other commercial real estate niches, like office, and retail, which – for retail, obviously, not a lot of buy here; a lot of sell actually. They have the top 20 here for retail, and number 20 is 0% buy. And the most is Orlando, which is 28%  buy; it’s kind of interesting.

Same thing for hotel, and then they have other rankings for markets. But again, I want to focus on the buying multi-family. So according to these experts, what are the top 20 markets that experts are recommending that you buy in? And of these top 20, more than 50% of the respondents said you should buy multi-family. And to put that in perspective, for office, for retail, and for hotel – I think they have one other one on here, which is industrial. But for office, for retail, and for hotel, the number one market to buy in, for all three of those, is less than 50%. So office is 45% in Salt Lake City, Orlando, 28% for retail. And then for hotel, it was 23% at Fort Lauderdale.

And so the number one market to buy in for those three asset classes, so less than the top, say, 15 multi-family markets to buy in, with industrial obviously being kind of, in a sense, better and more attractive, and more recommended than multi-family. We’ve talked about it on the show in the past before. So without further adieu, let’s jump into these actual markets. But the whole point of that is just introducing the fact that hey, multi-family is doing a lot better than these other asset classes. And these experts are predicting that it’s still going to do well in 2021.

So number one is going to be Raleigh, Durham, North Carolina. 72% of the respondents recommended buying multi-family in Raleigh, Durham. 20% said you should hold, and 9% said to sell. So that’s the number one market.

The next two are tied for second. Still very high recommendation, at 67%, buy in Tampa, St Petersburg, and Salt Lake City. For Tampa, St. Petersburg, 30% recommended to hold, and 2% recommended to sell. For Salt Lake you have 27% hold, and 6% sell.

In fourth place is going to be Austin at 63% buy, 28% hold, and here we see a pretty high sell of 12%, relative to some of the other ones on this list. Only a few of them have a double-digit sell recommendation. But still the majority think that Austin is a good market to buy in.

This one kind of surprised me, but Boston comes at number five. Boston, Massachusetts at 60% buy, 32% hold, and 9% sell. Now, for some of these, they actually don’t add up to exactly 100%, right? 72 plus 20, plus nine is 101%. I think they rounded these without a decimal point. So they’re all within one percentage point of 100%.

Number six is going to be Boise, Idaho. Now, if you remember from some of the rent analyses that we did in late 2020, Boise, Idaho experienced the greatest rent growth out of any major market since the onset of the COVID-19. I’m pretty sure it’s a double-digit rent growth percentage. So clearly, Boise is going to be on this top list of places to buy, with 59% recommending to buy, 34% recommending to hold, and 6% recommending to sell.

Next we have Nashville, Tennessee, 59% buy, 37% hold, 4% sell.

Next, coming in at number eight we have a repeat in North Carolina this time, it is Charlotte, North Carolina at 56% buy 36% hold, and 8% to sell. Number nine, we’ve got our first repeat for Texas, which is San Antonio, which is 55% buy, 35% hold, and 10% – so another double-digit, but still relatively low to sell.

And then rounding off the top 10, which is one of the only places on this list where no one recommended that you sell – it was a 55% buy, 45% hold, Columbus Ohio. So no one recommended that you sell in Columbus, Ohio. So that is the top 10. Again there’s Raleigh, Tampa, Salt Lake City, Austin, Boston, Boise, Nashville, Charlotte, San Antonio, and Columbus.

So kind of really all over the country. A lot of southern states, but also you’ve got Boston which is Northeast, you’ve got Boise which is in the West, and then you got Columbus in the Midwest. So really kind of all over the place. It’s not necessarily focused on one particular section of the country.

So I’m going to quickly go through the next 10 to round off the top 20. So at number 11, Washington DC at 54% buy, 43% hold, 3% sell. 12, Fort Lauderdale – 53% buy… I’m just talking about the buy here. I want to do all this. So, Fort Lauderdale, it was 53% buy, 39% hold, 8% sell. Atlanta 53% buy, 33% hold, 14% sell. Phoenix 52% buy, 30% hold, 15% sell.

And then the last location that the majority of respondents recommending to buy would be the Inland Empire, which is parts of California, 51% buy, 42% hold, 7% sell. Now the last one, Phoenix – that actually has the highest of these top ones, highest percentage of sale; but obviously, they’re only featuring the top 20. A lot of these markets are going to have a pretty high sell, but they  don’t include those ones on the list. So of the top 20, 17% recommending selling in Phoenix; that’s the highest one.

Next we got Long Island at number 16, which is 46% buy, 54% hold, and then another 0% here for selling. So Columbus, also Long Island – they’re not recommending that you sell. Either buy or you hold. 17 is Cape Coral, Fort Myers, Naples, so third is Florida on the list, in addition to Tampa, St. Petersburg and Fort Lauderdale. It’s 44% buy, 50% hold, 6% sell.

Back to the Midwest in Indianapolis at 44% buy, 56% hold, and the third one on our list where no one says to sell, also in the Midwest (I guess Wisconsin is technically Midwest), Madison, Wisconsin, at 43% buy, 57% hold, another 0% sell. And then lastly, number 20 is Virginia Beach, Norfolk at 33% buy, 56% hold, and 11% sell. So those are the top 20 markets to [unintelligible [00:16:57].21] real estate, but multi-family in 2021.

Now kind of going full circle back to the beginning, back to those three unbeatable laws of real estate investing… Just because 72% of people say you should buy in Raleigh, Durham, it doesn’t mean you should buy every deal in Raleigh, Durham, right? You still need to do your market analysis that we’ve talked about before, and you still need to buy right, you still need to underwrite, you still need to follow the Best Ever practices we’ve talked about on this show. But at the same time, you want to set yourself up for success by buying in a solid market. So these are forecasts, right? These are recommendations from experts. These aren’t, again, guaranteed. Raleigh, Durham is not guaranteed to be the best market. It’s not like — in Columbus they say no one should sell, but then if you own a property in Columbus it doesn’t mean you shouldn’t sell, right? It all kind of depends on where you’re at in your business plan, and things like that. But at the end of the day, the idea behind all this is “Okay, here are some of the top-rated markets.” So if you’re in them, great. If you’re focused on them, great. If you’re not focused on them, you might want to consider looking into these.

I might do some future episodes going more in-depth on this report, because there’s a lot of solid information on here; it’s really long, and I don’t expect every single person listening to this to read all 112 pages. So maybe I’ll do that for you, and we can dive into this on future Syndication School episodes as it makes sense.

So yeah, thanks for tuning in. Make sure you download this report and at least go to the multi-family section of this report, or at least read the key highlights of the executive summary to get an idea of where we’re at as it relates to real estate in general… And more particularly commercial real estate, and even more particularly, multi-family real estate. This link will be in the show notes.

Until next week, make sure you check out some of the other Syndication School podcast episodes, download all those free documents that we have available as well at syndicationschool.com. Thank you for listening, as always have a Best Ever day, and we will talk to you tomorrow.

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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.

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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JF2318: Red Flags to Avoid When Presenting New Deal to Passive Investors| Part 4 of 4| Syndication School with Theo Hicks

In today’s Syndication School episode, Theo Hicks shares the most common red flags that you should recognize before presenting syndication deals to potential passive investors. Not every red flag is a deal-breaker if presented the right way.

In this series, Theo lists 26 common red flags that stand in the way of finding investors and closing deals. To learn about the rest of them, make sure to check out the other three parts. 

To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit 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 Syndication School series, a free resource focused on the how-to’s of apartment syndications. As always, I’m your host, Theo Hicks. Each week we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy. For a lot of these episodes, we’ve given away free resources, free documents; these are PDF how-to guides, PowerPoint presentation templates, and most of them are Excel calculator templates that you can use to help you along your apartment syndication journey. So make sure you check out our previous Syndication School episodes; all of those free documents are available at SyndicationSchool.com.

Today we’re going to conclude the four-part series that focused on some of the things to avoid when you are underwriting and then presenting your new deals to investors. So these are things that you want to proactively address, that your sophisticated passive investors are going to recognize or look for when reviewing a deal. So they might have a checklist of things in their mind, and say “Okay, I’m not investing in deals that have these red flags.” So my goal for this series was to present to you what those red flags are, so that you can avoid them whenever you are underwriting deals and presenting them to investors, or at the very least understand why they’re red flags, and then maybe there’s a reason why you’re doing this, and you can explain that to your investors.

Not every single one of these things is a deal-breaker. Some of them are. A lot of them are just things that investors are going to ask, and so they make you look more professional if you’ve done these things already, that way they don’t have to ask.

So let’s jump into where we left off, which is at number 17 on our list, which is in our category of the pro forma. So the proforma is going to be your income expense projections broken out by line items for each year of the hold period. And then usually, it’s compared to the T-12 and/or the T-3, which is the trailing 12 month of income and expenses, or the trailing 3 months annualized of income and expenses. So when you are putting together your proforma, here are some of the things that you want to think about.

The first that’s gonna be a red flag – and again, this is 17 on the list – is that there are large variances between your projections and the actual T-12 or T-3, and there’s no explanation for why there’s a big difference. So a T-3 and a T-12 column is gonna include the most up-to-date information on the actual income and actual expenses at the property. And then next to that is gonna be your year one projections, year two projections, year three projections, year four projections. So since it’s presented in that fashion, investors are gonna very quickly look down and say “Okay, let’s take a look at the T-12 expenses, and then take a look at the year one expenses… Oh, wait a minute. Why is May’s repairs so much lower in year one? I’m gonna mark that down and ask the syndicator. Why are taxes so much higher? Why is insurance so much higher?” Things like that.

So to proactively address that, have a column to the right of the proforma, or you can have a footnote section at the bottom of the data table of the proforma explaining all of your assumptions for every single line item. So for gross potential rent – why is year one projections way higher than the T-12? Well, see rent comps for this explanation.

Why is concessions zero, whereas they’re paying X dollars per year in concessions? Well, the plan is to burn off concessions, because they’d been giving concessions for whatever reason.

Why is vacancy higher year one, and then not as high in year two and year three? Oh, because we’re doing renovations, and we assumed a higher vacancy rate during renovations. Why is maintenance and repairs so much  higher in the T-12 than on the year one projection? See cap-ex budget for deferred maintenance investment. Things like that. So any line item. There should be an explanation, even if it’s just same as T-12, or same as T-3. Or based off of current expenses, based off of current income. And for any differences, there should be an in-depth explanation as to why that is. If that’s not there, it’s gonna be a red flag for your investors.

Now, more specifically on the proforma would be the real estate tax assumption. So whenever you’d buy a property, you take a look at the T-12 and they’re paying 100k/year in taxes. And that’s based off of the current assessed value of the property. Usually, what happens after you buy a property with a new  purchase price, the taxes are reassessed based on the new purchase price, and then go up, usually, assuming the property was sold for more than it was bought. When that’s the case, taxes are gonna go up, which is why you can’t just set the year one and on tax assumption to the taxes on the broker’s proforma, or the taxes that the current owners are paying. You’re gonna need to determine what the tax rate is in that market, and then create your tax assumptions based off of that and your projected purchase price.

Again, in some cases it might be the same, but especially in the past five years and now, taxes are gonna go up, because of how much values have increased over the past 10+ years. So if you are assuming that the taxes are the exact same, that’s gonna be a red flag to your investors.

The last proforma red flag, which is something that if you’re a Best Ever listener you’re not gonna be doing this, but it’s still possible… And that would be not having a reserves budget. Now, you’re gonna have your upfront reserves budget, which I talked about last week a little bit. This reserves budget is the ongoing reserves budget. Now, most lenders require this anyways, so it’s gonna be included regardless. If you’re getting a loan, you’re gonna have to include a reserves budget, because your lender is gonna require it each month… So just make sure that you’re including this on the proforma, so they know that this is an operating expense. To not include that to make the net operating income look higher, and in reality you’re spending extra tens of thousands of dollars a year to the lender for the reserves budget… So make sure you’re including that in there if you’re securing debt.

That one’s not that big of a deal, because as I said, you’re gonna have to do it if you’re getting debt… But if you’re not getting debt – you’re either buying it all cash or something, or the lender does not require this, make sure you’re still saving some of the cashflow each month into reserves.

Okay, the end is in sight… Next category is rental and sales comparable properties red flags. So whenever you are doing any deal, you’re gonna have sales comps. These are comparable properties that have sold recently, and use that to determine if you’re overpaying for the property or getting a discount… So the sales comp that sets the market rates for buying. And then rental comps are gonna be comparable properties that you use to determine what the market rents are at the subject property.

So some red flags when it comes to these types of properties would be number 20 on your list, which is not actually a comparable property. So in your investment summary you should include your rent comps and your sales comps, or what properties you used to determine your purchase price, in part. Or what properties you used to determine your rental rates. And these properties should actually be comparable.

So when we’re talking about the sales comparables, a comparable property is gonna be a property that is similar to the subject property in its current condition. So not in its value-added condition, when it’s done with your value-add program, but in its current condition what are similar properties, that are in the same condition, that have sold. They should offer similar types of amenities; it’s not gonna be the exact same, but if a comp has a clubhouse and a pool and a fitness center and a Amazon package center, and free parking, and a barbecue area and a dog park, and then the subject property has none of those things, it’s not a sales comp.

This should have been sold within at least the past couple of years; It shouldn’t be a sales comp from ten years ago. So those are the three main criteria for a sales comp. For the rental comp, the comparable property should offer similar types and quality of amenities as the subject property once it’s stabilized and upgraded. So unlike the sales comp, this rental comp should be the final product. So once you’re done doing all of your upgrades to the property, your value-add business plan is completed, what’s that property gonna look like at that point – find properties that look like that. Similarly for the interior; it should be the same as well.

So the quality and types of upgrades to the amenities and the quality and type of unit interiors should be the same, or at least very, very close to being similar. And then the units at this rental comp property should have been renovated and rented within the past few years at most, ideally more recently… Because you don’t want a property that was fully renovated five years ago. You want a newly-renovated property, because you’re is gonna be newly renovated.

And then something else that’s important too would be that the fees that are included in the rent or excluded from the rent are the same. So if you plan on billing back utilities to the residents, the rental comps should also bill back utilities. So these are what make a property a comparable property, and if they do not meet this criteria, it’s a red flag.

Number 21 on our list is going to be that the market leader that your subject property that you’re buying, rental premiums are going to make it the market leader in rents, or the purchase price is going to make it the highest sales price per unit in the entire market. So assuming that you’re using the comparable properties, then in order to determine your rent premiums, you’re going to take the average rent per square foot of the rent comps, and then the price that’s the average sales price per unit, and get an average number. And then for the rent comps and for the sales price, based off of that average number, you’re gonna determine a rental rate assumption, as well as a fair market offer price.

Now, you should not be assuming that you’re going to achieve the same rental rates as the market leader, or rental rates that are above the market leader. Similarly, you should not have the deal under contract for a price per unit that is equal to or above the most expensive property that sold recently. Instead, they should both be closer to the average, or even better, below the average. So the sales price – that means you’ve gotten the deal below market value, and for the rents, it means you’re being very conservative in your assumption. If you are the market leader in rents or you’re the market leader in sales price, that’s a problem; that’s a red flag that your investors are going to be concerned over.

And  then last in this category would be that the comparable property is not actually near the subject property. So we talked about the material characteristics of the property, and we also need to talk about the location where the property is.

For both the sales comps and for the rental comps, they need to be near the property. And then the bigger the market, the closer it needs to be. If you’re in a rural market, in the middle of nowhere, it might be hard to find a comparable property within a mile of your subject property, so that’s fine. Or maybe you’re in a very unique part of a major market, that there aren’t a lot of comps on the water, on a lake, and there aren’t a lot of lakes nearby, so you need to find a property on a lake further away, or maybe even in a similar market across the country… But if you’re in a big market like Dallas, Chicago, or any other major market, it should be very close. It might even be on the same street, but at the very least, it should be in the same neighborhood, and then if not, in the same submarket. But if you’re investing in Dallas, you shouldn’t have one comp that’s in Fort Worth, another one that’s in Garland, Texas, and maybe another one that’s way out in a rural area somewhere. If that’s the case, if they’re all over the place, it’s a red flag.

Alright, the last section is gonna be the other red flags that don’t really fit any of these categories, but they’re still going to be things that you want to avoid when you’re creating your investment summary in particular. Number 23 on the list is that it’s a short investment summary. So your investment summary needs to be long, because it needs to proactively address any potential question that one of your passive investors might ask. The more information you include in your investment summary, the better. The less questions that the passive investor has to ask you, the better for you, because it saves you time, plus it shows that you’re a professional, experienced person that knows what information to include… Which means that your investment summary shouldn’t be ten pages long; it should even be longer than about 20 pages long… But anything less than that is a huge red flag.

24 is going to be not having a Risks and Disclosures section. Since you are raising money, you are working closely with your securities attorney, and in order to make sure you’re going by the book, there are lots of risks and disclosures you need to provide to your passive investors in that private placement memorandum.

Now, the investment summary is technically like a marketing piece, so you don’t need to include [unintelligible [00:16:32].17] but you should. That shows that you’re a professional, that shows that you’re working with your experiences securities attorney, it shows that you’re transparent, which overall builds trust with your investors.

25 may seem minor, but it’s still a pretty big deal, which is typos. So you’re dealing with hundreds of thousands of dollars, millions of dollars of people’s capital. If you can’t review your investment summary to make sure that there aren’t any typos in it, that shows that you don’t pay attention to details, it shows that you’re maybe inexperienced and you lack professionalism, which might be a problem.  Now, if you’ve got one typo in a 100-page document… But if you’ve got typos on every page, it’s a pretty big deal.

And then lastly would be not including any case studies. The case studies, assuming you’ve done deals before, will explain the deals you’ve done, and that should include your return projections, the actual projections, and if they sold or not. That will give your investors an idea of how aggressive you are on your return projections for this current deal, based off of if you’ve exceeded, or met, or under-delivered on previous deals. Plus, it shows that you’ve done this before and this isn’t your first deal.

So assuming you’ve done a deal before, make sure that those deals are included in your investment summary. But hopefully, they’re good deals. If they’re not, make sure you have an explanation as to what happened.

So those are the 26 red flags. I’m gonna quickly go over them, and then we’re going to wrap up this four-part series.

So the number one red flag, stagnant or shrinking population. Number two, stagnant or shrinking rental rates. Number three, low absorption rate. Number four, no neighborhood or submarket-level data. Number five, population demographic doesn’t match the property. So those are all the market-related red flags.

For the business-related red flags, number six, the property doesn’t match the business plan, and number seven – it truly isn’t a value-add deal or it truly isn’t a turnkey, or it truly isn’t a distressed/opportunistic deal.

Next, under projected returns red flags we’ve got 8) you’re guaranteeing a return, and 9) you are not providing a sensitivity analysis.

Under debt, 10) the total loan term is less than two times the business plan. 11) There’s no cap on the adjustable interest rate loan, and 12) you are including the refinance or supplemental loan proceeds in the return projections.

Under the purchase and sales assumptions red flags we’ve got 13) the exit cap rate is equal to or less than the in-place cap rate. 14) there’s a very aggressive revenue growth assumption. 15) you’re using the same vacancy rate during and after renovations, and 16) no contingency cap-ex budget. And 16.a) would be not having an upfront operating reserves budget.

Under proforma red flags, 17) no explanation for variances between the proforma, so your projections, and the T-12 or T-3, what’s actually going on on the property. 18) Real estate tax assumptions is the exact same as the T-12 taxes, and 19) no ongoing reserves budget. Under rental and sales comparable properties, which we’ve talked about today, is they aren’t comparable properties. 21) You’re assuming you’re gonna be the market leader in rents, or you have a property under contract at the market leader’s sales price per unit, and number 22) comparable properties are not nearby the property you’re buying.

And then the other red flags is 23) a short investment summary, 24) no Risks/Disclosure section, 25) typos, and 26) no case studies.

So those are the major red flags, 26, to look out for, to not do when you’re underwriting and creating your investment summary. Now, again, I said earlier, not all these are gonna be complete deal-breakers. One typo is not gonna result in you not doing the deal. Some of these other ones, like maybe not explaining every single item on the proforma… But most of these are major red flags, so make sure you’re avoiding these when you’re underwriting and when you are presenting your deal to your investors.

Thank you for tuning in. Make sure you check out parts 1-3 – this is part 4 – of the 4-part series, where we go over the red flags to look out for, the holes to poke in your underwriting. Besides those episodes, make sure you check out some of the other episodes we have on the how-to’s of apartment syndications. Download our free documents at SyndicationSchool.com.

Thank you for listening. Have a best ever day, and we’ll talk to you tomorrow.

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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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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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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JF2311: Red Flags to Avoid When Presenting New Deal to Passive Investors| Part 3 of 4| Syndication School with Theo Hicks

In today’s Syndication School episode, Theo Hicks shares the information about the purchase and sale red flags that can turn potential passive investors away from your syndication deal.

In this series, Theo lists 26 common red flags that stand in the way of finding investors and closing deals. To learn about the rest of them, make sure to check out the other three parts. 

To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit 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 Syndication School series, a free resource focused on the how-to’s of apartment syndications. As always, I am your host, Theo Hicks. Each week we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy. For a lot of these episodes there are free documents for you to download, especially for the first batch of episodes we did, where we walked through the entire syndication process in extreme detail, from A to Z; from being a complete noob, to selling your first deal.

So all the documents that were given away in that period are something that can help you on each step along the way in the process. And then every once in a while we give away free documents for episodes where we go into more detail on those steps… But those are all available at SyndicationSchool.com.

So we are in the midst of what was originally a three-part series, and depending on how long we go today, it might be turning into a four-part series, about some of the red flags when you are presenting a deal to your investors/originally underwriting your deal.

So these are things that a sophisticated passive investor is going to very easily recognize when they’re reviewing your deal as a red flag, and will either ask you what’s going on  here, to which you should have a good answer, or they just won’t invest at all, and you won’t hear from them, at least for that deal. So these are things that you want to avoid at all costs.

In part one we started out by talking about the market red flags. These would be 1) a stagnant or shrinking population, 2) a stagnant or shrinking rental rates, 3) a low absorption rate, 4) not including an analysis on the neighborhood or the submarket that the property is located in, but only the overall MSA, or the city, or even the state… I don’t think I’ve ever seen someone just say “Hey, I’m investing in this property in Dallas, Texas. Look how great the state of Texas is”, and that’s it. But I’m sure it’s possible.

Number five would be the population demographic doesn’t match the property. And then in part two we began by talking about business plan red flags – the property class doesn’t match the business plan – and then number seven would be that it’s not actually a value-add, or it’s not actually a turnkey, or it’s not actually a distressed or opportunistic type deal. It’s something else.

And then we talked about projected return red flags. So number eight overall would be guaranteeing a return, or guaranteeing anything to your investors… And then number nine would be not performing a sensitivity analysis, which is when you adjust different assumptions you’ve had –  the best-case scenario and worst-case scenario – and then present the best case, the worst case, and the baseline scenario to your investors.

And then we concluded part two by talking about debt red flags. So this was number ten, a total loan term that is less than 2x the business plan. So that would essentially be a turnkey when you plan on selling for value-add, and distressed when you plan on being done with all the renovations. Debt two times that length.

Number 11 overall was not buying a cap on an adjustable interest rate loan, and then number 12 would be including the refinance or supplemental loan proceeds in the return projections to your investors.

So parts one and two were  the first 12 red flags. We’re going to knock out as many as we can today in part 3, and then as I mentioned in the beginning, potentially go into a part four to conclude.

For now, let’s go on to part 3, but make sure you check out part one and part two, where I go into a lot more detail on those first 12 red flags that I talked about.

To kick off part three, let’s start talking about the purchase and sales assumptions red flags. This is something that [unintelligible [00:07:37].24] but again, we’re looking at this from the perspective of your passive investor – what are the things that you typically present to your passive investors, that you wanna make sure are conservative.

Now, on your end, we’ve talked about at length how to underwrite a deal properly, so we’re gonna go over some of the main assumptions that you make, and what would be considered a red flag or a hole in your underwriting, that a passive investor will definitely identify when reviewing your investment summary, because this information is either included and a red flag, or it’s missing, and is therefore a red flag.

So again, these are the assumptions you make when you’re underwriting a deal for the purchase and for the sale of the property. The first one, potentially the most important one – because this has the biggest impact on the returns – is going to be the exit cap rate. So the red flag would be the exit cap rate equal to or less than the in-place cap rate. So when you’re underwriting the deal, you input all your project assumptions; you input your proforma for every single year, what you think your operating income is going to be, and base off of that you hit the 7%, 8%, 10% preferred return to your investors. And if you’re doing a value-add or opportunistic deal, then once you sell, based off of that forest appreciation, based off of that value added via the increased net operating income, now that new year 5 (or whatever year) net operating income is going to be used to determine what the sales price is going to be.

Maybe you project to have a 50% return at sale. But if you change it change the cap rate just a little bit, that 50% return might be a 40% return, or a 30% return, or a 20% return. Or a negative percent return, depending on how high the cap rate is and how high the net operating income is.

So when you buy the property upfront, the in-place cap rate is set based off of the purchase price, and then the in-place net operating income. Or sometimes it’ll be based off of the purchase price, and then the stabilized net operating income. So essentially, what cap rate are you buying the property at?

If it’s  a really distressed deal, sometimes the in-place cap rate will be based on what the market cap rate is for similar deals that recently sold, based on the final product. So if you plan on renovating up to a class A, then you wanna look at other class A product at that time to see what cap rate they’re trading at. That’s the in-place cap rate – the cap rate you buy the property at.

Now, on the backend you want to estimate to the best of  your ability an exit cap rate. That is the cap rate in this future time, that will be used to determine the value of the property. Now, the red flag here being that you assume that the in-place cap rate is the exact same as the exit cap rate. Or you assume that the exit cap rate is less than the in-place cap rate, which is even worse… But just assuming that, in the first scenario, the market is the same at sale as at purchase; the second scenario, where the exit cap rate is less than in-place cap rate, you’re assuming that the market is better at sale than at purchase, which is totally possible.

It’s totally possible that you buy during a recession or you buy at a time where cap rates are really high, and then five years later the cap rate is actually lower. So not only do you get the value from the increase in net operating income, but you also get the increase in value from the reduction in the cap rate, because there’s an inverse relationship between the value and the cap rate.

But what if the cap rate doesn’t go down? What if the cap rate goes up? Well, then the return projections that you provided to your investors are gonna be way off in the wrong way. As opposed to saying “Okay, right now cap rates are 5%, and it’s possible the market keeps chugging along, or it’s possible that things get better… But to be safe, we’re assuming that the market is actually going to be worse at sale.” So a rule of thumb would be 0.1% every year. So if the in-place cap rate is 5%, you’re selling at year five, then you’re assuming an exit cap rate of 5.5%. Some people will go even higher than that, some people have a different way of calculating it, but in general, that’s a rule of thumb, 0.1% every year. That way, if the cap rate is still 5%, or 4.75%, or 4,5%, then your returns are off, but they’re underestimated, as opposed to overestimating your returns.

So a huge red flag is when you’re underwriting, you’re assuming that the exit cap rate is going to be better than the in-place cap rate. And then it’s also a red flag – still big, but not alarm bells going off as DefCon20 would be if the exit cap rate is equal to the in-place cap rate. So that’s number 13.

Number 14 is another assumption that you make, which is the revenue growth. This is separate than if you’re doing a value-add, or a distressed play, where you are renovating the property, and then renovating the interiors, and then you are raising rates based off of that. I’m talking about the natural revenue growth that you’re underwriting into the deal based off of the various rental forecast predictions and inflation.

Traditionally, apartment syndicators will assume a natural revenue growth of 2%-3% every year, and the same thing for the expenses. Now, sometimes you might come across a deal where you’re reading the OM, and the broker is telling you that “Oh, we’re assuming a 5% revenue growth every single year, because the past five years rents have grown by 10% every year. So we’re being conservative in saying 5%.” Well, just because you see that, as a syndicator that should be a red flag; when you’re [unintelligible [00:13:05].13] similarly a passive investor who is reviewing your deal will see that as a red flag.

So if you say that rents have grown by 10% every year for the past five years, and they’re projected to grow by 10% every year for the next five years, and you’re being conservative and assuming a 5% revenue growth every single year, you’re not being conservative. You don’t want to be aggressive with your revenue growth, for similar reasons as exit cap rate – what if those projections are wrong, and it grows by 3% instead of 5%? Then your returns are way off in the wrong direction, as opposed to if it actually ends up being 5% and you assumed 2% or 3% – well, there you go. Icing on the cake for your investors.

So make sure you’re being smart with these revenue growth assumptions and you’re not basing them off of forecasts or basing them off of the standard 2% to 3%.

Number 15 is going to be about the vacancy rate assumptions. This is assuming you’re doing a value-add or a distressed business plan; a red flag would be having a vacancy rate that’s the exact same the entire time. So year one, year two, year three, year four, year five, 5% vacancy rate, regardless of what you’re doing to that property. [unintelligible [00:14:16].03] that’s not actually the case, because when you’re doing a value-add deal, you go in there and just by taking over the property, and you start doing your exterior renovations right away, some of the residents are going to get the hint that “Okay, this new owner’s in here, they’re making the property look nicer… They’re probably at some point gonna do this to the units too, and I’m probably not gonna be able to afford that new rent, so I’m gonna move out. I’m gonna month-to-month lease, and I’m going to give my notice, or I’m going to just skip and just disappear, or somewhere in between. Or at the end I’m just gonna leave and not renew.”

So from  that you’re going to get some skips, and some people leaving, so that’s going to increase vacancy… And then once units begin to be turned over, as opposed to just going in there and maybe slapping on a new coat of paint and redoing the carpet and putting  a new renter in there, which might take a week or two, you need to go in there and renovate the entire unit. So it’s gonna be vacant longer.

So because of those reasons, you may even force vacancy up, where you go in there and everyone who’s on a month-to-month lease, you’re giving them a notice to vacate. So because of all these different reasons, when you’re doing a value-add business plan you want to assume a higher vacancy rate during at least the first year, maybe even into the second year.

And even if the current vacancy at purchase is 5% or 3%, it doesn’t matter. If you plan on going in there and doing renovations, expect tenants to leave, and expect units to be vacant longer. So you need to account for that in your underwriting.

So if you have in your investment summary that you plan on renovating 100% of the unit in two years, and the vacancy is gonna be 5% during those two years, as well as 5% afterwards, that’s a problem… Because you need to be assuming a higher vacancy rate – 8%, 10%, maybe even higher, depending on the market occupancy during your renovations. That way, if renovations go faster, if no one skips, if everyone’s willing to stay and just have their units renovated while they live there, and the vacancy ends up being 5% or lower, that’s great. But again, if it’s not, then you’ve already accounted for that in your returns to your investors.

The last assumption we’re gonna talk about would be your cap-ex budget. So even if you’re doing a turnkey deal, there’s gonna be some cap-ex expense. For the turnkey it might be very minor; maybe you repair a couple of small things, or maybe you’re just going to rebrand into something new, or whatever…

So there’s usually gonna be a cap-ex budget for everything, and then obviously for value-add it will be even bigger, and for distressed it will be the biggest. So this is important for all business plans, but probably the most important when you’re doing any sort of renovations.

So this budget is going to include – let’s just take a value-add, for example. It’s going to take all the costs to update the units, to replace whatever you’re replacing, to add the new stuff, and then the labor costs. Similarly for the exteriors, or any deferred maintenance – you’re gonna have the materials and labor costs. Any amenity upgrades – materials and labor costs.

You don’t wanna stop there though. You wanna also have a contingency for if something goes wrong. Again, the heavier the value-add, the more important this contingency budget is, because you’re not going to 1) know every single thing that’s wrong with the property before you buy it. 2) You’re not gonna have the actual quotes from contractors until after you buy that property. So you can get estimates from contractors, you can have an estimate based off of previous deals, but at the end of the day it’s still a pretty big unknown. So give yourself a 10%-15% buffer, which means that you have a 10% to 15%  contingency budget, so that you say “Okay, I plan on spending a million dollars on all these different things, but I don’t really know exactly how much this contractor is gonna charge, and maybe they’re breaking into a few walls and they might find issues back there… I’m gonna have an extra 150k just in case.” If it’s not used, that money goes back to your investors anyways. But if you need it, then it’s there to use.

So a big red flag is if you don’t have a contingency budget included in your budget. 10% to 15% is pretty normal… And again, this is on top of any operating reserves that cover any sort of shortfalls at the beginning of the business plan because of vacancies, and lower rents, people leaving, and things like that.

So I think we’re gonna stop there. We’ve kind of talked about that one a lot. We’re going to complete in part four the remaining red flags. We’ve got ten red flags to go. So we’re going to talk about red flags on your proforma, and then red flags in the rental and sales comparables.

So we’re kind of going in order of how these variety of things appear when you’re underwriting, as well as in the investment summary.

So that concludes this episode. Make sure you check out parts one and two, where again, we talked about the red flags as it relates to markets, business plans, and the projected returns, and the debt. Today we talked about the purchase and sales assumptions used when underwriting, and the next episode, part four, we’re gonna talk about the proforma, the rental/sales comparable properties, and then other red flags that couldn’t really fit into any of these categories.

Until then, check out our other episodes, download the free documents… Have a best ever day, and we will talk to you tomorrow.

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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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JF2304: Red Flags to Avoid When Presenting New Deal to Passive Investors| Part 2 of 4| Syndication School with Theo Hicks

In today’s Syndication School episode, Theo Hicks shares information about the red flags that can cost you the potential passive investors’ interest and turn them away from the deal.

In this series, Theo lists 26 common red flags that stand in the way of finding investors and closing deals. To learn about the rest of them, listen to the other three parts. 

Click here for more info on groundbreaker.co

To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 


TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners, and welcome to the best real estate investing advice ever show. I’m Theo Hicks, and today I’ll be speaking with Nathan Britten. Nathan, how are you doing today?

Nathan Britten: I’m doing great. Thanks for having me on, man. I appreciate it.

Theo Hicks: No problem. Thanks for joining us. A little bit about Nathan, he is a full-time insurance broker and a part-time real estate investor with five years of real estate experience. His portfolio consists of two flips and one rental. He is based in Oklahoma City, Oklahoma, and his website is www.pi-ins.com/nathan-britten. Just go to the show notes and click on his website. It will be easier that way.

Nathan Britten: [laughs] Yeah, I’m sure everybody’s writing that down, letter for letter.

Theo Hicks: Alright, Nathan, do you mind telling us some more about your background and what you’re focused on today?

Nathan Britten: Yeah. So I graduated from OU in 2014, with a degree in entrepreneurship, and that’s not a very common degree, but generally speaking, it’s kind of general business… Essentially, we started companies basically each semester and pitched to investors and banks and tried to prove viability, stuff like that. So that gave a lot of good background and training into sales and general business. After I graduated, I started a CNG conversion business with my dad, which was converting vehicles to run on natural gas. We sold that about two years once oil and gas was going down, and got out of that.

I knew of a guy who worked in insurance in Oklahoma City, and I was just kind of exploring all my different options, and interviewed with them. It was kind of the entrepreneurial spirit of being able to create your own book and go out and build your own thing, but kind of under the scope of a company, but haev a lot of freedom and a lot of freedom to do whatever you do in a great business. So with that, I got into running a lot of property for insurance, a lot of single-family investors, large schedules, apartment schedules… And being in Oklahoma, that’s a little bit more challenging than other places to ensure things. So with that, I met a lot of good contacts, I got involved a lot in real estate investing groups, and kind of learned from them and picked up some things along the way, and decided to kind of do my own things.  It really came out of needing a place to live… And it’s like, “Well, I guess we’ll just buy a house.”

[unintelligible [00:05:40].21] I guess what brought me to there, but I got into a deal that was a short sale. It was terrible, kind of a drug house almost, not in good condition; I turned that into basically a flip property. That was my first endeavor in that, and that’s kind of where it got me to this point of what I do now… And obviously, full-time as an insurance broker for a lot of property risks… And then now I just basically do it in my free time, just looking for deals and flips and other rentals.

Theo Hicks: So for your insurance job – that’s providing insurance for real estate, right?

Nathan Britten: Primarily, yes.

Theo Hicks: Interesting. It’s the first time I’ve heard of someone getting into real estate through insurance.

Nathan Britten: It’s an unusual path, and reall, because a property is not everyone’s favorite thing to do for insurance. It’s just something that I was kind of naturally drawn to. We’ve got a really great program now that we write nationwide; we probably have about 20,000 rental properties in there, and a great apartment program as well… So I’ve got to get my own plug in here – anybody looking for single-family rentals or apartment quotes, I’m your guy.

Theo Hicks: So when people are kind of first starting off, there are usually two philosophies. The one philosophy is after they’ve gotten interested in real estate, their main focus is to quit their job and then do real estate full time. And then there’s the other philosophy that’s “I’m going to keep working, and then do real estate part-time, because of the benefits of having a full-time job.” So from your perspective, is your plan to eventually do real estate full time? Or do you plan on doing it with this full-time job? And then whatever your answer is, why do you select that route?

Nathan Britten: I think there’s a line that you cross once you either have a certain amount of funds, or you have a model that you’re going after, and a situational job that would force you to go full time into real estate investing. Insurance is one of those, where – as I was mentioning earlier – there’s a lot of flexibility, a lot of freedom. And that’s what allowed me the two flips that I’ve done thus far. Granted, they were pretty close to my office, but I was spending primarily all my time during the day managing contractors and projects at the houses, and I can still get most of the insurance stuffs done through my phone. So it gives me that kind of freedom.

But eventually, I do enjoy investing in real estate and doing those types of projects more than insurance… But that’s the thing that provides me my money to do that. So there’s a line, I think it’s probably a money line; not to say you can’t go out and raise some money and partner with people, different ways to do that. But for now, what works best for me, and kind of how I see it for the foreseeable future is to keep the insurance boat rowing, and invest in real estate on the side, and kind of have the best of both worlds.

Theo Hicks: What would be your recommendation to someone who wants to get started in real estate, and they have a full-time job, but it’s not like yours, where it’s very flexible. Let’s say they have a full-time job and they’re in an office; they have a non real estate related full-time job. They’re in an office – I guess not now technically not in the office, but they need to be in front of their computer or in an office starting at eight o’clock, and they can’t get off until five o’clock. What would be your recommendation to them to get started?

Nathan Britten: Well, you’re going to have to delegate a little bit; if you buy a rental, you’re probably going to have to hire a property manager. I don’t have a property manager personally, just because I’ve just got one rental and I handle that pretty well, and they’re five minutes from my office if they ever needing anything. You’re going to have to put in some overtime. You can’t be looking for deals and meeting with people during your work hours. That’s a little bit of conflict of interest. The boss probably wouldn’t appreciate that.

But after hours – the internet is 24/7, so you can get a lot of stuff done on the internet, I’m sure you know, Theo. And as far as a lot of those real estate investing clubs – they meet after hours, and you can learn a lot there. Obviously a lot of books and articles and websites like BiggerPockets, where we connected… You can get a lot of information that way. As far as if you were to do a flip, that’s pretty tough, because I personally like to be very hands-on… And I don’t know everything off the top of my head, to tell you, “Hey, go do this and do it this way.” I need to be there. And if you ask me a question, I can answer it, say how I want it. But that’s going to be a lot more hands-on, so I probably wouldn’t go with the full flip… Otherwise, it’s going to either take way too long, or it’s going to be way too troublesome, I think, if you’re not actually there.

Theo Hicks: So obviously, it’s very difficult to do the flip. So if you did not have this insurance job, would you have not done the flip? Or would you have been willing to change to a more flexible job to do flips?

Nathan Britten: I would have found a way. I’m just kind of a problem solver by nature; this just happened to be the way I did it. I think if I was tied to a desk, eight to five, I don’t think I could do that for very long. I would probably be out in I would say less than a month, of that kind of situation. And I think I would have gone more towards drop that eight to five, go full-in on real estate, because obviously, I’m young, I can take a few more risks… I would figure out a way to raise some money and partner with people, and… I’m just a problem-solver by nature, so whatever situation I feel like gets thrown at me, I’d figured out a way to solve it and make it work.

Theo Hicks: Let’s talk about your rental. So you mentioned the first flip – did you go in with the intention of living there and it turned into a flip?

Nathan Britten: Yeah. I actually did live there for a bit.

Theo Hicks: Was it like a live and flip?

Nathan Britten: Yes. I got it on a short sale, which I had no idea what that meant, and I don’t think my realtor really did either. So I wasn’t very well-prepped for it. And I had a lease ending this month, and it ended up taking much longer to get the property actually closed. And once we did, I was like, “Man, we were right on the line here.” [unintelligible [00:11:48].18]  $30,000 and basically a full remodel of this place into one month. And we ended up doing it. And I was there pretty much all day, every day. It was definitely trial by fire… And I really enjoyed it, I thought it was awesome. And then it turned out exactly how I wanted it.

I kind of combined a few different of the entryways into real estate investing… I had a buddy who’s in med school, he was renting from me and basically paying my mortgage for it too at the same time, once we got it finished. So we did that for a couple of years and ended up selling it for basically double for what we had into it. So it was a good deal.

Theo Hicks: And then after that flip, was the rental next, or was the rental the third deal?

Nathan Britten: The rental was next. It was actually a place next door, and I just had been keeping tabs on it. It was a great area. I essentially did my exact same deal of how I bought this house, the first flip, and just bought the one next door. It was in even worse condition, and I had a little more time to evaluate the area… And obviously, now I have my contractors that I trust and know they can do good work, and more of an idea of what it would take to do this. So I got that fixed up and ready. Not as nice as the first one, because I knew I was going to be renting it, but I’ve had pretty much the same tenants in there for coming up on three, four years now.

Theo Hicks: You said it was next door… Was this something that you kind of just waited for it to go on the market? Or did you actively pursue this deal?

Nathan Britten: I did actively pursue it. I knew that they were renting it, and I didn’t like the neighbors. I didn’t like the renters. They were terrible. I think it was a drug house. And it was just a situation poorly kept, and I just reached out to the guy who owned it, found him online and was like “Hey, man. I live next door. I like this house, I’d like to buy it from you.” And it just turned out to be a situation where they were kind of a hassle for him. So we bought it, got some new renters in there and it worked out. But I definitely had to pursue him.

Theo Hicks: Did you use the same contractors on that deal that you used in your first deal?

Nathan Britten: Most of them. They’re not general contractors, but I just know a lot of people that do a lot of that type of work. As for bigger companies, I’d say ‘Hey, man. Do you know anybody that can do this?” And then they would refer me to someone that way. But for the most part, it’s kind of the same crew; a couple of different changes, but kind of the same crew.

Theo Hicks: So those contacts – that was from your insurance shop?

Nathan Britten: I’ve grown up in Oklahoma City my whole life, and my dad was in sales, so he just knows a lot of people around town… And that’s kind of how I came into contact with other people. And then they were nice enough to say “Hey, yeah. This guy’s great for this. Go ahead and use them.” It wasn’t really interfering with their business; he was one of their subcontractors,

Theo Hicks: Circling back to the rental really quick. So you call the guy, was he “Yeah, I’ll sell it to you right away”, or did it take some convincing?

Nathan Britten: Oh, it took some convincing. And I really kind of overpaid for what I thought was market, but it was a deal I saw long-term value in. I knew there was a commercial development going into the end of the street, and really that was my main driver. I was like, once this actually gets approved, then everything on the street – it’s really going to increase the value. So I was like “Well, I’ll overpay now for the market value, and I’m going to hold it for a long time, and I’ll be covering my holding costs anyway…” So yeah, it made sense to me.

Theo Hicks: That was my next question – so eventually he agreed to sell it. How did you determine the price? You said it was a little bit over the market. So a two-part question – how did you figure out the market, and then where did that over-the-market price come from? Was that just what he wanted?

Nathan Britten: I’m not extremely educated in real estate. So there’s a lot of terms, and outside factors, and equations, probably that I’m not familiar with… What I always boil it down to is, okay, what’s our average price per square foot around here of what sold recently, and then what’s on the market below that? And I’m not scared of an ugly-looking house, where nothing works. I think the two that I’ve done are some of the worst that you can do, as far as keeping the existing structure, and not just knocking the thing down and building it back up. So that’s never deterred me at all.

So I really just look for the worst house in the neighborhood, and if the price per square foot is right, then what I’ve done in my past is basically use a construction loan to do the costs. And then I know that my after renovation value is going to be enough to get my equity, and I’ll be set that way. So I boiled it down to price per square foot in the area and tried to find the crappy ones, and then go from there.

Theo Hicks: And what about the rehab cost? Do you typically know that before you buy? Or is that something that’s more narrowed down after you put the property under contract? Or is it not until after you buy it?

Nathan Britten: I can ballpark it before, depending on the projects that are needed. A lot of stuff you can research online and make a couple of calls to your contractors, and if you have the right people come out and inspect it beforehand, you’ll know exactly what you’re going to do before. And I try to jam in as many people as possible. Realtors hate me, because I try to jam in as many people as possible in that inspection period, and I try to extend the inspection period for as long as possible, so that way, I’m basically risk-free in my evaluation of this house, and I can just basically have all my guys come in and bid it during the inspection period. So that’s my plan about it.

Theo Hicks: Yeah. And then the construction loan, the down payment – is that just money you have saved up from work?

Nathan Britten: Yeah. I’ve got saved up from work and we sold our business, I had some funds there… And I just always lived pretty cheap as it is, so yeah. And I’ve got pretty good banking relationships as well around here, so been kind of flexible with me on down payment stuff as well. So it’s really just — if you find a good banker that can do that kind of stuff for you, that’s really, really valuable.

Theo Hicks: Okay, Nathan. What is your best real estate investing advice ever?

Nathan Britten: I could go basic and say buy low, sell high, but… I guess figure out the lowest barrier of entry, with the highest ceiling at the end of the project; that’s probably what I would say, especially just starting out. And anybody who invests in real estate kind of has the same mindset of “I want to make money in a way that’s passive. I want to make money in a way that is a little bit unconventional.” So the end goal, I think, for most people is making money. So if you’re just starting out especially, just find that lowest barrier of entry with the highest upside… So that’s the expanded buy low sell high.

Theo Hicks: Alright, Nathan, are you ready for the Best Ever lightning round?

Nathan Britten: Let’s do it.

Theo Hicks: Alright. First, a quick word from our sponsor.

Break: [00:18:34][00:19:17]

Theo Hicks: Okay, Nathan, what is the Best Ever book you’ve recently read?

Nathan Britten:  Recently read… I kind of went back into the archives a little bit and re-read How to Win Friends and Influence People, Dale Carnegie. And that’s not necessarily real estate focused, but the practices in there of dealing with people – you have to deal with a lot of people in real estate and just in life in general, and learning how to understand people and how to treat them, that’s key.

Theo Hicks: If your business were to collapse today, what would you do next?

Nathan Britten: So if insurance collapsed… Yeah, I think I would probably partner up with my family and we would probably start a real estate empire. I’d just go full bore at it.

Theo Hicks: What is the Best Ever way you like to give back?

Nathan Britten: Probably my favorite was Big Brothers, Big Sisters. Great national organization, still really involved in Oklahoma. It’s just awesome giving back to kids that haven’t been really been given a fair shot, for whatever reason, and being able to mentor them, and just be there for them to talk to them. Really cool, really rewarding.

Theo Hicks: And then lastly, what’s the Best Ever place to reach you?

Nathan Britten: Probably my cell phone. 405-802-9930.

Theo Hicks: Alright, Nathan, thanks for joining us and walking us through your journey from entrepreneurship degree in college, to insurance, to real estate. We talked a little bit about how to navigate getting into real estate while you have a job. So if you have a flexible job, then you’ll be able to work on things like flips during the day. If you don’t have a flexible job as a nine to five, and you’re not like Nathan, you [unintelligible [00:20:52].23] at the desk, then you have to put in time after hours, put in overtime, have property management. But if you’re like Nathan, you don’t like nine to five, and you’re young, and you can take risks, then you could just not work at all and go straight into real estate.

We talked about a few of his deals; his first deal with a short sale, a kind of live and flip that he sold for two times what he had into it, and his next deal was a rental that was actually the property next door. So I don’t think I’ve talked about this in a long time, but a really good way to find off-market deals is to buy the property, whether it’s a single-family or massive apartments, buy a property on that same street, because you kind of already have that credibility from owning something there. So they can look at this property –  and I’m sure in Nathan’s case, seeing a dump turned into a really nice property, they’re more willing to sell to someone like that than some random person they’ve never met before.

So he kind of walked us through his business plan with the construction loan, bringing as many people as he can during the inspection period to make sure that the rehab costs are super accurate, having good banking relationships to get those good loan terms, and then to determine the offer price using the average price per square foot on recent sales. So the sales comparable approach, in a sense.

And then lastly, his Best Ever advice was for those looking to get started, find that lowest barrier of entry, so that $30,000, $50,000 house that’s in horrible condition, because it has not only the lowest barrier of entry, but also the highest best potential exit, and the most upside. And then he gave us his phone number; if you want to learn more about him and his business, talk to him, text him.

So Nathan, thank you for joining us. Appreciate it. Enjoyed our conversation. Best Ever listeners, as always, thank you for listening. Have a Best Ever day, and we’ll talk to you tomorrow.

Nathan Britten: Awesome. Thanks, Theo. Appreciate it.

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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.

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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JF2297: Red Flags to Avoid When Presenting New Deal to Passive Investors | Part 1 of 3| Syndication School With Theo Hicks

In today’s Syndication School episode, Theo Hicks shares some information on putting together an investment summary and presenting it to passive investors. The three risk points of the deal are the market, the team, and the business plan. In this series, Theo will be talking about the red flags that can show that the deal might not be the best, and how to approach them when writing a deal summary. 

 

To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

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TRANSCRIPTION

 

Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.

Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.

 

Theo Hicks: Hello Best Ever listeners and welcome back to another episode of the syndication school series, a free resource focused on the how-to’s of apartment syndications. As always I’m your host Theo Hicks. Each week we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy. And for a lot of these episodes, especially the first batch of episodes we released, say first fifty or so episodes, we gave away some free resources, free documents with those. So make sure you go to syndicationschool.com and check out some of those earlier episodes, as well as more recent episodes too, and download all of those free documents we gave away; very helpful when starting and growing your apartment syndication business.

Today we’re going to kick off a series – it’s most likely going to be a three parts series – on some red flags when underwriting an apartment syndication deal. I wrote a very long blog post from the perspective of the limited partners on identifying holes or red flags when reviewing an investment summary document.

The idea is that your passive investors are not going to be experts on real estate investing. And the purpose of you creating the investment summary is to provide them with that data, which you know how to find, in a simple summarized format, so that they don’t have to go out there and do it themselves, right? They can just trust that you pulled the correct information and that you’ve included everything that you need to include on the investment summary, all that the data that they need in order to determine how to invest.

But you might have some passive investors who will simply scroll down to your returns section and say “Okay, they’re offering a 20% IRR, a 15% IRR, and a 10% preferred return… So, yeah, I like the returns, I’m going to invest.” Whereas on the other hand, on the other side of the spectrum, you might have passive investors who read every single word of the investment summary and then send you an email with a bunch of follow up questions they have on where you got these numbers from, why isn’t this included in here, things like that.

So what I wanted to do for this Syndication School series was to talk about the same concept of red flags when underwriting, making an investment summary, but from the perspective of you, the GP, the sponsor, the apartment syndicator, so that you can make sure you’re including all of the relevant information in not only your investment summary, but also in the conference call.

So we’ve done episodes in the past on the new investment offering conference call, how to put together an investment summary, but this is going to expand upon that and go over when you’re reading your investment summary, or when you’re making your investment summary, what to think about, how to proactively address things that a very detailed, meticulous passive investor is going to ask.

I’ve broken these into a couple of categories. So we’ve got market, red flags, business plan red flags, projected return red flags, debt red flags, purchase and sales assumptions red flags, proforma red flags, rental and sales comparable property red flags, and then some other miscellaneous red flags that do not really fall into any of the other categories. And so obviously, some of these are red flags that would come up based off of things you’ve done prior to identifying a deal, so I guess we are going to be covering more than just a deal, but also the market a little bit, as well as the business plan.

Now, keep in mind that the three risk points of the deal are going to be the market, the business plan, and the team. On most, we can maybe talk about a little about the market, but when it comes to the team, we have other episodes on that, on how to make sure you’re setting yourself up for success based off of your background and experience and knowledge, your partner, and the other various team members. But mostly, this is going to focus on “Okay, I’ve identified a deal, I’m making the investing summary… How do I make sure that I can, for one, save time without having to answer a bunch of questions from my passive investors if I left some things out? And two, how can I make sure that not only am I addressing those concerns, but in the eyes of the passive investor they see this opportunity and think that it’s a good deal.”

So let’s start off with the market. Obviously, the market is going to be the geographic location that the subject property is located in. Obviously, the first red flags for your market would be if they don’t meet the criteria we talked about in the previous Syndication School episodes on qualifying the market. The first thing would be the overall population, so are the people in the market going to be your customers? If you’re selling some widget, then you need to figure out who your demographic is that’s going to buy this widget; those are your customers, right? So in this case, your widget is not a widget, but an apartment unit. And in order to determine how many customers you have and if your customer base is growing or shrinking, you need to know what the population stats are historically, and then the projected population stats for that market.

Obviously, the more people that are in the market, the more people that are competing for apartments, and the higher the rents go; the less people competing for apartments, then you as an operator would need to do lower rents or offer concessions to attract the limited customer base. So you want to see a positive net migration, which is more people moving in than are moving out. And if it’s not the case, if it’s stagnant or shrinking then that’s going to be a red flag.

So if you don’t include any information about the population in your investment summary, by default your passive investor is probably going to think that “Well, there’s a reason why they’re not including that, and it’s because the population isn’t growing or it’s shrinking.”

So make sure that number one, you’re investing in a market that’s growing, and then when you are, include that information in your investment summary. Same thing for rental rates, same idea. You want to see an increase historically and forecasted, in rental rates in the average or median rent for the market; and then if it’s decreasing or stagnant, then that’s an issue.

So the rule of thumb here would be you want to see rental rates increasing by 2% to 3% every year in the years prior, maybe the five years leading up, and then 2% to 3% annually in the future is ideal. We’ll talk a little more about those percentages and where are those come in to play in part two or part three, when we talk about the rental comparable properties.

Another important factor when analyzing a market is the absorption rate. Another red flag would be a market with a low absorption rate. Like the population and like the rental rates, the absorption rate indicates the supply and demand of a market. So for multi-family, for apartments, the absorption rate is going to be the measure of newly created apartments that have been rented over three months. So for Q1, how many new apartments came online? And then of those apartments that came online, what percentage of those were rented in that 3-month period? So you’re never going to see 100% absorption rate, because that means that every single unit that came online during those three months, including the one that came online the day before in that three-month period was rented. That’s not going to happen.

So when it comes to the absorption rate, there’s two things you want to look at. Number one, you want to look at the absolute absorption rate for the market, and even more ideally, much greater than the national average absorption rate for multi-family. But then just like the rental rates and the population, you also want to take a look at the trends, so you want to take a look at the historical trend, where is the absorption rate going based off of where it’s been. And you want to see an absorption rate that is increasing, which again, indicates that there’s more and more competition, more and more customers to fulfill the supply that’s coming online.

Whenever you see a low absorption rate or a decreasing absorption rate, it may indicate that the market is in or entering into a state of hyper supply. So they’re building too fast, too many new apartments are coming online compared to the demand for apartments, whereas with the opposite case is that they can’t keep up with the demand. Typically, if it’s hard to build new apartment units, you’re going to see a very high absorption rate.

So low absorption rate – pretty big red flag; it might be something that you want to consider including in your investment summary. And of course, there’s other demographic information as well, like unemployment and economic diversity and things like that. So, same thing – any positive aspect of the market, you want to include that in your investment summary. Why did you pick this market? Why do you like this market? Let them know in as much detail as possible.

Now, another thing to consider – this is number four on my list – is not including neighborhood or sub-market-level data. So if you remember, [unintelligible [00:13:15].28] let you know that in the episodes where we talked about analyzing and qualifying the target market, you start off by looking at the overall MSA and city-level data. So you look at Dallas-Fort Worth, Houston, Orlando, and Tampa. It covers a pretty large geographic area, and we kind of want to take a look at what’s the average demographic, economic data, employment data for all of the submarkets in that overall MSA. And then after we pick the top MSA’s, then we say “Okay, well the averages are really high here. So let’s dig into more detail to figure out which neighborhoods are actually exceeding that already high average.” And then those are the neighborhoods and the submarkets that we want to target.

So you don’t want to just stop at the MSA or the city level, you want to take it a step further and go down into the submarket, and then in this really big markets, these really big MSA’s you want to dig into the neighborhood-level detail as well. So for the population trends, for the rental trends, the unemployment, absorption, economic, employment data, you not only highlight, again, the overall MSA, but also the neighborhood and talk about how much better this neighborhood is than the already better total MSA. Because what happens is if you just focus on Dallas-Fort Worth, or Tampa, St. Petersburg, Clearwater, your passive investors aren’t going to know “Well, okay, we’re not buying an apartment that’s a million units, covering the entire state. We’re investing in a particular neighborhood, so what are the demographics there? Is the population growing there or is it decreasing?”

So that savvy passive investor is going to put up an alarm in their mind if you don’t highlight and focus on the actual neighborhood. And to make sure for the absorption rate — they might not have the absorption rate for a neighborhood level, but at least the rental rates, the population, unemployment, things like that, you should find data for the neighborhood first, and then make sure you’re including that information in the investment summary to proactively address that in the minds of your investors. If you don’t, well that’s a red flag.

Now, something else that’s important that we haven’t talked about, and it’s kind of a subset of the population, which is going to be the population age, or the dominant generation in, again, the overall market, but also in the submarket. So, right now we’ve got on the younger end Gen Z, and on the higher-end baby boomers, and in then in between that is Millennials and Generation X. And all four of those generations want and desire different types of rental housing. So when a savvy passive investor is looking at your deal, they’re not just going to see “Okay, well the overall population is growing. That’s great.” Well, no. “I want to know what parts of that population are growing, and which parts of that are actually shrinking.” So they want to know who is this apartment syndicator targeting with their product, who is going to be their end customer.

And then based off of who the end customer is, what is the population trend for that group of people? And then based off of that, “Okay, so they’re targeting Millennials. Millennials are growing. Okay, well is this property going to fit the needs of Millennials? Or fit the needs of the baby boomers?” After, obviously, all the renovations and upgrades are done. So these need to match. The target demographic needs to be growing, and a large chunk of the portion of the total population in a target market.

And the property needs to match their needs. For example, a mismatch would be if I plan on buying a class B property, and then the plan is to add super high tech amenities, making it a really smart type eco-experience, with maybe smaller unit sizes, but very large common areas, a basketball court, and a lot of fitness-related things, and maybe having things for families or something, when a population expected to grow by 10% are baby boomers. That’s not going to be the best match. Whereas if those were Gen Z or Millennials, sure that might be a good match.

So those are actually just five red flags, and I think I still have about 26 red flags. So we’re going to stop there; this will conclude part one, where we talked about the market red flags. In part two we’re going to start off by talking about some business plan red flags, which will include red flags about the projected return you present as well… And then we’ll probably focus on the debt red flags as well. And then we might get into the purchase and sales assumptions red flags. And then we’ll conclude in part three with proforma red flags, rental and sales comparable red flags, and then some other miscellaneous red flags that didn’t fit into any of the other categories.

So that will conclude this episode. Thank you so much for tuning in. Make sure you check out some of the other syndication episodes we have so far, as well as those free documents, at syndicationschool.com. Thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.

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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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. 

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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.

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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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JF2290: 5 Ways To Get More Apartment Deals| Syndication School With Theo Hicks

In today’s Syndication School episode, Theo Hicks shares 5 ways of winning the bidding wars. When it comes to securing your bid, simply offering the most money doesn’t always work. Besides, sometimes you are competing against other investors who have way more experience and capital. In this episode, Theo talks about 5 ways to get more apartment deals by making your bid stand out and tell the seller that you are serious and capable of seeing the deal through.

 

To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit 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 syndication School series, a free resource focused on the how to’s of apartment syndications. As always, I’m your host, Theo Hicks. Each week, we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy, and for a lot of these episodes, we give away free resources. We gave away a lot of these documents in the past, so make sure you go to syndicationschool.com, check out some of those episodes and get those free documents.

Today, we’re going to be talking about how to win more bidding wars. So these are tactics that you can implement when creating offers to get awarded more deals. These are particularly good and beneficial in competitive markets, or if maybe you don’t have a lot of experience and you want to create a better offer to attract the seller to your offer, as opposed to someone else who has more experience.

Obviously, one way to create a better offer is to offer more money, which is obvious. So that’s not going to be one of these five. So these are five ways to win more bidding wars in addition to simply paying more money, which might not always work.

So the first is going to be offering a hard or a non-refundable earnest deposit. So the earnest money is what you give to the seller as a good faith deposit upfront, which is usually equal to about 1% of the purchase price. This is essentially showing the seller that you’re serious and capable of buying the property. Usually, by default, the earnest money is going to be refundable, that is a buyer will receive the full deposit back if the contract ends up being cancelled. Sometimes it might be a fee, but overall, you put down the money within the first few days of the contract, and if you cancel it, 30 days down the line or 45 days out, then you get that money back.

So one way to create a more attractive offer is to submit a non-refundable earnest deposit; this is more attractive to the seller because of the negative consequences of a buyer selling a contract. So for example, once a seller places their deal under contract, they’re no longer marketing the deal, they’re no longer taking other offers, they’re no longer doing tours… So if you end up closing, everything’s great. But if you don’t and you back out, then at the very least the seller is annoyed because you wasted their time, but there’s also other potential negative outcomes; maybe the economy changes and on the second round of offers, they get a lower offer price. Maybe the reason why they were selling is because they identified a new opportunity, that they now cannot purchase because they don’t have a capital that’s locked up in the property. Maybe they go back to other people who had submitted offers, maybe the second-best offer, third-best offer, and they’re no longer interested.  So it’s very advantageous for the seller to close the first person they award the deal to. So to prove that you’re capable of closing, you can go non-refundable.

Now, there’s a few different ways to go non-refundable. The first is going to be the timing, the money goes hard. So the most attractive timing to the seller would be if the earnest money went hard day one, so immediately. The second you give them the money, it’s non-refundable; they get to keep it no matter what.

Another option would be for the money to go hard after a certain clause is triggered, like at the end of a certain number of days or the end of the due diligence period, for example. Or it could be a hybrid of both, where the earnest money goes hard day one, so a portion of that earnest money goes hard day one, and then the remainder goes hard after a certain number of days or after a certain trigger clause is triggered. So for example, you can put down a 1% down payment on a deal, and then half of that money goes hard day one, or maybe 75% of that money goes hard day one, and then the remaining half goes hard after 30 days.

Another iteration of the earnest money going hard would be the amount of the earnest deposit. So it can be non-refundable, but higher than what is usual. So instead of 1%, you can go 2%. And then again, you can go hard day one, hard three days out, hard after a certain clause is triggered, or kind of a combination of both.

When you do the non-refundable earnest deposit, you still want to make sure you’re including some contingencies, and these are going to be things that are outside of your control. So if something outside of your control were to happen, then you can get your money back. But if you do something, you decide to cancel the contract, then the money is not refundable.

So examples of things that are outside your control would be a major lien on the title. If something comes up during the survey, if something comes up on one of the environmental reports, that’s really not your fault, so you shouldn’t lose your money because of that. But if you just had to cancel because you did improper underwriting, or you can’t qualify for financing, well, then they get to keep that money. So that’s number one.

Number two would be to shorten the due diligence period, to make a more attractive offer. So we’ve done episodes on due diligence before, so I’m going to assume you know what this means. But usually there’s a timeframe where you have this many days to perform your due diligence, and then there’s a contingency where if you’re not going non-refundable, you can back out and get your money back. But after that timeframe, you can’t back out and get your money back for a due diligence related issue. Usually this is going to be 30 days; it could be longer, but usually it’s 30 days. So during that 30 days, the buyer can cancel the contract. So if you offer a shortened due diligence period, then you’re shortening the time that you can cancel the contract.

Kind of like the non-refundable earnest deposit, this shows the seller that you’re more serious about closing on the deal since you’re willing to shorten the amount of time you’re spending on due diligence. And additionally, you might be able to close a little bit faster if you shorten the due diligence period, which results in the seller getting their capital back sooner. That may not necessarily the case all the time. But what is the case is that if you’re shortening it, they’re more confident in your ability and your seriousness to close, and it’s less likely or you have less time to cancel the contract. So that’s number two.

The third way would be to sign an access agreement while you’re negotiating the contract. So there’s usually a period of time – it could be very short, it could be very long – where you are awarded the deal and you actually sign on the contract. So you submit your LOI, they say, “Hey, we want to go with you,” you negotiate back and forth with the LOI to get a purchase sales agreement, you sign it, and the deal’s official and you’re under contract, and that’s when the time starts. But again, it could take a while; the time from LOI to signing the contract might take a while, or the negotiations just might fall through and the deal never comes to fruition, which is also a waste of time for the seller.

So to respect the seller’s time and to show that you’re serious about closing, you can sign an access agreement within a certain number of days after you’re awarded the deal. And by signing an access agreement, what this does is the seller is giving you, the buyer, permission to inspect the property before this contract is actually signed; your access is going to be limited compared to what the access is after the PSA is signed, but you can still get a head start on your due diligence. So this is not only shows that you’re serious about closing, but you can tie this to something else, which would be to stipulate that once this cross access agreement begins, the due diligence period begins.

In other words, from the time of you being awarded the deal – maybe it’s a few days of signing the cross access agreement. From the time when the cross access agreement, the due diligence period begins. So if it’s 30 days, then once you sign that cross access agreement, 30 days later, the due diligence period has expired… As opposed to waiting until the contract starts, you might be five days, 10 days, 20 days into the PSA, when the due diligence period expires. Again, it shows that you’re a lot more serious about closing on a deal and you have less time to back out of the contract.

Number four is kind of similar as number three, which is to use and mark up their purchase sales agreement. So again, there’s a time between the LOI and the PSA that is, in a sense, the time that the seller is not going to have access to their money. So the longer the negotiations draw out, the more likely the deal falls apart, but also the longer it takes them to get their money, because usually the contract starts and then it’s 60 days out and they close. So by offering it to use their PSA, and you mark up their PSA, you’re reducing that back and forth negotiation, plus you’re reducing any potential disqualifiers from legal language.

So essentially, instead of you sending them your PSA, you just use theirs. You give it to your lawyer, they use a red pen or red ink or red in PDF or some software they’re using, and they make changes to the seller’s PSA so that the seller can see very quickly what legal changes you made, as opposed to getting a 50 page PSA from you, they give it to their lawyer and they go through every single thing and they mark it up, there’s back and forth negotiation and then maybe there’s some disagreement over legal language that kills the deal. You just use theirs, they can see specifically what changes you made, and this lowers the chances of the deal being cancelled, plus it reduces that LOI to PSA timing.

And then number five, and this is something that might not always be a way to win more bidding wars, but it can be very powerful at a certain time of the year or if a certain event is occurring, which is to guarantee a closing date by a certain date.

So this can be really good for taxes, if you guarantee to close by December 31; then it’d be advantageous to them for taxes, depending on their business plan that they had for the property. Maybe they raise capital and it’s better that their investors get their money back this year. Or the next year — maybe there’s some tax changes coming up in the next year or at some point in the future, and they wanted to close before these new taxes come into effect. An election year, right? You might want to say, “ I guarantee to close before November 3rd,” or, “I guarantee close to the end of the year,” or, “I guarantee to close by inauguration during an election year.”

So essentially what this means is that you’re guaranteed to close by a certain date, which means no extensions to anything. It might also mean shortening the time from contract to close. So again, this might be attractive to a seller depending on what’s going on in the world.

So there you have it. Those are five ways besides paying more money to win more bidding war to create a more attractive offer to the seller. Number one is offer a hard non-refundable earnest deposit. Number two is to shorten the due diligence Period. Number three is to sign a cross access agreement or an access agreement while negotiating the contract before the contract is assigned. Number four is the use and markup the sellers PSA as opposed to giving them your own PSA created by your own attorney and then number five is to guarantee a closing by a certain date.

So you follow these five tactics, all of them, one of them is a combination of a few, you’re going to maximize the chances that you come out as a winner in a bidding war.

Now, one thing to mention is that when you’re in a competitive market, something like simply doing a non-refundable earnest deposit might not be enough, right? Because maybe all the offers have a non-refundable earnest deposit. And so the power is in increasing it, making it go hard day one or maybe only a portion of it going hard day one, it kind of depends on how competitive. The market is not competitive, the deal is. The same as shortening the due diligence period, maybe you need to shorten it a lot, maybe you only need to shorten it by a few days. And then maybe closing by certain date is completely irrelevant, they don’t care, which is why it’s important to understand why the seller is selling so you can figure out what’s important to them and then which of these to use, right? If they don’t pay taxes, if tax is increasing in three months. Well, you can guarantee to close by a certain date. If they want to close as quickly as possible, well, you can shorten the due diligence period and sign an access agreement. If they want to close no matter what, well then you can do the non refundable earnest deposit or a combination of those things.

So that concludes this Syndication School episode. As always, make sure you check out the other episodes we’ve done as well as those free documents at syndicationschool.com. Thank you for listening, have a best ever day and we’ll talk to you tomorrow.

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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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.

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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JF2276: Multifamily Lending Part 2| Syndication School with Theo Hicks

In this Syndication School episode, Theo Hicks explains what lenders look at before approving the loan for a multifamily real estate deal. He lists the qualifications that a prospective investor needs to have in order to be considered by various agencies, as well as how to get around them.

He also covers the specific metrics of the market and the deal that will be required to get the loan. This guide includes relevant information about the recent changes in response to the pandemic.

To listen to other Syndication School series about the “How To’s” of apartment syndications and download your FREE document, visit SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

Click here for more info on groundbreaker.co


TRANSCRIPTION

Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.

Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.

 

Theo Hicks:  Hello, Best Ever listeners, and welcome back to another episode of The Syndication School series, a free resource focused on the how-to’s of apartment syndications. As always, I’m your host, Theo Hicks.

Each week, we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy, and for a lot of these episodes we give away free resources, including today, this little mini-series we’re doing. So if you want to get these free resources – PowerPoint presentation templates, a lot of Excel calculators and templates, as well as a few PDF “how to” guides – make sure you go to syndicationschool.com and then all of the previous Syndication School episodes are there as well.

As I mentioned, this is going to be a continuation of a series we’re doing about multifamily lending. This is like a multifamily 101 course, breaking down how to select the ideal loan for your apartment syndication deal. Make sure you check out part one, which was released last week, or if you’re listening to this in the future, seven episodes ago, where we talked about how to decide what lender to use, and then do you always use agency loan, agency lenders…?

We also talked about the differences between a mortgage broker and a lender, the pros and cons of those and which ones you should use. And then we talked about at what point in the process should you be engaging the mortgage broker or the lender… Upfront, and then at what point in the process should you be engaging them again.

In this episode, we’re going to talk about the qualifications for agency loans. And then we’ll also talk about a few other things like upfront reserves and renovation costs. And then likely, we’ll finish it off in part three next week, when we go over what to look forward when actually reviewing options, depending on how long this episode goes.

So let’s get started. Again, this is assuming that you’re pursuing agency financing, because their qualifications, their criteria is going to be a little more strict than your bridge loan or when you’re working with a bank, typically. And as I mentioned in the previous part, the agency loan is in a sense like the holy grail of loans, because they have the best terms. So because they’re so good, not every single person is going to qualify for them. So the borrowing party, because it may be multiple people, which includes you—it’s less about who the borrower is, but the borrower is going to be analyzed, and then the deal itself is going to be analyzed, and it must meet particular criteria set forth by Fannie Mae and Freddie Mac in order to actually qualify.

So let’s start with a borrower. So the borrower is going to be the guarantor; this is the individual who guarantees the loan, who signs the loan, the people or peoples who sign the loan. So it might be you, it might be your business partner, it might be someone else, or one of your investors or something. And then the key principles, which is defined as any person who controls and/or manages the partnership or the property, that is critical to the successful operation and management of the parts of other property, and who may be required to provide a guarantee. So again, assuming you and any of your partners who are on the actual GP.

And then the third are going to be principals; this is any person who owns or controls a specific interest in the partnership. So for example, the LLC is going to be someone who owns 25% or more membership interest. So this could be the GP, but they’re already covered by the key principals; so it could really be someone on the LP that has a really big investment, then they’ll be considered a borrower as well. So they will analyze these group of individuals across a few different factors.

So first it’s going to be the organizational structure… This is important, but it’s not something that you’re not going to be able to do. So for example, for most agency loans, only single-purpose entities are eligible borrowers. So a brand new entity needs to be created for each transaction, which is not that difficult to do. And there’s really no, from my understanding, criteria that you need to meet in order to create an entity. There are some exceptions with small balance loans, where you can put that in your name, or in a non-single asset entity… But if you’re going to do an agency loan, you need to create a brand new LLC for that deal. So the LLC can be under another LLC, but the LLC that property’s name is going to be in needs to be an LLC that doesn’t own any other real estate.

The next thing they’re going to look at is the experience of the borrower. Again, the parties that are involved in the borrower. So both Fannie Mae and Freddie Mac have different ways in which they qualify the borrower, based on their experience. So Fannie Mae uses a service called Application Experience, ACheck. So their DUS lenders submit the information of the borrower to this ACheck system, and then it will take a look at the members and the borrower, their experience with Fannie Mae loans in the past, and then the DUS lender is going to get a go or no-go from ACheck, based on the borrower’s history.

So generally speaking, one of the borrowers needs to have been on a Fannie Mae loan in the past in order to receive that pass score from ACheck. If no one has ever had a Fannie Mae loan, then I’m not sure if it’s a definite no-go, but the likelihood of it getting a no-go goes way up.

Freddie Mac’s is a little bit different, and they also go into a lot more specifics on their website for how they qualify borrowers. So a borrower must have a minimum of three years in experience in the same capacity that it will have for the proposed transaction, which means that they must have three years of experience doing whatever they plan on doing for this particular deal. And they also say that they must have owned a minimum of three separate deals in the past.

They also must have owned and managed other property in the same market that the subject property, the property that is being purchased is located in. And then if the borrower is lacking in one of these areas, so if they don’t have the three years experience, they haven’t done three properties, they don’t own a property in the same market, then — that doesn’t necessarily mean they’re not going to qualify, but Freddie Mac might come back and say, “Well, you’ll have to put down a larger replacement reserve deposit in order for us to trust you enough to give you this loan.”

So again, Freddie Mac is a lot more specific than Fannie Mae. But overall, you’re going to need to have experience doing this. And if you don’t, then you’re going to bring someone on the GP who does have that past experience with Fannie Mae, Freddie Mac and multifamily in general.

Next is going to be a general credit check. So nothing too fancy here, just taking a look at any other loans or liabilities that the members of the borrower have, to make sure that they’re able to fulfill the debt obligations based off of a past debt obligations they’ve had, or current allocations they have; what’s your credit score, basically.

They’re also going to take a look at the current and prospective financial strength. So the agencies don’t have a specific liquidity and net worth requirement for their conventional loan programs, so it’s going to vary from deal to deal. And then if you have a weak liquidity or a weak net worth, again, combined with a borrowers, then you might need to put more upfront reserves. But to get a general idea of how much liquidity and net worth you’re going to need, you can take a look at the loan requirements stated for Fannie Mae and Freddie Mac small balance loans.

So for Fannie Mae, these are loans between $750,000 to $6 million. And for Freddie Mac, these are loans between $1 million and $7.5 million. And the requirements for both of these are nine months of principal and interest in liquidity, and then a net worth equal to the loan amount. So they’re going to want to see that amount of liquidity and that net worth between the borrowers in order to qualify for the small balance loan. So it’s safe to assume that for conventional loans, it is going to be something similar to that in order to qualify… Although it could be less, it could be more depending on your background and your experience. These are general rule of thumbs. So to get more specifics, you’re going to want to talk to the lender or the mortgage broker, because they’ll be able to look at your history, your finances to see if you qualify or not.

Now, assuming that the borrower qualifies for agency debt, it doesn’t mean that every single deal qualifies for agency debt. The first check is, “Okay, I qualify,” or “Me and my business partners and my guarantor, we qualify for Fannie Mae or Freddie Mac debt.” Now, you need to make sure you find the actual right property. So they’re also going to look at the specific deal, to make sure that it meets their requirements for agency loans.

So first is the actual property itself. So they only provide loans on certain types of properties. There’s a really long list of all the different checks that the property needs to meet. But as long as it’s like a normal multifamily property, then you’re going to be fine. Most of the things on there are just things that are kind of, obviously always at a multifamily property that’s fully developed and not in complete disarray. So it will check to make sure that it is actually multifamily, it’s accessible by a road, all the units have bathrooms and kitchen, there’s water and sewer services hooked, these are up to code, there’s access to emergency services, things like that.

The main criterion that the deal needs to meet relates to occupancy, and this is going to be the major factor that determines if a deal is going to qualify for agency debt or not. So for Fannie Mae’s conventional loan program, they want to see a minimum physical occupancy of 85%, and a minimum economic occupancy of 70% for 90 days leading up to close. And then the occupancy requirement is even higher for your small loan balance, at 90%. So, in other words, it needs to be a stabilized deal. Same thing for Freddie Mac, that has a minimum physical occupancy of 90% for 90 days. So the deal needs to be stabilized. If it is not, it is not going to qualify for Fannie Mae or Freddie Mac’s conventional loan programs. It might qualify for one of their more renovation type programs, but most likely, if it’s not stabilized, you’re not going to be able to get an agency debt.

And then lastly, they’re going to want to take a look at the property management company and the market. So they have some criteria for the company that’s actually managing the deal. They don’t really have any stipulations on whether it’s in-house or third-party, but the borrowers must have adequate experience with this particular size of property and type of property. And then I thought I remember seeing somewhere that you actually might have to have an in-house or third-party, depending on your experience and if you live in the market or not. But overall, the management company needs to have experience managing this type of property and this size of property.

And then for the market, they want to make sure that it’s a strong market, and so they look at these typical metrics like vacancy, demand, supply, jobs and [unintelligible [00:15:05].23]. And then for some of the loans, for example, for Freddie Mac, they have different minimum debt service coverage ratios and maximum LTVs based off of the market. So they break it down to top markets, standard markets, small markets and very small markets, where the terms are more favorable to the bigger markets.

Something else that you need to keep in mind when you’re dealing with the agencies, as I mentioned a few times earlier in the episode when talking about the requirements of the borrower and the experience requirements, and how they might have to put down a larger upfront reserve if they have less experienced or weaker financials… And one thing I wanted to mention – this is something that’s timely and is likely to change, so make sure you’re consistently staying up to date on these COVID-related changes, but they did change their reserve requirements in response to the pandemic.

So Fannie Mae is actually requiring 12 months of principal and interest for loans that are $6 million and more, and 18 months for loans less than $6 million. And then it could be as low as six months or down to zero dollars if you go past a certain debt service coverage ratio and loan-value ratio. So a debt service coverage ratio of 1.35 or higher, and an LTV that is 65% or lower, then it’s six months, and if the debt service coverage ratio is 1.55 and the LTV is 55 or less, then there’s no reserves required. So the more money you put down and the more cash flow there is, then the less reserves they’re going to require. But if it’s got a lower debt service coverage ratio, then they’re going to want more money upfront to protect themselves.

For Freddie Mac, it is nine months principal and interest on loans, with a debt service coverage ratio of less than 1.4, and then six months if it’s above 1.4 and then 12 months for their small balance loan. So pretty large upfront reserves.

And then when you have access to that money, it kind of really depends… So this is something that you really need to talk with your lender about, to know exactly what you need to have upfront in reserves… Because again, this is going to impact the cash-on-cash return to your investors, and also have an understanding of when you can distribute that money back to your investors or when you can tap into that capital to do a value-add renovation program.

Which brings us to my last point I wanted to make in this episode, which is going to be the renovation costs. So with Fannie Mae and Freddie Mac, with agency debt, can you get a loan where the rehabs are included? And the answer is yes, they both have a loan programs that cover renovation costs.

Fannie Mae offers a DUS moderate rehabilitation supplemental loan, aka the mod rehab loan. It’s actually you’re getting two loans; you get the regular conventional loan, and then you can get a supplemental loan on top of that to cover renovation costs. And the advantage here compared to other supplemental loans that Fannie Mae offers, is you don’t need to wait the full year to get a supplemental loan; you can get it right away, as long as the renovations are at least $10,000 per unit.

Freddie Mac offers two renovation loans – a moderate rehab loan and a value-add loan. And the difference between these two is going to be the renovation costs. And so for the second loan, the value-add loan, renovations need to be between $10,000 and $25,000 per unit. And then the moderate rehab loan would be renovations that are $25,000 to $60,000 per unit. And then the minimum of $7,500 needs to go into the actual interior. So that includes the exterior costs as well, obviously.

So if renovations are less than $10,000 per unit or greater than $60,000 per unit, then you’re going to need to get a bridge loan or pay for those renovations out of pocket, a.k.a. out of your passive investor’s pocket.

So that’s going to conclude and wrap up this part two. We talked about how to qualify for agency debt as a borrower, what deals qualify for agency debt, some of the changes to the upfront reserves based off of the Coronavirus, and then the fact that you are able to get a loan that covers the renovation costs.

So we’re going to wrap up next week with part three, where we’re going to go over the various different metrics of a loan – debt service, loan amount, interest-only, what these things mean, and then how you can analyze and compare and contrast multiple loan options based off of these variety of metrics.

We’re giving away a free document for this series. It’s the top loan programs document where you’re able to view more specifics on the different Fannie Mae, Freddie Mac, and the non-agency loans, the terms of each of those loans in more detail… Because in this episode and in this series we’re focusing more on not necessarily high-level, but we’re not going to go into detail on every single loan. Like here’s the interest rate, here’s the service coverage ratio, here’s the LTV, here’s all these various different terms. But we are, next week, going to talk about what those terms actually mean, and then what the pros and cons are for the different options that you’ll have.

So until next week, make sure you download the free top loan program’s document. Make sure you listen to some of the other Syndication School episodes. Have a best ever day and we’ll talk to you tomorrow.

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