This is the BiggerPockets Podcast show 651.
If your friend is asking about what you’re doing and how much you’re paying for the mortgage and how much he’s paying for the mortgage and all that, I always recommend being 100% honest because if you can empower somebody to do the same thing as you and to empower someone to house hack, then you’re going to completely change the trajectory of their lives, and that’s worth so much more than a couple hundred dollars a month or being a little bit sketchy about how much you’re getting paid or how much you’re paying and all that. So I highly recommend if you’ve got the opportunity to help somebody see the light and they’re asking to 100% just tell the truth. It’s way easier than lying.
What’s going on, everyone? This is David Greene, your host of the BiggerPockets Real Estate Podcast. Here today with a Seeing Greene episode, where I have called for backup. On this show, we’re going to be taking your questions as always, but with a little bit of a twist. We’ve got several other BiggerPockets personalities that have come in to help me by answering your questions. So you guys are in for a treat. You’re going to get my perspective and a lot of other people’s.
First, today’s quick tip. Do you need a group to help support you on your journey to your first or next property and a place to get your specific questions answered beyond this podcast? Well, check out biggerpockets.com/enroll if you want more info or to participate in one of our five different bootcamps. Thank you for being a loyal listener. We’re offering a 10% discount off your enrollment by using the code BOOTCAMP10. Almost 50 bucks off and a free year of pro membership can be yours. Already pro? You get a screaming price on this already great value opportunity. Invest in yourself and check out the BiggerPockets Bootcamp.
All right. Let’s go to our first question.
Hi, everyone. My name is Ashley Kehr, and I’m excited to be here today on Seeing Greene. I am the host of the Real Estate Rookie Podcast, along with Tony Robinson, and I’m also hosting two bootcamps coming this fall. So let’s get to today’s question.
Today’s question is from Juan Murano. His question is, “I’m getting into the thought of investment properties and I want a mentor. I do have a friend that does it, but she buys single-family in multifamily homes out of state, which scare me. I don’t know where to start my research for rental properties and areas to purchase in. How do I figure that out? I feel like little things like landlord states and tenant states leases for rental properties and finding people scare me. I don’t want to find videos on it. I want to be able to do my own research. Where do I start?”
Well, this is a great question, Juan, and there’s a couple things in here. So let’s start with your first one is that you want to find a mentor. So right in your question to me, you said that you do have a friend that buys single-family and multifamily homes, which I think right there is someone that could possibly be a mentor to you. Even if that ends up not being the real estate investing strategy that you want to go into, I think that they have invested in real estate there’s going to be a ton of value for you.
So just starting those conversations with that person, and even if you don’t feel like they’re adding a lot of value to what you want to do, it is going to motivate you and inspire you to be able to talk to somebody who is investing and also give you maybe that courage to get past analysis paralysis too. So I would say, start there with your friends. Start opening the conversation and talk to them as much as you can. Maybe offer to buy them some coffee or take them out to lunch I think is a great start.
Then you talked about where to start with the research or the areas to purchase them. So if you’re going to do out-of-state investing, one thing that I really like to look at is where are other people investing. I know you said you don’t want to watch a video on it. You want to be able to do your own research, but you have to start somewhere with finding markets and think about how many markets there are across the whole US. There are a ton.
When you look at the map, then you can bounce around from city to city. So if you were to pull up Zillow or realtor.com, you can hone in on one city, but you start zooming out and you start looking and, “Wow, there’s properties here that maybe in my budget.” Then you head over to Ohio, and then you’re bouncing down to Florida and going all over.
So what I recommend is go online. Go on the BiggerPockets forums. Go on social media. Start following other real estate investors, and look where they are investing. Then maybe pick three to five cities that interest you, and then do your research from there. So start your own market analysis and go through and look at the things that you want to evaluate in a market.
So for example, first of all, are properties within your budget? Maybe you have loan approval for up to 150,000 or that’s your cash to purchase a property, you’re not going to go into markets where you’re buying $500,000 houses and that’s maybe the average home sales. You’re going to look for markets that have houses that are available for $150,000. So that’s a big thing there.
The second thing is is you want to be a landlord, and you are 100% correct that there are different laws and regulations in different states. So there’s landlord states that are favorable to the landlord, and then there’s states that are also favorable to the tenants. So that also could be a great starting point for you is looking at states that have landlord-friendly laws, meaning that the laws there are beneficial to the landlord, and that is most likely going to give you a better investment than if you are going into states where the tenant has the benefit.
So I invest personally in New York. That’s where I’m from, and it is definitely a tenant-friendly state. So when an eviction comes up on a property, it is a lot harder to get that tenant out of the property than it would be, per se, if you were in Texas or a state that is a landlord-friendly state. So if you are going out-of-state anyways, that is definitely something to look at.
Other things to look at are possibly what is the median income in that market? Can people there afford the type of property or the type of rent that you want to charge? What are the rental rates there? So there’s a lot of things. Also, the industry, what kind of jobs are in this community, in this market? So if you’re looking at a market that only has one big business there, and that’s where a lot of employees, a lot of the people in the town, what happens if that business shuts down? All those people move to a different market because there’s no longer jobs there. So that’s why I always like to find at least three prominent places of employment that bring people in for those jobs.
So for example, in Houston, Texas, there’s healthcare, there’s a lot of oil jobs there. So looking at these markets, what’s bringing people into them? Then also look at the trends too of people moving into those markets. So those are just a couple of the many things that you can look at when you’re doing market analysis, but I would say start building a list of things that you want to look at in a market.
In my bootcamp, we go over this too, in the rookie bootcamp, as to all these things we list down to things you can analyze when you’re finding your market, but I think watching BiggerPockets YouTube videos and videos of other investors can definitely help you, but you still want to verify and do your own research.
So my recommendation for your question would be to go to your friend for a mentor, post it in the BiggerPockets forums to see if anybody out there is looking for help with anything. Do you have a special skill or something that you can do to add value to another investor so that they do mentor you?
Then second, look where other people are investing and then verify the data that you see in those markets to see if it suits what your goals and what your real estate investing strategy is, and then go from there, and make sure you do not get stuck in analysis paralysis. So make sure you take action. Every deal is not going to be a home run, and your first deal does not have to be a home run deal. So make sure you remember that and you don’t get too stuck in over analyzing.
Well, thank you, David, so much for having me on Seeing Greene. If you guys want to learn more about what I do, you can follow me on Instagram, @wealthfromrentals, and back to you, David.
All right. Well, thank you, Ashley. That was a fantastic answer, and what a way to start this show. There’s enough information in that reply for an entire podcast. I love the points that you made. The looking for the employment is really big. I think a lot of investors look at the cashflow they’re going to get. They want to find the ROI, but they don’t dig in and say why is it doing that, why are people moving here, what are the driving forces and fundamentals behind the number that pops up on your spreadsheet. That’s what a real good investor does is they understand at a pretty high level what makes a market drive, why the supply is what it is, why the demand is what it is, what the benefits of that market are, and what the drawbacks are as well because every market’s going to have drawbacks.
You just have to understand, “Why are they drawbacks? What are they? Is that something I can live with?” You’re never going to find a perfect market. That’s a mistake a lot of people make because they keep looking forever because every market they find has something wrong with it, but there’s always going to be something wrong with every single market. That’s just the way that life works because if there wasn’t, somebody else would’ve already bought all of those houses and there wouldn’t be an opportunity. So thanks for that, Ashley. That was fantastic advice.
Our next question comes from Tony Spencer about short-term rentals, and we have none other than BiggerPockets published author Avery Carl here to answer on this topic.
Hey, guys. It’s Avery Carl, BiggerPockets author of Short-Term Rental, Long-Term Wealth, and the BiggerPockets short-term rental bootcamp instructor. Today’s question comes from Tony Spencer in the Seattle area. Tony currently owns his home with a basement apartment and is about to go live with his first Airbrrrrnb and will have 300,000 to put down on a second Airbnb suit. He says he’s a member of several Airbnb social media groups and, “I’m looking to buy my second short-term rental very soon.” He also says he sees that everyone is panicking about their lack of bookings compared to the last few years. Sounds like it could be due to maybe the new algorithm with Airbnb and/or inflation in general.
His question is, “Do you see the STR market trending in any certain direction with fears about the economy or do you think that there might be an upcoming opportunity in this asset class cooling off in the near future? Finally, I’m basing this question off anecdotal evidence from social media posts, but I’ve yet to see any current data about STR bookings being down across the board. Do you know where I can find such current data to support or deny this information? Thanks as always. Love the show.”
Okay. So Tony, this is a really, really good question, and I’m going to try to not be too long-winded in my answer. So I have seen a lot of people panicking about bookings over the past few months, I would say, especially back in April and May when Airbnb rolled out their new algorithm. It did affect some things. That has since been corrected. Airbnb has walked that back a little bit. So we’re not seeing as much of an issue with that.
I also think that a lot of the panic that we see in social media posts is from people who bought in the last 18 months, especially people who bought at the end of 2020 or during 2021 who have not been through normal seasonality yet. So May is typically a slow month because it’s right between everyone having been on vacation in April and for spring break, and then also everyone about to be going on vacation for the summer. So May is a pretty quiet month in terms of STR. So I think it’s a combination of owners who bought in a really high year who haven’t been through normal seasonality yet, and then the Airbnb algorithm messing with everyone’s bookings on top of that.
In terms of the market trends, I think with my real estate agent business, I’ve seen that now really is the best time in the past two years to get under contract on a short-term rental. In 2020 and 2021, every single property that hit the market, even if it was just a completely astronomical number that made no sense at all, was getting a hundred offers. Now with the uncertainty with the economy and also interest prices, I mean, interest rates going up, there’s some uncertainty in the market, which has created an opportunity for buyers.
So the weaker-handed buyers have been shaken out of the market, and also, there’s a lot of sellers who I call them FOMO sellers. They’ve seen that their neighbors have sold six months to a year ago for just crazy prices, and they see the market changing and they’re like, “Oh, no. I missed the boat. I guess I better list now.” So it’s creating more supply in the market.
So last year, you had to make these crazy aggressive offers on every single property. Now, you can actually negotiate with sellers. You can offer under asking. You can ask for sellers to contribute to closing costs again. You can actually get better deals than you’ve been able to in the past two years. Now, interest rates are certainly a factor, so you want to make sure that you account for that line item, but in terms of actually being able to get deals, it’s a really good opportunity right now for buyers.
In terms of finding current data on booking, so I’ve seen people answer that question both ways of some people have less bookings than last year, some people are doing better. My personal ones are actually doing a little bit better than last year. So I think that’s due to a number of factors. I think that time in the market, so people who have more reviews are typically seeing a little bit more traction in the current market.
So I don’t necessarily think that bookings are down across the board just like the real estate market in terms of sales is not national but regional. I think that with short-term rental and bookings and things like that, everything is really very market-specific as well. So what’s happening in one market with bookings is not necessarily happening in every market with bookings. So there might be some that are up or down, but it’s not necessarily an across the board thing.
A really good place to find current data on what bookings are looking like, there’s a few different places where you can find short-term rental data. AirDNA is one. It’s paid. Rabbu is another one. It’s free. Then also, if you already are a short-term rental owner and you have PriceLabs, which is a pricing tool that is used to dynamically price your property, there’s a function within PriceLabs called the Market Dashboards, and it’s a 30-day snapshot of how the entire market in that area has been performing. So I would check out all of those places and use data from several different sources because no one dataset is necessarily perfect. So take a look at all of that data from all three of those sources and draw your own conclusions from there.
Wow. Thank you for that, Avery. Once again, just like with Ashley, you brought a ton of value in the reply there. Couple things stand out to me that I want to capitalize on and highlight for our listeners. First would be very good point, 2021 was probably going to be known as in baseball, that was the juiced ball era when everyone was hitting the home runs or maybe it was the steroid era, but numbers were artificially inflated for that period of time because COVID had shut down a lot of the world and people wanted to travel to get away from the big cities that were closed and go to more areas that had a little more freedom and less restrictions. So they traveled and Airbnb exploded.
Now, we’re still sitting on the momentum of that amazing time and that’s why many listeners here are thinking, “Hey, I want to get into short-term rentals.” I traveled during that same period of time and I enjoyed it. I want to buy the house. You combine that with the fact that it’s becoming very difficult to find cashflowing properties as more demand continues to flood into the asset class that we at BiggerPockets love real estate investing, but supply stays relatively constrained and you’ve got more competition. So in order to make a cash flow now, you’re looking at short-term rentals.
So there’s several factors that have evolved to create this world that we’re getting into, and I do think this is just my two sense, right? I’m planning that over the next three to five years there’s going to be a ramp up period to get the short-term rentals that I’m buying right now going. I don’t think I’m going to buy it and step into 100% occupancy or close to that right off the bat. I think it’s actually going to be slow. I think in the future, the people who manage really good short-term rentals are going to be getting repeat guests. I think that because there’s so much competition for people going on Airbnb and they have tons of homes to choose from. As more and more people start renting out their houses, more and more investors like us buy these houses and put them on VRBO, on Airbnb, everywhere that you can find them.
There’s more supply to choose from. So as supply goes up and demand stays the same or doesn’t keep up with it, you’re going to see prices come down. So to combat that, I’m planning on getting return guests. I want to give every guest such a great stay that instead of going on Airbnb and saying, “Where should I stay in this market?” they go, “I’m going back to that house that I stayed at last time.” I think that many people would be good to do the same.
So think about your reviews. Think about the experience you’re giving your guests. Remember, when you buy a short-term rental, you are not buying passive income. You are actually buying a business and you’re going to have to run it with the same effort that you put into a business or hire a manager that will do that for you. It’s a great asset class to get into, but it is definitely not the same as just buying a fourplex and letting your property manager that you pay 8% rent the units out and collecting that check. There’s more work that goes into it.
Avery, thank you very much for that awesome answer and the level of detail that you put into that. All right. Next up is a question from Daniel Leja about house hacking, and who better than BiggerPockets house hacking extraordinaire Craig Curelop, who wrote the book on house hacking for BiggerPockets publishing to help me answer?
Hey, everyone. This is Craig Curelop, house hacking extraordinaire and instructor for the BiggerPockets house hacking bootcamp. Today’s question comes from Daniel Leja from the bay area of Berkeley, California. Here it goes. “On the BiggerPockets Podcast I’ve been listening for years,” and he hears a lot of people talking about house hacking, but doesn’t recall too much about renting to friends and family. He did a 14 plus bedroom house hack for a few years, which is a little bit crazy, and from his experience, there’s a lot of differences between renting to a standard tenant and renting from friends and family. So Daniel’s question is, “How do you differentiate and how do you treat renting to a family member and a friend versus just a standard tenant like a stranger you don’t know?”
So there’s a few different things that I would personally do differently here when renting to friends and family or a stranger. Obviously, when you’re renting to a stranger or just traditional tenant that you’re getting, it’s a little bit more of a transaction. So you need to make sure you do your background check and credit check and all that good stuff.
So I wouldn’t do a background check on a friend or family, but I would do a credit score because you definitely want to make sure their credit score is still good, but if they’re friends and family, then I’ve probably got a pretty good idea of their background. Now, if you are curious about their background, I would definitely recommend doing the background check, right? It doesn’t really matter either way, but, again, I probably would avoid doing that for friends and family.
The second thing is that if you’re renting to a friend or family member, you already know them, you likely already know their tendencies, and so there’s a little bit less of a risk for you. When you’re renting to a friend or family member, there is that obligation to give them the friends and family discount. So I would probably charge them 50 to 100 dollars less in rent so that they can basically live with you, and again, it’s a little bit less of a risk for you because you know that you get along with this person and you know their tendencies.
For a security deposit, I would charge the same amount that I would anybody else, but I would just charge one month’s rent. So if you’re going to give them $100 discount on the rent, give them $100 discount on the security deposit. Then there is that balance when you’re dealing with a tenant-landlord relationship. You would like to be friendly with your tenants, but you don’t really like to be friends with your tenants. However, if your friend is moving in, you have to be friends with them.
So I always like to use the reference of hats, right? So 95% of the time when you’re moving in and out of the house and you’re going out to dinner and all that, you guys are going to be friends, but if something ever comes up where you need to discuss something in the lease, you need to discuss renewing rent, you need to discuss a late payment, then you say, “Hey, man. I know we’re friends, but right now we’re not friends. I am your landlord. You are my tenant, and that’s the relationship we’re going to have for this conversation. You need to pay me this amount on this time,” or whatever the discussion is. You make sure you have that and you make sure the roles are defined in that conversation, and you sit down and you be serious with them, right? I think with friends a lot of times you’re going to be joking around and smiling, but don’t do that if you’re having a serious conversation with them.
You 100% have them sign a lease. I have seen time and time again friends just do verbal leases. I literally witnessed this less than a week ago. They signed a verbal lease, didn’t really sign any lease, and then the guy decided they wanted to move out early, but there was no lease in place. So now one guy is getting screwed and it’s the landlord that’s getting screwed over. So I recommend always signing a lease, whether it’s your sister, your friend or a complete stranger. Always sign a lease.
If your friend is asking about what you’re doing and how much you’re paying for the mortgage and how much he’s paying for the mortgage and all of that, I always recommend being 100% honest because if you can empower somebody to do the same thing as you, and to empower someone to house hack, then you’re going to completely change the trajectory of their lives, and that’s worth so much more than a couple hundred dollars a month or being a little bit sketchy about how much you’re getting paid or how much you are paying and all of that. So I highly recommend if you’ve got the opportunity to help somebody see the light and they’re asking, then 100% just tell the truth. It’s way easier than lying.
Oftentimes too, friends will ask for a little bit of leeway, a little bit of discounts, all of that kind of stuff. I really would not discount it any more than the already agreed upon amount. So if you’re going to do $100 off, stick to the $100 off. Make sure they pay on time, and if they don’t pay on time, charge them the late fees, right? Treat your business like a business even though a friend is moving in.
So that’s my answer on how you treat family and friends differently than tenants. A lot of it is the same. You just maybe give them a little bit of a discount and you have a little bit more leeway.
Also some great advice. This is an amazing episode. I should have done this a long time ago. Just bring in the Avengers to do the heavy lifting for me here. All right. There’s something that I really want to call out about the question as a warning sign. So one of the things that you learn in jujitsu is people will get themselves into a horribly compromising situation. Okay? It’s almost like a checkmate, and then they go to the instructor and they say, “How do you get out of this?” The answer is usually, “You just never let yourself get into that. Okay? You made a mistake three moves ago that led to this.”
If you think about like going down a slide at a waterpark or something, when you’re three quarters of the way down and you’re like, “Okay. How do I stop? How do I go back to the top and start over?” once there’s that much momentum going in a negative direction, probably you’re not getting out of that situation. It’s going to happen. There’s a big word I was trying to think of there, but it’s still too early in the morning and I couldn’t find it.
So when somebody says to you, “Are you making a profit on this property?” that’s letting you see what’s in their mind. They are tipping their hand, if we’re going to use the jujitsu thing here. They’re showing you what they’re about to do. You need to be very careful about that.
So let me give you an example from my personal life. This was when I was young David. I still had hair. I was about 100 pound skinnier almost. My dad was very handy. He was still alive at that time. So there was a house down the street from where we lived and I had a lot of capital and I had already bought maybe one or two investment properties or maybe I hadn’t bought anything yet. I think I’d just been toying around with the idea.
I looked at the numbers and I was like, “Hey, why don’t we buy this house and flip it?” My dad knew how to do the work. I had the money to buy it. So we were sitting there talking about it. My brother Chris said, “Hey, I want to do this too.”
I’m like, “Okay. Well, if you put in part of the down payment, you can have that percentage of the profit.” We were just going to pay my dad to do the work.
He said, “Okay. Well, how much would I have to put in?”
I basically wrote it down, “Well, if you take X amount of the capital we’re putting into the deal, you will get that same number of the profit. So if you’re putting in 20% of the equity, you’ll get 20% of the profit.”
My brother thought for a minute and he’s like, “That’s not fair.”
I was like, “Well, what do you mean?”
He’s like, “You’re asking me to put in 80% of all of my money, but I’m only going to get 20% of the profit.”
He was very young, and I just remember thinking, I got frustrated, “It doesn’t matter what percentage of your money it is. It matters how much we’re putting in the deal,” but he had a different standard of fairness than I did. Eventually, that’s why I didn’t bring him in to doing that deal.
That’s what I want to bring up is there are many different standards of fairness. The entire concept of fair is actually very subjective. There’s an article in BiggerPockets blog if you go look up, Google what is fair in the blog. I can’t remember who wrote it, but I remember it was very well-written that talks about different ways of looking at the world.
So if your friend or your family is going to rent your house, their idea of fair might be, “You’re going to give me a hookup. You’re not going to make me pay like a normal landlord did. We’re friends. You won’t treat me like everyone else because that wouldn’t be fair. Remember when I bought the ice cream when you didn’t have money? Remember on your birthday when I got you a better present and you forgot about my birthday last year?”
Well, now you’re just making that up to me. You see how this can get out of hand very easy. So if someone’s asking the question, “Is that fair that you’re making a profit?” it’s probably just not someone you want to rent to. There was another example that I can think of in my life where I was going to rent out rooms to different people and fair market rent was $500 a room or $600 a room. So I said, “Hey, this is what you would pay.” The question that my friend came back with is, “Well, how much is that of the total rent? Why am I having to pay more than one quarter of what the mortgage would be on this house?”
I was like, “Because we’re not basing your rent off of what my mortgage is. We’re basing the rent off of what you would pay somewhere else,” and that tipped their hat. I realized, “Ooh, I’m not renting to this person. They’re already showing me that we’re going to have problems later,” because if my mortgage was $2,000 and market rent would’ve been $3,000 or maybe $500 a room for a six bedroom, they were wanting to be paying one fourth of what my mortgage was, not what market rent was.
So keep an eye out for that. If you get any kind of an inkling that someone has a completely different standard of fairness, it’s like trying to have a conversation with someone in a different language. You would not ask someone for help. If you went and spoke English and they replied back in French and you didn’t speak French, you would go on and find another person to ask for help. This is the same thing. The standard of fairness is like a language. Everyone needs to speak a common language if you’re going to move forward with your deal. So save yourself some headache by keeping that in mind.
Next question is from Austin Weber out of Fort Worth, Texas. “Hey, David. I love the show, especially you’re Seeing Greene episodes. My question is about where the lines are drawn for bill splitting versus claiming house hacking income. My girlfriend and I just bought our first house, which is on a conventional loan, only in my name currently. She isn’t particularly interested in learning about real estate, but she’s happy to help me do it, except she does not want to house hack. However, she will be paying me rent every month. So it isn’t exactly a house hack, but the money is going towards paying down the mortgage. I was curious if that is something I could claim as additional income and pay the taxes on in order to supplement on a W-income to show a history of rental income to help with additional loans in the future.”
So it sounds like Austin here is he’s going to charge his girlfriend a little bit of rent, that rent is going to, hopefully, he’s asking if that rent will count as income and his debt-to-income ratio to help him qualify for a larger mortgage. I would say, oftentimes, if you can get a lease signed, then your lender will take 75% of that lease and use that towards your debt-to-income ratio.
Now, each lender is different and these rules seem to change pretty frequently. I feel like almost every six months these things are changing. I would say, one, try to get your girlfriend to sign a lease and see if the lender would accept that, and then you may not have to really pay taxes on that amount because it is going to be such a small amount you’re going to be leaving there and all that. If you do want to claim that as income, supplemental income, again, it’ll be a pretty nominal amount. It’ll probably get washed out from depreciation anyway. So I would recommend doing both, right? Claim the income. It’ll get washed out on the depreciation on your house more likely than not, and then use that lease to help you boost your income and your debt-to-income ratio. David, I know that you’ve got a mortgage company here. So I’m curious to hear your thoughts on what Austin can do.
Thank you for that, Craig. This is a very good question. Unfortunately, the answer is not a positive one. No. If you own a primary residence and you collect income for that property, you cannot use that income to help qualify for future property. So it will not be included in your debt-to-income ratio. So if your girlfriend’s paying you 800 bucks, you can’t use that $800 and say that that is your income. However, if you claim it, it will still be taxed. So that’s just something to keep in mind that IRS rules are much different than the lending rules when it comes to your DTI.
All right. Our next question comes from Max Wheelhouse in Philly, and who better to answer a question from Philly than my good friend Matt Faircloth? Also a BiggerPockets published author. You wrote the book on raising private capital. Matt, let’s hear what you have to say.
Thanks, David Greene. Hey, guys. Matt Faircloth here. I am the author of the awesome book BiggerPockets bestseller, Raising Private Capital, and also one of the educators in the BiggerPockets multifamily bootcamp. Seats are limited so make sure you join us. Can’t wait to see you guys there. Honored to be here with you guys. Got a question coming in here, which is really interesting, a multifamily question, David. This is coming from Max from Philadelphia. Max lives in Philadelphia. He’s doing some deals all the way up in Redding, Pennsylvania Scranton area. He’s got a smattering of multifamily assets, 30 units, so scattered around. His cousin is running it for him. Max, like a lot of people, wants to trade up and scale into larger multifamily properties, which means selling all those assets and buying something larger. So really exciting stuff. A lot of people that have built a smaller portfolio want to scale into larger portfolios.
Here’s a few tips, Max, a few thoughts that I got for you. Love that you’re keeping into the family. You got your family want to invest with you. You got your cousin that’s running those assets for you. That’s awesome. Just don’t treat family like family when you do business with them. You still got to have written contracts when you’re working with family. So don’t not have the level of paperwork you will with someone else just because it’s family. Because it’s your blood doesn’t give you a discount on paperwork and LLC setups and those kinds of things. So as you scale up and do larger deals, make sure that you and your cousin have a written agreement and that your family members that want to invest with you also have written agreements.
Great attorneys are there to do that for reasonable numbers. Use an attorney to do it to set up yourself for a syndication because what you’re talking about for people investing with you as you scale your business and as you roll up, even though they’re family, it’s still a syndication. So you still need to do those things.
Other things that I want to just point out here for you, Max, is that in your question you talk a little depth about how, “Well, I don’t have this kind of skillset yet to run a larger multifamily, and I don’t want to let my family down.” I get it. Here’s a few consolations for you. Larger multifamily functions just like smaller multifamily in a few facets. Unit turns, well, you’re going to go and turn an apartment the same way you would in a bigger apartment building that you would in a smaller apartment building. It actually gets easier because the units are likely around the same size. If you’ve seen one of them, you’ve likely seen all of them. They look all the same in that.
So the upgrades and turns that you do on a small multifamily are going to be very, very similar to what you’re going to do in a larger multifamily. You’re still going to have common area maintenance, probably grass to mow, and maybe hallways to get swept and things like that. You’re still going to have utilities that are paid by the landlord. Some are paid by the tenant. You’re still going to have real estate taxes you need to monitor. Make sure the town’s treating you fairly with regards to your tax bill. Those are all the same.
Here’s a few things that are different in large multifamily that you need to prepare yourself to get ready for and to start to think about as you scale into larger multifamily. You’re going to start setting aside a little bit of money each month for capital reserves, X amount of dollars per unit. There’s a lot of opinions on that. The older the building, the more you want to set aside for things like roof repairs and window replacements and HVACs going out on you and that kind of stuff.
Additionally, and this is a good thing, for larger multifamily, there is a compounding effect to rent increases. If you have a 100-unit department building and you’re able to raise rents by 50 bucks on every apartment, that is $5,000 per month that you’ve increased the income on that property, and 50 bucks, it’s not that much to do. You might be able to justify 50 bucks from every tenant by doing some common area improvements, by maybe adding a small amenity onsite, one of those kinds of things. So there is a way to force appreciation very quickly in larger multi. So be prepared for the algebra that it takes to raise rents times the amount of units that you have. Over a shorter period of time, you can increase your revenue.
The biggest factor you got here, Max, before I leave you is that payroll is a major factor. The small multifamily portfolio you have likely does not have full dedicated staff. If you go and do what you’re talking about doing and buying a 50, 60, 70-unit apartment building, you may have a dedicated maintenance technician or even a dedicated leasing agent. As you get into larger and larger properties, you may have a dedicated site manager that runs the entire property for you and does all the ins and outs of that property. Be prepared to budget for the payroll for that person. Maybe it’s partially your cousin. Maybe it’s someone that works for or with them in managing that portfolio.
Best of luck, Max. Sounds like you’re well on your way. David Greene, back to you, my friend.
Okay. Thank you, Matt. That was also awesome. You’re in a really tough spot there, Max, and I can understand. I think that you should listen to your feelings in this. When your emotions are telling you, “I don’t want to borrow money to get into an asset class for the first time,” you should listen. You need to be especially careful when you’re borrowing other people’s money. That’s not a position that you should ever be in when you’re new and you’re learning on somebody else’s dime. My personal opinion, you learn on your own dime. Once you’re really good at it, then you can actually start borrowing money from other people.
So I’ll give you another personal anecdotal example from my life. It’s funny that this came up because today is the first day ever that I borrow money from a family member. My mom and her new husband have just let me borrow $200,000, and I’ll be paying them 10% interest on that money, and she was terrified, which is funny, because of everyone in the world that she could trust to give her money, do you think I would be at the top of that list? I probably am, but she was still just so, so nervous.
So she finally signed the documentation today and she’ll be wiring over that money, and she just texted me during this and said, “Man, this is such a relief. I feel so good. I’m finally taking some steps to take control my financial future. I worked for that money and now that money is working for me.” So congratulations, mom and Bruce. Glad that I could help you guys out, but this is a good example of how borrowing money from family becomes complicated. Even though I’m her son and she can trust me, there’s still some nerves when it comes to letting people borrow money. So don’t get into that space until you’re actually experienced in doing it.
You’re already doing the right thing. You’re reading the Multifamily Millionaire by Brandon Turner and Brian Murray, who works at ODC with Brandon. I love that because that book talks about how you make money in small multifamily, which Brandon specialized in and how you make money with big multifamily, which Brian specialized in. So once you understand both sides, there’s a pretty clear connection between the two. So you’re on the right path. Don’t give up. Keep going. Thank you, Matt, for your encouraging advice.
Okay. Let’s keep it moving. Our next question comes from Ethan F. in Utah and will be answered by Ashley.
Hey, you guys. It’s Ashley again, and I have another question. This question comes from Ethan in Utah. “My wife and I have stumbled into real estate and we have a question about it. We call this strategy property waking, leaving a wake of rental properties as we change our personal residence. There are two principles to the strategy. The first principle is to not sell your primary residence, but turn it into a rental property when you move. It’s okay to refinance, but ideally, you will have a cashflowing property. The second principle is the next primary residence has to have a house hack or rental in it. This will ensure you have the ability to save for the next property. Also, when house shopping for your next primary residence, you should be thinking about how you will have rental income while you are in it, for example, short-term rental, duplex, et cetera, and how you will maximize rental income when you leave.
Our question is, is there an opportunity cost to doing this that will hit us later on? Are we missing some critical details in this plan? Do we have an obvious blind spot we just aren’t seeing? Something worth noting, we also have the ability to invest in the stock market and other assets with decent returns and little management fees. So we are thinking not just about cashflow and equity, but what will the cash out look like and how will it be taxed. Would we be better just selling off properties and just invest the profits?
So we do know when you sell your primary residence and have lived in the property for two of the last five years, you can avoid capital gains tax, which is a huge benefit. If we have to sell rental property down the road, we will get hit with capital gains if we don’t do a 1031 exchange, but hopefully, we’ll have more equity in the home at that point, and we will net out with a higher profit. Instead, the goal is to have each home we leave become a rental property that cash flows. Typically, we are buying at nice zip codes because we live there. So we will have to leave more money in the property in order to have it cashflow. Thank you for answering our long-winded question.”
Okay. Ethan, let’s go through this. First of all, this is awesome because I recently last year discovered a wake surfing behind a boat, so I love the name property waking, and I think this is great. Congratulations on your success of doing this thus far of getting these rental properties in place using house hacking for your primary residence and being able to save money that way. That is super awesome, and I’m really excited for you guys.
The best part is is that you’re asking a question where you are having options. Yes, it may seem like a hard decision if you’re doing the right thing or the wrong thing, but I think you’re in a position where no matter what path you choose to go down with your real estate investing strategy, that’s going to be a win for you, but I understand that you’re asking this question because you want to maximize your return and maximize your investing. So let’s break this down.
So the first question you had is, is there an opportunity cost to doing this that will hit you later on? So are there any blind spots, something that you weren’t seeing? The first thing to think of is, are you actually ever going to sell these properties? So as you mentioned, if it is a primary residence, you will not get taxed on the property. You lived in the property for two of the last five years. So one option you could do is to when you get a property, if you lived in it for two years, is that fifth year, go and sell it and you will get the tax-free gains on that.
The next thing is if you do decide to go and sell the investment property and you are getting taxed at capital gains is what is the value of that to you? Why would you want to go and sell the property? Why do you need this lump sum of money? So you did mention that you have the ability to invest in other asset classes that may be more passive to you.
So let’s look at how much time are you putting into managing these properties, how much time are you putting into acquiring these properties, and figure out maybe what … Is it every week you’re putting in five hours towards this? One thing that you can do is you can do a time study. So actually, sit down for two weeks in everything you do, just write it down and how long it took you. So you can do this for your personal life. You could do it just for managing your properties, but take a look at that, and what is your time worth to you. So what are you cashflowing off those properties right now and how much time are you putting into it? Put a dollar amount to each hour that you’re putting into this property. You also have to take into account any cash that you have put into these properties too.
So put a dollar amount to your time and say, “You know what? I’m actually not getting that great of a return because I’m putting so much time into this,” where maybe you’re getting a 15% return on your investment when you’re investing into these rental properties, but if you go and put it into, say, the stock market and you expect to get a 10% return on your money, maybe it’s worth giving up that 5% because you don’t have to do anything except put your money into the account and let the stock market do its thing. So I think time freedom and evaluating your time that you’re putting into it is going to play a big part into helping you figure out which investing strategy is best for you.
As far as blind spots down the road, yes, you could get hit with a huge tax bill, but if you bought this house for $100,000, and 20 years from now, and you’ve cashflowed from it, made money from it every single year, and 20 years from now you go and sell it for a million dollars, okay, what’s the tax going to be on that? It’s going to depend on what the capital gains tax rate is at that time, but say you get hit with 30% on your taxes. So you’re going to take that 30% away, but you still made that huge gain. So it might be worth it to take that lump sum and pay the taxes too on it. So that’s definitely something you have to look at is, are you going to see as much appreciation and value of when you want to sell the property?
If you’re going to hold the property just for a short period of time and then you’re going to sell it and maybe it hasn’t even appreciated that much, you’re going to get hit with a tax bill because of your depreciation on the property that has … So when you are taxed on the property, you’re going to look at the depreciation that has come off the property too to see what profit is actually going to be calculated by the IRS when you’re selling that property. So even though you bought the property for $100,000, if you held it for a while and it’s depreciated down to $50,000 and you’re selling it for 200,000, that tax basis is going to be that 50,000 minus the depreciation, not what you bought the property for.
So all these things are definitely great to tax plan with an accountant or a CPA, especially one that has experience with real estate investing. Every year, sit down with them. It’s great to have a CPA to do your tax return, but even better to actually tax plan and say, “Hey, these are the things I’m looking to do in my business with my real estate investing strategy this coming year. What are some things I need to know?” Having that CPA to help you tax plan can save you so much money.
Another option that you could do too is if you decide, “You know what? This is too much work for me managing these rentals, I don’t want to outsource it. I just want to be done and I want to take the money, invest it into the stock market,” go and do seller financing. So find another investor who wants to take over these rental properties, and then that has your taxes spread out over time because you’re not taking that lump sum from the property, and you’re getting monthly payments from the seller financing, and then you can go in turn and take that and invest it into the stock market or another asset class, and it spreads out how much you are taxed each year onto the income you received from that property sale.
So let’s go on to the next question that you had is that you want to look at investing the profits into something else. So even though we are a real estate investing show here, I think it is great to diversify your portfolio. So maybe if you decide that, yes, you want to invest into the stock market and maybe you’re going for some index funds, which I love to invest into, is that you look at, “Okay. What’s the property we should sell this year, and we’re going to take the profit from that, and we’re going to invest that into the stock market, but we will hold the other properties?”
So in that scenario, I would look at which property right now is going to qualify for the lived in it for two years out of five years, and that’s going to be a tax-free gain. That’s the one I would sell. That’s the one I would get rid of. Then I would invest that lump sum, but you had also said in here that you have saved some money and that you use that because you are house hacking your current property now.
So maybe you just take those savings and keep everything you have in your portfolio now. Take those savings instead of buying your next rental and invest that into the stock market or the other passive income stream that you want to have and then start saving again and then go towards your next rental.
So I think it’s awesome. I think it’s amazing that you have so many options. One thing to note to look at too is when you are house hacking and you want to do them as short-term rentals or long-term rentals, make sure you’re understanding in the market that you’re investing in if those short-term rental laws or regulations can change. So are there really strict short-term rental regulations in place now where it’s a very small chance that they will change because if you have these properties and they’re running as short-term rentals right now and they’re in a market that maybe doesn’t have any rules or regulations so that one day the town or the village can come and say, “You know what? We need to start regulating this. It’s getting out of hand,” and they put a stop at that, is that going to hurt your business too?
So I think looking at your strategy and making sure that it’s foolproof going forward to help you make your decision as to what houses you want to keep and which ones you want to get rid of, but Ethan, congratulations to you and your wife on property waking, and best of luck to you guys. Send me a message on Instagram, @wealthfromrentals. I’d love to talk to you about this more and maybe get you on the Real Estate Rookie episode. So that would be great. Well, David, thanks for having me back to answer this question.
All right. Thank you, Ashley, once again for some very good feedback. I really love seeing you flourish in your role as a BiggerPockets Podcast host. You are clearly stepping up your game. So thank you for that.
All right. What Ethan F. refers to as property walking, I think, is probably one of the most solid strategies that everyone listening to this should be doing. You combine it with house hacking and you’ve got a guaranteed way to become a real estate millionaire without much work. You literally just buy a new primary residence every year using a very low down payment option anywhere between three and a half to five percent. Maybe you could get up to 10 for multifamily properties, and then next year you move out of it and you do it again, and you got yourself a rental property that you put 5% down instead of 20 to 25 percent down. It is a no brainer.
The only thing I would add to this is that in addition to buying one house to live in for yourself, maybe try to buy another house long distance real estate investing using the BRRRR method, flipping a house, some of the other strategies we talk about, but make this your meat and potatoes. This should be the staple of your diet, and then anything that you’re buying on top of that every year can be the fun food that you supplement your regular diet with, but this is a great strategy. Keep it up, keep doing it, and let us know how it goes.
Our next question comes from Steve in Reno and will once again be answered by Avery Carl.
Hey, guys. It’s Avery again. This next question comes from Steve in Reno. Steve says, “Reno is a tough cashflow market so I’ve been looking into short-term rentals. I feel like it’s a great market for STRs with lots of conventions and close proximity to Lake Tahoe. Assuming the yield curve inversion does, in fact, lead to a recession in the next year or two, travel and vacationing tend to be one of the first things to go away. How would you suggest I proceed so I don’t get caught with my pants down?”
Okay, Steve. So I have a lot to say about this particular question. I would say the number one thing you want to do before you even do anything else, check the regulations in Reno, and not just the current regulations, call the city and see if there’s anything coming down the pipe, if there’s anything that’s been discussed or brought up in the most recent city council meetings about potential changes because just because the rules are the way they are now does not mean that they’re always going to be that way, especially in a metro market like that.
If we are, in fact, entering into a potential recession, I think the most important thing when choosing where to invest in a short-term rental is choosing the right market. So I don’t know a lot about Reno, specifically, but the first markets to go in a recession are the markets that are really difficult and expensive to get to. So if it’s an area where you pretty much have to fly there if you want to go there, you can’t really drive, the majority of the tourism coming to that area or visitors coming to the area are having to fly and it’s expensive, that is going to be a red flag for me. I try to stick to markets that are more drivable, that most of the visitors and tourism coming in are driving because along with that, it makes it a little bit more affordable to get there. So accessibility and affordability are really important when it comes to what tourists are willing to pay and what they’re willing to do. So keep that in mind.
How would I suggest that you proceed so you don’t get caught with your pants down? So if you’re buying in a metro market like Reno, I would suggest that you are able to convert it to a long term if possible, and I don’t give that advice for every single market. If you’re buying in a vacation market, totally different. That’s a separate strategy, but talking about a market like Reno, I would want to make sure that it is something that you can still cashflow or at least at the very least breakeven on if you do have to convert it to a long term because people just aren’t traveling there.
I really don’t think that we’re going to see a situation where no one will be traveling anywhere like COVID, for example. So you will still probably be able to at least breakeven without having to convert to a long term, but it is nice that you can do that if you want to in a market like that. So I would just say make sure you don’t spend too much to where the numbers don’t work as a long term, and then also of course, always the BRRRR strategy. You’re not necessarily a full BRRRR but a value add, where you’re buying a property that you can add a lot of value to so you’re not spending as much on the property itself, so your expenses will be less when it comes time to start short term running it. So I hope that answers your question, Steve.
All right. Thank you, Avery. Great advice. I think, in general, anytime you’re buying a short-term rental, if you can find the angle of you could convert it into a long-term rental so that it would cash flow, I’m a fan of that, in general. Then also just to put in there, if you can figure out a way to add value, adding square footage, buying a property below market value, buying a property that needs some work and fixing it up so that you’re going to make the ARV higher, all of that is a great way to hedge the risk that is inherent in short-term rentals because it is true that we could be seeing a recession, that it’s very likely that travel could go down.
So what I’m doing when I’m telling everyone else is plan that whatever numbers you’re running you’re going to maybe get 70% of that. So whatever the data is telling you, just takes 70% of it and run your numbers that way and make sure that you’re at least breaking even or coming close, and you can weather that storm if it does come because we don’t invest in real estate for one year, we invest in real estate for the long term.
Our next video comes from AJ in Long Island and will be answered once again by Craig Curelop.
Next question is AJ from Long Island, New York, who started house hacking back in 2012. He’s got a whole lot of equity in his house. So his question is if he wants to buy another investment property, does it make more sense to just pull equity out of his current home using a HELOC to invest in another or are there are other options that he can do?
So AJ, there are a lot of options you can do. I would like to say you probably have a good amount of equity in your house if you bought it back in 2012. So the HELOC would be my personal favorite. The reason why is that you can get a pretty good amount in your HELOC if it’s appreciated over the last 10 years, and that’ll likely be enough for a 20% down payment somewhere in the US. The great thing about that is that you’re only going to be paying for that HELOC when you draw down upon it. So you’re not really in a rush to find a deal, you’re not really increasing your mortgage right away, and all that kind of stuff.
So another option would be to refinance it. So if you refinance it, then you’re going to get a whole bunch of cash back, probably a little bit more than you would if you just did a traditional HELOC, but you’re going to be required to pay that additional monthly payment no matter what. So you don’t really have that option of acting when the deal comes you’re going to have the money, you’re going to be paying the extra cash flow, and you’re going to feel the pressure to find a deal as soon as you can.
That’s my thoughts. Again, you have the option between a HELOC and a refinance. My personal, what I would recommend is just go with the HELOC so you have a little bit more of that flexibility. David, what would you do?
Thanks, Craig. Love your help with that answer. This is going to make a lot of people a lot of money. I’m glad to see you guys on the Seeing Greene episode helping me out here. We’re going to switch it up for a little bit at this segment of this show. I like to read some of the comments that come out of our YouTube channel. If you didn’t know, if you’re listening to this as a podcast, you can also listen to it on YouTube. I’m not paid or endorsed by YouTube to say this, but one of the things that I did was I switched over to YouTube Premium. I think it’s $15 a month or something. YouTube will play even when the app is closed. Ever been listening to a YouTube video that you were really liking and then a text message came in and you’re like, “Ah, I can only open it up when the banner shows up on my screen and YouTube will keep playing, but if I have to close the app to reopen my text app, then the YouTube video would stop playing?” and you’re stuck like, “Do I keep listening or do I reply to this person?” I know many of you are smiling because you’ve been in that same dilemma.
Well, I solved that by getting YouTube Premium and now, I can listen to it all the time. So YouTube is pretty much always playing. When I combine that with my AirPods that I have, I could always be getting new content, and that’s how I stay ahead of the game. It’s why I don’t get caught off guard by changes in the market or different strategies or problems that could be coming because I’m always staying educated, and I would love for you guys to do the same. I’d love to be in your ears all the time with this soft silky voice warning you about how you can avoid mistakes in real estate and pointing out areas where you can make money.
So with that being said, go to YouTube, listen to us, and then leave some comments. I want to hear what you think about this show. What did you like? What do you wish we would talk about more? What topics do you want us to get into, and where do you think I screwed it up? Yes, you can give me negative feedback as well. I don’t take it personal.
All right. Our first comment comes from Chris Calero and he says, “Absolutely love these kind of videos. I feel like many of my questions were answered.”
Well, thank you, Chris. I believe when you say these kind of videos, you’re referring to the Seeing Greene episodes. I’m really glad to hear you guys like these. You know when Brandon Turner stepped away from the podcast, go do other stuff, we wanted to figure out a way that we could continue to bring you even more value in different ways because we didn’t have that big, beautiful beard right behind me helping give commentaries. So glad that you guys like these. I want to keep them going too.
Next comment comes from SL, “I’ve heard you mentioned basically staying away from Missouri on a few episodes and I’m wondering why. I’ve relocated here and have four flips going on and two BRRRRs going. That’s a lot happening here. I think you underestimate Kansas City, Missouri and Kansas City a lot.”
Well, to my knowledge, I don’t think I’ve ever specifically said don’t invest in Missouri. You may be referring to where I talk about the Midwest. I have given some warnings about staying away from those markets, and I appreciate you saying this because it gives me a chance to clarify what I meant when I make those kind of comments. I don’t think that there is a bad market in the country. Every market works if you understand the strategy. I think that there are people who take shortcuts and are prone to making mistakes in certain areas more than others.
So one way I think investors get into trouble is it’s very obvious right now that there’s not a lot of cashflowing properties available. Very hard to find anything that cashflows at all. So when the road becomes steep, you got to climb uphill to find the better deal. Many human beings will stop walking up and they’ll just look for a downhill road. If you’re trying to get cash flow, which most investors are, and if you’re newer and don’t have a ton of capital, which the majority of investors are in that situation, the downhill road leads into the Midwest.
Homes are priced much cheaper. The price-to-rent ratios are much stronger. It becomes very attractive to say, “Oh, I’m just going to go there. I’m going to go buy in Indiana.” I have mentioned Indiana more than Missouri just because I hear so many new investors saying, “I’m buying in Indiana.” 90% of them are all in Indiana. I don’t think that that market is strong enough to warrant having 90% of investors there. So why are they there? Well, they’re there because the prices are very low and it doesn’t feel as scary.
The concern that I would have is that you think that when you buy a property with a low price point and a strong price-to-rent ratio, but you don’t factor in. You’re not going to see growth. Rents don’t go up there. The money that I’ve made in real estate from the cashflow side has not been when I bought it on year one, it’s been five years later, 10 years later. Think about buying in Denver, Colorado five years ago or even 10 years ago. When you first ran the numbers on your duplex, they probably didn’t look all that sexy. Five years later with high growth wages going up inflation, you’re looking really, really good. It’s that idea of delayed gratification that I’m really getting at. I want more people to take a bigger picture of you. I don’t want them looking for a quick fix where they can get a bunch of cashflow and then start spending that money or quit their job or make major life decisions because they bought two properties. You want to be in this for the long haul.
Now, it sounds like you, SL, are doing great in Missouri. If you have four flips going on in a market that’s tough to flip in, you’re finding deals below market value. You should be doing what you’re doing there. If you have two BRRRRs going on, which are very similar to flips, I’m assuming these are deals that you got below market value that also cashflow. If you’re finding stuff below market value, you can make it work anywhere. So you should keep doing this, and other people who are understanding the Kansas City, Missouri market or Kansas City, they can do the same thing, but I don’t want people who are not getting stuff under market value, who are not getting great deals to just go pick something off Zillow and go buy it and say, “Well, everybody else is doing this so I will too.”
Our next one comes from Stephanie Mocris who says, “I’m honored to have my question answered by David Greene.” She got the E at the end of my name right. Way to go, Stephanie. “It was pretty surreal hearing him say my name on the podcast. David, I am saving your words like gold. Thank you again for all that you and your team are doing for other learning real estate investors. You guys are changing people’s lives.”
Well, thank you, Stephanie. Not only did you put yourself out there and asked the question on YouTube, but then you looked and saw that we put your name out on the podcast and went on YouTube again and put another comment, and now you’re getting mentioned again on the BiggerPockets Podcast. You can now officially tell people, “My name is Stephanie Mocris and I have been featured on the biggest real estate podcast in the world.” So way to go. Good for you.
In case you guys are wondering why my background looks different than normal, well, this month, maybe the last 30, 40 days or so, I will be traveling looking at different investment property, checking out properties I’ve already bought, attending a couple different events. So right now, I am in Scottsdale, Arizona looking at new investment property out here. After that, I’ll be headed to Austin for Keller Williams Mega Camp, and then I’ll be heading up to the Blue Ridge Mountains in Georgia to check property out there.
So join me on this journey wherever you are, where you’re looking at properties. Put the podcast on. Listen as you’re going. There’s nothing as fun as looking at houses, analyzing opportunity, and hearing BiggerPockets in the background doing it while you’re there. It’s a perfect combination. It’s like peanut butter and jelly. It’s like Pop Rocks and Coke. You can’t do anything better than this.
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Hey, Dave. We’ve got a good one here. I’ve got one from Janelle from Bay City, Michigan. Another multifamily question. Janelle faces a problem that a lot of people do when they’re looking for multifamily deals. She’s like, “Hey, guys. I’m looking on LoopNet, and Crexi, C-R-E-X-I, for multifamily deals. First question is, should the price be valued and based on the cap rate of the area and the actual NOI?” Get back to what she means by actual in a second here. “Then if the new owner is able to create an NOI increase in the performance, shouldn’t that be to the benefit of the new owner to then refi and/or sell based on the new NOI?”
In essence, what Janelle’s saying here is that when she’s looking at properties, the broker is pricing the property based on future performance. Let’s break that down. First, let’s talk about how properties are priced. They’re priced based on a cap rate, which is simply a risk factor on a neighborhood. So Detroit, Michigan may have a higher cap rate because Detroit has a perceivable higher risk factor as an investment area than some city based on Raleigh, North Carolina may have, right?
So without drilling into local cap rate specific inside of a market or whatever, it’s just simply a risk factor that folks may want to have, maybe willing to take a higher risk and invest in an area like Detroit versus Raleigh. So the cap rates will be high. The higher the cap rate, the higher the rate of risk that you’re willing to take for an investment in that market. Cap rate’s calculated by looking at the purchase price of a property. So if a property is selling for a million dollars and you look at the cap rate of 5%, that if I take that million, multiply it by the cap rate of 5%, the property should be able to produce a NOI of $50,000.
NOI is simply the rent that a property produces minus all of it expenses except for debt. So all your expenses except for debt service equals NOI. So income minus expense, NOI. There it is. So a million dollar property at a 5% cap rate should be producing 50 grand per year in downside and downline revenue after expenses are paid and you can apply that revenue towards debt service or another way to look at it is the NOI is how much money a property would make if you owned it free and clear. So that’s what all that stuff means.
Now, what Janelle’s facing here is a broker is saying, “Well, we’re going to take a property and we’re going to sell it to you for more, let’s say 1.2, 1.3 million based on that $50,000 NOI because at some point in the future, you should be able to raise rents or build a laundry room or do some common area improvements or … Well, the market has gone up more and the owner hasn’t increased rents.”
That’s not really the way the broker should be doing it. So what Janelle’s saying is that the broker’s pricing, putting today’s price for future performance, which isn’t really a fair way to do it. There’s some kid glove guidance I’ll give you guys here. Okay? You want to talk to the broker. This is always worth a phone conversation, not worth just a, “Oh, it’s overpriced and move on,” or you don’t want to rub the broker’s nose in something where like, “Hey, you’ve included future performance or work that I’m going to do as a buyer. You’ve given credit to the seller for those improvements that haven’t been done yet.”
You don’t really call them out. You want to just say, “Well, I’m going to be making an offer. I make my offers based on current performance, Mr. and Mrs. Broker.” So just tell them this is how you do it. This is how you’ve been taught to do it, and this is how you’re going to be pricing the property. Just say, “Well, here’s what the last 12 months worth of performance says the property did. That’s called a trailing 12, and I’m going to look at the trailing 12 on the property and say it did $20,000. The market cap rate that I understand it to be is this,” and you could even ask the broker what they think the market cap rate for that market is and they’ll tell you. Then you give them a price based on actual performance.
If it doesn’t match what they’re asking on the property, then kindly, politely call out that, “Well, I’m pricing it based on actual performance. You can put your own factors on there, but this is how I’m pricing it,” and be willing to put your offer in writing and put some backup in writing too, but again, you don’t want to go calling names or throwing rocks to the broker here because this is they’re living. You can kindly approach them with some feedback and don’t be afraid to put your offer in writing with some real backup of how you’re coming up with your calculations.
I’ll underscore one more thing I just said. Make sure the broker tells you what they think the market cap rate is because it’s given them some input. If they’re completely off on that, then that’s another factor you could dig into or maybe talk to some other brokers about what they think the cap rate for the market you’re looking at is. It is a bit of an art in this kind of thing. So make sure that you’re willing to do that art and get your conversation skills really, really tight and talking to the broker about these kinds of things. Best of luck, Janelle. Sounds like you’re well on your way. Back to you, David.
All right. Thank you, Matt Faircloth, once again for a great answer. Appreciate you and appreciate all of you listeners as well. This has been a little bit of a longer episode because we brought a ton of value. So I’m going to let you get out of here. Thank you again for checking out this Seeing Greene episode while I’m in Scottsdale, Arizona. Appreciate your guys’ attention, time, and love, and we love you back. Check out another episode and let us know in the comments on YouTube what you think. I will catch you on the next one.
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