The SFR Show

In this episode we have Dana Dunford from Hemlane Property Management back on with us to discuss what actually goes into managing properties. 

Check out Hemlane at www.Hemlane.com 

Send your questions for Dana to [email protected]

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Transcript

Michael:

Hey everybody. Welcome to another episode of The Remote Real Estate Investor. I'm Michael Albaum and today I'm joined by my co host,

Tom:

Tom Schneider.

Michael:

And we've got Dana Dunford back on the podcast with us again from Hemlane. She's gonna be talking to us today about property management, and a lot of things that we need to be thinking about and considering when choosing them and thinking about property management in general. So let's get into it.

Tom:

Dana Dunford, welcome back to the podcast.

Dana:

Great. Thanks for having me.

Tom:

So it's been a few months since we've had you on, let know any updates with a company with Hemlane. I mean, today's episode, we're going to talk and to go into detail about the time behind effectively managing properties. But before we get in, how's everything going?

Dana:

Things are great. We've launched 12 more cities on em lane, which has been fantastic overlapping markets with you guys, as well as revamped some of the financial reports for real estate investors, which has also been a huge thing for taxes and everything coming up for 2020 reporting.

Tom:

Awesome. Yeah, tax time. Like as an investor, it's like one of my least favorite time of year wrangling down all the different stuff. That's very cool. Alright, so let's go ahead and jump into the episode. So again, this episode is on the the truth behind the time it takes to effectively manage properties does all the different timing requirements involved in property management?

Dana:

Yeah, so one of the things that I realize, in speaking with a lot of real estate investors, especially ones who've just come in to market is they don't understand how long it takes to manage a property and they they don't value their time. And so what I mean by that is, on average, it's about four hours. That's the general rule of thumb, four hours per month that you spend managing your rental property, it's about four hours per month that you spend managing your rental property. If you compare that for hours, as a general rule of thumb with what we charge for property management, what a full service property manager charges, it's really not that much. If you value your time to be more than, you know, 30 to $40 an hour. It's not that much the property management charges. based on you know how long it takes to manage your property.

The rental housing survey also did an estimate across both property managers as well as real estate investors, landlords asking them how long it took for them to manage their property. Even when you account for traditional property manager who has operations built in house like scalability, etc. It was still around three hours on average that it took per month. Of course, that will fluctuate you might have one month where you literally just need to confirm a rent check was collected. And then you'll have another month where you have some situation where there's a leak, and you have to be much more involved. But as a general rule of thumb, I like to tell people if you budget four hours a month, you should be in good shape.

Tom:

That's great. You know, I think the time volume, you know, four hours isn't that bad, but would kill me is like not knowing it's like, okay, Is this our gonna show up on Friday night at 9pm? When the toilet breaks? And, Michael, I think you were…

Michael:

Yeah, it's just interesting, I would question how the four hours number kind of came into fruition because if I had to wager, I would say that most brand new landlords are going to be spending a lot more than four hours a month getting their own systems up and running and getting comfortable with all the things so maybe this is a seasoned self manager after doing it for a while. But just to get up and running. Like you don't know what's legal and illegal in your state, you don't know what systems you don't know who to reach out to, like, every time you have a new issue pop up, you have to go spend time searching out the folks to do those types of repairs. So it just seems really low as I guess what I'm saying here, in so many words, it seems like a professional property manager is so much more efficient, that I'm surprised that they're so similar in terms of hours spent on the job.

Dana:

Yeah, so as far as the property management have the four hours per month that's on management, so collecting the rent, recording all of your expenses, doing the repair, coordination, taxes, everything that basically goes into the property management side of it, but and that's including inspections that you would do annually, etc.

There's another component of property management, which is equally the same amount of time, but all built into 30 days or less, or you would hope it's under 30 days. And that is what we call finding and placing a tenant finding and placing a tenant is of just as much work as basically 12 months of management. And you see that if you think about it in the cost structure because the fee to find a place to tenant is about equal to the amount that someone charges for 12 months of property management.

And that's where you're right. Once you have processes down you have some efficiencies built into the process. But when you're a brand new landlord, you don't know anything you don't have tenant landlord law, you don't understand where to advertise the rental property, you waste your time on showings. Because you show up and then you meet a tenant who you found out has been evicted three times, and you learn that you should have pre qualified them before ever showing up at the property. So from that person's perspective, it is a lot of time. And that's why we really do recommend, if you're a first time landlord, use the leasing agent to help find and place a tenant get a state specific lease, learn from their process. And then eventually, if you happen to move close to the property, or you want to do some showings or have a little bit of experience, you can do it later on. But it will be worth the fee that you pay for someone to find in place a tenant,

Michael:

I think you're being way, way, way too generous, because I would consider myself a semi seasoned landlord investor. And I still don't know anything. So just because someone's new or seasoned doesn't necessarily mean that they know anything, I'm still in that same camp.

Dana:

Yeah, and that's a good point. Usually what happens that how people learn is by making mistakes, right? Like, I could teach a class on property management of exactly what to do. But it isn't until that first case where you have a difficult tenant, and that you say, Okay, next time I'm building into my lease agreement that they are responsible for window cleaning, because I don't want to have another fight about a tenant about window cleaning, or gutters, I never want to have that fight again. So I'm going to put it into the lease agreement. So a lot of those types of things you learn as you go along. And the only way I can really say that you could mitigate that even where you are right now, my goal and your stage of real estate investing is to focus a lot on your state specific or your county, specifically, whatever at least you're using, really making that concrete as well as as the education but a time will also allow you to really understand what you missed throughout the process.

Michael:

Wasn't it Mike Tyson, I think he said everybody has a plan until they get punched in the face. Like going to the school of hard knocks, experiencing going from that classroom setting to that real world setting. Anytime dealing with people, really anything can happen. And so that's why I've put all my eggs so to speak in the professional property management basket, because there's just too much out there that I'm not aware of or can't foresee. So I'll leave it to the professionals.

Dana:

Yeah.

Tom:

So that was a great overview on the different time requirements and kind of bucketing it in into the leasing and the property management. Let's talk about reserve requirements of effective property management, and kind of thoughts on that.

Dana:

Yeah, I'll tell you what our reserve requirement is how it works. But then I'll give a caveat to it. So we say at a minimum, you should have a reserve of $500 at a minimum, right. And we actually don't hold reserves, you just have to have that in your bank account. Because at point of service, when it's completed, that's when the charge goes through $500 is to essentially cover emergency calls where we have to dispatch someone up to that amount.

However, you should definitely have a reserve higher than that in your bank account, right? Whether you're self managing, or whether you have a property manager, but you can figure out what your reserve is by actually doing an inventory count of appliances, what appliances you have, how old they are lifespan value, as well as huge capital expenses. And what I mean by that is an example would be a roof, if you know that your roof is going to have to be replaced within the next three to four years, you should have that built into your reserve that okay, I suspect I'm going to have to replace the roof. That should be there's going to come a day where there's a leak, my tenants are complaining because it's going straight through the walls, we need to get it fixed. And we're actually going to have to redo the entire roof but it can't be a patch.

So there's certain things like that it's it's specific to your property. Um, same thing with one of the biggest ones we see is water heaters where the water heater goes out, it's really emotional time for a tenant, because they want their hot water. And so you do need to budget for that. And a lot of times if it's a newer property, with some sort of warranty, you're going to need that $500 is probably fine. But if it's an older property, you know, something's going to come up in the next five years, you should have some sort of reserve to say, okay, when do we expect these things to happen?

So that's where I say get out your Excel spreadsheets and actually put that in there of here's everything from a capital expense, as well as appliances like, well, that's still capital, but replacement of those. Those are the huge ticket items that we see.

Michael:

That makes total sense and curious to get your thoughts on how you think about home warranties.

Dana:

Yeah, that's a great one. One of the things I will say about home warranty, first of all, on Angie's List, it's the lowest rated category.

Michael:

That makes so much sense.

Dana:

And the second lowest rated is property management.

Michael:

That's a good frame of reference.

Dana:

There's a couple of things one, not all Home Warranty companies are created equal. That is One thing I will say we work with them all we have some of them like American Home Shield on speed dial where they like know our number coming in, right. So they're not all created equal. And usually what happens when something goes wrong with home warranty is that the real estate investor says great, I have home warranty, they're gonna cover everything. And I just have to pay my $79 service call rave. The biggest mistake you make with home warranty is not reading the terms of service, the terms and conditions because they will say we cover all these things. But here's the things we don't cover. And actually the things they don't cover is actually a longer last right?

And we've gotten in so many situations where someone's dispatched, the owner just assumes that it's going to be covered. And then there's something in fine print that is font six and like you'd literally need binoculars to read it, where it says Oh, but in this certain situation with a piping, we don't cover X, Y and Z. And suddenly, there's a huge bill for the owner. A lot of real estate investors love Home Warranty because it's steady, right every month, you know, the most you would pay is maybe one or two service call rates at most, everything else is covered. This is great, I can forecast my expenses and have capital expenses also paid for through home warranty. Depending on what you have and your home warranty list of services. That's great.

However, then you get into this situation where you have an unforeseen large bill and investors get upset. That's why think home warranty is the lowest ranked on Angie's List is that if you're going to get one and I'm fine, if people get it I personally wouldn't, I'm fine. If you get a home warranty, I think they're great for a lot of people and give a peace of mind. But if you do read the fine print know exactly what's covered, and have those expectation that something's not covered.

There's one other point that's very important with home warranty. And this is SOAs for emergencies. With plumbing requests we've seen with plumbing and no heat or no air conditioning, where there's extremes it's over 90 degrees versus you know, under 40 degrees in the house, they have not been able to meet SOA is that we consider this would be a good experience for tenants, they cannot get someone out in enough time.

Michael:

And what's an SOA for our listeners,

Dana:

That's the amount of time to get someone on site to assign to the property and on site for an emergency. Usually, when I'm talking about emergencies with home warranties, it's usually something with plumbing, like there's a leak an active leak that cannot be contained, or it's something where there's no heat, and it's you know, 20 degrees outside and the person has a baby that screaming and it's a very emotional time as a real estate investor. If you're doing your own self management or using a property manager, you have to think quickly you have to understand, can we get someone out there in enough time? If not, if it's something like no heat? Can we put them up in a hotel? Can we get them radiators? Like what can we do to make this a better experience for them?

But what we've seen with home warranties, they'll say yeah, we'll get someone out call us in an hour calls in two hours, call them in two hours totally new person you're talking to? Oh, wait, yeah, we call the companies they can't get out. And then suddenly you're talking about It's been eight hours of something. And then you're having to say can we dispatch someone? Get them out there? And can you reimburse us for it? And they say yes, of course if they're licensed, if they're insured, were like, of course, they're going to be licensed and insured, you get that person out there. The second they hear home warranty, they go, we don't want to work with them, they're going to price set and then you get in the situation where the tenant is like what's going on. This is a chaotic situation. And it makes you as a real estate investor look really bad. Because suddenly, it looks like you don't have your operations down.

So that is one thing we tell people, if you use a home warranty, for some people, it's fantastic. People love it, you know, case by case basis of who wants to use it. But if you use a home warranty, know that you might still have to go outside of the home warranty, especially in emergency cases. Again, the last thing you want is a tenant that's upset and they don't renew their lease, because they remember that situation when there was a leak and active leak. And now their floors were flooded. And there's all these renovations that have to go on because you couldn't get someone out in enough time.

Michael:

Yeah, that's my experience to a tee. That's that's very real benefits.

Dana:

Yeah.

Tom:

Not necessarily property manager related but just on reserves. Do you have any? I don't know kind of general philosophies around reserves as a relates to if you have a mortgage and insurance costs and tax goes I don't know. Do you like do you back out a couple of months would you in and kind of general thoughts and holding reserves on those type of fixed costs?

Dana:

Oh, you should already have Yes. Sorry. I thought you're talking about repair reserves.

Tom:

All the reserves, we'll put them

Dana:

All reserves. Yeah, you definitely need that because the most emotional situation for a real estate investor. Like the worst decision you can make is I am leasing out my property I need to make My mortgage payment, you know, that's one. And I've got one tenant who's interested in the place, they have three evictions on their record. Now, this is an extreme case, but they have three evictions on their record, but they're the only person I have. And they said, they can come to me with first month's rent and security deposit today, and they have it in all cash, and I need to make that payment. And so I am going to go ahead and rent to this tenant.

That is a bad situation, because it's going to cost you more in the end, if you do something like that. And you're not really setting up solid operations, it only catches up in the end, you're gonna have more to pay for, if you don't have the money to pay the mortgage, right? Go into foreclosure, all these things that can happen will happen is just a ticking time bomb, right? And so from that perspective, from having reserves for the unforeseen you 100% need and I think COVID has really been a stress test for a lot of investors out there today, to say, oh, wow, there has been these unforeseens and I definitely need some cash in the bank. If there's one rule I've ever learned in life, it's don't run out of cash. And and you definitely don't want that to happen, right? You don't want to be making bad decisions on who's in your rental property or what you do with it. Just because you need to make your mortgage payment

Tom:

Panic, renting can turn into panic selling the domino effect. Some people ask like, how many months Do you think about having those types of fixed costs reserves, I've heard three before, it was just love just to hear your thoughts.

Dana:

I'm super conservative with that kind of stuff. I say six months, and I'm more conservative than most. So like someone with three, it's probably okay. On average, you'll rent a property in this day and age, especially with single family homes, you should be renting it within 15 days, top market. Now, it depends on where your rental property is. But as long as you're priced correctly, you should have it off market within 15 days there if if you're pricing it correctly, and or at least a lease sign up, the tenant moved in, but at least signed.

So from that perspective, the reason I say six months is if something unforeseen happens, I never want a situation and that might be dispersed across a couple properties, right? If like I have to, and instead of three months, it's like basically six months total. But let me give you an example, you have something happen. And I've actually seen this recent case with an HOA, where the unit above flooded. And so of course in the real estate investor, nothing to do on their end, but the tenant had to move out had to deal with the HOA, you're trying to deal with insurance, it takes a while for some of these insurance claims to come in and money and you have to get the tenant out of there, like the tenant literally can't stay there.

So they're out, you've lost that rent, you're trying to do the insurance, money on it, you don't have any idea of how long until you can actually re rent the place how long it's going to take. And you could be in a place where like, that's a condo situation. But like in a place like Houston, when there's flooding in Houston, try to get some contractors out there to get your property back up. Like it's going to take months to do that. And every insurance company works differently, and how it some are great, and they can get you the funds quickly but doesn't happen in all cases.

And so if you have only one rental property, like I say six months, if you have more than one and then they're diversified a little bit, you might be able to say, Okay, I can get by with lower reserves per each one, because the chance of something happening to all of them is much smaller. So it would be on a case by case basis, I tend to be a lot more conservative than any other real estate investor.

Michael:

That sounds Yeah, it makes total sense. It's something that I talk a lot about in the academy is people ask that question all the time, how much should I reserve, you know, per unit or per building, and I agree with you then 100% and that per building, as I add more buildings to the portfolio, more units, the portfolio, the net dollar amount has increased in reserve, but on a per unit basis, it's tends to decrease its statistical likelihood of having a loss or a repair or major catastrophe at every single property every single month is highly unlikely.

Dana:

Yep, that's correct.

Tom;

So next question for you, Dana. I, you probably have a lot of interesting stories related to tenants. I'd love to hear some of your stories related to tenants. I think there's probably a lot of interesting stuff happening.

Dana:

Yeah, tenant stories we have a lot.

Now, Michael mentioned this earlier, right? That it's only through time that things happen and you learn your lessons and you'll never make that mistake again. The most extreme case that we've had was in Springfield, Ohio back in I think it was between 2015 and 2016. We picked up a portfolio of properties and actually had an on site license manager not on site but local property manager just based on the properties being in that very low class C almost Class D type of investment and picked up quite a few properties there.

At the same Time, which wasn't even quite in the news as much as it was, you know, six months later, but the opioid epidemic was happening. And as the property manager said, these tenants are dropping like flies, like literally, she told us that and it was a terrible situation, we were doing the repair coordination for it. But what you're talking about for the real estate investor is no income coming in, because the tenants are just dying, left and right from these opioids, and then you're dealing with all these legal things of what to do with the property, then we're dealing with a turnover, there was like feces on the wall, like, I mean, everything was just terrible, everything was unbelievable in the amount of time we spent on it. And then for the real estate investors, the prices didn't go up at all right, they wanted these to be cash flow, and then they were making no money to turn them over, it made no sense because the amount of work that required to turn them over versus what they could make and renting them over the next, you know, even three years was just not going to make sense.

And the properties were destroyed, you couldn't find tenants that were qualified, it was just a terrible situation. And one thing I learned from that really talk to real estate investors about especially before they purchase is really know your market, and really understand where you're investing and what's going on. And that's where actually I think Roofstock does a good job, because you guys, the types of properties are ones that will cash flow, but you can get a qualified tenant in them. And I think you need that balance, you need ones where you can get a qualified tenant and also cash flow it like you want both, right.

And in this particular case, the numbers looked great on paper, if you put them on Excel for like buying these properties for $40,000, versus how much you got in rent, they looked great on paper, but then the operations associated with them for everyone involved, the owners, the property manager, so as the platform that was helping with repair coordination, and the operations associated with the management, and technology, it was it was just beyond anything that we could do.

And so one thing I learned from that a lot is, there's only so much you can do on the property management side, right. And that's why it's really important to work very closely with on the purchase side to make sure that it's also going to perform on the property management side, some properties just won't perform. That's just the first one.

A second story, I would say with tenants is inherited tenants, we've had situations where we have inherited tenants that don't have leases, they're in cities that are super tenant friendly. And the rules are basically against us and the landlord, right, there's nothing you can really do to get them out of that property except a ton of legal fees, and a ton of legal bills. And you know, there are certain situations like that as well, that you can see happen. Those are extreme cases that I don't think happen, obviously, with Roofstock properties. But definitely we have seen that happen where there have been horror stories with tenants that are inherited. And there's not much you can do about that except get lawyers involved and make sure you can get a really good situation good tenants who respect the lease, as well as for the owner, they're getting their cash flow.

Michael:

So in both those instances, is it fair to say that those were four hour a month properties in terms of management or the maybe a little bit over?

Dana:

Oh, way over that way over that? And that's where the four hours is average? Right? But those ones spent way, way, way too much time on them. But you know, in hindsight, we learned a lot of lessons on it. Right. And real estate investors learned a lot of lessons on it as well. So all in all, it was a good lesson learned to make sure we're always under four hours going forward.

Tom:

Yeah, I think one of the mistakes that newer investors make is they just look at Excel and don't…

Michael:

Live in the spreadsheet!

Tom:

Yeah, live in the spreadsheet and don't account for risk adjusted returns.

Michael:

Yeah, I've got a question. Dana, I'm curious to hear, from your perspective, when should owners change property managers? Or what are maybe some red flags that folks should be on the lookout for that the property management relationship isn't working? Because I know that I've fired property managers, Tom, I think you have as well. So getting some insight, kind of from the property management side of things, I think would be really helpful as to shedding some light on, you know, how do I know when it's gone too far off the rails?

Tom:

Good question, Michael.

Michael:

Yeah. First of all, when people have a good property manager, if things are going well, you know, because they're transparent, all the numbers make sense. And then you see all the numbers, you don't get a lot of calls, there's qualified tenants in the place. And I always tell people don't change property managers. You know, we've even had people come to him lane and say, Hey, I'd like to use him lane. Everything's great with my property manager. And it's like, Great, yeah, we'd love for you to transfer over. But if things are going well, that's a good sign with your property manager. And there's a couple of things I've seen and I'll give you three primary ones. Where it's time to change property managers.

Number one is transparency, if your property manager is not transparent about costs, and like, for example, one that I've seen happen very often is your like, my maintenance and repair line items are a lot more than I would expect for it in this property, you know, maintenance repairs a lot more than other properties I have in my portfolio or other people that I know who have similar real estate investments are experiencing, right? And then you reach out to them. And you're like, Can I have the invoices from the service professionals, etc. And they give you their invoice, not the service professional actually did the work, but like their invoice for it, and you're like, hmm, these costs seem very high.

If you're starting to question things like that with repair and maintenance, that is a bad sign. So it's transparency. You know, if they're using an HVAC expert, where you're like, oh, their service call rate seems high, but it's a third party, you have the invoice, it's a verified person who has five star reviews, that's not necessarily a bad situation. bad situation, if you're saying, hey, are they hiding something are up charging, and I don't know. Um, so that's number one.

The second one that I see happen a lot is on the side of communication, if I contact my property manager, and they don't get back to me, within one business day, maybe two business days, and sometimes they might get back of Hey, boss, this message will respond to you in three days, that's okay with me. But if I don't hear from them at all, and I'm asking them a question, and I have to follow up multiple times with them to confirm that they did something that's a bad sign. And it's a bad sign for two reasons. One, they're not on top of their operations, right, because something's probably being missed. And two, which I think is even more important is, something's probably getting missed. Like, if they can't respond to you, they're probably not responding to tenants who are going to view the property, they're probably not responding to a service professional who might need approval, like if they can't even respond to you on time, they're not going to be able to respond to them on time.

And so I really think that communication is so crucial. And one of the things I see with traditional property managers, for the most part is, you know, it's 122,000 property managers with an average of three employees. So they are overworked trying to do everything and don't have that operations to say I need to get back to them within a day, right? Because they they have so much going on. And so that's why I do think that even when you're looking at your property manager, they might have been great at the beginning, but they've scaled too quickly. And they haven't hired the right people to make sure they can get on top of everything and get it done. That's the second one.

Michael:

Can we chase that down just a little bit? Well, I want to dig in because I agree with you, 110%. But I also think that there's a big, big, big difference in cultural norms as you go throughout the country. I think the coasts are pretty similar and timely, when it comes to that response time. How would you respond to someone if they said, Well, that's just kind of how we do things here. We're just a little bit slower paced here. And they may say it with a twang.

Dana:

Yeah, I would say that their expectations if they want to work with you needs to change, or you need to find a manager that drives with you. And here's why I understand that something might be slow paced, and what I mean is, Hey, I got this request, or even if you get an out of the office, I'm out of the office, I'll return ness, and you know, three days, whatever. Or if it's not a business day, if it's a Saturday or Sunday, I totally agree that like that they'll respond to you when they're back in the office.

I think the how to respond to that is, well, if you can't communicate to me when things are going to get done, right, what about emergencies? Right? Like if there's an emergency, how do I even know if you're not even responding to this, that you've received it? How do I even know that you can respond in an emergency situation? We're talking about people's homes here, it's a totally different game. And the more things wait, and there's weeks go by, it's kind of like your inbox when something falls, unless you like Boomerang it back to the top, you're just gonna forget about it. And it's the same thing.

So that's where I do think the communication needs to be there. And they definitely need to get that stuff done. But then to your point, I mean, sometimes they're slower where they say, Oh, yeah, don't worry, I do that every Friday. I don't do it every day. I don't pay my invoices every day, I pay them every Friday or once a month, or you know, net 30 that's fine, but they just need to communicate that with you. I don't think there's an excuse not to communicate at all.

Tom:

Love it. Expectation setting.

Dana:

Yeah. And then personalities is huge. We've had leasing agents on our platform where we talked to one real estate investor who says I love this person, they are fantastic. And then you talk to another one who says I didn't really like working with them. And a there's personality things there as well. Um, but to me, personally, what I've seen is the top performing agents and managers are ones that can turn things around pretty quickly, even if they just respond, I've got this, I'll get back to you next week on it, it's on my to do list something like that is better than no response because no response means I don't even know if they received it. That's the second one.

The third one is based on your cash flow. Obviously, if you're finding that you're having way too many evictions, they don't really know what's going on in the property. There's just way too much drama with the tenants, then the question is, are they screening the tenants properly, because this should be passive. Now don't get me wrong. There are cases where you have a lemon in your property like a tenant, where are actually I would more call it a professional tenant attendant who looks great on paper, they come in, they're a great salesperson, and they fooled the property manager. And that has happened, don't get me wrong, that happens. It's very rare, but it does happen. And we've seen it happen.

That's not that bad of a case. Because as long as your property manager is on top of it, and dealing with it, and making sure that they get this professional tenant out who's causing nightmares for you, and they get a qualified tenant into the property, that's fine. But if consistently, they're getting tenants in there where no one's qualified, no one's paying bills, there's evictions and you're suddenly seeing this affect your cash flow, because you're having increased expenses and reduced income it like your cash flow is affected, then that's another reason to say this person is not performing. And I need to change property managers.

Tom:

On the flip side, so horror stories from owners. So we've talked about some horror stories with tenants talked about some horror stories related to property managers, or just cause about some love to hear some stories related to bad situation with owners.

Dana:

In other words, I think with owners who are just difficult to deal with, is that correct?

Tom:

Yeah.

Michael:

And name names. Just kidding. Yeah.

Tom:

Name names. Yeah, email address?

Dana:

Well, Michael.

You know, I think there aren't any horror stories, but there's miscommunications or unrealistic expectations. Let me give you some examples of ones I've seen owner is remote, right, and a repair request comes in. And you know, it's about $250, to fix it, the service professionals on site, the owner has a threshold of $200. So we don't perform the work, we call the owner to get approval to let them know it's over your threshold. We don't want you to have any surprises. Here's a breakdown into parts and labor, you know, here's everything, do you approve it? And they say, Can you give me two more estimates for this?

And it's like, I don't think they understand that their service calls with those other estimates. So like, it's gonna cost you more in the end to the service professionals are, you know, verified? And we're checking the pricing on every single one to see, should this person go back out? Are there is their pricing higher than average? Should we not send them out like we're doing that ourselves and for attendant to have to coordinate with three service professionals for three estimates suggest to get some small repair done something under 500. If it's over $500, I totally get getting multiple estimates. And I actually, we actually recommend that. But for smaller jobs, the amount of stress that causes your tenant, and the amount you might save, which is maybe $50, or $25, which you actually don't save, because then you're paying multiple service calls, it doesn't really make sense.

I think it's just expectations and setting like, Hey, we could do that. But here is why you might want to reconsider. And again, we deal with it every day. And our interests are aligned, right? We want to get you the job done as quickly as possible at the lowest price with most qualified person, like our interests are definitely aligned with them. But there's some times and especially with newer real estate investors, usually the ones with four plus properties are like, oh, wow, this is great. You guys totally get it on. But the newer ones don't understand that part. So that's what I would say.

The other one is with rental rates. And this one comes up so often where the tenant or the owner say, Well, I expect to get this price on the property right and list it for that. And week one, no leads, like no one's interested in the property, right? And we've listed it on every website out there. Like there's not a website, it's not on. So tenants are finding it and we say other properties in the area tenants are looking at are going for these prices. And the owner says, Yeah, but mine has granite countertops, and those ones don't. So I think that's why mine should be going for $200 a month more and you suddenly get in the situation where actually we have like a calculator that does the math. If you drop it by this amount based on the amount of days it will stay on the market at this rate, you're actually getting more money more income by just dropping it and getting it rented now.

And so I think a lot of it has to do with the rental rates a lot of investors get attached to this is the rate the rental should go for and they get fixated that somehow miraculously they're going to get that price. And a lot of times it's no, this is the price of the market today. This is what else is on the market. This is what your tenants are comparing your property to. So you need to compete against that, right? You have to be at that market rate. So that's the other one we get. Actually, we don't get that with Roofstock clients at all. I think you guys do a good job on price on expectations. I think it usually happens with a lot of investors who are accidental landlords who end up renting out places they've lived in, and they're emotionally attached to them.

Michael:

But my kids grew up here.

Dana:

Exactly. It happens more often with those. But I think you know, a lot of stories where there hasn't been anything as Super outrageous, but it's things like that, or slum lords, right, that's another one where the landlord doesn't want to fix things for tenants and doesn't realize it's this person's home, and it becomes a inconvenience for the tenant, the tenant is your customer. And you need to remember that. And so fixing something for them.

Now I get some things like the ice machines broken, great, we'll just buy your ice cube trays, because it's going to cost too much to fix the ice machine, that type of stuff, saving money. In that case, that's fine. But if it's something where, yeah, the hot water heater is out, we're gonna get a new one. But we want to get a used one from this used company in Florida. And we're shipping it to the property in Texas, because we're going to save $300 from what the price would be to get the water heaters here. And the water heaters can arrive in 1.5 weeks. It's like what your tenants can't really go without hot water for 1.5 weeks. And so it's certain things like that, I think it's more of an educational thing. More so than a horror story

Michael:

Dana, the last thing that I want to ask you about and you brought it up is the alignment of incentives, your incentives are aligned to get the repairs done as fastly? And as cost effectively as possible. What about the folks out there property managers out there that charge an overage on the job, you know, job estimate plus 10%. So the property manager actually stands is financially incentivized to choose the most expensive bit.

Dana:

Yeah, those property managers. So we don't do that, for that very reason of I don't know how you can justify it right? That your incentives are aligned. What I've heard from those property managers who charge 10%, on top of their repair coordination is they usually say, Oh, my monthly fee is a lot less than like the market rate. And if you have a property that doesn't have a lot of repairs, I want to reward you for that by charging you less every month. And those properties that have a lot of work to do. And I'm constantly out there doing the work, I want to charge those people more. And so my incentives are really aligned with you. That's that's something I do here.

And actually, to their point, it's a valid point, right that that incentive is aligned. The real question is, well, how do you make sure that you keep those repair costs down if you're getting paid more for hire bill? And that is where I would say the devils in the details. So understanding like, Okay, well, how many bids did you get? Can I see the bids associated with these? How do you know these people, right? I'm having all of that if they are really transparent, and like, Yeah, we got three plumbers bids, here they are, here's the one we chose, maybe it's not the cheapest, maybe it's like the second cheapest, because the cheapest wasn't going to get as much work done, it was going to be like a patchwork versus actually fixing the root cause. Maybe it's something like that. And they have a reasoning for it. That's built with trust over time.

Again, it's a relationship and you have to trust the person, if someone does charge 10%. It's not necessarily bad, but then you really do need for them to be able to justify time and time again, this is my incentives are aligned with yours. Even though I make more, I'm more aligned to keep you as a customer. And so I want to keep those bills down, that I can justify a little bit more. But then again, the devils in the details, and it's building that trust over time, and you can't build a trust with property manager until you've worked with them over time.

It's a performance thing, right? It's it on day one, you're not going to trust the person, you're going to trust them by them proving they can get you the cash flow. Keep peace of mind, where it's easy, um, there's not a lot to do and that will be built over time.

Michael:

That makes total sense.

Tom:

I feel like we can we're running up into our 11 o'clock, but I feel like we can do like a whole nother other episode on just the self management that we've done so far is really great. And like the stuff that you have on self management, like I think is like worthy of its own episode.

Michael:

Yep. No, this was great. Danna, thank you so much for for sharing the wealth of knowledge. And like Tom said, We'd love to have you back and dive deeper on more of this stuff. Because there's just I think so much so much here to talk about.

Dana

Awesome.

Tom:

Well, awesome. Thanks again for jumping Dana

Michael:

Awesome. Perfect. Dana, if people have more questions about him lane or want to reach out to you specifically, where should they go? How can they reach out?

Dana:

There's two different ways. Um, one is www.Hemlane.com. Um, the other thing you can do is email [email protected]. Those are two ways to get in touch with us.

Michael:

Fantastic.

Tom:

All right, thanks again for jumping on.

Dana:

Thanks, guys. Have a great weekend. Talk to you later. Bye.

Michael:

Thanks you too. Bye.

Alright, everybody. That was our episode. Thanks so much for listening in a big, big, big thank you to Dana. She's always a pleasure to have on and we look forward to having her on. Again. If you'd liked this episode, feel free to give us a rating or review wherever it is you listen to your podcast, they really help us out and we're constantly looking for recommendations for additional episodes, so feel free to leave us a comment in the comment section. And we look forward to seeing you on the next one. Happy investing.

Tom:

Happy investing.

Tom let his insurance expire and his lender chose him a sub-par policy. Michael coaches Tom on cleaning up his insurance situation, saving him some money.

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Transcript

Tom:

Greetings, and welcome to The Remote Real Estate Investor. On this weekend wisdom, we have a fun episode here I am joined by Michael album, and today we're going to do a coaching session. So if any of you guys have listened to previous episodes, I am not doing the job managing my insurance. I'll talk more about that in a minute. But I'm going to have a live coaching session here with Michael, this is also a good example of what coaching sessions are like within Roofstock Academy if you guys are interested in checking that out. So we're going to do a live session in today's episode specific to insurance.

So Alright, let's do it.

Michael, thank you for podcasting, this coaching episode.

Michael:

Yeah, totally no pressure on either of us, right. It's only gonna be the world hearing about your insurance book and my expertise or lack thereof, rather.

Tom:

Yes. Okay. So within this session, what I want to do is, you know, there are various terms to an insurance policy. And, you know, this isn't investing advice, I'd love to know, kind of, based on your understanding of me, what do you think like a reasonable, and we can talk about in defining that deductible is and we can find the terms and then also in working with a broker, what do I need to provide them I've been really dragging my feet in going through this exercise in those of you guys are not familiar, I let my insurance expire. And then my lender bought me new insurance that is not great, and making myself accountable by putting it on the podcast and going through the process of updating it. So does that sound good?

Michael:

It sounds great, Emil, and I've been hounding you. Since What? December November? Yeah, yep. So we'll put it out there for the world now.

Tom:

So in this coaching session, I'm going to drive the agenda here and feel free to pepper or change direction as you think it makes sense. So why don't we start with the terms of the policy kind of ranges that you think would make sense, and this is going to be for a collection of single family homes that are held in my name? And I'm open to doing some like a group policy? What are the terms that you think general kind of ranges would be common for my kind of a profile? Let's start with that.

Michael;

Sure. So you've got homes all over the country, right? You're in four different markets, five different markets?

Tom:

That's right. Yeah.

Michael:

So doing a group commercial policy might be difficult to do, just because every insurer is going to underwrite each area a little bit differently. And so you might not be able to have a single policy covering multiple properties. So the broker is likely going to quote you as separate individual policy for each property. Hopefully, it'll be with the same carrier, just because that makes things easier. But that might not be the case.

So first and foremost, what you want to be looking for is what your replacement coverage is. And you also want to make sure that it is what they call replacement cost, as opposed to actual cash value. Those are two different types of policies, replacement cost is much more comprehensive, actual cash value gets you a depreciated value, if there is a loss in the property to replace whatever is damaged. So that's abbreviated in the insurance industry as RC for replacement cost versus ACV, for actual cash value.

So first of all, first of all, to make sure that every property is is RC replacement costs, then you just want to do a quick check on what that value is. And so let's say on a single family home, they're quoting you 140,000 for a replacement cost. And that property is 1000 square feet. So what you do is you want to determine what that rebuild cost is.

Tom:

Who's quoting that number? Is it the insurance company that's recording?

Michel:

Yeah, 95% of the time is gonna be the insurance company got it, you can often change that number and push it higher, if need be, but they're gonna give you a minimum, typically, and that's who's driving that number. And they have an underwriting model and blackbox, that's where it spits out. Okay, this is the square footage, the age into their algorithm, and it spits out a number. So what you want to do is double check that number against the square footage, and basically divide that coverage by the property square footage to get your replacement cost to rebuild that property on $1 per square foot basis.

So in this example, if we took 140,000 divided by 1000, that's $140 per square foot to rebuild a single family home, let's say that's in the Midwest, somewhere, that's a pretty reasonable rebuild cost. When I see things in the 75 8085 $90, a square foot range, that's when I start to get a little bit nervous. Because Can you really go build a house for $90 a square foot? Or if it's burned to the ground to totally ground up

Tom:

Skimping it? For sure. Yeah. And then that just puts you in that liability, where you actually have to use the insurance and it's like, oh, not enough to cover. So sorry, it was that kind of rough estimate roughly 100 bucks.

Michael:

Yeah, I like 125 to 150. Got it. For most parts of the country, you know, California is closer to 250 to 300, New York is up there as well. So based on geographically where you are, you just want to get an idea of what that number looks like. And if you're north of 100, it's probably good and just ask your property manager, hey, what's reasonable rebuild cost for the area. So that's number one.

Second is your ordinance or law coverage. I always get those on my policies. If the property burns to the ground, they have to rebuild it for today's code, you just wanna make sure you have coverage of that. And because the insurance company's not gonna pay for a betterment or improvement, they're gonna give you like for like, so if you have an older property, this is really important to have that's typically a very nominal additional cost to have on the policy. Another thing I like is sewer or drain backup coverage. Again, relatively nominal cost, and it's a nice coverage to have loss of rents, something you absolutely need to have.

And most landlord policies come standard with that, but you just want to double check the timeframe. And so different companies, different carriers will quote it differently. Some companies will tell you, oh, we're gonna give you 12 months of coverage or 18 months of coverage, or whatever that is, and they'll just cover the dollar amount, however much lost rent, you lost in that timeframe, while the property was down, or other companies will get, quote, you $1 amount and say, Tom, we're gonna give you $12,000 in coverage, and your property rents for 1000 bucks a month, so that you can back into determining, hey, that's 12 months of coverage, I like 18 months of coverage personally, just because anybody who's familiar with the Chico fires, or some of the California wildfires, we had those fires occurred a couple years ago, and those properties haven't been rebuilt.

So there's absolutely the possibility of the loss going beyond that 12 month time frame that comes standard on the policy. The other thing I like is liability, I personally get a million, you can get more than that with an umbrella, you could also get more than that quoted on your dwelling policy, you can get you know, a million and a half 2 million, pick a number that you're comfortable with, and then layer it between the dwelling policy and the umbrella

Tom:

And that liability that would be separate from the individual property, or that would just be part of each individual ones. I'm doing these for a bunch of properties. Got it.

Michael:

Yeah, so each property policy is going to have its own liability limit attached to it most likely, if they're gonna quote you a blanket policy with all four properties in the same policy, which again, I doubt that they would be able to, they could have a single liability limit across all four properties. But again, that's going to be unlikely. So if you go get four separate policies, each one is going to have a liability limit associated with it. And you can pick and choose what you want that to be. And if you're uncomfortable with the limit, you can go get an umbrella as well to sit above that that umbrella will sit over all those properties as long as they're named on that umbrella polic.

Tom:

And that's just a common myth of a lot of people that don't put their property in an LLC. Well, so

Michael:

I put my properties as like a Yeah, well, yes or no. So I put my order. So I put my properties in an LLC, and the LLC has an umbrella as well. Those are the big ones to just be cognizant of something else to think about is is called guaranteed replacement cost or extended dwelling replacement cost. Basically, the way I formulate the question is if your limit says 140,000 on your single family home, you ask the agent, hey, what if it actually costs 170,000 to rebuild this property? Who is responsible for that 30,000 Delta, and there's a coverage you can get either called guaranteed replacement costs. Well, the insurance company says Yep, the limits 140. But we'll cover it, even if it's 200, whatever it will pay for it. That's a coverage.

And if they don't offer that something called extended dwelling replacement coverage is usually a percentage off in 25, or 30%, of your dwelling limit. So if you're 140, they'll just give you as an additional buffer. So if you had additional 25%, on your 140, that's an extra 35 grand, so you in reality have 175,000 in coverage. And that extended dwelling replacement cost coverage is extremely nominal. In most cases.

Tom:

This is saving me so much time. I'm really happy to be doing this. Alright, any other aspects on types of things to include within the coverage?

Michael:

Those are the big ones. And then I get every policy quoted three times, I get a credit thrice lowest deductible, next highest and then next highest. Because what I've often found is that the increase in deductible, which happens often is about 1000, to 15 $100 increments. So they might do 1020 500. And then 5000, or 20 570 500, is that savings that you're getting in terms of your premium reduction by taking a higher deductible is so often miniscule, you're often best served taking the lowest deductible, if they're going to give you an extra $13 or $20 a year in savings, but you've got to take on additional $1500 of risk every single year. That might not make a lot of sense. Now if there's a huge Delta, yeah, okay, we want to be thinking about it. But I've seen, especially on single families, not a huge variance between those higher deductibles.

Tom:

This is great. And also just real quick. If you want to just define deductible real quick for folks not not familiar with that aspect.

Michael:

Yeah. So the deductible is how much money you have to pay for a loss before the insurance company will come on to a loss. So let's say you had a small fire in the kitchen, and the assess damage is $5,000. If my deductible is $1,000, I've got to pay the first 1000 to get that fire damage repaired. And then the insurance company is going to come on for 4000 on top of that, assuming it's a covered loss, and they deem that I have coverage for that loss.

Tom:

Got it out of pocket liability. Got it. And I love that that's such a great advice of getting three quotes, just to confirm that that was the lowest deductible and then the three tiers above that.

Michael:

The next two above that Yeah, for a total of three.

Tom:

Next two above that.

Michael:

So you get three Yep.

Tom:

I'm fired up, Michael,

Michael:

As you should be

Tom:

to my broker. You know, I had this, what I'm learning now was a wrong idea that I need to provide my own whatever coverage I don't need to provide that to an insurance broker,

Michael:

You need the address, you likely need the age of the building. They can pull a lot of this stuff a lot of the property specific information online, so you should ask them what they need. Every broker is going to be a little bit different, but the address should be enough to at least get started on a quote. They're going to come back with a basic quote and you're going to go back and forth massaging it with them and basically what I'll do is anytime an agent is Quoting me something, I'll just send them kind of a skeleton of those coverages that you and I just talked about, and say, quote me this, then they'll send it back. And they'll tell me, I can't get this coverage or this or that. And then we massage back and forth.

And I say, Great, this is the package I want. Now, give me the three different deductible pricings. And let's see what makes the most sense.

Tom:

Lastly, in, I get to a point where I find something I like, and I'm ready to find it, do I need to reach out to the lender to cancel all my other insurance? Or what is that consideration?

Michael:

They should do it automatically. So oftentimes, the insurance company will work directly with the lender. And so you should be getting the date of effective coverage, the insurance company will notify the lender, then the lender will hopefully cancel your old coverage. And then you should get a credit back for if you pay that premium in full, or whatever premium you haven't used, you should get a refund. But yeah, definitely chat with your lender and let them know hey, this what I'm doing this is the effective date. Can you cancel the old coverage or there's anything I need to do? Because you don't want to have that be fumbled? Just by not asking a question.

Tom:

Over communicate. Love it.

Michael:

That's right.

Tom:

Awesome. Any any final things before we close out the weekend? wisdom?

Michael:

No, I think that's it, just you know, keep on it. Go get multiple bids. And you can talk to multiple agents do it too, because not every agent will work with every insurance company. So if you've got a property in Indianapolis, there might be 30 insurance companies that are willing to quote it, but the agent that you're talking to only works with five. So talk to multiple agents, find out what carriers they're able to write with and in that geographic area, and then see if they can get you quotes for multiple.

Tom:

Awesome. Thanks, Michael.

So I hope you guys enjoyed this episode. This was kind of fun, because it's very self serving, like a lot of the episodes we do, but there's also a good taste of like what an academy joining the mastery program that we have like what the coaching session, in this particular coaching session, I was kind of prepared with a bunch of questions, there was something very specific that I needed to do and I feel like I've been thinking that I'm a happy customer right now. Thank you, Michael. Awesome. If you enjoy this podcast, please rate us subscribe, tell your friends, all that good stuff. And as always, happy investing.

Michael:

Happy investing.

Tax season is nigh, that is why we have authors and real estate tax experts, Amana Han & Matt MacFarland join us on this episode to highlight what you need to know to keep as much of your money as possible. 

Amanda & Matt's website: https://www.keystonecpa.com/ 

Suggest a topic for the podcast: https://linktr.ee/remoterealestateinvestor 

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Transcript

Michael:

Hey everybody. Welcome to another episode of The Remote Real Estate Investor. I'm Michael Albaum and today I'm joined by my co host, Tom Schneider. And we have with us two very special guests, Amanda Han and Matt McFarland authors, CPAs real estate investors extraordinare. They're gonna be talking to us today about all things tax related that real estate investors should be aware of. So let's get into it.

Amanda Han, and Matt MacFarland, thank you so much, again, for joining us on the podcast. Really, really appreciate you coming on.

Matt:

Well, thank you for having us.

Amanda:

So excited to be here, lots to talk about

Michael:

Lots and lots and lots of talk about so I want to be very respectful of your time. So before we get into it, I would love Love, love. If you could both give us a little bit of background on yourselves a little brief introduction of who you are and how you got started in real estate and tax. You both have been guests on numerous other podcasts including the bigger pockets podcast, so floor is yours.

Amanda:

Yeah, I guess I'll go first. So my name is Amanda. I tell people's I'm the third generation of real estate investors in my family. My grandparents had real estate investing, my parents dabbled in it. But I was never taught to do real estate investing. I think like a lot of people I was taught to just go to school get a good job. And it wasn't until several years after I worked as a CPA for real estate investors that I realized that you know, real estate is such a great tool to wealth building and to tax savings. So that's where kind of Matt and I got started in real estate

Matt:

Yeah I'm Matt MacFarland and I married well!

Yeah. But yeah, our practice focus on real estate investors, it's kind of where we got our start and what we like and what we understand, and we don't focus on, you know, manufacturing clients or retail clients, just because that's not what we know. So I've been doing it over 20 years now. And Amanda is close to that as well. And so probably 80 90% of our clients are real estate investors. So it's, it's always fun stuff to talk about.

Michael:

So that was your family also involved in real estate, or how did you get involved in that space?

Matt:

You know, my parents did a little bit of it back in the 80s, when it was kind of you know, everybody in their mother could invest and get right off skin before they change the tax code. But we kind of got into it through the job. You know, I remember like, my mama was working on some of these taxes, who was probably in his 60s, and he was retired and he was making, you know, like six figures in cash flow. And it's like, Okay, this is, this is what we got to do, you know, so that was kind of how I got turned on. Yeah.

Amanda:

Yeah, it's so interesting, because, you know, for me, for both of us, even though we worked in taxes, you know, that was our profession is to do tax planning and tax strategies for for investors. And for me, specifically, growing up in a family who was, you know, fairly extensively involved in real estate, we never put the two to two together, you know, and for years, we just kind of went to work that our thing, never thought that maybe we might do real estate for ourselves, you know, until we read Robert Kiyosaki his book, Rich Dad, Poor Dad. So it took us just, you know, reading a book, not about taxes to really apply that to our own situation.

Tom:

I was curious, you know, you said like a third generation, what kind of investing did your parents do and your grandparents? Who is it all kind of similar residential real estate? Or what type of real estate investing did they do?

Amanda:

Yeah, all sorts. So I think my grandparents, I'm from Taiwan originally, so my grandparents, they were business owners who, you know, also bought the underlying real estate, which ended up being kind of a very, almost like, you know, Time Square type of a property back in Taiwan. And when they first immigrated to the US, they dabbled in land, you know, which is different, right? No, no rental stuff. But if you guys follow the real estate of Vegas, those have appreciated so much, right, like all various parts of the US. And then yeah, you know, just single families, condos and things like that. So I think like a lot of real estate investors, you kind of start out with one type, but you end up expanding into different types of real estate as well.

Michael:

Okay, so I would love to dive into the meat and potatoes of the subject here. And if you could give us a little bit of insight into how real estate is taxed, and whether or not that's different than somebody's earned income, and shed a little bit of light on kind of the high level tax picture, that is real estate.

Amanda:

That's a really great question. I think there's a misconception about that, that real estate has a different tax rate. But the reality is a real estate is actually taxed at ordinary income tax rate, which is the same rate as your W2 and other income. Okay. So, uh, rate wise, you know, you don't get any lower tax rate or preferential rate.

But the benefit of being a real estate investor, though, is that we are afforded with a lot of write offs. So when you hear people talk about, hey, the tax code is filled with loopholes and write offs for business owners that really Is the Golden Nugget because real estate also falls under the category of business owner. So when you're a landlord, when you own rental properties, you you are able to utilize those same tax write offs as business owners do.

Yeah, I mean, it's actually incentivizing you to build a business invest in real estate. And so that's the key that they're they're given these incentives that you know, you can make the money but with some of the write offs, you get, like depreciation and things like that you can kind of shelter, you know, some or a lot of that cash flow that you're making from, you know, buy and hold property, for example.

Amanda:

Yeah.

Michael:

So, Matt, you when you talk about business, and having a real estate investing business, you know, I don't have an LLC. So do I need to have one in order to qualify for these business deductions or to be considered from a taxation standpoint as being a real estate? Or is having a running a real estate business?

Amanda:

Yeah, I love that question. Because that is always naturally the question that follows when we talk about, you know, the business deductions. And that is such a misconception in that a lot of investors are told that they need to have an LLC or a corporation in order to take tax write offs. And, you know, unfortunately, it's something that we see every day when we meet new investors is like, Oh, I'm sorry, I love your podcast, but I don't have an LLC. And that is not correct at all.

Basically, if you are a landlord, right, meaning you own rentals, or if you're a flipper, or wholesaler, you are able to use these business write offs, whether or not you hold your rentals in a legal entity. So as an example, if you know, Michael, you have a property on Main Street, that's a rental property, you can take a tax deduction, you know, write off part of your home office, part of your car expenses, certain business meals, travel costs, you can write those off, regardless of whether that Main Street property is held in your personal name, or inside of a legal entity.

So IRS actually doesn't really care who holds the real estate, what they care about is that they expense is actually necessary or reasonable for you as a landlord, your landlord, your rentals, is it reasonable to say that you invested in a real estate course or you traveled to Tennessee to look for properties? Those are the things they're looking at, more so than did he have a legal entity for?

Michael:

So then, if I understand correctly, and I know that we can't say anything with the total blanket statement, but is there really then no tax benefit to having or investing via an LLC?

Amanda:

There's no absolutes in the tax world. So there are going to be instances where Yes, someone might get a little bit of a tax benefit, if they were to, you know, hold their real estate in an LLC. But I will say 99% Okay, for 99% of the…

Matt:

For rental properties, at least.

Amanda:

Yeah, for 99% of investors were landlords, the vast majority of expenses that we normally have on a day to day basis, that are legitimate deductions, you can take those with or without an LLC, it's a little bit different if you're someone who's doing fix and flip or wholesale in terms of, you know, different tax treatments of those, but for landlords, for the most part, you know, if you're just someone starting out, you got one, two or three single families, make sure you're tracking your expenses, right? Because those are deductible. Even if you didn't have an LLC for last year, right. A lot of us are maybe getting ready to file last year's tax returns or getting rid of this year's taxes, do make sure you track those and present your tax preparer or CPA with it. Because a lot of those are legitimate write offs.

Tom:

Do you think there are deductions that most people could be taking that are not necessarily aware of it? Like I know, one thing you talked about is, I don't know like a trip to Nashville to look at or I don't know, I'd be curious on common misconceptions on like, what falls in the deduction bucket versus what doesn't fall?

Matt:

Yeah, no, it's a good question. I think there's a lot of them, actually. I mean, the ones that are probably the most common ones we see are our travel expenses, like you mentioned, auto deductions, just people using their vehicle to kind of run their day to day real estate business. They're just not capitalizing on the opportunities, they're not maximizing their deductions because they're, you know, not keeping track of their miles or what have you, or they don't know that they can home office deduction. That's another one that we see a lot that gets missed.

Amanda:

Yeah. I mean, you know, most investors we work with are working from home, you know, we rarely have someone who's a landlord that goes out and rent an office space, just to manage their rental properties. Unfortunately, there are still a lot of CPAs out there who have are using the scare tactic of if you claim a home office, you will be audited. You know, it's not you're not able to do that as an investor in that information has been so outdated. The IRS has actually in the last couple years, they've made it easier for investors or anyone to claim a home office deduction by giving us a standard per square foot write off.

So the IRS is you know, they're understanding that a lot of people are working from home and I certainly you know, if you're someone who's tax advisor saying hey, you know, you shouldn't take it as a huge red flag, then it might make sense to look elsewhere interview other CPAs because you're likely getting very outdated information. But I think to second what Matt was saying the, you know, some of the most commonly missed ones are like the travel in the car. And the reason is because a lot of people feel that they can only write off these expenses if it's directly related to a property. Right? So so you might be going to Nashville to look for properties, but you don't own one yet. So people think, oh, maybe I can't write those out, because I don't own a property yet. But the tax perspective, you know, if before you left for that trip to Nashville, you had already scheduled meetings with realtors or brokers or property management companies, then you have a really solid case to make the argument that the reason you went there was for real estate investing, and therefore it's a real estate related expense.

Michael:

Oh, fantastic. Okay. So can you talk to us and our listeners a little bit about something that I've heard often called is the three DS of real estate investing and why they're so powerful from a tax point of view.

Matt:

Yeah, if you want to refresh your memory about what the three Ds are! Dirt Dogs and something?

Tom:

Dinosaurs.

Matt:

There you go. Yeah.

Michael:

Yeah, it's depreciation deduction and deferment.

Amanda:

I like that. Maybe I'll use that as a…

Michael:

Yeah, consider yours

Matt:

Apparently we should be using that as marketing.

Amanda:

I like it. You know, we already talked about deductions, right, which is all these you know, legitimate write offs, Home Office, car, travel, you know, cell phone, computer, laptops, things like that. That's the low hanging fruit, because these are expenses that you are spending money on anyway, right? You have a home, and you have a car. And a lot of people have, you know, cell phone, computer, we have those anyway. So it's a way of shifting that from what's usually non deductible into legitimate write offs

Matt:

and stuff on the actual property side, most people don't, they don't miss the insurance. The mortgage is just the property taxes, the repairs, or utilities for the rental properties, those that I get to talk to, but those are ones that kind of get overlooked.

Amanda:

Yeah. And depreciation. I mean, clearly, it's just something that we love as real estate investors.

Tom:

My wife works in tax as well. And every time I say write off, she's like, you mean deduction, Tom, you mean deduction? And Am I understanding that correctly? Am I being corrected correctly?

Matt:

Yes, your wife is correcting you correctly? Yes.

Tom:

I knew it. I just, you know, yeah, good. Good.

Matt:

Yeah. And then depreciation is a form of a deduction or a write off. The main difference between that and the man was saying, though, the auto and other expenses is that you're not actually paying for the depreciation every month or every year. I mean, obviously, you bought the property, you paid something for the property. But the incentive in the tax code is that, you know, you put $100,000 down on a rental property, but the purchase price is 500. Your depreciation expense, which is really a paper write off every year is the starting point for that calculation is your purchase price, not your down payment, they're letting you write off, essentially, the bank's money, right. So that's why we like it, because you can use leverage, you can use that right off to shelter your cash flow. So you've got the regular deductions, you've got the depreciation, and then talking about on the deferral side.

Amanda:

Yeah, so I mean, for tax deferral, you know, usually people are referring to 1031 exchange, right, where for real estate investors, you have the ability to sell a rental property, and instead of paying taxes on the gain, you are deferring the taxes by purchasing one or multiple replacement properties instead. So it's the whole concept of, you know, play Monopoly where, you know, three red houses trade up to a green house or something like that.

Matt:

I think it's a green house for red hotel, house or red hotel, maybe, maybe you're right, to verify that what the what the pull out our Star Wars monopoly house.

Amanda:

So that, you know, what's so interesting about the 1031 exchange is that that's a tax benefit, or some people like to call it a loophole that's been available for years and years and years. But actually, back in the back when the tax cuts and jobs act took place couple years ago, there was a significant change that was made to it, where prior to that tax change, businesses could have also done 1031 exchange as well. And they took that benefit away. So in the past couple years, 1031 exchange was only available to real estate investors. And, you know, but we don't hear about that a lot, you know, within our industry only because we specialize in real estate, but what you know, people used to be able to 1031 exchange, like a car, you know, a business card, they could have done a 1031 exchange.

And of course, you guys probably heard that there might be potential changes or limitations to 1031 exchange that might be coming up under the new proposals. So it is something that we're definitely keeping a very close eye on because although some people say oh, they'll never change that. They'll never take that away, because so many people use it. But you have to keep in mind that a big part of that was taken away in the tax cuts and JOBS Act. So as of today, this strategy is really only limited to real estate investors. And I think in the next, you know, few months or a year or two, we'll we'll see kind of whether investors still get that deferral benefit of the 3ds increases.

Tom:

Such a neat aspect of just on how it's just like such a moving target, you know, on on the tax code. And you had mentioned before looking at some of taxes, and back in the I don't know, I think you might have mentioned the 70s, were kind of just curious of super high level, you know, some of the major, like changes to the tax code in history from, you know, in the 70s, to how it's moving today.

Matt:

What I remember is that, you know, I made it look like I'm 70 years old, I was only born in the 70s. So, the major change, actually, the tax code happened, and I think it was 1986. So my understanding prior to that was that it was, you know, you are a limited partner, limited investor, you know, you're investing in somebody else's real estate deals, and they were allowing just, you know, no limits to your right off. So if the entity split off, you know, depreciation, net losses, whatever, everybody could write off their share of it without any limitations. So they really kind of tweaked that in 1986, to, you can still get write offs for investing in other people's real estate deals, it's just not as easy anymore, it's a really want to incentivize the, I guess, the day to day investor, the person doing it all the time versus the you know, the kind of the passive investor on the side who's just earning their income, you know, working a W two job, but then investing all of it on the side and hoping to offset all their w two income as a passive investor, I think that was the major change that they did.

Amanda:

And that's where the real estate professional status that we are always talking about nowadays, right? It's kind of the big hurdle and the big opportunity. So prior to the major change, that wasn't even an issue, you know, you just are able to utilize rental losses to offset other income. So yeah, the good old days.

Michael:

So I have a question about the depreciable value or where the depreciation number comes from. So I know that you can only depreciate the building value. And when you buy a piece of real estate, it's broken down into building and land value. So if the county tax record shows the building value at 10,000, but I bought the thing for 150,000. I mean, how do I figure out how much of that is land? How much of that is building? And if the tax record number is different than my purchase price? How does that work?

Matt:

Yeah, it's a great question. Because obviously, unlike a situation like that, a lot of times your property tax basis is lagging behind your purchase price, right? Because you, you know, it's based on the previous owner, the brand previous two owners for that matter, and then you buy for 150. And they don't update that for, I don't know, six months to a year, right. But essentially, your starting point for depreciation is going to be based on your purchase price.

And then typically what will happen is you can use the property tax records, but what you're looking for is not the the actual number, per se, you're looking at for the breakdown of building versus land. So even if they have it as the property's worth, right, so if they have is probably worth 50, but you paid 150, for it in that 50,000 they have, they're still gonna have a breakdown of building versus land, you know, maybe it's 35 for building and 15 for land. So it's a percentage, that's, you know, I can't do math in my head. But you know, whatever that ratio is, you would apply it to your purchase price. That's how you apply that ratio to your purchase price. Now, that's the I think that's probably the typical way most people do it. There's other ways like, people sometimes use appraisals, if that works out better for you, if it gives you a sometimes you're looking for, as you mentioned, Michael, you know, you can only depreciate the building part. So in areas where you know, Southern California, like where we are, land is, you know, most property tax statements, you see the land is 80%, or something not great from a depreciation perspective, because that only these 20% are right off, right?

So in ways when you're looking to get more building, then with the property tax ratio is going to give you sometimes you can base it off an appraisal, if the you know, the appraiser is saying, Yeah, you paid one do this property is worth 150. But the building is really worth, you know, $130,000 or something like that, you know,

Amanda:

Yeah. And also, if you're someone who is going to be doing a cost segregation project for your rental properties, this cost segregation firms sometimes use different methodology to re evaluate so that you get a higher percentage to the depreciable building and less to land as well. So there's multiple ways I think, you know, if you're just someone like doing your returns yourself, usually just use the property assessors information.

Michael:

So if you get an appraisal done that chosen a new value, does that open up a can of worms with the county? And are they able to then tax your property at a different rate? If you say that there's more building value there for your tax purposes?

Amanda:

No, not at all. So you're not challenging the county at all right? The county is not involved. You're just saying for income tax purposes, when you're preparing your tax return your CPAs preparing the tax return. We're just saying we're using the appraisal information to calculate our depreciation. At no time do we contact the county to say hey, I realized that.

Matt:

I would like to pay more in properties.

Amanda:

Yeah, exactly. Yeah, exactly. So they're completely different. So so we're using the information, but those two numbers are always still gonna be, you know, fairly different.

Michael:

So the IRS is willing to utilize an appraisal for the building portion of the depreciation values. I mean, that that's good enough. They're not gonna rely just on county tax records or anything of that sort.

Matt:

Yeah, I mean, it's more than what we've seen is if you're hiring like a qualified appraiser Give me a written report and everything that usually will is enough to hold up to it, you know, if it got audited or scrutinized for any reason, that's usually enough. But typically, like sometimes clients say, Can I just get like a online, you know, Zillow or some other, you know, opinion that's not not from a, you know, qualified appraisers that in our experience isn't enough to pass muster. If you've got questions.

Amanda:

you know, we are talking to someone just last week, they said, hey, I've heard of CPAs, you know, for high areas like California or coastal places where the CPA just says, I think it's going to be 15% land, I'm just going to use that for all my clients. So that's the kind of stuff you want to avoid. Because I CPAs we have no license or any, you know, we have no standing to say what, what exactly is this and of course, a house on the beach versus a house inland is going to be very different. And you just across the board, say 15% land, you know, there's no substance behind that. So that's kind of what you know, that's the kind of stuff that they would try to disallow.

Tom:

Could you change your appraisal method? Like, if it was advantageous to use like an income approach with like a cap rate? Or is it just strictly like sales comparables in using in your basis for depreciating?

Matt:

I mean, that's a good question. I haven't To be honest, I haven't dived into details enough to know that I mean, I would kind of my recollection of those. And you guys may know better than I do, I think they typically lay out like three or four different methods, right? And then at the end of the day, the appraiser decides on, you know, based on these four methods, this is what we went with or something right, like, Yeah, I don't know, if it ever got, if they go that deep into it, if they could challenge, you know, like, hey, well, yeah, you decided to use this one. But on page 12, it mentions this one, you know.

Amanda:

I mean, I don't think you know, in the tax world, I think what they're looking for, obviously, is just that, I think the main thing would be that it's done by an actual qualified appraiser, right? That would probably be the key versus getting into the nitty gritty of which methodology because, you know, at the end of the day, from an audit perspective, don't assume all auditors understand real estate, right? And of course, you know, not many of them understand.

Matt:

So that might be Mind blown right there for everybody listening to.

Amanda:

Fortunately, we don't have a lot of audits go through our firm, pretty proud of that. But I always hesitate to say, because I feel like I'm not bringing us bad luck. But in the few that we've had, you know, in the past couple years, I've come across auditors who really have very little understanding of real estate, where, you know, I have to sit down and walk through a closing disclosure, HUD with them to say, this is what this line means. This is what that means.

Matt:

So in today's training your agent, we're gonna go over hud.

Amanda:

So yeah, so when we, you know, and we know so much about you every line on the HUD and like you're saying different methodology of appraisals, I honestly don't think that they're getting into that level of detail. For the most part.

Michael:

It's so funny, you say that Amanda, I was just chatting with a lender the other day, and I sent them over my tax records and returns and stuff and applying for this loan, and they go, Oh, well, it looks like your real estate didn't perform very well. You got all these negative cash flows here. And I'm like, Yeah, because I did a cost segregation study, and I'm using depreciation, it's not actual loss. It's like, come on,

Matt:

It's funny. You mentioned that. I mean, I got an email like two days ago that that exact situation where someone's like, our client, you know, kind of done a cost segregation study, which is, you know, more advanced strategy, I get that, but they're like, why is this big? $200,000 write off on line 19. And, you know, you give him a line explains what it is, or what the tax code says it is. And they're like, I still don't understand that. I can't help you. I'm, I'm not the lender, you know, like, yeah, it's just one of those signs that maybe you're not working with the right lender, right. Like, and to be fair, you know, totally fair. Not all CPAs or tax people understand real estate. But not all doctors do the same thing, either. Right. Not all lawyers do the same thing. So it's just, you know, making sure you're working with the right people on your team. Right. I mean.

Amanda:

Yeah, I think as an investor, one of the things that you want to make sure you do, as you're getting ready for tax time is make sure when you meet with your CPA, provide them with the closing disclosures, right, any properties you've purchased this year, and you've sold this year, any refinances you've done this year, make sure you bring all those closing disclosures, closing statements with you, because it's one thing for us to say, Hey, I bought a rental for $100,000. But we really paid probably more than that, because we had closing costs, we had fees, we have title transfers, there's all kinds of costs associated with it, and not all CPAs. Ask for that. Right? And so sometimes they'll just say, hey, how much do you buy for 100,000? Great, and that's the number you use, but just by not bringing that information could be 1000s of dollars of write offs that you missed out because they're not seeing a closing disclosure.

Right. And I know a lot of people did refinances last year and probably going into this year just because of interest rates. So make sure you bring all the closing items from the refinances because there are a lot of costs associated with that for the most part.

Michael:

Okay, I want to shift gears here a little bit. And Amanda, you said something you mentioned this previously, and so doesn't want to circle back to it. What is a real estate professional status? So what is it? How do people use it and do I have to be a real estate agent to take advantage of it?

Amanda:

Oh, yeah. All right. So at a high level, the IRS, you know, we're talking earlier about back in the days anyone could invest in real estate. Yeah, you can use real estate and use that to offset, you know, W2 and other income, right? There's no limits or anything. But under current rule, if you're someone who makes less than $100,000, total income, then you can use up to 25,000 of rental losses to offset w two and other income. And by loss, we don't mean actually losing money. We mean, you know, after you take your home office and travel and depreciation, right, so we create a loss from a tax perspective strategic. And so usually, if your income is under 100,000, you can use up to 25,000 of that to offset taxes on the W2.

So that's really great. Because the more real estate you buy, the larger write off, we can create, and then you start to see your taxes go down significantly, once your income exceeds 100,000, let's say you're between 100 and 150, then your ability to use those losses start to decrease, as income goes higher, your ability to use the losses goes lower,

Matt:

So say 25 grand gets phased out, basically. So once you get to 150, that cap of 25, where you conduct is now down at zero.

Amanda:

And once your income reaches 150,000, this is as a married couple, okay. And once your income exceeds 150,000, then you can no longer use rental losses to offset taxes on the W two and other income you have. So that's the issue we have is a lot of high income earners who also happen to invest in real estate on the side, maybe you don't get to use the benefits to offset W2 So you're still paying tax on the W2.

So the main thing I want to tell people though, is it's not the end of the world, okay, doesn't mean we lose out on the deductions, you get to carry forward any of the losses you're not using. So if you claim the home office car expenses, if you're not able to use it this year, you do carry it forward indefinitely. And you can use that to offset taxes from future rental income, or eventually when you sell the property, you then can use that to offset taxes from your W2 income, so we never lose it. I know we have people who say, Hey, you know, I tried to hold my expenses, but I'm not seeing the benefit. But that's okay, because you will see the benefit in the future. Right, it will still help you offset taxes. So that's one of the restriction,

Michael:

It's like going back to the future.

Matt:

We can talk about the future if you want!

Amanda:

Back to the Future. Exactly, exactly. So one of the ways around that is if you or your spouse can qualify as a real estate professional, then you can use the rental losses to offset w two capital gains and all types of income without limitation. So if you're someone who makes a million dollars in your W2, and your spouse is a real estate professional, you can then use rental losses to offset W2 income without any limitation. And that's, you know, the the benefit of being a real estate professional for higher income.

Michael:

And so when we talk about these income limits, something I've always struggled with, and I have a hard time putting my finger on is what is that based off of. So let's say I have a salary of 130,000. But then I make contributions to a retirement plan. And maybe I pay for medical, and so I'm bringing home, you know 110,000 after that, how does that work?

Matt:

It's technically based on adjusted gross income. So in that situation, if you know typically your retirement contribution of work as a pre tax deduction, if your medical that you were referring to is also a pre tax deductions or like in a fringe benefit plan that your employer provides. So if your taxable w two gets down to 110. And that's all you have, they're gonna base it on the 110. But it's also the W2, its interest in dividends, it's other capital gains, it's, you know, other business income, if you have an unemployment comp, you know, a lot of people have unemployment right now, you know, it adds a lot of things, basically to get to, you know, what they consider adjusted gross income.

Amanda:

Yeah, so the ones that will help you to get lower, the main ones that you mentioned would be retirement contributions, because that does bring down your income, and then any pre tax medical that you're taking advantage of. So for some people, you're kind of at the border, where you say, hey, yeah, if I just maximize my retirement contributions, and I can get there, but you know, sometimes we have clients who, you know, who alone is, you know, 300 400. So, you know, it's a lot more difficult to say, hey, how much retirement can I do to get that down to as low as possible?

And that's where real estate professional comes in, right? Where it's, you know, if maybe, if you're someone who is married, and you have a spouse that's either working part time or not working out, you know, because they're staying at home or something like that. That's where the real opportunity comes in. In that you can be making 500,000 of W2, but we don't really care if because one of you is able to claim real estate professional status.

Naturally, one of the questions we get is what is a real estate professional, right? How can I be a real estate professional, something you mentioned, you know, do you have to get licensed or be a realtor, and you actually don't have nothing to do with what licenses you hold so you never have to be licensed as a realtor. In fact, a lot of our clients who are real estate professionals don't have their license, it doesn't hurt, of course, right? If you also want to be licensed, sure, that's fine. But really, it's looking at a hours and activities test. So to be a real estate professional, there's really three main criteria. One is that you have to spend more time in real estate than your job where other jobs, okay, so if you're someone who's working full time of 2000 hours a year, that's probably difficult, because you need more than 2000 hours in real estate, to be a real estate professional. But if you are someone who's working part time or stay at home, then you can probably fall under the second requirement, which is at least 750 hours in real estate. Okay, so looking at January through December, are you able to spend at least 750 hours in real estate activities, then If so, you might be real estate professional.

Matt:

It’s that situation talked about earlier to where maybe one spouse is working full time, the other one is working on the real estate. And that situation, that first test of spending more time in real estate they do their job is doesn't apply because they don't have another job, right? So then it would come down to the 750 hour requirement. And then the third main requirement is which is also vitally important is that you've got to be what they what the IRS calls materially participating in all of your real estate activities. So what that means and you know, layman's terms is that you're kind of doing a lot of the day to day or boots on the ground, you're really involved in your rental properties or other real estate activities, if you have them to get to your 750 hours, what they're trying to prevent is the you know, we kind of alluded to it earlier, right? The passive investor sitting back collecting a check from their property manager once a month looking at the property manager statements. And you know, even if they have an extreme example, let's say they have 100 properties, where they're doing this on, they just sit back and collect a check. And somehow they can get to 750 hours by doing this, because they have so many properties, that won't qualify as a real estate professional, because they're not, you know, materially participating. They need to be, you know, doing a lot of the day to day stuff that, you know, active investor would be doing, I guess, for lack of a better term.

Amanda:

Yeah. But I think that, you know, a common misconception too, though, is people have been told they have to self manage their rentals in order to be a real estate professional. And that's not necessarily a true statement. Because, you know, we do have a lot of clients who have out of state investments, you know, they invest in out of state properties that are not local to them, it's very much a case by case situation.

An extreme example, if you're someone who works full time you have one rental property out of state that's a turnkey with tenants in them, you're not doing anything at all. Sure, that might be difficult for you to be a real estate professional, because how will you need to have 500 hours of working on the property or working with property managers. But as that person's real estate portfolio grows, maybe they go from one property to five to 10, then it becomes a lot easier, even though they have property management companies, there's probably still quite a bit of stuff that they would need to do as an investor. And then it might become easier and easier to qualify as real estate professional.

Michael:

So question for you both. I'm a W2 employee, but I'm just really, really, really efficient with my time hope my boss isn't listening. And I only need 1000 hours to do what most employees do in 2000 hours. Does that make it easier for me to qualify as a real estate professional?

Amanda:

I love that. I love that. You know,

Matt:

You're you're a creative real estate investor at heart.

Amanda:

Yes. You don't know how many times I've heard that question. That's exactly the question that was brought up in several court cases under the IRS. Right. And what Matt said, although sounded like a joke, does your employer know this? That's kind of the the stance of the IRS. So they said the way they look at it is, hey, you're paid as a full time employee, your full time employee benefits, and don't really care how efficient you are, the time assessed for your job is going to be a full time. So 2000 or, you know, 2100 hours, whatever that is the full time equivalent.

So yeah, that's not the you know, the best answer, but that's how they've looked at it in court cases to say, you know, sure, you might be efficient, but we're still looking at it that your full time salaried employee, and therefore that's still the number of hours to meet.

You know, numbers wise, we don't have a lot of clients who are full time workers that qualifies real estate professional, we have some, but the percentage is fairly small. The ones who are are really doing a lot of stuff in real estate, but maybe in your situation, you know, where you have a bunch of rentals, you run a real estate company, you also have podcasts, and you're just doing a lot of different things for real estate, where maybe real estate is taking up, you know, 2000, or more than $2,000. But I think, you know, for most investors, right, it's like they're really working on the full time job, they got a couple properties, you know, here or maybe out of state, that becomes a little bit more difficult to be able to beat the number of hours that way.

Michael:

That makes total sense, Tom, forget everything you just heard. So I just want to highlight really briefly here the fact that you both have written not one but I think two books now that are about tax strategies, is that right?

Matt:

Yes, that is the rumor.

Amanda:

Yeah, the first one is called Tax Strategies for the Savvy Real Estate Investor

Matt:

The Advanced Book on Tax Strategies. Along with the 3ds, we should probably really know that.

Amanda:

Yeah, I mean, the book, we use a lot of real life stories from clients that we worked with throughout the years in showcasing what strategies can work, you know, how is it done when it's done correctly?

Matt:

Horror stories for ones that didn't work?

Amanda:

Yeah, exactly. So it's kind of like the you know, I don't know Chicken Soup for the Soul type of book in story format. But the Themis is tax savings.

Michael:

And for all of our listeners, I've read them both. They're both excellent, excellent books, and very easy to digest with a lot of actionable steps, and actionable takeaways. And then we just read the advanced book on tax strategies, their second book at the Roofstock Academy book club, and Matt and Amanda, you both joined us for our book club, happy hour session at the end of the month, which thank you again, for joining us, it was a lot of fun, and all the members of the academy had a really, really good time

Tom:

There on Audible too. So I joke that I don't know how to read, but I can listen really well. So they're on Audible for folks that want

Matt:

At least you're honest, right?

Tom:

Yeah.

Michael:

So I want to ask you both the question here, as we're starting to wrap up, but what can we as real estate investors do or you know, any real estate investor, for that matter, do to work more cohesively with their tax professionals, or to make their lives a little bit easier?

Amanda:

Gosh, that's a great question. I think one of the most important things, as an investor that you want to be able to do is to keep your line of communication open with your tax advisor. And what I mean by that is not really waiting until, you know, January, February, or April to talk about last year's taxes. And that's very difficult for, for people to do because nobody likes to think about taxes in our day to day where we're so excited about investing and growing their wealth. And, sure there's tax strategies, but I'm sure my CPA understands it. And they're going to do all that next year when I go to them for taxes.

But that's really not how it works. We just talked about real estate professional status, right? And how do you try to qualify? And so the best time to learn how to qualify and get your documentation, right, is actually at the beginning of towards the beginning of the year. Why? Because now you have all year to make sure you're doing the right things to qualify as real estate professional, right versus have no now it's next April, and you talk to your tax person say, Hey, I really think I should try to qualify, while they're going to come back as if you have documentation. What did you do? And, you know, maybe you didn't meet the number of requirements for hours but you could have done that, had you done a little bit more in real estate, or maybe if you had bought one more rental property?

So I think the two main ways to work cohesively is one understanding, what are some of the things you should be doing throughout the year? How do you track those items throughout the year, so that you'll be you know, ready by the end of the year with everything you needed to do like, you know, checklists and worksheets, and, and ways to track all of your expenses. And then the second thing is just to make sure you keep that line of communication open with your tax advisor, are you buying a property? Are you getting into a new state that you're investing in? Did you form, are looking to form an entity? Did you do a refinance, these are all times to talk to your tax person, it doesn't always have to involve, you know, very long extended conversation.

Matt:

Yeah, it can be just a simple email, right? Like I'm have just closed on this property, or I'm thinking about doing, you know, especially if you're selling properties, it's always we want to know that you're selling a property before you even enter the contract to sell the property. No. So you can, you know, plan from a tax perspective, how much gain Are you going to have? What are your options? What are you going to do with the money? You know, is there deferral opportunities, 1031, exchange, you know, things like that, that that's a lot better and easier conversation to have up front, then it's March and I sold a property eight months ago, what can I do to reduce my taxes? Right?

Amanda:

Exactly. Because at that time, there's very few things that could be done, you know, so we talked about real estate professional, and there are a lot of other strategies you can use. If you don't qualify as real estate professional, right, maybe you get into short term rentals. And there are easier ways to use losses from short term rentals to offset w two and other types of income. So if that is a strategy for you, maybe instead of looking for long term out of state rentals, maybe you start looking for short term rentals, whether in state or out of state. So yeah, just think your tax advisor should be part of your team when you're making investment decisions as well throughout the year.

Tom:

Fantastic.

Michael:

So Matt, Amanda, I want to be very conscious of your time. Thank you both so much for hanging out with us. if people have questions, comments, want to reach out to you for your tax services advice. What's the best way for folks get in touch with you?

Amanda:

The best place I think is just check out our website. It's www dot Keystonecpa.com. We have a lot of great information on there. We have some free downloadable ebooks and things like that. So that's the place to start.

Michael:

Thank you both again, really appreciate you coming on. I would definitely love to have you back on the podcast at a future date when there have been some tax changes and really thank you both again, look forward to catching up. soon.

Tom:

Thanks, guys.

Amanda:

Thanks a lot, appreciate it.

Michael:

Hey everybody that was our episode a big big big big thank you to Amanda and Matt, thank you both again so much for coming on the show. It was such a pleasure. So great to catch up with you guys also at the Roofstock Academy book club session that was so much fun. We look forward to having you both on again. And if you have any comments questions, ideas for an episode, please feel free to use the link tree in the show notes of this episode and submit those there. If you liked this episode. Want to hear more please feel free to leave us a rating or review wherever you listen your podcasts and we look forward to seeing you on the next one. Happy investing.

Authors of The Book on Advanced Tax Strategies, Amanda Han and Matt MacFarland explain the owner occupant sales exclusion strategy. 

Amanda & Matt's website: https://www.keystonecpa.com/ 

Suggest a topic for the podcast: https://linktr.ee/remoterealestateinvestor 

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Transcript

Michael:

Hey everybody, welcome to another episode of the remote real estate investor. I'm Michael album and today I'm joined by my co host, Tom Schneider, and two very special guests, Amanda Han and Matt McFarland, two very distinguished notable authors, CPAs, tax experts and real estate investors. And in today's weekend wisdom, they're going to be talking to us about the owner occupant sales exclusion, that can really boost real estate investors gains. So let's get into it.

So one thing I want to make sure that we highlight for for listeners, and a question that I want to ask too, is about the owner occupant sales exclusion. Can you talk to us a little bit about what that is? And how folks might be able to utilize it?

Matt:

Yeah, it is actually a great strategy. And, you know, again, why don't we use the word incentives that they provide people out there in the tax world, essentially, homeowners, if they own and use a house for at least two out of the previous five years, and they go and sell the property, they a single person can get up to $250,000 of gain tax free married couples, $500,000.

So that's just by itself, you know, if you're a homeowner, you're not even, you know, investing in rental properties. And that's great. If you're looking to sell your property, and you, you know, lived in the last five years, you've got some game, you know, good chances are, you know, a good chunk of if not all of it can be totally tax free.

Now, the cool thing is, we've actually seen this coupled for real estate investors. So and you know, and a good example would be somebody lives in a house for two years, they move out for whatever reasons, but they don't sell it right away, they rent it out for up to three years. So let's say they sell it right before the end of the year five, they say if they're looking back, they meet the two out of five rule, they can actually still exclude the 250 or $500,000. Again, even though it's been a rental property at the time of sale. So that's we've seen clients take advantage of that. Now, if you will, you know, you want to totally supercharge it, we've seen clients take advantage of that. And then also, maybe their gain is more than the 250 or 500, then they do a 1031 exchange to defer the rest of the gain because they're selling a rental property and buying another rental property, you know, so there's a lot of different ways that you can use it to your benefit.

Michael:

So question for you both if I if we want to string a couple of these concepts and tactics together, could I buy a owner occupant house live in it for two to five years, rent it out for just under three years, then when I go to sell it for a gain of more than 500,000? Maybe called 750? I do a 1031 exchange and get the owner occupant exclusion so that I get that 500 tax free. And then I can 1031, the additional 250 on top of that, go buy an investment property and then have it be an investment property for a little bit and then do a refinance to an owner occupant primary mortgage. Is that possible?

Matt:

Yeah. So on the front end, they're selling your property, there's a primary they're gonna, you know, probably pay some taxes, whatever the exit the gain, it was an excess of 500. Yeah, what you do with the money doesn't matter with respect to those rules. So you can still utilize exclusion if you're buying an investment property on the on the back end. But yeah, you can always buy an investment property and change it into a primary, but there's definitely things you want to be aware of. And there's things you can do with a 1031 exchange, if you're selling a rental buying another rental, and then you move into that rental later on, then you can do that. But I think that the key is you want to give it enough time as a rental property that if it ever got question is not that, hey, my intention all along was to move into it for four months, you know,

Amanda:

Yeah, there's always facts and circumstances that come into play. So we actually had a client who did a 1031 exchange, a very large transaction, he bought a rental property, but because of fires where he was living at the time that volcanoes erupted in Hawaii, he decided to move. And you know, the best placement to move into was that replacement property for the 1031 exchange. So he ended up doing it. But you know, that's a kind of an extreme scenario where we thought, well, you can clearly demonstrate a change in facts where, you know, it was supposed to be a rental, but he moved into it shortly after it because of the location and things like that.

But the key like Matt, what Matt was saying, the key is at the time of the exchange, your replacement property should be a rental, or at least the intention of it should be that it's going to be a rental, that you move in thereafter. You know, that's not that big of a deal.

Michael:

So what you're saying is that you should get your tax professional involved on the front end and not after the fact and tell them Oh, hey, by the way, I sold this property

Matt:

Ahead of time!

Tom:

Proactive, not reactive,

Amanda:

We had a client who use that, you know, primary home exclusion rule, not as rentals, but just as primary home. They just use that over and over again, you know, so they move into a house, they do full rehab, they live in there for a couple years, they sell it, you know, 500,000 tax free gain and move into another house and do that whole thing again. And so you know, that's a strategy to you know, that's you know, if you're not really looking to to rent it out, but just continue to get that tax free gain, that's also a possibility

Matt:

as long as you like moving and rehabbing properties and you can totally take advantage of that.

Amanda:

Exactly. If you have spouses or kids they have to be okay living in for two years.

Michael:

Yeah, that's a pretty amazing strategy. I mean, if you just think about the pure math behind that every two years, you could be generating an additional $500,000 in tax free gains that that's a million bucks every four years. It's pretty unbelievable.

Matt:

Yeah, for sure.

Amanda:

Yeah. Exactly. of waiting federal and state taxes, right. I mean, that could be as high as 40%.

Michael:

Hey everybody that was our show. Thanks so much again to Matt and Amanda. So such a such a pleasure having you both on looking forward to doing it again soon. If you liked this episode, please please feel free to leave us a rating review and subscribe wherever you listen to your podcasts. And if you have any comments or ideas for episodes that you'd like to hear, please leave those in the link tree in the show notes of this episode. Thanks so much for listening and happy investing.

In this episode, Nate Trunfio shares a wealth of information on the domain of private lending.

Find Nate at https://limaone.com/nate/

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Transcript

Tom:

Greetings, and welcome to The Remote Real Estate Investor. On this episode, we have Nate Trunfio of Lima One Capital. This episode, we're going to cover a lot of materials focusing specifically on portfolio loans. All right, let's do it.

Awesome. And welcome to the podcast Nate. Thanks for jumping on.

Nate:

Hey, thank you guys for having me. honored to be here.

Tom:

All right, so before we get into the main content, let's start with a little bit about your background.

Nate:

Sure, yeah, I'll try not to bore too many people here. My career in life has been spent in all things real estate related, and specifically financial services and lending, younger ish type of guy. So graduated college in the mid 2000s, and got right into the residential mortgage lending world sort of conquered a lot of that through becoming a top sales producer, than stepping into the management came very early on. So some great learning lessons as a leader and manager, 24 years old, managing people twice plus my age, and then really just continued on that path through just growing and climbing the ladder.

The residential lending space serves a huge need, but it's a lot of red tape and a slower sales cycle than what I was looking for. So I jumped out of residential lending into alternative b2b, ran to different private debt funds there that led to another big need of small businesses in dire need of capital, especially today in this COVID world. And then I found my happy home and private lending over the last four years was the president of a smaller company, prior to now being at Lima One where I run all the sales and marketing and throw my hat in the ring of just a lot of other areas just to help the business grow.

And my sort of inner inner driving question is always How can I make myself others people process and things better around me, and that's what just keeps me ticking every day and has led me throughout the journeys and stops in my career.

Michael:

I feel like we're about to interview a Swiss Army Knife of residential real estate investing, this is gonna be super exciting.

Tom:

So when you started, was it more in like traditional residential lending versus private capital?

Nate:

Exactly, yeah. So learn through the red tape and all the rigmarole but you know, it's important in that world to be very knowledgeable and all the nuances if you want to be successful. But yeah, so when I was getting into financial services, it was very much a refi. Boom. So it was mainly focused on refinances to homeowners predominantly their primary residences, certainly to del purchase as well, with that got me you know, introduced to financing and real estate in general.

Michael:

Were you involved in that space during the 08-09 housing crisis, Or did you exit prior to then?

Nate:

That's when I got it right around there. So it was a great welcoming to all things, real estate,

Michael:

And you still managed to become a Top Producing salesperson during that time?

Nate:

Yeah, man, look, I certainly don't have the looks for those on video. I'm not, I'm not the smartest guy in the room. But my nack is I just I grind. I work hard. You know, I think that's the lesson to anybody younger in their career. You know, you don't have to have all the skills, knowledge and experience to be a top producer and anything. You just have to work your tail off.

Michael:

Yeah, that's great advice.

Tom:

That's fantastic. So let's learn a little bit about more about Lima one right now. So I've been to several conferences and somewhat familiar but for audience who have not heard of Lima, one capital?

Nate:

Yeah, absolutely. So Lima, one capital is a premier private lender in the top three to five in the nation, we lend in 46 different states, our sole purpose and mission is to provide financing solutions for real estate investors, because we know that the residential realm just doesn't suit investors who need to move quickly. They need different products than you know, traditional financing. And so that's exactly what we provide.

So we lend on all things related to different real estate investment strategies. It's fix and flip new construction, single family rentals on a single asset level as well as large portfolios. And then last but not least also multifamily. You consider us to be a private lender, most people will call it hard money. although in reality, I'd liken it to a lot more soft money. It's not hard money like it used to be. It's become somewhat institutionalized. And at least by that I mean that Wall Street has has an appetite for it, which is allowed us to drive down the cost of capital in terms that we provide out to investors.

So you know, we are a very big player in the space and again, we help numerous different types of real estate investors, whether it's their first deal, they do 100 deals a year, they buy, you know, 200 unit multifamily complexes to five unit complexes. I mean, no matter what shape and size you are, no matter what your investing strategy is we should have a financing solution for you.

Michael:

Awesome. is one of the 46 states Alaska or is that on the no go list?

Nate:

That is on the no go list, if I recollect.

Tom:

Contiguous. Michael, you gotta be contiguous.

Michael:

I know. I know.

Nate:

We're in Hawaii though.

Michael:

Oh, yeah? Oh, man. All right. Let me know when you guys are up in Alaska.

Nate:

Will do yeah,

Michael:

I'll be your first client!

Nate:

We'll fix and flip some igloos.

Tom:

I think you kind of answered my next question I was going to get into is the customer profile that you guys serve. So but it sounds like all over the board from individuals to funds, if you guys have like predominantly like more in one area are really pretty spread all over the place.

Nate:

Yeah, I mean, we're pretty diverse. Our core client is somebody that sort of graduated to real estate investing full time. But it's not to say that we don't finance a lot of people that are doing it is sort of a second job or supplemental income or creating additional cash flow on top of their W2 jobs, you know, our products in a process or they're designed to move quick, without a ton of paperwork, we don't collect tax returns on any of the products that we have, just to put that in perspective. And certainly, that's a mainstay in residential lending.

So we look at things a little bit differently. And we're customized to make sure that we can provide investors with what they need from a product perspective, but just as importantly, a process as well.

Tom:

How about if I'm buying through a self directed IRA, and with that type of a product? I can't get traditional lending, because I'm buying it with LLC? Do you guys do a lot of work with that type of customer?

Nate:

The short answer is yes. The lending to somebody who's purchasing through an IRA can be a little convoluted we, we absolutely have solution for it. But yeah, I mean, that that's definitely one of the corners of our customer segments that we service, most of the time you find people with that sort of investing strategy to be, you know, have a W2 job or retire from their W2 job in our investing is, you know, for long term cash flow purposes. So we absolutely service that as well, as you know, people that are using combination of that strategy of IRA, verse raising their own private money for their own equity, among many other different types of categories of our customer profile.

Michael:

You mentioned that you guys are private capital lenders, but also been classified as hard money. What would you say is the difference between the two? Because people are categorizing number one, as both? You know, should somebody go Google private money? Or should they go Google hard money? How do people know where to go look for those types of different options?

Nate:

Awesome question we could go on. And I can talk about sort of the debate in our industry. Yeah. Regardless, whatever you look up online, you're probably gonna find us and certainly our peers slash competitors in the same realm. But there is a differentiation, when you truly look at, you know, what I would call the definition of the nowadays private lender, versus hard money. And when the use cases are so hard money, if you didn't know actually started BC, before Christ times. So it's been around forever, it's one of the longest forms of lending…

Michael:

I thought it was before COVID, the new BC now.

Nate:

That's a good one, I might steal it.

I'll save you from the litany of other, you know, historical progressions from there, but it is one of the longest, you know, oldest forms of financing is hard money. Hard money is asset based lending, truly looking at an asset and lending off of the the assets value, really without taking much else into account.

So when you're looking at prior hard money today, it would be somebody that doesn't maybe have a track record of investing in real estate maybe has some blemishes on credit, and is looking for just a more of a financing solution that is just truly based on the asset for a number of reasons. Private lending is really developed because of Wall Street's appetite for it. And some of the backing by the largest institutions in the world. Now invest in this space, it's become institutionalized. They call it on Wall Street residential transition loans, because what I was told was over in Asia, they didn't like the sound of fix and flip, it just didn't go well. So they named it residential transition loans, sort of on the trading desk level at Wall Street.

So the difference is that private lending does look a little bit at the combination of borrower and asset level, although we don't look at tax returns, we predominantly look at an investor's track record and experience in investing, because we believe that shows proof of concept so there is a little bit more paperwork. And you know, in our world, we are appraisals, where as hard money is typically more lent by somebody in that region that doesn't need to go through formal processes of like appraisals, and they're looking at just the asset value, they know the market well, they know the asset well, they give a low percentage of the value of the asset to mitigate against the other risks and not looking deeper in the profile of the borrower. So hopefully that does that help give a sort of delineation between the two?

Michael:

It does, it does. And it would be great to learn a little bit more about kind of some case uses or case studies about if you could define and describe your ideal borrower, who are they? What kind of things would they bring to you versus who might be not a good fit for private money? Or for the one specifically?

Nate:

Sure, yeah, so the easiest way to answer that question, which is a great one, is if you're looking to continuously grow and scale and investing in real estate and do it on a consistent basis, you're going to get a lot more value and benefit out of the private lending realm, mainly because of two reasons. One, we'll be able to provide typically higher loan amounts more proceeds, which allows you to spread your capital to more deals and assets, and then to our cost of capital is going to be cheaper than what true hard money would offer you. There's a lot of different variables and reasons why somebody uses hard money and it certainly has its use cases.

But most often you find it's somebody that maybe isn't necessarily in real estate investing per se, or focused on scaling and growing in it. But yet they have a real estate based asset that they want to pull some quick cash out on. Maybe they have some blemishes on their credit profile, whether it's bankruptcies, previous foreclosures, or what have you, but as people that do have equity and assets that want something quick in order to obtain financing on it, but for the most part, people that consist, you know, that are the most common and using hard money, it's really hard to grow and scale a portfolio with just that type of lending compared to, you know, higher leverage and lower cost of capital in sort of the private lending world.

Michael:

Great.

Tom:

I'd love to walk through a couple of use cases of just as it relates to product as well as process. So I think a common one with a lot of remote investors is you know, they take advantage of the the 10 loans they can get just within their own name. And then it's like you get beyond that it's like, okay, what's next?

So let's say I an investor, I have whatever 10 properties to my name, and I'm acquiring a small portfolio of five, like, what would that conversation of kind of strategizing with that person? Like? Do you roll it all into a portfolio loan, this is getting very much kind of in the weeds in the tactics, I think that this type of a conversation is probably pretty common for a lot of investors who are getting some traction within their portfolio. And and they're growing. And I'd love to hear the different products and process as it relates to a solution like Lima One.

Nate:

Yeah, absolutely. And we're excited about the continued partnership with Roofstock, because our financing solutions are an add on to those that, you know, typically are growing their initial cash flowing rental, you know, assets or portfolios with traditional financing, which, as you said, allows them to typically get up to 10, under Fannie Freddie type rules, and then they had to look for alternative options where absolutely those alternative options. So let me continue down that path. And then I do want to talk briefly on the do I package this in a portfolio, do I get single loans on assets, that's another great point that you brought up there.

So where we come into play is either you don't qualify any longer for conventional financing, meaning Fannie Mae, Freddie Mac, you know, investment loans, or you surpass the maximum 10 loans. Either way, we come into play because we don't follow any of the underwriting guidelines of Fannie and Freddie. It's sort of our own world and rulebook. And the way that we look at deals is on what we call from a rental perspective, debt service coverage ratio.

So we don't get tax returns, we don't look at personal income, we look at the income on the asset compared to the underlying debt. And then we make sure it cash flows properly. And we have very similar like loan to value leverage mechanisms that the residential world would have, you know, we're minimum 20% down on an acquisition in that world and 75% cash out on a refinance. So you know, whether you hit the ceiling of 10 deals a Fannie Freddie, or you got through a couple and now your lenders telling you, hey, you have a dti, you have a debt to income ratio problem, we can't qualify you because debts outweigh your income to the 45 ish dti that they underwrite to, that's when we would come into play.

The other thing is, for the most part, across all our products, we can close a lot quicker than residential lending. We don't for better or for worse, we don't have to follow what they call like respa and Tila, which is different disclosure processes that are very impactful and really helped right side the residential lending industry from some of the wrongdoers in the 2000s that were scapegoated for the bust, you know, but that does slow the process down by having those disclosure process put in place, anywhere from three to five total days. And you know, to us investors, we know executing and showing up at closing it, you know, at the close of escrow date is imperative to retain your name and then get further deal flow from the sources that you do.

Michael:

Oh, that all sounds that sounds great. Nate curious. For most of our listeners, I think they're very familiar with conventional mortgages, Fannie Freddie mortgages, government subsidized cheap interest rates, especially right now when we're recording this in February of 21. into twos and threes and investment properties, similar 30 year fixed products, what are some different products that you've seen investors use to scale quickly? I mean, do you have 30 year fixed products? Or what kind of interest rates are you seeing in today's market?

Nate:

Sure, a couple of ways to attack that question. So we delineate our product suite amongst sort of two sections. One are bridge loans, and the other are more permanent financing loans. So to talk about the permanent financing first, those would be products that have a 30 year amortization, we can do them in a five one arm, which is the lowest rates at seven 110, one arms, adjustable rate mortgages or a 30 year fixed. So we do offer those types of terms.

Now because we're not doing as deep of a dive is Fannie and Freddie would from an underwriting perspective, and we're only looking at you know, debt service coverage ratio income on the asset predominantly, there is more perceived risk to us in the way that we lend. As a result, we have to pass along higher interest rates, right. The inevitable question becomes, well, what how much higher and what do they look like? So you know, your Fannie Freddie investment property rates will certainly vary depending on a number of factors, but for the most point, our product in the private lending world rental type investment loans, it's going to be about 200 to 300 basis points higher, what that is, is two to 3% higher than conventional rates, typically. Certainly exceptions to that where it can be less than 2%. But I'm going to be conservative in what I say in the estimates.

And then a lot of listeners might be saying, Oh, crap, I'm never gonna call these guys because that's way too expensive of money for me, right. And certainly, that may be the case for your investing strategy. But as I said, Before, we find our niche and our void to where you're looking to grow significantly. And you by nature and laws of residential lending, you can only own 10 investment properties unless you start trying to cheat the system some way. So which there are ways to get around that by having other borrowers buy the properties and things like that, we won't go down that road. But not only that, you just need to make sure that your investment strategy aligns with your financing vehicle. I think that's just an important point. I mean, there are a lot of really great real estate investors that do use hard money, true hard money, that's more expensive than us, but only because, you know, maybe they move even quicker, they can get loans on assets that we might not land on.

But the bottom line is, you know, you can make money in real estate any which way, you know, there's different beliefs in Should I financed or do it all in cash, we definitely won't have that conversation, because that's a deep one. But if you're going to use a financing vehicle or a loan of some sort, you have to make sure that the vehicle is aligned with your strategy and your end goals. And yeah, I mean, it will eat your cash and cash returns a little bit or your total returns because the rates higher your interest payments higher. But at the end of the day, if it allows you to buy more assets and add to your overall cash flow, that's the essence of continuing to create true generational wealth, that end of the permanent financing products. And yes, we do offer 30 year amortized 30 year fixed might be a little bit more expensive, but certainly serves its purpose.

And then on the bridge side, just to put it very simply, a bridge loan is taking an asset or a financing vehicle that allows an asset to go from A to B, right, we are the bridge between A and B. So those products are you know, the the bread and butter is a fix and flip, we're buying a distressed asset that needs X amount of renovation work or some level of repair, sometimes they're severely distressed. So we financed not only the acquisition, but the renovation hold back so that you don't have to come out of pocket for that in full and wait for it to sell. And then we allow you to navigate through the reposition the value add as they say, to get to destination B, which is either one of two items of sell the property and flip it or hold it and you follow along the lines of the investment strategy of bur I can't roll my Rs so pardon me. Buy renovate rent, refinance, repeat, right. So that's the burn mentality, we can service the bridge loan for the repossession and the renovation and the rental loan, or you can go get a conventional loan, if you have less than 10. And qualify, that's sort of where investors use those different types of products. And sometimes they're combined, and you're using two vehicles to one strategy. But the bottom line is, you know, we're here to serve as either end of that.

Michael:

That's such a good explanation. And a point I want to touch on is like about the expensiveness, or the cost of the loan or in terms of the interest rate. So often I hear that same issue is like, Oh, you know, I've met this lender, and they give me three and a half for this lender Give me three and a quarter. But at the end of the day, I think it's so important to look at like the bottom line is okay, how does that half a percent or maybe in this case, two to 3% affect your bottom line in terms of dollars and cents. And on smaller loans, it tends to become more negligible. And so again, to your point, if it gets you in the deal, and you're still cash flowing, versus not doing the deal and not cash flowing, sometimes it is worth you know, paying that extra cost.

So, again, to all of our listeners, don't let the numbers scare you. But go see if the deal makes sense. And then move on.

Nate:

One other quick tip I do want to give here because it is a great point. So I appreciate you articulating and summarizing my points probably better than I did. But one thing that's important to you know if a lot of listeners are used to the conventional, Fannie, Freddie world, and some may use that product to almost fix and flip assets. Well, the problem with that is if you think that through, you know, conventional loans, Fannie and Freddie have started to come out with renovation type loans for even investors, it's a lot more tedious than ours, they take a lot longer to close, and then to move through the like the draw and rehab process is extremely cumbersome.

So that aside, if you're going to look to buy an asset and say put 20% or 25% down and then invest another 25,000 renovation on top of that you're not only down you're 25% down payment and the 25,000 renovation, you know, but you're also paying for holding costs along the way. With a bridge loan, like a fix n flip will finance the combination of the two purchase and renovation amount. So you don't have to be out that 25,000 renovation because you don't get that money back until you either refinance and recoup and recapitalize or you sell the property, but that 25,000 could be used to go buy another $100,000 asset at 25% down. Right?

So that's where a lot of people will overlook that we will provide higher leverage when you're using a method that involves renovation. And by going the conventional route that yes has a lower cost of capital less interest that you pay, it can be well designed if you're only trying to do one offs. But if you're really trying to scale and spread your money among multiple deals, using a lender that gives you the highest proceeds and loan amounts to facilitate the transaction is going to serve you and be best suited.

Tom:

Makes a lot of sense. I'd love to hear you touch on, you know, this use case, again of you know, having whatever 810 properties and that question of Okay, do I roll this up into a portfolio loan? Or do I just, you know, do a bunch of, you know, 30 year individual loans? When would it make sense to do either or say you have this growing portfolio?

Nate:

Yeah, so great question. And to me, and this is the same for any type of loan product, it's, you know, first you really need to understand where you're going to go and what your overall vision investment strategy is. Because if you're going if you're you think you only have the capacity and the goal and the dream to acquire a smaller amount of assets, it may not make sense to put a portfolio loan sort of into your plans, if you're looking to really significantly scale you do you want to analyze looking at portfolio loan options for a number of reasons, a lot of the portfolio products will allow you to remove them from Fannie Freddie loans, which then opens you back up to using those again, number one, but it also just depends on again, the overall your overall strategy.

So if you know you're going to hold assets for a long time, and you know, you're not going to sell them no matter what the markets doing, you know, then portfolio loan may make sense. But the word portfolio on won't make sense, if you really know you need that flexibility of moving one asset in and out of your own portfolio, because in portfolio loans, they have what's called a turbo pay down, which essentially, you pay down your loan amount a little bit more per each asset that you pull out, which therefore you don't get access to as much of the return of capital on selling an asset. So that's where I go back to, you need to know your long term vision. And if it's to acquire a lot of properties and hold them for a long time, a portfolio loan might make sense.

And then this is shared necessity of a portfolio loan is, again, you know, conventional, you can only get up to 10 assets, Fannie Freddie, so if you're looking to buy in bulk, you know, you have to get some form of portfolio loan. And you know, even if you don't you do them individually, you're going to be limited at some point cost can be costs are consolidated in a portfolio loan. So a lot of times it can be cheaper than doing them on a single asset basis. And then you'll eventually get to a level of the portfolio realm, that the terms are significantly more favorable than when you do get them on a single asset. So not to confuse people. But what I talked about before was sort of a, like a smaller single asset rental loan, we have large portfolio rental loans, that's for anything of minimum five properties 500,000, up to 5100 properties, 10 $15 million in total assets value, and that product is maybe 100 basis points above residential lending, but you have to gain that critical mass to be able to get eligible for that. So I know I'd sort of shotgun and spread among that question a little bit, but hopefully gave some valuable tips.

Tom:

Love it. Yeah.

Michael:

Nick, can you give everybody an overview of what a portfolio loan is for those that might not be familiar? And also, if we could maybe touch on the differences? Because I think there's a lot of misnomers around portfolio lenders and portfolio loans. And the portfolio lenders keeping it on their books versus portfolio loan, what that product looks like. So, riff on that for a minute, if you would.

Nate:

Yeah, absolutely. So, a portfolio loan is simply put, you know, writing a blanket loan across multiple assets. So what happens is, you know, whatever the amount of assets you want to say is, let's say 10. You write one loan, that encumbrance all 10 units. And within that loan, there's different segments of the of the larger loan that is assigned to each property. By doing that, and taking out portfolio loans you can alleviate, you know, the need to go conventional and the limitations of having 10 properties at a given time. As well as there's some cost savings by doing things in bulk. Just like when you go shopping at Costco and BJs. When you buy in bulk, a lot of times you can get discounts. And that's probably a good way to look at a portfolio type loans.

 So we have a phenomenal product when you own one you either own or you're buying five properties and 500,000 that are $500,000 or more, we'll put it all in one big portfolio rates on those are very aggressive. They're only about maybe called 1% 100 basis points above conventional rates. And the reason why it's lower is it's less risk, we have more assets to sort of pool into the loan, again allows us to pass along cost savings to investors.

Michael:

Real East Coast guy with the BJs drop in there.

Tom:

I know I noticed that. Is most of the portfolio loans that you guys originate, like off of the acquisition or through a refinance, or is it pretty split?

Nate:

Yeah, great question. I would say it's probably 7525 refinances. So I think that's a great point is that the other purpose portfolio loans a lot of times is that you're buying one offs, whether you're buying them with a conventional type loan, or you're buying them with a bridge loan and fixing and repairing them. And so you're aggregating them, and then you go take it out with permanent financing and a portfolio loan. So again, that is either allowing you to pay off more expensive bridge loans, or wiping the slate clean of Fannie, Freddie and then starting back at zero, because you just paid them all off the ones that you accumulated. And then you can go and run wild and getting Fannie and Freddie rooms and dealing with all the red tape over and over until you get back to your 10.

Michael:

So I got a portfolio loan a couple of years ago, and I think they're the best thing since sliced bread. I got them with a commercial lender out in the Midwest, and I've got them on to commercial properties. How does a refinance work? Let's say two of the 10 have appreciated. How does a refinance work? Are you looking aggregate at the entire portfolio value? because these things are cross collateralized or talk to us a little bit about that?

Nate:

Yeah, great question. I'll touch on two points in reference to that. So we do look at the values of everything combined. So because they are cross collateralized, you're essentially looking at the, you know, gross total value of all the properties in a portfolio loan. And then there's a guideline called seasoning, that will depend on exactly how much you can take sort of cash out on. So seasoning references, how long somebody own an asset, typically, in the portfolio realm, it's either six months or 12 months. And once you've surpassed that timeframe, and you've seasoned the properties, then you can get a loan that's just based on the loan to value of the accumulation of the assets.

So if it's two or three assets that accumulate to a million dollars, and you've owned the property for two years, you've certainly passed those seasoning guidelines that I talked about, you know, for us, we provide 75% cash out. So on that pool of million dollar properties, we'd be able to give a $750,000 loan amount.

Michael:

Great. Now I want to touch on kind of shifting gears just a little bit is value. It's a super hotly debated topic, I think in the real estate community. Most of our listeners, I think, are very familiar with single family homes, and going to get an appraisal done determines the value based on a comparable sales approach. Versus in the commercial world. They use the income approach for the appraisal to determine value. If I have 10 single family homes as part of a portfolio and I'm trying to get financing for it. How do you How does Lima One determine the value? And I mentioned DS debt service coverage ratio is very looking at income. Are you looking at comp sales?

Nate:

Yes, the very easy answer as both.

Michael:

Okay.

Nate:

So when we value and get appraisals, as you said very well on single family assets, we do use and look at a sales comparison approach. So to determine what we can lend in the LTV, the loan to values, which I said 75% cash out will be dependent on the sales comparison approach determined by an appraiser and then we'll lend that X percent up to it again, cash out world we can go up to 75%. Now, where it comes into sort of both, is that we have to make sure that that loan amount based on our maximum loan to value also passes the debt service coverage test, essentially. So again, the debt service coverage ratio is looking at your assets income compared to the liabilities in the asset, which is not only the mortgage, but it's also the property taxes, the homeowners insurance, any HOA dues as well if it's a condo or pod or anything like that.

And so as long as it will surpass the minimum ratios, that is the income based approach. So the values themselves are not based on income base. But there are underwriting guidelines and stipulations that require a certain income level. And the easiest way to put what is that income level, it's typically anywhere from 1.1 to 1.2, debt service coverage ratio.

So again, your income must surpass your mortgage payment debt, your taxes, your insurance, and your HOA dues, if applicable by 110%, or 120%. Why is that important? Well, the easiest answer I'll give you is we too, as a lender, we don't want to take your properties back. So we want to make sure that you can afford to pay your mortgage payment and your expenses. Therefore, we want to ensure that we underwrite a loan amount that doesn't make your debts and your expenses higher than your income and puts you in that tough situation. Unfortunately, a lot of landlords now with COVID with you know, people not paying rent are in that situation regardless, but that's why we put that rule into place is to make sure your property cash flows with our debt.

Michael:

Yeah, great explanation that makes total sense. And Darren, that's a bummer. It'd be so great, right? If we can get all this killer performing asset Well, that's worth a whole crap ton more awesome. So we can we can borrow against it. But that's really good to know. And I think that's really the responsible way to do it. Right, is make sure that people aren't biting off more than they can chew.

Tom:

Absolutely. I look into my notes. I have one more question on costs of going through private capital. How do origination fees differ from traditional loan using private capital? Are they love to hear your thoughts?

Nate:

Yeah, great question as well, to be very blunt and transparent. Typically going through the private lending realm is going to be more expensive from a fee perspective. You know, there's a number of ways to price out conventional Fannie Freddie loans that you could incur more fees, but most of them is, as they say, in the residential mortgage world are written at par, which is essentially you know, you're paying usually just an underwriting fee and no people think is very evil points, right? In the private lending world points. origination points is something of norm.

So typically, it's anywhere depending on sort of the the level of investor that you are anywhere between like one and two, one and two and a half percent of points, origination fees on the loan. So that is more expensive for from that regard. But the lender, excuse the credit excuses, it's more risky. So there's a cost effect as a result of that.

Michael:

Nate, for those people who aren't familiar, what's the point?

Nate:

A point is 1% of the loan amount, so on $100,000 loan 1.1% would be $1,000 in fee.

Michael:

Perfect, love it. Well, don't love it. But that's a great explanation.

Nate are a lot of the private lending world or maybe just you know, speak for the Lima one, are these non recourse loans? Or all these are these full recourse?

Nate:

Yeah, really good question. More often than not, they are full recourse. But there are also alternative options to get non recourse on most products. So that's speaking generally here at Lima One, we do have non recourse across most of our options across most of our product sets. But you know, in the world of private lending, especially the bridge side of it, you sort of should expect recourse, you know, which is the same as Fannie, Freddie, you know, that those are recourse based loans as well. But a great question, we can certainly service a non recourse loans and provide them, it just depends on a couple variables. And sometimes there is a little bit of an interest rate price to pay, not much, but a little bit just for that compensating factor.

Michael:

Sure.

Tom:

This is a quick kind of definition, do you mind defining recourse non recourse,

Nate:

It means that you are guaranteeing repayment and that you are liable for repayment of the full loan amount, no matter what happens, you know, if you can't pay off the existing loan, so whether that's, you know, you can't make payments, and you can pay it off in full, then you owe the full balance. Or if for some reason, like in a flip scenario, the flipped info is what you thought and you sold the property for an amount that's less than what you owe, then the lender has recourse or the ability to go after you for that remaining difference of what you sold the property for versus the larger amount that you owed on the asset.

Non recourse essentially means that, you know, there's not formal ability for a lender to take the mortgage back as a liability against you personally, most of the time non recourse or all that I know at least is written to an entity. So the entity still has to like there's still the ability to go after the entity for it, but you as an individual warm body person, or not on the hook for it. Unless you can commit what's called a bad boy act sort of what it sounds essentially you commit fraud.

Tom:

Reminds me of those like shirts from like the 90s. And early on that bad boy shirt. Nevermind.

Michael:

Like that movie with Will Smith, bad boys.

Tom:

Sure, yeah.

Michael:

Good, both good enough.

This is gonna seem like kind of a to Prague, maybe silly question. But first and foremost, if somebody if you're gonna be working with somebody, you're like, Oh, I want non recourse a, is that a red flag? And B, if that's an option, why wouldn't any everybody go the non recourse route?

Nate:

Yeah, another great question. Why wouldn't everybody go the non recourse route? Well, sometimes it's just not available. You're absolutely right to most people, I would rather have non recourse and recourse. Yeah. My counter to that. And rebuttal is always do not have confidence in your project, you know, do you not have confidence in your ability to execute on your deal in your strategy, to not have confidence and paying back this loan? Are you going to screw me? Right? I mean, that's sort of so so that leads me to the you're the other part of the question, you know, yes, from to some extent, maybe that's looked at somewhat negatively, but at the same time, non recourse is most prevalent on larger loans, larger assets, with larger scale operators and real estate investors that do this for a living.

Many of them have companies of employees that work under them within their real estate, investing arms. And in that world, it is just a lot more common for non recourse products, the multi million dollar type loan scenarios. And that's just because you're dealing with typically very high net worth individuals that, you know, certainly have potential meat in the bone that a lender could go after. And yes, they're confident in their business strategy. But they've also worked their entire life to build up the 5, 10 million dollar net worth and they don't want to sacrifice the Armageddon potential instance, or the COVID type of pandemic world events that we've occurred is unforeseeable, that could come back and bite them in the butt.

So it's a great question. Yes, sometimes there's a negative connotation from the lenders perspective on some sorts of deal levels. But as you go sort of upstream, as I'll say, that's when it becomes a lot more than norm and is not really not looked at negatively from a lender's perspective.

Michael:

Okay. Good to know.

Nate:

And it doesn't hurt to ask, right? I mean, just like anything, asked, you might as well ask because the worst thing you get is No, we can't help you.

Michael:

Sure we are getting pretty long here. I feel like we could go on for days chatting with and asking questions. But I know we were chatting before we started recording here that you are also drinking the Kool Aid when it comes to real estate investing.

Nate:

I try man, I got my sippy cup.

Michael:

So you mentioned that you're in the middle of a couple of flips. Can you give us just kind of a high level overview of what you're doing? And then do you use Lima One capital to fund some of those rehab projects? Yeah, so the first is a resounding yes, absolutely. Use leave on capital. That's just the truth.

So I have two projects going now. I honestly never really have the ability or time to do more than two, you know, a lot of people watch HGTV and house flipping is really cool and sexy and probably easy to do. It's, you know, is it cool? Yeah, you know, beauties in the eye of the beholder. You know, sexy, I don't know about that. But it's not necessarily easy. So I want to make that clear. It's not to scare people away from it. But it takes a lot of work. There's a lot of variables, there's a lot of things that can go wrong. I will also sort of give my one piece of real estate investing advice. This is probably very cliche, but you make your money on the buy in a real estate investment.

What I mean by that is that if you buy a property at a discount to what it's worth today, it's hard to not make money on it. And so why I say that is the only deals that I'll personally do are ones that I know I'm buying, right that technically, there's some room for error, because on the two deals that I got going, there were some errors and you know, I can't point fingers and blame COVID you know, you know, very real, but at the end of the day, you know, they didn't go as planned. Most people lie on the real estate investor side, when they try and say like, Oh, I can predict my budget on a flip in a renovation very accurately. That's not true.

Michael:

Bunch of garbage.

Nate:

The average variance even for your top tier flipper is probably 15 to 20% in cost on your renovation expected budget, I'm already self deprecating that I'm not the best at it, per se, I'd work in the lending space into this supplementally. But I mean, I ran into that through COVID, you know, and I've gone through, I needed to connect sewer to public sewer on one property, the initial route that I predicted to go wasn't available, it couldn't happen, didn't work, had to go a new route, had to fire a contractor through COVID because he ran out of money, really unfortunate, but my project was dragging and he was ahead of me on sort of terms and payments, I then had to step in as my own GC, find my own subs. I mean, it was snowballed, and it was very cumbersome.

But the bottom line is, you know, you stay disciplined. And I'll make money on both those deals just because I bought them right. And so I know I cover a lot there and can go into deeper detail on sort of this any stories you'd like within it. But the bottom line is, you know, I will opportunistically invest in real estate because I've tons of passion for it. I like to think I know what I'm doing. You know, at least when I tell myself that. And you know, the bottom line is as long as I'm buying right, it's it's going to be hard to lose money on the deal. I'm not going to make as much money as I would have thought. But at the end of the day, because I followed sound principles, I will make money on both these assets.

Tom:

Great, make the money on the buy. I love that it's so good is like pretty much stapled up on the wall. And one of the one of the companies that I worked at one of the very first single family rentals was make money on the buy make money on the buy. I'd love to hear one of your stories you'd mentioned before. You had one I don't know if it was what it was related to get time.

Nate:

Which story do I want to tell so honestly, you know, one cool story of one of the properties I had that literally was bought, I mean, I'm under contract to sell it, but it was bought March 12 of 2020, which was not too long before the formal full nationwide announcement of COVID. But it was actually crazy enough. I'm at home working right now. It's my neighbor's house. It's right here. So what happened was over about two month period of time, I saw nobody was living there anymore. Every week when there's trash day, they'd be pulling out two or three trash cans worth of junk among some bigger items. And one day I just approached him said, Why are you doing this? Because I have a feeling I know why. And sure enough, it was you know, the patriarch and matriarch of the family that bought it in the 1950s passed away, pass it on to kids who couldn't take care of it anymore. They had one of their kids in the property she moved out and now they're you know, they needed a quick option to sell it. I said, Look, I can buy this property, essentially cash without you having to move any more junk out. And what a great project for me because it's literally right there next door to me. And you can find deals anywhere that way.

So to me, that was a pretty cool story. You know, I would never have imagined fixing and flipping my neighbor's house. And now since I'm under contract, I'm doing my best to not let the buyer know that I did the work because I don't want to door knocks on my door a week or two later saying Hey, isn't this done right or I want you to fix it. So we're trying to secretly trying to sell it right now.

Michael:

How cool is that? Yeah. So are all the projects you're working on? Are they all flips? Or do you do any burrs any kind of long term buy and hold or are buying hold?

Nate:

Yep. So good question. I'll liken it back to what is your investment goal and strategy. The last couple years, my world has been focused to drive income larger amounts of income, which means that right now I'm only doing fix and flips. So to me since it is a lot of my late night work or early morning work before I plug in for, you know, full days of Lima one, I want that larger gratification tied to that extra work. And that's why I'm currently fixing and flipping but I know there will be distress coming in the market. You know, I think 2021 is going to be a good year. But soon at the end, or thereafter, we'll be transitioning to buying and holding, because I think there'll be a lot of product that comes online that it'd be a lot easier to find. It's hard to find deals right now. I mean, it's it's one of the hardest challenges that real estate investors have.

Michael:

Cool. Thanks for sharing.

Tom:

Awesome, Nate. Well, thank you so much for coming on. I feel like we have more episodes in the future with you. I mean, we're, very quickly, you know, over 45 minutes onto it. But thank you so much for jumping on any final plugs on how to get ahold of you or Lima One?

Nate:

Sure yes. So check us out online Limaone.com. To get in touch with me directly or to make sure that you get in touch with a senior sales representative to find out your financing options for real estate investing. You can simply go to Limaone.com/Nate, that'll come right to me once you fill it out. And I'll make sure you're good hands and we take care of you and work towards finding true solutions for your investing needs.

Michael:

Fantastic. Oh, Nate, this is great, man. Thanks again.

Tom:

Yeah, thanks again.

Nate:

Thank you guys. Just let me know when Episode Two is teed up!

Michael:

Totally.

Tom:

Thanks again to Nate for a very insightful episode on portfolio lending and Lima one. If you enjoyed this episode, please rate and subscribe us wherever you listen to podcasts. And as always, happy investing. Happy investing.