The SFR Show

In this episode, we bring back the showdown! Tom and Michael debate whether you should maximize rent growth or minimize vacancy.

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Transcript

Emil:

Hey everyone. Welcome back for another episode of The Remote Real Estate Investor. My name is Emil Shour and my co hosts are,

Tom:

Tom Schneider,

Michael:

and Michael Albaum.

Emil:

And in today's episode, we're going to be doing an old school style showdown episode. And today's showdown topic is going to be rent growth versus vacancy.

Emil:

All right, before we get into this episode, guys, we mentioned that we were doing a little giveaway to help us get over 100 reviews and we are now at 103. So thank you everyone who answered the call there and left us a review. We're going to choose two people at random here. And if you guys just reach out to us, we'll get you some some goodies. So first winner, drumroll please. First winner, Big Red 13 Thank you big red 13 for an awesome review. And let's see here. Our second winner is going to be drumroll again please.

Tom:

Papa, papa, papa. Boom.

Emil:

All right. And our second winner is Bobby tonsils. Bobby tonsils. Thank you for an awesome review as well. So if you guys just want to reach out to us, I'm at [email protected], Michael is [email protected] and then Tom is just [email protected] . Just reach out to us. Let us know we call your name. Since these are kind of like usernames, we don't know your first and last name. So just reach out to us. And we'll use the honor system. And we'll send you some goodies. Thank you guys so much. So let's hop into this episode. Alright guys, so today's showdown is going to be rent growth versus vacancy. And this is a good one because I think it is well debated. And there's good points to be had on both sides.

Michael:

But there's better points to be had on my side. So let's go That's right. Well,

Emil:

what is your side? Michael? What's that? Are you taking on this showdown?

Michael:

I'll take the stance of rent growth because I think that's the more difficult position and I want to be a gentleman and give these your position to Tom to start.

Tom:

A lready handicapping himself already sowing the seeds of defeat. I'm gonna reap a lot of failure harvest, okay, go ahead.

Michael:

Good thing I studied Agricultural Engineering. I'm the best harvester in this group.

Tom:

Oh, yeah.

Michael:

That's like such a tough comeback. Like, Oh, yeah. Yeah.

Emil:

So Tom, you're taking the side then of vacancy?

Tom:

I'll start with vacancy. And then in tradition of the showdown, we'll switch it up.

Emil:

By vacancy, we mean, making sure are trying the best you can to not incur a vacancy. Right.

Michael:

Yeah, I guess that's good. Clarify.

Tom:

Yeah, well, let's clarify the bait first. Yeah, they can see versus rent growth.

Emil:

Yeah, like, We're not saying we want vacancy, we want to not have vacancy. So the question is, do we do all we can to keep the tenant in place, and maybe not charge higher rent, lease renewal, or we always go in for rent growth. So who wants to kick us off?

Tom:

Well, in format, right, one side starts the other robots, and then the initial side gets to go again, Michael, why don't you lead us off, just cuz I feel like, you know, there could be some upfront bias on both sides. So sure, go ahead, lead the way. And then you'll then we'll change the order next time around.

Michael:

I appreciate you baiting me now. So that's great…

Tom:

Gentlemanly move, just trying to…

Michael:

Humble brag. So I think it's so important to maximize rent growth, and really prioritize that over vacancy for a couple of reasons. One is when it comes to property performance, if we're maximizing rent growth, that's gonna have an immediate impact on the property's performance. And, as a lot of our listeners know, I'm a big fan of multifamily investments, I own a lot of multifamily investments. And so, minor incremental rent increases on a property on a per unit basis can have really profound impacts on the noi of a property and the ultimate value of a property.

So let's just walk through a quick mathematical example, if I can increase rents $15 a month on a 10 unit building, so that's $15 a month across 10 units at $150 a month in additional noi, if I multiply that number, then by 12, that's 1800 over the year, if that building is valued at a 5% cap rate, I'm going to divide the increase in noi by the cap rate to get my additional value added to the building. So when I take 1800 divided by point O five that's $36,000 in value I've just added to my building by increasing rents $15 a month per unit. Now that's mind boggling when you think about that and the power to do that is also mind boggling.

So when we Think about rent growth, it's in addition to having a profound impact, potentially profound impact on the value of the property. I think it's also important to just be reasonable and fair with your tenants. And so if you can increase your rents incrementally year over year, as opposed to keeping them stagnant and then having to hit tenants with a massive rent hike down the road, I think you're treating tenants a bit more fairly. And I think a lot of people expect minor increases, as they do with just average inflation, the cost of living the cost of goods and services costs more year over year. So of course, why wouldn't the rent keep up with that year over year? Mike, drop exit stage left? Tom, you have the floor?

Tom:

All right. You know, before I like to talk about stuff, just quickly, defining our terms, right. So this is a debate about do you want to be penny wise, pound foolish and what I mean by that, if you are 100%, about rent growth, you're going to be pound foolish, you know, you may try to increase and jam on your tenants an extra 10 bucks, 15 bucks, 50 bucks a year. But ultimately, you're the one that's going to get jammed, because that tenants going to be like, No, thank you, you are jamming me, I'm gonna move somewhere else. Like, it's, it's stress. I don't if you guys ever rented in a place and every year, your landlord jamming you 25% I got out of there as quickly as I can. So that's the Pennywise great, you're earning an extra 10 bucks, you know, hundred and 20 bucks a year awesome pound foolish, you're going to run into vacancy, you're going to have people get leave, you're going to have people basically have the house open, where you calculate how much it costs to do a turn, versus those incremental increases in income that you're getting by raising the rent, the math speaks for it self, you're going to want to be have that occupancy, the weight of the costs that you have on a turn greatly, greatly are going to exceed those marginal benefits that you're going to get by raising the rents a little bit.

And also, if you have a good tenant that is paying on time and keeps the house in great shape, what a great way to mess up your investment by just continuing just poking them with needles with little increases in dollar rent, you know, do you want to be a needle poker, I don't think you want to be a needle poker I think you want to be an effective investor who is making sound decisions. And being Penny dumb, pound smart by really thinking having the big picture and making it work.

Michael:

I love that you use this analogy of poking holes in the tenants because I want to come back to something that you've said over the years and that's being long term greedy. And as your expenses increase year over year, your property taxes might go up incrementally the cost of goods and services is likely to go up incrementally, your returns are now getting those same pin holes poked in them poke, poke, poke the return, poke, poke, poke your return, and you're going to start bleeding. And there's a phraseology out there death by 1000 cuts. And so how do you reconcile with yourself or with the potential return that you keep your rent stagnant while you then have to eat those additional costs year over year?

Tom:

You as a savvy investor, you know, there are ways that you can look for more competitive rates. Because a lot of those costs me one of the beauties about real estate investing is you get these fixed costs, right, you lock in a lot of things, you fixed financing rates, taxes may move a little bit. But if you're proactive about them, you can make a case to the county and keeping those nice and low. So win win situation, you manage a few of those costs that might move a little bit of time. And you manages the expenses that related around terms by not incurring them by keeping your tenants in the house by keeping that vacancy number low.

I mean, every investor needs to look at the balance sheet of their property. And what's going to come up quickly come to the conclusion that you know, there's two ways to make money as in business as an investor. In any case, minimize your expenses, maximize your gains, and sometimes there's a little bit of trade off and in this question related to keeping your vacancy low or increasing your rent growth, it's a pretty simple equation, keeping your vacancy low you're gonna win.

Michael:

Yeah, I agree. The equation is pretty simple, but $36,000 in additional equity is a pretty amazing. Emil care to step in here?

Emil:

All right, guys. Yeah, you guys are starting to throw haymakers. So I'm gonna step in here.

Michael:

It’s a bloodbath.

Emil:

Yeah, it's there's there's blood everywhere. You guys both bring up good points. Michael, just to clarify your example there, increase in value that will typically be seen only on a commercial property. So in our case, talking about housing, that's a five plus unit building, right? If I own a single family up to a four unit building, increasing the noi doesn't really have an effect on the value of the building because it's not valued on cap rate is valued on sales comp,

Michael:

Well if you sell it to an investor, but when if someone comes in to buy that building the bank with a mortgage, the bank is likely going to still make them get an appraisal and the appraisal is going to be based on comps.

Emil:

Yeah, that's a good point. If you are able to raise the rent you are making it a more attractive investment for another investor right? So if you're selling it Yes, as an investment, you're right. It will be attractive even if it's not valued on cap rate. So good point there. And then Tom Really good points in turn costs, right? Like anytime you have a vacancy, those are one of the biggest of the like times where you have the biggest expenses or you can write, especially if the tenant has been there for a while, there's been a lot of deferred maintenance. I know personally, like whenever I've had a turn, that's when I have the biggest R&M costs. So and that's not even account

Tom:

Plus no income. What's your sorry, I just took it right out of your mouth. I saw it in your mouth. I took it right out.

Emil:

Come on, man.

Tom:

Go ahead.

Emil:

You're in your corner Tom. Is the referee speaking? The bell has rung. You guys both bring up various solid points. One thing I have this one property manager who every time the lease comes Do they have these three levels of rent increase, right, so they'll have like, aggressive, normal, and then do nothing. And so aggressive is like, Hey, we're gonna raise rent X amount. To get right up to market, the standard one, which I always go for is like a smaller increase. But what they say is that if the tenant looks like they're going to leave, because of the rent increase, they'll work with them to basically either keep rent the same, or maybe only increase it half of what they were going to do or something. So it's basically they're going to propose it and be flexible, obviously not going to say it up front. But when push comes to shove, they're going to be flexible with the tenant, versus instead of just saying no, this is the rent, increase, take it or leave it, that kind of deal. So I've always actually appreciated that what we're doing these consistent rent increases, but they're small, and we're willing to work with the tenant. So we don't have a vacancy. So let's switch roles. Tom, you're going to take the rent growth side. And Michael, you're going to take the reducing vacancy side. And hopefully let's let's not try to touch on anything that the other has already said. So better rack our brains for four cases. Michael, you started last one, Tom, kick it off.

Michael:

Let's touch gloves, Tom.

Emil:

Ding, ding.

Tom:

All right. You guys feel that? It’s the winds of change. Historically real estate, as an investment, at least in the single family space has been limited to sales comparables. But it's a really flawed system for a variety of reasons. It's why commercial uses return base. And I think the winds of change is single family rental is going to go in that direction too. Just because the value of an investment, it shouldn't have to be with some arbitrary value of what the home's next to it is. It's it's what are you getting on that return? Right. So I think that over the next five to 10 years, there's going to be a dramatic shift in the way that valuations are done with single family rentals and being able to get debt based on what kind of returns you're getting. Because you know what, this is an investment and you know what the value of an investment is what kind of returns you're getting. So in the ability to increase the value of your home by continuing to push up that rent, it's really impactful and just playing defense and not necessarily pushing it up, you're leaving money on the table.

And I think this is going to be the shift that's going to be happening over the next several years with single family rentals, and the ability to get that in the same way that you're able to do with commercial stuff kind of a little bit repetitive, I'm going to say this is a Gandhi quote, Be the change that you want to see and the kind of change that I love to see his rent increases. So to that point I was talking about earlier, generally speaking, it's pretty fixed costs. So you know, say I am getting a return on a property like a cash on cash, like whatever 10% or something when those rent, when that rent increases, Ooh, baby, that's just like going directly to my net operating income. So be the change that you want to see. And that change that you want to see is rent growth and more annual increase in the rent that you're collecting.

I think also to not really piggyback but there's a couple of other values in increasing the rent. By doing it, you are creating general market pressure that other landlords are going to see. And it creates sort of a wave effect, or that's not the right word to use wave effect. But it has a bit of a compounding effect in that when you increase your rent, it creates a market comp for every other landlord to continue to tweak up just a little bit. And over time, you are helping that market rent increase by increasing your rent just a little bit. Now I'm not saying you want to necessarily jam it up, and it should be reasonable. But by sitting back, you're letting the market rent as a whole stay stable when you could be contributing to comps that is going to raise pretty much all market rents. So are you a market leader? Are you a market follower? I don't know. saw me someone pulled my mic. Oh, my mic.

Emil:

All right. All right.

Tom:

Those are all really great points. And clearly, you're going to be the Pioneer with the arrows in your back. The first one's always are. I never want to be the first one to do something in a market because there's a high degree of failure that can occur. So, you know, I think that's a really interesting point you make about being the comps are typically based on numerous I think are based on numerous indicators, not just a sole or single operator owner. And so I don't know if we can say that one, your rental being higher than the others is going to increase and raise up some of these other rents. And I just think that they can see is the fastest way to kill your returns on a property. And so like you were mentioning, if you are juicing your returns by increasing the rent, and your fixed expenses stay fixed, that the return is only to increase, if we have a month of vacancy, I mean, that could just decimate an entire year's worth of cash flow.

And to make an extra hundred hundred and 20 150 bucks annually, the risk reward is the risk is a full year's worth of cash flow and the reward is an extra couple hundred bucks maybe just doesn't seem worth it to me. And then, as you mentioned previously, this is when you have to take care of all your turn costs. So not only are you losing out on all of the income, but now you're forced to reckon with all of the repairs and maintenance issues that are needed. In order to get a new tenant in place, you're also going to be slapped with a new tenant placement fee. If your property manager charges one, you're also going to have to pay for any utilities that are associated with that property while it's vacant. So I think a lot of people don't really tally up all of the totals associated with losing a tenant and placing a new one. And I just think the the risk reward scale tips very heavily and very rapidly in favor of keeping a tenant in place even at a slightly lower than market rents.

Emil:

Tom, you get final rebuttal.

Tom:

You know what Michael? I agree. Wait, hold on, come on. Come on, Tom, get your face on get your game face on.

Michael:

Get this guy some coffee.

Tom:

Yeah, you're you're either making plays Michael or you're getting played? Right? Way. All right, Tom. Okay, we're not talking about Armageddon. We are not talking about raising the rent, you know, over the market rate, we're talking about just slow, steady, incremental, I think being reasonable with your tenants. But what I'm advocating with increasing market rate is not, you know, throwing a hail mary and increasing it to the tippy top of the market, I'm talking about just incremental steady increase in rent. And over time, if you make these steady, reasonable things, you know, increases, not only are you going to see your returns increase, you're going to increase the value, not only the immediate income, but also the value of your property, as we talked about the winds of change, thinking about the value of a home on a valuation basis, which, you know, I'd say, to be honest, isn't really the status quo now, but I think over time, it's going to be going that direction.

But my final point is, it's not about these huge rent changes, it's about just being putting a little thinking about it. And subtly making continuing to make those improvements over time, and not getting so below under market and just kind of keeping up with the times right with what the rent growth is. If you can increase the rent less than the cost of move, you should know what those values are, and you know, have an open discussion with your property manager about what they think. And really, that's the best way to go about is to have an open mind. But Michael’s here old, don't ever change the rent strategy. Now you're just leaving money on the table. I wouldn't want to leave money on the table, would you?

Michael:

I'm going to speak on behalf of all renters because I was one for a very long time and we make impulsive emotional decisions. If you raise the rent on me out, you just solidified a way to lose every single one of your tenants every single year. Congratulations.

Tom:

You sound like a renter I don't want, good news. I just put in built in laundry, you don't get it now.

Emil:

Back to your corners back to your corners. Gentlemen, a great show, please cut me I don't really have anything that I think we hit the pros and cons of each. I want to dive deeper with a couple questions. follow up questions for you guys. What about when you buy a property that already has tenants in place? And they're like, a couple hundred dollars under market rent? What do you do there?

Tom:

First off, that's such as a great way to find deals or properties that have undervalued rent. I love that as a strategy. And to answer the question, I don't think first you're honoring the lease, it's their, their lease that they have, I would gameplan it with my property manager, I would first get an assessment of the house and of the tenant and if they have a long track record of paying on time and the property is still getting like reasonable returns, I know that I have a big pop in rent growth at some point in time, I wouldn't see necessarily see a reason to move it like immediately. I mean, there could be some states like California where you you know there's rent control and there's nothing you can do about it but even in an area if it doesn't have rent control if the property is continuing to operate well, you know, as they're paying their rent and isn't really bad repairs and maintenance. I'm okay just floating on that lesser cash flow, knowing that there's this big pop at the point at which the tenancy ends.

Michael:

I think it's a super great point, Tom. And I would say it depends too, on how you bought it. And so if you're buying it, and it's performing well, like Tom says, great, if versus if you're buying on pro forma. So let's say the rents at 1000 bucks and investment only makes sense that you can get 1200 bucks for the property and market rents call it 13. So you think it's very realistic to be able to achieve that 1200? Well, are you forced to move it to 1200 in order to make the returns work? Or is it okay at 1000. And you can wait until like Tom mentioned, the lease ends, and then we can bump it to 12 or 13. So it depends on how you bought it, I would argue that you should be buying it based on today's performance and recognizing future value add opportunities, like raising the rent.

Tom:

I'm nodding my head over here a great point, I think in evaluating it and buying it, you shouldn't put on pink rosy glasses, you should just assume that for whatever reason, the 10s are gonna be there for a little bit, and just have the Yeah, today's rates in the way that you're evaluating it and knowing that there's some pop on the other side.

Michael:

And also, if you keep the current tenant in place, or tenants in place, and you're getting some cash flow, you can start to build up your reserve for when you ultimately do raise the rents if that tenant or tenants ultimately leave. So you can align your pockets a little bit, so to speak, for that inevitable expense for that vacancy expense, and all those other expenses that we talked about in the episode.

Emil:

Awesome. I like that I bring this up. Because I mentioned on a previous episode, I'm in contract for a three unit building. And it's definitely way under market rent on two of the three units. And I'm going back and forth on this personally, right? There's there's one tenant who their lease comes up in February, there's another one who's month to month, and I'm asking myself, Well, should I get it to market rent right now? Or do maybe something a little bit lower, wait till there's like a natural vacancy. It's still cashflows at the current rent, but obviously, I want to get it to market but I'm also trying to buy other properties, I wouldn't want to have a turn that is expensive right now. So it's like, Do I go buy more property and kind of just sit and wait on this one a little bit to raise rent, and have turns, or do I just do it now? So some of them I'm debating myself

Michael:

Something to think about that I've used in the past as a stair step increase, where there are $200 at our market rent, you raise it $25 every other month, until you're in line with where you need to be keeping them month to month, so they can leave at any time, you can raise rent anytime, but you kind of talk about that or you know, $50 a month or whatever it is, but just in a way to ramp up into it. So it's not such a drastic increase. Because I think there's there's a pretty sure fire way that most of your tenants are going to hate you because you're the new owner jacking up the rent now, like Tom was mentioning, and so if you can just tell them, Hey, this is how this is going to work this, you know, this is why we're doing it and just have that open dialogue with your tenants. I think that makes that a much easier pill to swallow.

Tom:

We are in a super weird time, like in the middle of a pandemic. So, you know, I'm not going out of my way to jamming any tenants on on rent, like if they have a place that they can live in. So I think that fits into an a broader discussion at least, which is like specific to now like a human being human about it. Like it's my last little tidbit.

Emil:

 100%

Michael:

No, it's such a good PSA.

Emil:

Yeah, absolutely. That's another part of it, right? Like one of the tenants has a daughter. So it's a family there. And it's like, okay, we can bring the rent out. But a lot of people are going through some tough times right now. And it's like, again, property cash flows, can we do some, you know, solid by the tenant and wait till things kind of just get better as a country and do it then?

Tom:

I think it's a misnomer that as an investor, you need to like jam everything.

Emil:

Yeah, one last thing to say here. I think this is where your property manager is so good to lean on. They've done this a million times, right? Like they know, how much can we raise it? What are some good tactics to potentially keep them but raise it. And so like just having the conversation with the leasing agent, whoever your property management team to like talk this through and figure out what's a good strategy. Any other tips you guys kind of have in terms of when you decide to raise rent versus keep things that steady?

Tom:

My tip would be to know what market rent is. So you know, you may change it, you may not. But you should know what that value is kind of in the same way that you know what the, the value of the home is, you should know what the value of the rent the market rent is, it may not necessarily be actionable. But just to kind of know where you sit is an important value. Even if it's not the current round, knowing what that market rent is, I would say to know that at any point in time.

Michael:

Absolutely. And also if you are going to be raising the rent, if you can raise it and you're okay with being a little bit under market rent, that can be a really great way to go to because if folks are going to move they're likely going to look to move in the same neighborhood. And if all the properties are more expensive than where they currently are, well that's a really great reason to stay put. So again, just being aware of what's going on in the market. What the markets commanding.

Tom:

My last tidbit is had calls with respect khadem II with with members talking about properties being vacant, it's like well, your rents probably too high. You know, like it's a pretty simple equation with if your property's not getting rented and it's a safe capital property. Take a look at what your rent is that look at market rent, look at how your property can be hairs and work with your property manager and you use one where it may make sense to adjust the rent just because as Michael was alluding to earlier, like vacancy kills like as an investor you it's hard to make money if you're not have any income coming in the door and paying off all those costs that the drums beat every month, mortgage payment taxes, all that stuff. So really thinking long and hard if you do have vacancy, changing the rent to lower it.

Emil:

And even the inverse right like let's say you list it and day one you have like 100 applicants or something that probably means you're on our market, right? So it's it's the same vein and the inverse, maybe you're under where you should be. If you're just getting flooded when you first listed.

Michael:

Something I'm worked in through right now is I've got this multifamily building I just process a finishing rehab and we're getting units online slowly but surely getting them listed and they're sitting for a little bit longer than I would like and so knowing Okay, well this is how much I spent. This is how much we projected we could get for and rents. Do we lower that and take a lesser rent or is it just kind of a weird time in the universe right now we just rent is taking a little bit longer units are taking a little bit longer to get leased up knowing where that balancing act is is so tough, because you definitely don't want to take you know, a real haircut on your rent after you just spent a ton of money on rehabs. It's a balancing act for sure.

Emil:

Guys, this is probably a good spot for us then this one. Thank you guys again for bringing everything to the table leaving no punch on thrown on thrown is that a word? I don't know. We say a lot of things that were like is that word is that a phrase? That's kind of just like our mo on the show.

Michael:

just own it. Just say it like it's a word.

Emil:

Just make up words and don't even correct yourself. Alright guys, well debated episode. Hopefully our listeners got a ton of value. And we will check you guys out on the next episode. Happy investing.

Michael:

Happy investing.

Tom:

 Happy investing.

In this episode, we bring back the showdown! Tom and Michael debate whether you should maximize rent growth or minimize vacancy.

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Transcript

Emil:

Hey everyone. Welcome back for another episode of The Remote Real Estate Investor. My name is Emil Shour and my co hosts are,

Tom:

Tom Schneider,

Michael:

and Michael Albaum.

Emil:

And in today's episode, we're going to be doing an old school style showdown episode. And today's showdown topic is going to be rent growth versus vacancy.

Emil:

All right, before we get into this episode, guys, we mentioned that we were doing a little giveaway to help us get over 100 reviews and we are now at 103. So thank you everyone who answered the call there and left us a review. We're going to choose two people at random here. And if you guys just reach out to us, we'll get you some some goodies. So first winner, drumroll please. First winner, Big Red 13 Thank you big red 13 for an awesome review. And let's see here. Our second winner is going to be drumroll again please.

Tom:

Papa, papa, papa. Boom.

Emil:

All right. And our second winner is Bobby tonsils. Bobby tonsils. Thank you for an awesome review as well. So if you guys just want to reach out to us, I'm at [email protected], Michael is [email protected] and then Tom is just [email protected] . Just reach out to us. Let us know we call your name. Since these are kind of like usernames, we don't know your first and last name. So just reach out to us. And we'll use the honor system. And we'll send you some goodies. Thank you guys so much. So let's hop into this episode. Alright guys, so today's showdown is going to be rent growth versus vacancy. And this is a good one because I think it is well debated. And there's good points to be had on both sides.

Michael:

But there's better points to be had on my side. So let's go That's right. Well,

Emil:

what is your side? Michael? What's that? Are you taking on this showdown?

Michael:

I'll take the stance of rent growth because I think that's the more difficult position and I want to be a gentleman and give these your position to Tom to start.

Tom:

A lready handicapping himself already sowing the seeds of defeat. I'm gonna reap a lot of failure harvest, okay, go ahead.

Michael:

Good thing I studied Agricultural Engineering. I'm the best harvester in this group.

Tom:

Oh, yeah.

Michael:

That's like such a tough comeback. Like, Oh, yeah. Yeah.

Emil:

So Tom, you're taking the side then of vacancy?

Tom:

I'll start with vacancy. And then in tradition of the showdown, we'll switch it up.

Emil:

By vacancy, we mean, making sure are trying the best you can to not incur a vacancy. Right.

Michael:

Yeah, I guess that's good. Clarify.

Tom:

Yeah, well, let's clarify the bait first. Yeah, they can see versus rent growth.

Emil:

Yeah, like, We're not saying we want vacancy, we want to not have vacancy. So the question is, do we do all we can to keep the tenant in place, and maybe not charge higher rent, lease renewal, or we always go in for rent growth. So who wants to kick us off?

Tom:

Well, in format, right, one side starts the other robots, and then the initial side gets to go again, Michael, why don't you lead us off, just cuz I feel like, you know, there could be some upfront bias on both sides. So sure, go ahead, lead the way. And then you'll then we'll change the order next time around.

Michael:

I appreciate you baiting me now. So that's great…

Tom:

Gentlemanly move, just trying to…

Michael:

Humble brag. So I think it's so important to maximize rent growth, and really prioritize that over vacancy for a couple of reasons. One is when it comes to property performance, if we're maximizing rent growth, that's gonna have an immediate impact on the property's performance. And, as a lot of our listeners know, I'm a big fan of multifamily investments, I own a lot of multifamily investments. And so, minor incremental rent increases on a property on a per unit basis can have really profound impacts on the noi of a property and the ultimate value of a property.

So let's just walk through a quick mathematical example, if I can increase rents $15 a month on a 10 unit building, so that's $15 a month across 10 units at $150 a month in additional noi, if I multiply that number, then by 12, that's 1800 over the year, if that building is valued at a 5% cap rate, I'm going to divide the increase in noi by the cap rate to get my additional value added to the building. So when I take 1800 divided by point O five that's $36,000 in value I've just added to my building by increasing rents $15 a month per unit. Now that's mind boggling when you think about that and the power to do that is also mind boggling.

So when we Think about rent growth, it's in addition to having a profound impact, potentially profound impact on the value of the property. I think it's also important to just be reasonable and fair with your tenants. And so if you can increase your rents incrementally year over year, as opposed to keeping them stagnant and then having to hit tenants with a massive rent hike down the road, I think you're treating tenants a bit more fairly. And I think a lot of people expect minor increases, as they do with just average inflation, the cost of living the cost of goods and services costs more year over year. So of course, why wouldn't the rent keep up with that year over year? Mike, drop exit stage left? Tom, you have the floor?

Tom:

All right. You know, before I like to talk about stuff, just quickly, defining our terms, right. So this is a debate about do you want to be penny wise, pound foolish and what I mean by that, if you are 100%, about rent growth, you're going to be pound foolish, you know, you may try to increase and jam on your tenants an extra 10 bucks, 15 bucks, 50 bucks a year. But ultimately, you're the one that's going to get jammed, because that tenants going to be like, No, thank you, you are jamming me, I'm gonna move somewhere else. Like, it's, it's stress. I don't if you guys ever rented in a place and every year, your landlord jamming you 25% I got out of there as quickly as I can. So that's the Pennywise great, you're earning an extra 10 bucks, you know, hundred and 20 bucks a year awesome pound foolish, you're going to run into vacancy, you're going to have people get leave, you're going to have people basically have the house open, where you calculate how much it costs to do a turn, versus those incremental increases in income that you're getting by raising the rent, the math speaks for it self, you're going to want to be have that occupancy, the weight of the costs that you have on a turn greatly, greatly are going to exceed those marginal benefits that you're going to get by raising the rents a little bit.

And also, if you have a good tenant that is paying on time and keeps the house in great shape, what a great way to mess up your investment by just continuing just poking them with needles with little increases in dollar rent, you know, do you want to be a needle poker, I don't think you want to be a needle poker I think you want to be an effective investor who is making sound decisions. And being Penny dumb, pound smart by really thinking having the big picture and making it work.

Michael:

I love that you use this analogy of poking holes in the tenants because I want to come back to something that you've said over the years and that's being long term greedy. And as your expenses increase year over year, your property taxes might go up incrementally the cost of goods and services is likely to go up incrementally, your returns are now getting those same pin holes poked in them poke, poke, poke the return, poke, poke, poke your return, and you're going to start bleeding. And there's a phraseology out there death by 1000 cuts. And so how do you reconcile with yourself or with the potential return that you keep your rent stagnant while you then have to eat those additional costs year over year?

Tom:

You as a savvy investor, you know, there are ways that you can look for more competitive rates. Because a lot of those costs me one of the beauties about real estate investing is you get these fixed costs, right, you lock in a lot of things, you fixed financing rates, taxes may move a little bit. But if you're proactive about them, you can make a case to the county and keeping those nice and low. So win win situation, you manage a few of those costs that might move a little bit of time. And you manages the expenses that related around terms by not incurring them by keeping your tenants in the house by keeping that vacancy number low.

I mean, every investor needs to look at the balance sheet of their property. And what's going to come up quickly come to the conclusion that you know, there's two ways to make money as in business as an investor. In any case, minimize your expenses, maximize your gains, and sometimes there's a little bit of trade off and in this question related to keeping your vacancy low or increasing your rent growth, it's a pretty simple equation, keeping your vacancy low you're gonna win.

Michael:

Yeah, I agree. The equation is pretty simple, but $36,000 in additional equity is a pretty amazing. Emil care to step in here?

Emil:

All right, guys. Yeah, you guys are starting to throw haymakers. So I'm gonna step in here.

Michael:

It’s a bloodbath.

Emil:

Yeah, it's there's there's blood everywhere. You guys both bring up good points. Michael, just to clarify your example there, increase in value that will typically be seen only on a commercial property. So in our case, talking about housing, that's a five plus unit building, right? If I own a single family up to a four unit building, increasing the noi doesn't really have an effect on the value of the building because it's not valued on cap rate is valued on sales comp,

Michael:

Well if you sell it to an investor, but when if someone comes in to buy that building the bank with a mortgage, the bank is likely going to still make them get an appraisal and the appraisal is going to be based on comps.

Emil:

Yeah, that's a good point. If you are able to raise the rent you are making it a more attractive investment for another investor right? So if you're selling it Yes, as an investment, you're right. It will be attractive even if it's not valued on cap rate. So good point there. And then Tom Really good points in turn costs, right? Like anytime you have a vacancy, those are one of the biggest of the like times where you have the biggest expenses or you can write, especially if the tenant has been there for a while, there's been a lot of deferred maintenance. I know personally, like whenever I've had a turn, that's when I have the biggest R&M costs. So and that's not even account

Tom:

Plus no income. What's your sorry, I just took it right out of your mouth. I saw it in your mouth. I took it right out.

Emil:

Come on, man.

Tom:

Go ahead.

Emil:

You're in your corner Tom. Is the referee speaking? The bell has rung. You guys both bring up various solid points. One thing I have this one property manager who every time the lease comes Do they have these three levels of rent increase, right, so they'll have like, aggressive, normal, and then do nothing. And so aggressive is like, Hey, we're gonna raise rent X amount. To get right up to market, the standard one, which I always go for is like a smaller increase. But what they say is that if the tenant looks like they're going to leave, because of the rent increase, they'll work with them to basically either keep rent the same, or maybe only increase it half of what they were going to do or something. So it's basically they're going to propose it and be flexible, obviously not going to say it up front. But when push comes to shove, they're going to be flexible with the tenant, versus instead of just saying no, this is the rent, increase, take it or leave it, that kind of deal. So I've always actually appreciated that what we're doing these consistent rent increases, but they're small, and we're willing to work with the tenant. So we don't have a vacancy. So let's switch roles. Tom, you're going to take the rent growth side. And Michael, you're going to take the reducing vacancy side. And hopefully let's let's not try to touch on anything that the other has already said. So better rack our brains for four cases. Michael, you started last one, Tom, kick it off.

Michael:

Let's touch gloves, Tom.

Emil:

Ding, ding.

Tom:

All right. You guys feel that? It’s the winds of change. Historically real estate, as an investment, at least in the single family space has been limited to sales comparables. But it's a really flawed system for a variety of reasons. It's why commercial uses return base. And I think the winds of change is single family rental is going to go in that direction too. Just because the value of an investment, it shouldn't have to be with some arbitrary value of what the home's next to it is. It's it's what are you getting on that return? Right. So I think that over the next five to 10 years, there's going to be a dramatic shift in the way that valuations are done with single family rentals and being able to get debt based on what kind of returns you're getting. Because you know what, this is an investment and you know what the value of an investment is what kind of returns you're getting. So in the ability to increase the value of your home by continuing to push up that rent, it's really impactful and just playing defense and not necessarily pushing it up, you're leaving money on the table.

And I think this is going to be the shift that's going to be happening over the next several years with single family rentals, and the ability to get that in the same way that you're able to do with commercial stuff kind of a little bit repetitive, I'm going to say this is a Gandhi quote, Be the change that you want to see and the kind of change that I love to see his rent increases. So to that point I was talking about earlier, generally speaking, it's pretty fixed costs. So you know, say I am getting a return on a property like a cash on cash, like whatever 10% or something when those rent, when that rent increases, Ooh, baby, that's just like going directly to my net operating income. So be the change that you want to see. And that change that you want to see is rent growth and more annual increase in the rent that you're collecting.

I think also to not really piggyback but there's a couple of other values in increasing the rent. By doing it, you are creating general market pressure that other landlords are going to see. And it creates sort of a wave effect, or that's not the right word to use wave effect. But it has a bit of a compounding effect in that when you increase your rent, it creates a market comp for every other landlord to continue to tweak up just a little bit. And over time, you are helping that market rent increase by increasing your rent just a little bit. Now I'm not saying you want to necessarily jam it up, and it should be reasonable. But by sitting back, you're letting the market rent as a whole stay stable when you could be contributing to comps that is going to raise pretty much all market rents. So are you a market leader? Are you a market follower? I don't know. saw me someone pulled my mic. Oh, my mic.

Emil:

All right. All right.

Tom:

Those are all really great points. And clearly, you're going to be the Pioneer with the arrows in your back. The first one's always are. I never want to be the first one to do something in a market because there's a high degree of failure that can occur. So, you know, I think that's a really interesting point you make about being the comps are typically based on numerous I think are based on numerous indicators, not just a sole or single operator owner. And so I don't know if we can say that one, your rental being higher than the others is going to increase and raise up some of these other rents. And I just think that they can see is the fastest way to kill your returns on a property. And so like you were mentioning, if you are juicing your returns by increasing the rent, and your fixed expenses stay fixed, that the return is only to increase, if we have a month of vacancy, I mean, that could just decimate an entire year's worth of cash flow.

And to make an extra hundred hundred and 20 150 bucks annually, the risk reward is the risk is a full year's worth of cash flow and the reward is an extra couple hundred bucks maybe just doesn't seem worth it to me. And then, as you mentioned previously, this is when you have to take care of all your turn costs. So not only are you losing out on all of the income, but now you're forced to reckon with all of the repairs and maintenance issues that are needed. In order to get a new tenant in place, you're also going to be slapped with a new tenant placement fee. If your property manager charges one, you're also going to have to pay for any utilities that are associated with that property while it's vacant. So I think a lot of people don't really tally up all of the totals associated with losing a tenant and placing a new one. And I just think the the risk reward scale tips very heavily and very rapidly in favor of keeping a tenant in place even at a slightly lower than market rents.

Emil:

Tom, you get final rebuttal.

Tom:

You know what Michael? I agree. Wait, hold on, come on. Come on, Tom, get your face on get your game face on.

Michael:

Get this guy some coffee.

Tom:

Yeah, you're you're either making plays Michael or you're getting played? Right? Way. All right, Tom. Okay, we're not talking about Armageddon. We are not talking about raising the rent, you know, over the market rate, we're talking about just slow, steady, incremental, I think being reasonable with your tenants. But what I'm advocating with increasing market rate is not, you know, throwing a hail mary and increasing it to the tippy top of the market, I'm talking about just incremental steady increase in rent. And over time, if you make these steady, reasonable things, you know, increases, not only are you going to see your returns increase, you're going to increase the value, not only the immediate income, but also the value of your property, as we talked about the winds of change, thinking about the value of a home on a valuation basis, which, you know, I'd say, to be honest, isn't really the status quo now, but I think over time, it's going to be going that direction.

But my final point is, it's not about these huge rent changes, it's about just being putting a little thinking about it. And subtly making continuing to make those improvements over time, and not getting so below under market and just kind of keeping up with the times right with what the rent growth is. If you can increase the rent less than the cost of move, you should know what those values are, and you know, have an open discussion with your property manager about what they think. And really, that's the best way to go about is to have an open mind. But Michael’s here old, don't ever change the rent strategy. Now you're just leaving money on the table. I wouldn't want to leave money on the table, would you?

Michael:

I'm going to speak on behalf of all renters because I was one for a very long time and we make impulsive emotional decisions. If you raise the rent on me out, you just solidified a way to lose every single one of your tenants every single year. Congratulations.

Tom:

You sound like a renter I don't want, good news. I just put in built in laundry, you don't get it now.

Emil:

Back to your corners back to your corners. Gentlemen, a great show, please cut me I don't really have anything that I think we hit the pros and cons of each. I want to dive deeper with a couple questions. follow up questions for you guys. What about when you buy a property that already has tenants in place? And they're like, a couple hundred dollars under market rent? What do you do there?

Tom:

First off, that's such as a great way to find deals or properties that have undervalued rent. I love that as a strategy. And to answer the question, I don't think first you're honoring the lease, it's their, their lease that they have, I would gameplan it with my property manager, I would first get an assessment of the house and of the tenant and if they have a long track record of paying on time and the property is still getting like reasonable returns, I know that I have a big pop in rent growth at some point in time, I wouldn't see necessarily see a reason to move it like immediately. I mean, there could be some states like California where you you know there's rent control and there's nothing you can do about it but even in an area if it doesn't have rent control if the property is continuing to operate well, you know, as they're paying their rent and isn't really bad repairs and maintenance. I'm okay just floating on that lesser cash flow, knowing that there's this big pop at the point at which the tenancy ends.

Michael:

I think it's a super great point, Tom. And I would say it depends too, on how you bought it. And so if you're buying it, and it's performing well, like Tom says, great, if versus if you're buying on pro forma. So let's say the rents at 1000 bucks and investment only makes sense that you can get 1200 bucks for the property and market rents call it 13. So you think it's very realistic to be able to achieve that 1200? Well, are you forced to move it to 1200 in order to make the returns work? Or is it okay at 1000. And you can wait until like Tom mentioned, the lease ends, and then we can bump it to 12 or 13. So it depends on how you bought it, I would argue that you should be buying it based on today's performance and recognizing future value add opportunities, like raising the rent.

Tom:

I'm nodding my head over here a great point, I think in evaluating it and buying it, you shouldn't put on pink rosy glasses, you should just assume that for whatever reason, the 10s are gonna be there for a little bit, and just have the Yeah, today's rates in the way that you're evaluating it and knowing that there's some pop on the other side.

Michael:

And also, if you keep the current tenant in place, or tenants in place, and you're getting some cash flow, you can start to build up your reserve for when you ultimately do raise the rents if that tenant or tenants ultimately leave. So you can align your pockets a little bit, so to speak, for that inevitable expense for that vacancy expense, and all those other expenses that we talked about in the episode.

Emil:

Awesome. I like that I bring this up. Because I mentioned on a previous episode, I'm in contract for a three unit building. And it's definitely way under market rent on two of the three units. And I'm going back and forth on this personally, right? There's there's one tenant who their lease comes up in February, there's another one who's month to month, and I'm asking myself, Well, should I get it to market rent right now? Or do maybe something a little bit lower, wait till there's like a natural vacancy. It's still cashflows at the current rent, but obviously, I want to get it to market but I'm also trying to buy other properties, I wouldn't want to have a turn that is expensive right now. So it's like, Do I go buy more property and kind of just sit and wait on this one a little bit to raise rent, and have turns, or do I just do it now? So some of them I'm debating myself

Michael:

Something to think about that I've used in the past as a stair step increase, where there are $200 at our market rent, you raise it $25 every other month, until you're in line with where you need to be keeping them month to month, so they can leave at any time, you can raise rent anytime, but you kind of talk about that or you know, $50 a month or whatever it is, but just in a way to ramp up into it. So it's not such a drastic increase. Because I think there's there's a pretty sure fire way that most of your tenants are going to hate you because you're the new owner jacking up the rent now, like Tom was mentioning, and so if you can just tell them, Hey, this is how this is going to work this, you know, this is why we're doing it and just have that open dialogue with your tenants. I think that makes that a much easier pill to swallow.

Tom:

We are in a super weird time, like in the middle of a pandemic. So, you know, I'm not going out of my way to jamming any tenants on on rent, like if they have a place that they can live in. So I think that fits into an a broader discussion at least, which is like specific to now like a human being human about it. Like it's my last little tidbit.

Emil:

 100%

Michael:

No, it's such a good PSA.

Emil:

Yeah, absolutely. That's another part of it, right? Like one of the tenants has a daughter. So it's a family there. And it's like, okay, we can bring the rent out. But a lot of people are going through some tough times right now. And it's like, again, property cash flows, can we do some, you know, solid by the tenant and wait till things kind of just get better as a country and do it then?

Tom:

I think it's a misnomer that as an investor, you need to like jam everything.

Emil:

Yeah, one last thing to say here. I think this is where your property manager is so good to lean on. They've done this a million times, right? Like they know, how much can we raise it? What are some good tactics to potentially keep them but raise it. And so like just having the conversation with the leasing agent, whoever your property management team to like talk this through and figure out what's a good strategy. Any other tips you guys kind of have in terms of when you decide to raise rent versus keep things that steady?

Tom:

My tip would be to know what market rent is. So you know, you may change it, you may not. But you should know what that value is kind of in the same way that you know what the, the value of the home is, you should know what the value of the rent the market rent is, it may not necessarily be actionable. But just to kind of know where you sit is an important value. Even if it's not the current round, knowing what that market rent is, I would say to know that at any point in time.

Michael:

Absolutely. And also if you are going to be raising the rent, if you can raise it and you're okay with being a little bit under market rent, that can be a really great way to go to because if folks are going to move they're likely going to look to move in the same neighborhood. And if all the properties are more expensive than where they currently are, well that's a really great reason to stay put. So again, just being aware of what's going on in the market. What the markets commanding.

Tom:

My last tidbit is had calls with respect khadem II with with members talking about properties being vacant, it's like well, your rents probably too high. You know, like it's a pretty simple equation with if your property's not getting rented and it's a safe capital property. Take a look at what your rent is that look at market rent, look at how your property can be hairs and work with your property manager and you use one where it may make sense to adjust the rent just because as Michael was alluding to earlier, like vacancy kills like as an investor you it's hard to make money if you're not have any income coming in the door and paying off all those costs that the drums beat every month, mortgage payment taxes, all that stuff. So really thinking long and hard if you do have vacancy, changing the rent to lower it.

Emil:

And even the inverse right like let's say you list it and day one you have like 100 applicants or something that probably means you're on our market, right? So it's it's the same vein and the inverse, maybe you're under where you should be. If you're just getting flooded when you first listed.

Michael:

Something I'm worked in through right now is I've got this multifamily building I just process a finishing rehab and we're getting units online slowly but surely getting them listed and they're sitting for a little bit longer than I would like and so knowing Okay, well this is how much I spent. This is how much we projected we could get for and rents. Do we lower that and take a lesser rent or is it just kind of a weird time in the universe right now we just rent is taking a little bit longer units are taking a little bit longer to get leased up knowing where that balancing act is is so tough, because you definitely don't want to take you know, a real haircut on your rent after you just spent a ton of money on rehabs. It's a balancing act for sure.

Emil:

Guys, this is probably a good spot for us then this one. Thank you guys again for bringing everything to the table leaving no punch on thrown on thrown is that a word? I don't know. We say a lot of things that were like is that word is that a phrase? That's kind of just like our mo on the show.

Michael:

just own it. Just say it like it's a word.

Emil:

Just make up words and don't even correct yourself. Alright guys, well debated episode. Hopefully our listeners got a ton of value. And we will check you guys out on the next episode. Happy investing.

Michael:

Happy investing.

Tom:

 Happy investing.

In this short episode, Michael Zuber shares his advice for new investors in todays changing market. 

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Transcript

Emil:

Hey everyone welcome back for another weekend wisdom episode of The Remote Real Estate Investor. My name is Emil Shour. And in today's weekend wisdom, we're talking with Michael Zuber again, who if you guys have been listening to the show for a while, you're probably familiar with him. But if not, he is the author of a book called One Rental At A Time. He also has a YouTube channel by the same name, putting out daily videos. It's one of my favorite books, one of my favorite YouTube channels, highly recommend both of them for both new inexperienced investors. So if you guys enjoy this one.

And so for this episode, we asked Michael, given the current market and economic environment, what are some tips he has for new investors? So let's hear Michael's answer to that question here.

Michael:

So when I would tell a new investor in today's market, you have to be very careful. What I would tell folks today is you need to really understand where your market is going not where it's at. So this is what I mean by that. So is your market going to grow or shrink in the next 12 to 24 months? I think without question, there are some markets San Francisco being the most obvious is going to shrink. New York City going to shrink any market that is very vertical and has very shoe box and is freaking unaffordable, is going to lose add on top of that high taxes like New York and California recipe for disaster. That said, there are some markets that are the complete opposite, they are going to win, they are going to attract people.

And once you get to do in this market, when you really understand that is you can invest ahead of that. Now most people when I say this, they think Texas, I would tell you Texas has already had the time in the sun, I think somewhere else, right? There were so many other markets that are going to get net population growth. And here's the wrinkle and why I don't think Texas is great. I just think it's already been chosen. What you need to find is a market that wasn't ready, what market didn't have new development, what market are all these people moving into, and there hasn't been a new housing construction of size for a decade.

That is when existing home sales explode higher. That is when rent explodes higher. That's how we can have a national appreciation of 15%. That was reported in September, I have never seen national appreciation of 15% in a month, there are just some markets that weren't ready for the flood of people from high tax areas like California in New York. And if you can invest in one of those markets, man, you are going to have a good couple of years run. But if you're in a hot market that's going to lose people, man, there are people in San Francisco that are just flat out going to lose their properties. And they're going to start with apartments, right rents in San Francisco are down 30% already, if you bought an apartment in San Francisco in the last two years, you are done. You're giving that back to the bank, just how cap rates and groceries, just how it all works. Your equity is gone. You're underwater that you're technically in default.

So there are cities that are going to lose. So if you're investing in one of the ones that's going to be net migration out, might want to sell certainly don't want to buy. But I would tell folks there are going to be they're going to be generational wealth created in the next couple of years. If you can invest in front of the cycle of population growth that's coming. It's going to be massive in my opinion.

Emil:

All right, thanks again to Michael Zuber for hopping on the weekend wisdom to share a little nugget there. And as always, we'll catch you on the next one. Happy investing

In this short episode, Michael Zuber shares his advice for new investors in todays changing market. 

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Transcript

Emil:

Hey everyone welcome back for another weekend wisdom episode of The Remote Real Estate Investor. My name is Emil Shour. And in today's weekend wisdom, we're talking with Michael Zuber again, who if you guys have been listening to the show for a while, you're probably familiar with him. But if not, he is the author of a book called One Rental At A Time. He also has a YouTube channel by the same name, putting out daily videos. It's one of my favorite books, one of my favorite YouTube channels, highly recommend both of them for both new inexperienced investors. So if you guys enjoy this one.

And so for this episode, we asked Michael, given the current market and economic environment, what are some tips he has for new investors? So let's hear Michael's answer to that question here.

Michael:

So when I would tell a new investor in today's market, you have to be very careful. What I would tell folks today is you need to really understand where your market is going not where it's at. So this is what I mean by that. So is your market going to grow or shrink in the next 12 to 24 months? I think without question, there are some markets San Francisco being the most obvious is going to shrink. New York City going to shrink any market that is very vertical and has very shoe box and is freaking unaffordable, is going to lose add on top of that high taxes like New York and California recipe for disaster. That said, there are some markets that are the complete opposite, they are going to win, they are going to attract people.

And once you get to do in this market, when you really understand that is you can invest ahead of that. Now most people when I say this, they think Texas, I would tell you Texas has already had the time in the sun, I think somewhere else, right? There were so many other markets that are going to get net population growth. And here's the wrinkle and why I don't think Texas is great. I just think it's already been chosen. What you need to find is a market that wasn't ready, what market didn't have new development, what market are all these people moving into, and there hasn't been a new housing construction of size for a decade.

That is when existing home sales explode higher. That is when rent explodes higher. That's how we can have a national appreciation of 15%. That was reported in September, I have never seen national appreciation of 15% in a month, there are just some markets that weren't ready for the flood of people from high tax areas like California in New York. And if you can invest in one of those markets, man, you are going to have a good couple of years run. But if you're in a hot market that's going to lose people, man, there are people in San Francisco that are just flat out going to lose their properties. And they're going to start with apartments, right rents in San Francisco are down 30% already, if you bought an apartment in San Francisco in the last two years, you are done. You're giving that back to the bank, just how cap rates and groceries, just how it all works. Your equity is gone. You're underwater that you're technically in default.

So there are cities that are going to lose. So if you're investing in one of the ones that's going to be net migration out, might want to sell certainly don't want to buy. But I would tell folks there are going to be they're going to be generational wealth created in the next couple of years. If you can invest in front of the cycle of population growth that's coming. It's going to be massive in my opinion.

Emil:

All right, thanks again to Michael Zuber for hopping on the weekend wisdom to share a little nugget there. And as always, we'll catch you on the next one. Happy investing

In this episode, Michael and Tom speak with Zac Breverman about how to start investing and ways to get capital without taking a bank loan. 

[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 Tom Schneider and a very special guest, Zac Breverman. I'm gonna let Zac introduce himself today, but we're going to be talking about all things financial advisor related and how we as real estate investors can use some of the tips, tricks and resources, Zack is going to be sharing with us as rocket fuel for our investing. Let's get into it.

Theme song

Michael:

Alright, so Zac Breverman, you are a financial advisor and certified financial planner, the executive vice president with Duncan Newman and Associates. Welcome to the show, man. So happy to have you.

Zac:

Thank you. I'm really excited to be here.

Michael:

And just so everybody knows, Zac, you and I go way back, we went to high school together, we went to Cal Poly together, we were roommates at Cal Poly. And for some reason I've known some you were still friends to this day.

Zac:

I mean, you really locked me in here, and I couldn't help it. But just stick around. And it's been amazing to watch your journey throughout your real estate investing career that you've really paved the way for,

Michael:

Right on. Thanks so much, man. So today, I would love it. Obviously, I know your story in your background, we're gonna be talking about Certified Financial Planning stuff, financial advisor type stuff, but we'd love for you to share with our listeners a little bit of background on you, and how you got into the CFP game. And then also a little bit about your investing background, because I know that you're also a real estate investor.

Zac:

Yeah, definitely. So I've been a financial advisor for about nine years now. And really, it was one of those things where right after college, I was looking around at different career paths. And I noticed that in the financial advisor world, there were a couple things I really loved about it first part, obviously being able to work with clients and help them accomplish these goals. And I know it kind of sounds cheesy, but it is pretty incredible. To see people start to invest and kind of see those dreams turn into realities over time, no different than in real estate, right. So I really gravitated towards that. Not to mention, I do just love the investment side of it. I really love getting involved in picking mutual funds, or ETFs, or stocks or bonds for that matter and working with clients to figure out a portfolio and a game plan for them.

So I've been doing this for about, like I said 9-10 years now, during that period of time, I realized diversification is important in our in our portfolios that we manage for clients. And then I was looking at myself and how I manage my own portfolios. And I quickly realized that there's one big asset class that I thought was important to add to my portfolio. And so going back to 2015, I bought my first investment property, I say, give you an idea of where I live. I live out in Los Angeles in California, of course, and I found a property out in Texas outside of Houston, that turned out to be a really solid investment and own it to this day, and it's continuing to cashflow well and we've been continuing to look for opportunities from there.

More recently, I actually moved and was able to convert my previous primary residence to a rental. And so that's been a really fun adventure as I've not only turned it into a rental and started getting some nice income from it. But the fun part for me was it was local, and so I could actually manage it. So I was the one boots on the ground, found the renter setup the all of the processes it took to make sure collecting payments and making sure that if there's anything wrong at the property, I could fix it. And so it's been a really fun adventure to not only have an investment property out of state, but also have one local that I could actually manage.

Michael:

That’s so killer. And so you're drinking the kool aid to which I love your CFP and you're doing real estate investing?

Zac:

Absolutely. I think everyone needs that diversification. And so it became really important component to me. And I fell in love with that, quite frankly, that's awesome.

Tom:

I’m curious. How did you find that property in Texas? You know, back in 2015? Are you talking to moneybags Albaum here for some advice on investing, but yeah, just curious.

Michael:

You should have been using Roofstock.

Zac:

Yeah, that's true. I should have I quite frankly, it was one of those things where, actually, Michael, I don't even know if you had real estate at that time.

Michael:

I did.

Zac:

You did. Okay. Yeah, I didn’t remember. So my dad had connections to Houston from his. He went to college at University of Houston. And he had some friends there that became real estate agents. And so over time, he made those connections and quite frankly, I kind of just jumped on board this bandwagon. So my family has some houses in Houston as well. And using that real estate agent, he's also a property manager and made it an easy process for me to buy that property as well. I was going to mention one of the things that it was pretty cool about that Houston house is fortunately, it's gone up quite a bit in value. And so I've been able to do some cash out refinances. And that's really what led me to being able to buy our place in LA, at least a good portion of it along with my wife's savings as well. So it has been one of those vehicles that they always talked about that is supplemented my life also.

Michael:

Zac I talk about that realtor all the time with other friends, because does he own like 50 houses in Houston and self insure?

Zac:

Yeah, so he owns more than 50. There's some crazy stories from back in the day, how he was able to buy all these houses on the insanely cheap price. So he has all these properties. And he decided that there's just no reason to insure, because of the cost of actually ensuring all of them, he might as well self insure the income is incredibly good. He has provided I understand very, very little in the way of debt on these properties. So it's just their cash flow machines. Yeah. So why do you need insurance, when he's not spending nearly the income that's generated? So he's really helping to control his expenses a lot.

Michael:

I was explaining to somebody recently what the whole concept of self insuring was. And, you know, let's say it was 50 houses and you know, it was about 1000 bucks a year to ensure each one that's 50 grand, he's throwing away at insurance, when if the house even if the house does burn down, it might cost 50 or 60, to rebuild it. So right, it's a wash, you know, one year in and the likelihood of that happening is pretty close to nill.

Zac:

Yeah, absolutely. And especially when you're talking about properties, and in Texas, where the values are dramatically less than what they are, are here in California.

MIchael:

Right. And the rebuild cost is cheaper.

Zac:

Exactly. Yeah. So you know, here in LA, if you can find a house for as we were actually just recently talking about this, Michael? Yeah, you know, if you could find a house for under a million, you're feeling pretty good about it. If you're in some of the the bigger cities, or bigger parts of LA, I should say, were out there. It's nothing in comparison. It's pretty amazing, different California perspective, it's really amazing.

Michael:

Alright, Zach. So I want to shift gears here a little bit and talk about, you know, the financial advisement things and the financial advising aspect of real estate investing. And so if someone has been saving up for real estate, you know, they want to make a purchase, but they don't have enough money yet. How would you advise them? What would you tell them to do with their cash? Do they put it in a bank? Do they invest it? You know, what, what are some options for these folks?

Zac:

Sure. Yeah, it's an interesting question, because obviously, it takes time to build up for that first downpayment, if you're planning to put 20%, down, or even even less than that. And so it really comes down to more about timeframe. So if you think it's going to take more than one year, as an example, to accrue enough money to actually buy a property, in many cases that make sense to go and invest, right, there's risk associated with it, of course, right, the stock market goes up and down this year, with a pandemic, we've learned that all too well, we saw the stock market dropped dramatically, and in February and March and come roaring back up, and then the rest of it from that point to today. And so you have to understand that there's some risk associated with it.

But hopefully, over a year or two years, if you have that kind of timeframe, the market will grow and help you build up that savings account so that you can go out and buy the property, give you a little bit of a boost to there. The hard part is if you're if you're really close, if you're six months, you're nine months to buying a property, it just doesn't make sense, in my opinion. And the reason is, is because we don't know if a pandemic is going to come in three months from now, right in December. Sure, there was some news coming out out of China, but we didn't know what was how that was going to affect us here in the US. And next thing I know, we're we're talking about a stock market that's down 35%. And so because of that, you really have to make sure that you have enough time to let the investment recover, if there is a pullback, and in a 3-6-9 month timeframe, in my opinion, it's not enough. And even in a in a year, it's a little it's pushing it depending on how high risk or how much you're in the stock market versus the bond market. So just want to make sure that you've got enough time frame to ride through any of the volatility that may come in the short term. And then hopefully, it helps you give that give you that boost.

Tom:

It's a super insightful and just thinking about, you know, time horizon of buying and how much at risk, you want to put those funds. I'm curious, I'd love your input on just kind of general position on you know, you have your wealth and your investments in certain places, right, and real estate and equities and bonds. Is there any general guidelines you give to clients or friends or whatnot as ways to kind of mix that around it? Also, do you typically recommend having a what kind of cash position you know, as a as a percentage, and I know everyone has a unique situation, but I'd be curious to hear your kind of general guidelines.

Zac:

Yeah, absolutely. It's a good question. So from my perspective, you I'll start with the emergency fund part of it. You, you really do want to always have some cash position or an emergency fund, from my point of view, it does depend on who you are. But if you have somewhere in between, I always say three to six months of expenses, right? So look at your budget, and try and figure out what three months of expenses looks like or six months, then you're you have enough time, I should say you have enough cash to cover a potential hard time, right? Whether you lose your job  or a pandemic. But if you're tying real estate, what if someone doesn't pay their rent for one month or two? Are you able to cover it through your cash that you have in your reserves? So I always like at least three to six months worth of cash on hand.

From there, that's when you start talking about investing, right? That's cash is kind of the core part of your portfolio to allow you to do all this other stuff. And once you start looking at at the broader perspective of Do you want to buy stocks? Or do you want to buy bonds as an example, not to sound like a broken record, but it comes down to the timeframe. If you've got 10 years, you can go ahead and be fairly aggressive, and take advantage of the stock market opportunities, right, we know the stock market, at least historically, has gone up quite a bit more than what the bond market has done historically. Bonds are still great investments getting you way more than what the banks are paying, you obviously take on risk their bonds can, you know, companies can go bankrupt and so that bond can can lose its value.

But you know, if you're buying quality there, you're probably okay. Or you're buying a mutual fund or an ETF you'd be just fine. So the longer the timeframe, the more you want to add to the stock market. So it is something where Unfortunately, it is a bit of a time horizon question. Younger investors definitely can take on more risk, assuming that they've got a job, and they're planning on continuing to work and take advantage of the different investment opportunities out there.

Michael:

And Zac, when you say time horizon, what do you mean?

Zac:

Yeah, so it's really about how long until you think you're going to need the money. So I know in, say, for example, I need I need to buy a car. And two years from now, two years in the investment world is a relatively short period of time, it's not six months where I need to keep the money in cash. But maybe in two years, I need to be a little bit more in a balanced portfolio, I say balance, it has stocks and bonds in there. If you're talking 10 plus years, then you can start looking at having more allocated toward stock and less towards bonds. So it's just a matter of trying to find your comfort, right? If you're looking at the stock market, and the downturns make you really uncomfortable, then it's probably something where you don't want to have a lot in the stock market.

It's no different than real estate in that case, right? Sorry to cut you off there. But I was gonna say it's no different in real estate, right? If If you can stomach the market changes or something happening, where you have a huge expense because the AC goes out? And you'd be okay long term. But if, if that makes you really uncomfortable, it's a little bit of a different story.

Michael:

Where would you put on the risk spectrum, real estate? Now, we know that there's some liquidity aspects of it, where it's not as liquid as some of these other. But in talking about time horizon, you know, where do you plug real estate in and thinking about that?

Zac:

Yeah, I mean, for a time around, then I always like to think about real estate as at least a five year investment, personally, five year or greater. And the reason I use that as my scale is because if there is a market downturn, then there is time to allow the real estate prices to recover. You don't want to have to sell when the market goes down, whether that be stocks or real estate. So I always think about it at least a five year timeframe. And ideally, if it's a good investment, and it's performing like you want it to, hopefully you hold it a lot longer.

Michael:

But so as far as categorizing it, if we had to put investments on a spectrum, where would we categorize stocks, bonds, real estate, as far as risk is concerned?

Zac:

Yeah, that's a tough one. Because obviously, there's lots of different real estate. As long as you have all these other components where you have plenty of cash built up. I think real estate is part of a portfolio could be a little bit under the stock market. But you have to make sure you have diversification. If you've got one property, quite frankly, it's probably a little bit higher than the stock market. Because if that tenant moves out, that's a high risk. So as you build out your real estate portfolio, naturally, the average risk goes down. I think a diversified real estate portfolio is more conservative a little bit than the stock market.

Michael:

Yes. Great answer.

Zac:

So did I pass?

Michael:

Yeah you did. We'll send you a check in the mail.

Zac:

Thanks.

Michael:

I'm circling back and this is you tell me this splitting hairs. But in circling back to your car analogy, if you got to get a car in two years, does that mean that you're you know, you're investing in the stock market, whatever the equities market to generate some additional income to buy that car. Does that mean that you're pulling out of the market at one year, eight months to have that in cash? Because if you have a down cycle and that six month time window like you were talking about, that means you take your winnings and walk away and say, Okay, now I know I can buy the car, do you keep riding that train, hopefully upward and kind of gamble with it?

Zac:

Yeah, I can tell you that financial advice from a financial advisor,

Michael:

And then what you would do?

Zac:

It depends on what you're comfortable with. Personally, if you say if you have a solid income, and you're not worried about making up any difference, sure, you can go and wait till take the money until you truly need it. But to be protective, to be a, what we call prudent investor, right? You would probably take the money out a few months in advance in preparation for buying the car.

Michael:

That makes sense, right?

Zac:

It that just depends on personal situation. But surely from a financial advice perspective, you'd want to take the money out and not risk it in the market.

Michael:

Okay, good to know. All right, so let's shift gears again here. And I would love, love, love. So we were talking before we had you on the show and about the different ways that investors can get access to money for real estate investments that might be a little bit non traditional, or might not be so front of mind for folks. Because I think what a lot of people think about investing in real estate, they think, Okay, I got to bring 20% I'll go to a bank and get 80% or 75%, whatever it is. And that's that's all there is to it. And there's no other way. Can you shed light on some of the other options that might be available for folks?

Zac:

Yeah, for sure. Our broad perspective, it's great to go out and get loan. But if you could bankroll yourself, that's even better, right. And there's pros and cons to it all course. But I think the couple ideas that I wanted to share today are really ways that you can at least partially bankroll yourself. So you don't need underwriting to prove you and all that. So,

Michael:

Which is the worst for anybody who's ever gotten a loan will tell you?

Zac:

Yeah, especially now with the refinance moving as crazy as in my…

Michael:

Oh my gosh with COVID. Right. It's insane. And Tom what about you, you’ve been waiting, like four or five months. Right. Your refi?

Tom:

Yeah, it’s been a while, I think just you know, the combination of COVID plus the interest rates being there at just like resulted in a slog fest of getting through. Literally just closed after, like you just like you said, Michael, I we do our like, you know, updates sometimes on the podcast. And it's like the same thing again, and again. I'm still waiting.

Michael:

I'm still waiting, still waiting.

Tom:

Anyways, yeah, closed? Yes.

Zac:

Well, congratulations. That's a big deal these days.

Tom:

Ugh, thanks.

Michael:

It's a huge milestone.

Zac:

Yeah, yeah. So if you're trying to figure out how you can get money on through your savings and other ways, you know, you can always look at your retirement accounts. And like I said, there's pros and cons to everything. But one of the ways that I think does work pretty well is looking at your 401k. So if you're working at an employer, you can been contributing to your 401k. And you've been contributing for a long time, hopefully, you've accrued a pretty good amount of money in there, and you can borrow from your 401k up to certain levels, I'll go through that in a second. And what you would do is, you actually pay yourself back at whatever that interest rate is that they are, that your employer tells you, the rate would be. So as an example, maybe you're borrowing and the company allows you to borrow four and a half percent. When you pay yourself back, you're saying essentially paying your 401k, the loan back with four and a half percent interest, right?

The interesting part is, so you can take up to 50,000, right, it's actually 50% of your account balance up to 50,000. So the most you can ever get as 100 is 50. Grand. So if you have, let's say you have 35,000, or say 30,000, just for easy numbers, 15,000, you could borrow from your 401k. If you have 100,000, you could borrow 50,000, from your 401k. Right. So it's an easy way to get money out of you're not exactly getting it out of your retirement accounts. But it's allowing yourself to borrow your retirement accounts to go and do other things, other investment options. Normally, the way that it works is. And so this is something you'd have to check with your employer, because everyone, every company is a little different. But they would just start taking the repayments directly out of your paycheck.

So just be prepared when you're obviously when you're going through this process, that your paycheck is going to go down a little bit because you are repaying that loan. And the one big risk that I'll have to point out is if you leave your company, whether it's by choice or not by choice, there is a possibility where they can actually put that out as a distribution, which is a that's the risk, the big risk here. Right? Because if it is turned into a distribution, you have taxes on that money, most likely, and it's very possible that you could be paying a penalty if you're under 59 and a half. So it is a great option. Just you got to be aware of the risks and leaving the employer that risk I'd say.

Tom:

So I think I know the answer to this. What have you in a previous employer, you know, had saved up a bunch of money and what was 401k I'm guessing that kind of sweetheart lending where the lenders herself and is not necessarily available if you have some some older retirement accounts that from previous companies.

Zac:

Yeah, so there's a couple things, the question is really about if you're still working, right, if you're still working and your new employer has a 401 K, you can and there's a lot of different options, but you could roll that account into your new 401k. And so now let's just say for example, you got 50 grand at the old 401k, and another, and you've been saving in the new one, and you got another 30 grand, well, most of the time, the employer says, Okay, you've got 80 grand, we're gonna allow you to borrow 50%, so 40 grand, you could borrow from that account, and then go ahead, and, of course, invested in any manner you'd like,

Tom:

Man, this is like our, I think our like 60th or 70th episode, right? You know, and this is one of the coolest things like, I don't know, that like that I've learned. Like, this is magic. So you know, you're paying whatever interest rate, it's just going directly back in your pocket. It's like forced savings, and a forced loan at the same time. This is like, Yeah, I don't know, upside down. Awesome world. This is a

Zac:

We could go down this rabbit hole. And these are all the ideas that are that allow us to do that. I mean, it is pretty cool. I have all these different options.

Michael:

So Zac, just to summarize, because I remember when I learned about this a long time ago, and it blew my mind. Just Of course, I learned that a long time.I was doing 401k loans when you were in diapers.

Zac:

Right, exactly.

Michael:

Well, there was a point eventually got it. I'll get there in a minute. But so what you're saying is that you can take a loan from yourself, and it's not taxed as if you were to take it out when you're in retirement age.

Zac:

Exactly. Yeah, it's since we're on a real estate podcast, I'm sure a lot of the listeners will will be able to do quarter coordinate, or at least think of refinances as exactly what this is. It's kind of like a cash out refinance in a way where you're taking the money out, you're really borrowing it from yourself. There's no tax consequences, just like when you refinance, you take that money out, and that, of course, you have to pay the bank money. In this case, you're paying yourself money,

Michael:

Right? Yeah, no,

Zac:

It's a different different source.

Michael:

That's a great analogy. I actually did this for a property to get the downpayment, a while back, and it was an amazingly easy process. I just, I was through Fidelity at the time, and I just told them how much I needed. And it's a great exactly, you're saying that 50 grand or up to 50%. And then it happened to be four and a half percent interest. And so every two weeks, it just got deducted from my paycheck. And I could choose the repayment period, from one to five years. So I just chose the maximum five years because that made the paint the repayment as small as possible. But it was just I mean, I had the money in my account, like the next day or two days later, it's it's so easy to pay it back. Because I did a refi and paid it all back in one lump sum, and there was no penalties, it was just the easiest thing, probably the easiest money I've ever borrowed.

Michael:

I think that's the true value of it, quite frankly, as I look at that, they call it a bridge loan, right? Where you're borrowing money from one place. Normally, it would be from like a hard money lender or something like that. This case, it's just from your your self, quite frankly. And you take that money and you go and you rehab a house or you do something but that adds value to a property. And then you can refinance, get a more traditional mortgage, or you don't have to worry about it, and you pay that loan right back. I think that personally, I think that's where the real value of something like this comes in play.

Tom:

And just the last kind of practical, tactical question is, is it all be managed through the company that manages your company's 401k? Is that Right?

Zac:

Yeah, exactly. So all of this would happen through your employer's 401k. And it has to be your current employer, because like I said, If you leave, that's they're not going to let you borrow anymore, since they can't take from your paycheck anymore.

Michael:

Awesome. And then I guess one of the other big downsides would be the opportunity cost of not being in the market. Yeah. Because those funds are actually out of the account. Now, raise your borrowing on margin or anything like that.

Zac

Correct? Yeah, that's definitely one of the big potential downsides, right? So if you're an aggressive investor, and you're in 100%, of the stock market, you're missing out on whatever those stock market returns are. So you definitely have to make sure it's worthwhile and say, I get I'm getting that interest rate. I'm getting that. You know, you mentioned four and a half percent right on your loan, Michael?

Michael:

Yeah.

Zac:

You're getting four and a half percent, but could you be getting more money on that money by doing something else? Right, by leaving it in the stock market? And that's possible, right? It just depends on the timing. But you want to make sure if you're doing this, that that investments and awesome cash on cash return kind of investment.

Michael:

We're gonna be digging in here. Just a minute about a couple of different retirement vehicles and retirement plans. Can you give everybody kind of a high level overview of what some of the different vehicles are, you know, 401k IRA, Roth IRAs, you know, what are those and who might have one?

Zac:

Yeah. So I always think about as if there's three different buckets for that you can invest money in. So bucket one, number one is your taxable money that's like if you have a individual name, joint checking account that you want to move money into an investment account, or buy property or whatever the case may be, that's all non retirement related, right in the sense of, there's no tax benefits by using retirement accounts. So bucket number one, taxable accounts. That's, that's number one. Number two, would be traditional retirement accounts. And traditional retirement accounts are available to essentially whomever but there are limitations depending upon income, if the contributions are deductible, and there's some tax conversations that you want to have with either with your financial advisor or with your CPA.

But the traditional retirement accounts, the basic gist of them is, you can put money into this. Ideally, it is tax deductible, so it comes off your income. And then on the other side is once you turn 59 and a half or older, then you can take that money out penalty free, and you just pay taxes on those distributions. So where's the big benefit, there are one, it's on the contribution, right? You, you have the ability to deduct that contribution from your income. Assuming you fall within these guidelines, like I said that you can work with your CPA to narrow down. But the big benefit comes when the money's in the account itself. While your wallets going you don't have to worry about taxes at all. Right. So if you sell an investment, for a gain, you don't have to pay taxes on that gain. And so the money can compound a lot quicker over time.

So for younger investors, these are retirement accounts are really great opportunities to have quicker compound interest, because you're not paying taxes on those gains, you're just paying taxes when you take it out, hopefully in a really long time from now in retirement. So traditional IRAs. Now, traditional, I say traditional retirement accounts probably more broad. And that's because you can include a lot of different types of accounts. So you can have a traditional IRA, you can have a traditional 401k. If you're self employed, you can have what's called a SEP IRA account, or simple IRA account. These are all pre tax or traditional retirement accounts. So that would be the second bucket. The third bucket is Roth IRA accounts or Roth accounts in general Roth retirement accounts.

Now, a Roth has benefits as well, but they work in different ways. So there's, of course, the contribution, and there are limitations based on your income. So if you make too much money, you might not be able to contribute to a Roth IRA account, they have, they cut you off, essentially, the IRS cuts you off at some point. And so when you put money in there, if you can, you don't get any tax benefits for doing that. So first year, quite frankly, you're probably a little annoyed, you're like I'm putting this money into an account, I can't touch it till I'm 59 and a half or older. And then, you know, at the end after that, then I can finally start using this money. But the big benefit here is that even though you pay taxes, you put the money in this account, once it's in that account, it grows completely tax free. If you're a young investor as an example, or you you think you're not going to need this money at all, if you're already into or are close to retirement, this money is hugely important, because the money that grows tax free is about as good of money as it can get.

Right. So Roth retirement accounts are absolutely and considered the third bucket a really important part of a portfolio. And the the considerations there or I should say the different types of accounts, your traditional IRA. So in here you have a Roth IRA, and you can have a Roth 401 K, but depending upon your employer, some employers allow you to have a Roth 401 K, which is one quick note, regardless of what your income that you can contribute to a Roth 401k. There, like I said, there are limitations on Roth IRA accounts. So kind of weird that they forgot to include the Roth 401 k as part of that limitation.

Michael:

But so Zack did, maybe I misunderstood you what you said in the traditional 401 K, the growth is also tax free. So why is one How is that different than a Roth 401k?

Zac:

So officially, that would you would with a traditional retirement account, you would say that it's tax deferred, right? So you put money in there, it's all pre tax money, so you don't pay taxes until you take it out after 59 and a half. Like I said with the first time homebuyer, that, things like that there are a few ways where you can take some money out without paying a penalty before 59 and a half. But the way that we would always like to think about as these retirement accounts are for retirement. So you'd wait till after 50 and a half to start taking distributions and you don't have to pay penalties, but you do still have to pay taxes on this account.

Michael:

Okay?

Zac:

The Roth Ira in sorry, if I was confused in the first go around was really where you pay the taxes on the way in. You don't have to worry about taxes while it's in there. The benefit is afterward when you take those, those funds out after 15 and a half the money comes out tax free.

Michael:

Perfect. All right, what else you got?

Zac:

So the next one is actually if you've got IRA accounts. So and this actually applies to 401 K's also, but it's an borrowing from yourself. In this case, you actually can take money out of an IRA account. And this could be a for a Roth IRA, or traditional IRA, up to $10,000. And if you're married, it can be 10,000. For each of you, if you're buying a new property, essentially, it's a first time homebuyers. And so the rules around this are actually a little bit more flexible than I think a lot of people would imagine. Right? The the definition is that your first time homebuyer is just that you don't have ownership interest in your main home or primary home anytime within the last two years of the new purchase. So it does make it quite a bit more accessible to you than just saying first time homebuyer maybe you bought a house 10 years ago, and you've been renting for a few years or something like that, and you want to go back to buying this gives you a huge opportunity to get a little bit more cash.

So that's one ways you can do this first time homebuyer exception to take money out of retirement accounts before the age of 59 and a half. And for traditional IRA. Well, for both of them, you don't pay penalties for traditional IRAs, you just got to be careful because there are still taxes involved. Right, because all that money is still pre tax. With Roth, it's actually quite a bit easier. There's just they waive the penalty for first time homebuyers. And Roth is after tax money. So you're good there to like I was saying with both traditional IRA accounts and Roth IRA accounts and 401K's for that matter, you can do that $10,000 for each you and, and your spouse, if you're married, to take that money out and use it for the first time home purchase.

The one other way that you have the opportunity to, in a way borrow from yourself, it's a little different than the 401k loan option. But it's actually called the 60 day rollover. And so there are lots of different ways that you can roll your IRA account money to other IRA accounts, maybe at a different firm or move it from a 401k to an IRA, or whatever the case may be. There's lots of different considerations. So you want to understand all those different options. But one that's really interesting is called a 60 day rollover. And what that means is that you're going to take money out of your IRA account or out of your 401k account, borrowing, it's literally a distribution. But you have 60 days to get that money back into the account. And as long as that money's back in that account, within 60 days, you avoid taxes and penalties. And the the reason that is really helpful my opinion, is because let's say you do need to you maybe you want to pay cash for a house. And this kind of pushes you over the top to be able to pay cash, so you can get a better deal.

And then you can go and refinance and assuming it's not the middle of a pandemic, and rates are really low. And all those things that are causing mortgages to take forever to close, aren't around at that point. 60 days hopefully would be enough time for you to close and get that money back into the IRA before you have to pay taxes and penalties on it.

Tom:

It's like a like a vacation. Just want to go out a little bit, see the world. You so you can do that with…

I was gonna say conjugal visit, that's not the right term. Wrong term. The opposite of that. Just so you can even do it. Even if you're moving to a different account. So it can be even be in that same account, jumped out of it and then put it right back into that same account.

Zac:

Yeah, yeah, for sure. Mm hmm.

Michael:

Like how stringent it is like the 60 day Really? 60, 61 62 days?

Zac:

It depends on everyone. The IRS knocking on your door. You know, if you want the IRS knocking on your door, sure. Take it out for however long you want. No, I mean, that the reality is that, from what I understand, and this is where a CPA question because they're the ones that I get actually reported, of course, the IRS, it's 60 days. I wish I could say otherwise. It'd be awesome if you had more time, but I wouldn't push it.

Tom:

 And this is all just in a similar question I had practical tactical, is your you would just manage this with your the company that is you know, what's the right word? The investments holder?

Zac:

Exactly. That's holding that Yeah, yeah. So you can just work with your whatever investment firm you're with. They'll help you with the distribution. And as much as you know, I, you'd like to trust the person that you're working with, I would put a calendar reminder for, you know, 45 days out. And make sure that that money is kind of getting wrapped up with whatever refinance or whatever you're doing to make sure that money gets back in the account on time.

Tom:

Incredible. I'm fired up about both of these magical money.

Michael:

So Zack, what happens if you don't get it back in on time the bank takes too long to refinance done, you know, we can we can tell the IRS Oh, it's the bank's fault. My guess is they're not gonna buy that.

Zac:

Yeah, they don't care at all.

Michael:

If this happens how fingers do you lose?

Zac:

I start with 10. And then each time it happens, I just lose one. So I'm down to four fingers? No, no, the reality of this is that if you don't put that money back in, and it's a it's a, it's a traditional IRA account your tax on it and if you're under 59 and a half, you could be penalized to right. So that penalty right now is that is 10%. So you could be paying depending on your incomes a lot in taxes on that distribution, which is why getting it back in 60 days, is really important. Nobody wants to pay the government any more taxes, and then the CPA tells you to do. And so you want to manage that as best you can.

Michael:

Make total sense. And that's great. Okay, you must be out of ways to get money, or

Zac:

Almost.

Michael:

But wait, there's more?

Zac:

When you get two options, we give you the third for free. Now they. So the cool part is actually with Roth IRA accounts, there's a lot of different options there to where you have, there's a lot that goes into it. So it is something that you really want to be careful. And you can look this up on, there's tons of websites that you can go to, to get the details in your own situation. But the basic idea is that if you have a Roth IRA account, you can actually take, potentially take money out of that account, your contributions specifically. And as long as you've had that account for more than five years, then it's potential where the the earnings would come out tax free as well. So you can get because you already paid taxes on your contribution, right? You don't have to worry about those taxes, but you could potentially take the earnings out on top of that.

And it really just comes down to making sure you have the account for a long enough period of time. And making sure you're not taking too much money out, you're still limited to the reason why you're taking money out in the first place. So first time homebuyer ideas and things like that. So but after 59 and a half, then this matters, right? As long as the money's been in there for more than five years. You're not paying taxes, you're not paying penalties. And you can take as much as you want out. Before that there's a couple complications that that you just want to be careful. But there's definitely ways to access money from your Roth IRA accounts and not have a huge tax bill, at the end of the day.

Mihcael:

So what are some of the other reasons that you could take out the earnings on the Roth IRA?

Zac:

Good question. So there's quite a few. So you could take it out for qualified education expenses, you could take it out for a disability or a death in the family. I believe it's for a family I know, if you pass or as an example, God forbid, then your beneficiaries could take it out at that point, regardless of age. So there's a handful of other factors that can come into play to allow you to take the money out without paying taxes or penalties on that money. You just want to I know it sounds boring, but you just want to check with your CPA. I mean, that's the big thing. These are the CPA is gonna be the one to make that final call, because that's, that's the world they live in.

Michael:

Fortunately, and fortunately for us, unfortunately for them, I don't know how you want to look at it.

Zac:

Yeah. faxes and dealing with the IRS does not sound like the greatest job to me, but there's probably people who hate the idea of being a financial advisor too.

Michael:

So that’s why I leave it to the big dogs.

Zac:

That's right.

Michael:

Perfect. Okay, Tom, any other questions?

Tom:

No questions, just comments. I'm just tickled pink with what I have learned today. I'm like, immediately gonna, like round up me and my wife's retirements house and then go, go make some more. Make some more money with some more money. Anyways, yeah. Incredible, incredible content. This is this is great, Zachary.

Zac:

Yeah. Now, I'm glad that this is helpful. And yeah, I think that big thing is just creating, making sure that everybody has a team around them. Like just like as a real estate investor, you want to have your property manager, you want to have, you know, your contractors or, you know, whoever creates that full team around you. The same idea for financial planning and financial advising specifically, it's like, you want to have your financial advisor, want to have your CPA, you want to have your state attorney kind of get make sure everything's in line. I think after that, ever, collectively, everybody can help make sure that you're successful in your investments.

Michael:

Right on and speaking of Zach if people have other questions, questions about financial planning or financial advising would love to utilize you for your services? How what's the best way folks get in touch with you?

Zac:

Yeah, they can send me an email the email for long one but it's we can maybe post it in description or something like that for here totally. But it's [email protected].

Michael:

Right on. And Zac, when the world opens back up, the pandemic is over. We can go eat at restaurants again. Where's the first place you're headed to?

Zac:

That's a tough question. Good. Potsie fancy. Yeah, this is oily water. Honestly, this is the most nervous I've been. Quite honestly, I've actually been okay with eating takeout more often.

Michael:

Okay.

Zac:

It's just easy. You know, you don't have to get all dressed up and do anything fancy.

Michael:

Well, that's not a fun answer tells me to go sit down and eat.

Zac:

Quite honestly the one thing that I right now I really miss is having a really good steak, like from a high end steak restaurant.

Tom:

Zac:

It is tough. It is tough. And I can try and make a steak as much as I can. And it just don't ever come out. Not like Michaels the least.

Michael:

Yeah, it’s because you use a microwave. Of course it doesn't.

Zac:

Yeah. Well, you know, I always mess up the timing. So it’s problematic.

Michael:

Right on. Well, Zac, thank you so much for hanging out with us. This was super super insightful, as all of our conversations are. I really appreciate you taking the time today.

Zac:

Thanks for having me. I appreciate it's been fun.

Michael:

Okay, everybody that was our episode a big big, big thank you to Zac Breverman for coming on the show was such a pleasure to have you, looking forward to doing it again in the future. We talked about a lot of things in that episode. So go back and give it another listen if you didn't get all of it. Use it as a jumping off point to go research and have additional conversations with financial advisors in your world. Looking forward to seeing you on the next one. Happy investing.

In this episode, Michael and Tom speak with Zac Breverman about how to start investing and ways to get capital without taking a bank loan. 

[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 Tom Schneider and a very special guest, Zac Breverman. I'm gonna let Zac introduce himself today, but we're going to be talking about all things financial advisor related and how we as real estate investors can use some of the tips, tricks and resources, Zack is going to be sharing with us as rocket fuel for our investing. Let's get into it.

Theme song

Michael:

Alright, so Zac Breverman, you are a financial advisor and certified financial planner, the executive vice president with Duncan Newman and Associates. Welcome to the show, man. So happy to have you.

Zac:

Thank you. I'm really excited to be here.

Michael:

And just so everybody knows, Zac, you and I go way back, we went to high school together, we went to Cal Poly together, we were roommates at Cal Poly. And for some reason I've known some you were still friends to this day.

Zac:

I mean, you really locked me in here, and I couldn't help it. But just stick around. And it's been amazing to watch your journey throughout your real estate investing career that you've really paved the way for,

Michael:

Right on. Thanks so much, man. So today, I would love it. Obviously, I know your story in your background, we're gonna be talking about Certified Financial Planning stuff, financial advisor type stuff, but we'd love for you to share with our listeners a little bit of background on you, and how you got into the CFP game. And then also a little bit about your investing background, because I know that you're also a real estate investor.

Zac:

Yeah, definitely. So I've been a financial advisor for about nine years now. And really, it was one of those things where right after college, I was looking around at different career paths. And I noticed that in the financial advisor world, there were a couple things I really loved about it first part, obviously being able to work with clients and help them accomplish these goals. And I know it kind of sounds cheesy, but it is pretty incredible. To see people start to invest and kind of see those dreams turn into realities over time, no different than in real estate, right. So I really gravitated towards that. Not to mention, I do just love the investment side of it. I really love getting involved in picking mutual funds, or ETFs, or stocks or bonds for that matter and working with clients to figure out a portfolio and a game plan for them.

So I've been doing this for about, like I said 9-10 years now, during that period of time, I realized diversification is important in our in our portfolios that we manage for clients. And then I was looking at myself and how I manage my own portfolios. And I quickly realized that there's one big asset class that I thought was important to add to my portfolio. And so going back to 2015, I bought my first investment property, I say, give you an idea of where I live. I live out in Los Angeles in California, of course, and I found a property out in Texas outside of Houston, that turned out to be a really solid investment and own it to this day, and it's continuing to cashflow well and we've been continuing to look for opportunities from there.

More recently, I actually moved and was able to convert my previous primary residence to a rental. And so that's been a really fun adventure as I've not only turned it into a rental and started getting some nice income from it. But the fun part for me was it was local, and so I could actually manage it. So I was the one boots on the ground, found the renter setup the all of the processes it took to make sure collecting payments and making sure that if there's anything wrong at the property, I could fix it. And so it's been a really fun adventure to not only have an investment property out of state, but also have one local that I could actually manage.

Michael:

That’s so killer. And so you're drinking the kool aid to which I love your CFP and you're doing real estate investing?

Zac:

Absolutely. I think everyone needs that diversification. And so it became really important component to me. And I fell in love with that, quite frankly, that's awesome.

Tom:

I’m curious. How did you find that property in Texas? You know, back in 2015? Are you talking to moneybags Albaum here for some advice on investing, but yeah, just curious.

Michael:

You should have been using Roofstock.

Zac:

Yeah, that's true. I should have I quite frankly, it was one of those things where, actually, Michael, I don't even know if you had real estate at that time.

Michael:

I did.

Zac:

You did. Okay. Yeah, I didn’t remember. So my dad had connections to Houston from his. He went to college at University of Houston. And he had some friends there that became real estate agents. And so over time, he made those connections and quite frankly, I kind of just jumped on board this bandwagon. So my family has some houses in Houston as well. And using that real estate agent, he's also a property manager and made it an easy process for me to buy that property as well. I was going to mention one of the things that it was pretty cool about that Houston house is fortunately, it's gone up quite a bit in value. And so I've been able to do some cash out refinances. And that's really what led me to being able to buy our place in LA, at least a good portion of it along with my wife's savings as well. So it has been one of those vehicles that they always talked about that is supplemented my life also.

Michael:

Zac I talk about that realtor all the time with other friends, because does he own like 50 houses in Houston and self insure?

Zac:

Yeah, so he owns more than 50. There's some crazy stories from back in the day, how he was able to buy all these houses on the insanely cheap price. So he has all these properties. And he decided that there's just no reason to insure, because of the cost of actually ensuring all of them, he might as well self insure the income is incredibly good. He has provided I understand very, very little in the way of debt on these properties. So it's just their cash flow machines. Yeah. So why do you need insurance, when he's not spending nearly the income that's generated? So he's really helping to control his expenses a lot.

Michael:

I was explaining to somebody recently what the whole concept of self insuring was. And, you know, let's say it was 50 houses and you know, it was about 1000 bucks a year to ensure each one that's 50 grand, he's throwing away at insurance, when if the house even if the house does burn down, it might cost 50 or 60, to rebuild it. So right, it's a wash, you know, one year in and the likelihood of that happening is pretty close to nill.

Zac:

Yeah, absolutely. And especially when you're talking about properties, and in Texas, where the values are dramatically less than what they are, are here in California.

MIchael:

Right. And the rebuild cost is cheaper.

Zac:

Exactly. Yeah. So you know, here in LA, if you can find a house for as we were actually just recently talking about this, Michael? Yeah, you know, if you could find a house for under a million, you're feeling pretty good about it. If you're in some of the the bigger cities, or bigger parts of LA, I should say, were out there. It's nothing in comparison. It's pretty amazing, different California perspective, it's really amazing.

Michael:

Alright, Zach. So I want to shift gears here a little bit and talk about, you know, the financial advisement things and the financial advising aspect of real estate investing. And so if someone has been saving up for real estate, you know, they want to make a purchase, but they don't have enough money yet. How would you advise them? What would you tell them to do with their cash? Do they put it in a bank? Do they invest it? You know, what, what are some options for these folks?

Zac:

Sure. Yeah, it's an interesting question, because obviously, it takes time to build up for that first downpayment, if you're planning to put 20%, down, or even even less than that. And so it really comes down to more about timeframe. So if you think it's going to take more than one year, as an example, to accrue enough money to actually buy a property, in many cases that make sense to go and invest, right, there's risk associated with it, of course, right, the stock market goes up and down this year, with a pandemic, we've learned that all too well, we saw the stock market dropped dramatically, and in February and March and come roaring back up, and then the rest of it from that point to today. And so you have to understand that there's some risk associated with it.

But hopefully, over a year or two years, if you have that kind of timeframe, the market will grow and help you build up that savings account so that you can go out and buy the property, give you a little bit of a boost to there. The hard part is if you're if you're really close, if you're six months, you're nine months to buying a property, it just doesn't make sense, in my opinion. And the reason is, is because we don't know if a pandemic is going to come in three months from now, right in December. Sure, there was some news coming out out of China, but we didn't know what was how that was going to affect us here in the US. And next thing I know, we're we're talking about a stock market that's down 35%. And so because of that, you really have to make sure that you have enough time to let the investment recover, if there is a pullback, and in a 3-6-9 month timeframe, in my opinion, it's not enough. And even in a in a year, it's a little it's pushing it depending on how high risk or how much you're in the stock market versus the bond market. So just want to make sure that you've got enough time frame to ride through any of the volatility that may come in the short term. And then hopefully, it helps you give that give you that boost.

Tom:

It's a super insightful and just thinking about, you know, time horizon of buying and how much at risk, you want to put those funds. I'm curious, I'd love your input on just kind of general position on you know, you have your wealth and your investments in certain places, right, and real estate and equities and bonds. Is there any general guidelines you give to clients or friends or whatnot as ways to kind of mix that around it? Also, do you typically recommend having a what kind of cash position you know, as a as a percentage, and I know everyone has a unique situation, but I'd be curious to hear your kind of general guidelines.

Zac:

Yeah, absolutely. It's a good question. So from my perspective, you I'll start with the emergency fund part of it. You, you really do want to always have some cash position or an emergency fund, from my point of view, it does depend on who you are. But if you have somewhere in between, I always say three to six months of expenses, right? So look at your budget, and try and figure out what three months of expenses looks like or six months, then you're you have enough time, I should say you have enough cash to cover a potential hard time, right? Whether you lose your job  or a pandemic. But if you're tying real estate, what if someone doesn't pay their rent for one month or two? Are you able to cover it through your cash that you have in your reserves? So I always like at least three to six months worth of cash on hand.

From there, that's when you start talking about investing, right? That's cash is kind of the core part of your portfolio to allow you to do all this other stuff. And once you start looking at at the broader perspective of Do you want to buy stocks? Or do you want to buy bonds as an example, not to sound like a broken record, but it comes down to the timeframe. If you've got 10 years, you can go ahead and be fairly aggressive, and take advantage of the stock market opportunities, right, we know the stock market, at least historically, has gone up quite a bit more than what the bond market has done historically. Bonds are still great investments getting you way more than what the banks are paying, you obviously take on risk their bonds can, you know, companies can go bankrupt and so that bond can can lose its value.

But you know, if you're buying quality there, you're probably okay. Or you're buying a mutual fund or an ETF you'd be just fine. So the longer the timeframe, the more you want to add to the stock market. So it is something where Unfortunately, it is a bit of a time horizon question. Younger investors definitely can take on more risk, assuming that they've got a job, and they're planning on continuing to work and take advantage of the different investment opportunities out there.

Michael:

And Zac, when you say time horizon, what do you mean?

Zac:

Yeah, so it's really about how long until you think you're going to need the money. So I know in, say, for example, I need I need to buy a car. And two years from now, two years in the investment world is a relatively short period of time, it's not six months where I need to keep the money in cash. But maybe in two years, I need to be a little bit more in a balanced portfolio, I say balance, it has stocks and bonds in there. If you're talking 10 plus years, then you can start looking at having more allocated toward stock and less towards bonds. So it's just a matter of trying to find your comfort, right? If you're looking at the stock market, and the downturns make you really uncomfortable, then it's probably something where you don't want to have a lot in the stock market.

It's no different than real estate in that case, right? Sorry to cut you off there. But I was gonna say it's no different in real estate, right? If If you can stomach the market changes or something happening, where you have a huge expense because the AC goes out? And you'd be okay long term. But if, if that makes you really uncomfortable, it's a little bit of a different story.

Michael:

Where would you put on the risk spectrum, real estate? Now, we know that there's some liquidity aspects of it, where it's not as liquid as some of these other. But in talking about time horizon, you know, where do you plug real estate in and thinking about that?

Zac:

Yeah, I mean, for a time around, then I always like to think about real estate as at least a five year investment, personally, five year or greater. And the reason I use that as my scale is because if there is a market downturn, then there is time to allow the real estate prices to recover. You don't want to have to sell when the market goes down, whether that be stocks or real estate. So I always think about it at least a five year timeframe. And ideally, if it's a good investment, and it's performing like you want it to, hopefully you hold it a lot longer.

Michael:

But so as far as categorizing it, if we had to put investments on a spectrum, where would we categorize stocks, bonds, real estate, as far as risk is concerned?

Zac:

Yeah, that's a tough one. Because obviously, there's lots of different real estate. As long as you have all these other components where you have plenty of cash built up. I think real estate is part of a portfolio could be a little bit under the stock market. But you have to make sure you have diversification. If you've got one property, quite frankly, it's probably a little bit higher than the stock market. Because if that tenant moves out, that's a high risk. So as you build out your real estate portfolio, naturally, the average risk goes down. I think a diversified real estate portfolio is more conservative a little bit than the stock market.

Michael:

Yes. Great answer.

Zac:

So did I pass?

Michael:

Yeah you did. We'll send you a check in the mail.

Zac:

Thanks.

Michael:

I'm circling back and this is you tell me this splitting hairs. But in circling back to your car analogy, if you got to get a car in two years, does that mean that you're you know, you're investing in the stock market, whatever the equities market to generate some additional income to buy that car. Does that mean that you're pulling out of the market at one year, eight months to have that in cash? Because if you have a down cycle and that six month time window like you were talking about, that means you take your winnings and walk away and say, Okay, now I know I can buy the car, do you keep riding that train, hopefully upward and kind of gamble with it?

Zac:

Yeah, I can tell you that financial advice from a financial advisor,

Michael:

And then what you would do?

Zac:

It depends on what you're comfortable with. Personally, if you say if you have a solid income, and you're not worried about making up any difference, sure, you can go and wait till take the money until you truly need it. But to be protective, to be a, what we call prudent investor, right? You would probably take the money out a few months in advance in preparation for buying the car.

Michael:

That makes sense, right?

Zac:

It that just depends on personal situation. But surely from a financial advice perspective, you'd want to take the money out and not risk it in the market.

Michael:

Okay, good to know. All right, so let's shift gears again here. And I would love, love, love. So we were talking before we had you on the show and about the different ways that investors can get access to money for real estate investments that might be a little bit non traditional, or might not be so front of mind for folks. Because I think what a lot of people think about investing in real estate, they think, Okay, I got to bring 20% I'll go to a bank and get 80% or 75%, whatever it is. And that's that's all there is to it. And there's no other way. Can you shed light on some of the other options that might be available for folks?

Zac:

Yeah, for sure. Our broad perspective, it's great to go out and get loan. But if you could bankroll yourself, that's even better, right. And there's pros and cons to it all course. But I think the couple ideas that I wanted to share today are really ways that you can at least partially bankroll yourself. So you don't need underwriting to prove you and all that. So,

Michael:

Which is the worst for anybody who's ever gotten a loan will tell you?

Zac:

Yeah, especially now with the refinance moving as crazy as in my…

Michael:

Oh my gosh with COVID. Right. It's insane. And Tom what about you, you’ve been waiting, like four or five months. Right. Your refi?

Tom:

Yeah, it’s been a while, I think just you know, the combination of COVID plus the interest rates being there at just like resulted in a slog fest of getting through. Literally just closed after, like you just like you said, Michael, I we do our like, you know, updates sometimes on the podcast. And it's like the same thing again, and again. I'm still waiting.

Michael:

I'm still waiting, still waiting.

Tom:

Anyways, yeah, closed? Yes.

Zac:

Well, congratulations. That's a big deal these days.

Tom:

Ugh, thanks.

Michael:

It's a huge milestone.

Zac:

Yeah, yeah. So if you're trying to figure out how you can get money on through your savings and other ways, you know, you can always look at your retirement accounts. And like I said, there's pros and cons to everything. But one of the ways that I think does work pretty well is looking at your 401k. So if you're working at an employer, you can been contributing to your 401k. And you've been contributing for a long time, hopefully, you've accrued a pretty good amount of money in there, and you can borrow from your 401k up to certain levels, I'll go through that in a second. And what you would do is, you actually pay yourself back at whatever that interest rate is that they are, that your employer tells you, the rate would be. So as an example, maybe you're borrowing and the company allows you to borrow four and a half percent. When you pay yourself back, you're saying essentially paying your 401k, the loan back with four and a half percent interest, right?

The interesting part is, so you can take up to 50,000, right, it's actually 50% of your account balance up to 50,000. So the most you can ever get as 100 is 50. Grand. So if you have, let's say you have 35,000, or say 30,000, just for easy numbers, 15,000, you could borrow from your 401k. If you have 100,000, you could borrow 50,000, from your 401k. Right. So it's an easy way to get money out of you're not exactly getting it out of your retirement accounts. But it's allowing yourself to borrow your retirement accounts to go and do other things, other investment options. Normally, the way that it works is. And so this is something you'd have to check with your employer, because everyone, every company is a little different. But they would just start taking the repayments directly out of your paycheck.

So just be prepared when you're obviously when you're going through this process, that your paycheck is going to go down a little bit because you are repaying that loan. And the one big risk that I'll have to point out is if you leave your company, whether it's by choice or not by choice, there is a possibility where they can actually put that out as a distribution, which is a that's the risk, the big risk here. Right? Because if it is turned into a distribution, you have taxes on that money, most likely, and it's very possible that you could be paying a penalty if you're under 59 and a half. So it is a great option. Just you got to be aware of the risks and leaving the employer that risk I'd say.

Tom:

So I think I know the answer to this. What have you in a previous employer, you know, had saved up a bunch of money and what was 401k I'm guessing that kind of sweetheart lending where the lenders herself and is not necessarily available if you have some some older retirement accounts that from previous companies.

Zac:

Yeah, so there's a couple things, the question is really about if you're still working, right, if you're still working and your new employer has a 401 K, you can and there's a lot of different options, but you could roll that account into your new 401k. And so now let's just say for example, you got 50 grand at the old 401k, and another, and you've been saving in the new one, and you got another 30 grand, well, most of the time, the employer says, Okay, you've got 80 grand, we're gonna allow you to borrow 50%, so 40 grand, you could borrow from that account, and then go ahead, and, of course, invested in any manner you'd like,

Tom:

Man, this is like our, I think our like 60th or 70th episode, right? You know, and this is one of the coolest things like, I don't know, that like that I've learned. Like, this is magic. So you know, you're paying whatever interest rate, it's just going directly back in your pocket. It's like forced savings, and a forced loan at the same time. This is like, Yeah, I don't know, upside down. Awesome world. This is a

Zac:

We could go down this rabbit hole. And these are all the ideas that are that allow us to do that. I mean, it is pretty cool. I have all these different options.

Michael:

So Zac, just to summarize, because I remember when I learned about this a long time ago, and it blew my mind. Just Of course, I learned that a long time.I was doing 401k loans when you were in diapers.

Zac:

Right, exactly.

Michael:

Well, there was a point eventually got it. I'll get there in a minute. But so what you're saying is that you can take a loan from yourself, and it's not taxed as if you were to take it out when you're in retirement age.

Zac:

Exactly. Yeah, it's since we're on a real estate podcast, I'm sure a lot of the listeners will will be able to do quarter coordinate, or at least think of refinances as exactly what this is. It's kind of like a cash out refinance in a way where you're taking the money out, you're really borrowing it from yourself. There's no tax consequences, just like when you refinance, you take that money out, and that, of course, you have to pay the bank money. In this case, you're paying yourself money,

Michael:

Right? Yeah, no,

Zac:

It's a different different source.

Michael:

That's a great analogy. I actually did this for a property to get the downpayment, a while back, and it was an amazingly easy process. I just, I was through Fidelity at the time, and I just told them how much I needed. And it's a great exactly, you're saying that 50 grand or up to 50%. And then it happened to be four and a half percent interest. And so every two weeks, it just got deducted from my paycheck. And I could choose the repayment period, from one to five years. So I just chose the maximum five years because that made the paint the repayment as small as possible. But it was just I mean, I had the money in my account, like the next day or two days later, it's it's so easy to pay it back. Because I did a refi and paid it all back in one lump sum, and there was no penalties, it was just the easiest thing, probably the easiest money I've ever borrowed.

Michael:

I think that's the true value of it, quite frankly, as I look at that, they call it a bridge loan, right? Where you're borrowing money from one place. Normally, it would be from like a hard money lender or something like that. This case, it's just from your your self, quite frankly. And you take that money and you go and you rehab a house or you do something but that adds value to a property. And then you can refinance, get a more traditional mortgage, or you don't have to worry about it, and you pay that loan right back. I think that personally, I think that's where the real value of something like this comes in play.

Tom:

And just the last kind of practical, tactical question is, is it all be managed through the company that manages your company's 401k? Is that Right?

Zac:

Yeah, exactly. So all of this would happen through your employer's 401k. And it has to be your current employer, because like I said, If you leave, that's they're not going to let you borrow anymore, since they can't take from your paycheck anymore.

Michael:

Awesome. And then I guess one of the other big downsides would be the opportunity cost of not being in the market. Yeah. Because those funds are actually out of the account. Now, raise your borrowing on margin or anything like that.

Zac

Correct? Yeah, that's definitely one of the big potential downsides, right? So if you're an aggressive investor, and you're in 100%, of the stock market, you're missing out on whatever those stock market returns are. So you definitely have to make sure it's worthwhile and say, I get I'm getting that interest rate. I'm getting that. You know, you mentioned four and a half percent right on your loan, Michael?

Michael:

Yeah.

Zac:

You're getting four and a half percent, but could you be getting more money on that money by doing something else? Right, by leaving it in the stock market? And that's possible, right? It just depends on the timing. But you want to make sure if you're doing this, that that investments and awesome cash on cash return kind of investment.

Michael:

We're gonna be digging in here. Just a minute about a couple of different retirement vehicles and retirement plans. Can you give everybody kind of a high level overview of what some of the different vehicles are, you know, 401k IRA, Roth IRAs, you know, what are those and who might have one?

Zac:

Yeah. So I always think about as if there's three different buckets for that you can invest money in. So bucket one, number one is your taxable money that's like if you have a individual name, joint checking account that you want to move money into an investment account, or buy property or whatever the case may be, that's all non retirement related, right in the sense of, there's no tax benefits by using retirement accounts. So bucket number one, taxable accounts. That's, that's number one. Number two, would be traditional retirement accounts. And traditional retirement accounts are available to essentially whomever but there are limitations depending upon income, if the contributions are deductible, and there's some tax conversations that you want to have with either with your financial advisor or with your CPA.

But the traditional retirement accounts, the basic gist of them is, you can put money into this. Ideally, it is tax deductible, so it comes off your income. And then on the other side is once you turn 59 and a half or older, then you can take that money out penalty free, and you just pay taxes on those distributions. So where's the big benefit, there are one, it's on the contribution, right? You, you have the ability to deduct that contribution from your income. Assuming you fall within these guidelines, like I said that you can work with your CPA to narrow down. But the big benefit comes when the money's in the account itself. While your wallets going you don't have to worry about taxes at all. Right. So if you sell an investment, for a gain, you don't have to pay taxes on that gain. And so the money can compound a lot quicker over time.

So for younger investors, these are retirement accounts are really great opportunities to have quicker compound interest, because you're not paying taxes on those gains, you're just paying taxes when you take it out, hopefully in a really long time from now in retirement. So traditional IRAs. Now, traditional, I say traditional retirement accounts probably more broad. And that's because you can include a lot of different types of accounts. So you can have a traditional IRA, you can have a traditional 401k. If you're self employed, you can have what's called a SEP IRA account, or simple IRA account. These are all pre tax or traditional retirement accounts. So that would be the second bucket. The third bucket is Roth IRA accounts or Roth accounts in general Roth retirement accounts.

Now, a Roth has benefits as well, but they work in different ways. So there's, of course, the contribution, and there are limitations based on your income. So if you make too much money, you might not be able to contribute to a Roth IRA account, they have, they cut you off, essentially, the IRS cuts you off at some point. And so when you put money in there, if you can, you don't get any tax benefits for doing that. So first year, quite frankly, you're probably a little annoyed, you're like I'm putting this money into an account, I can't touch it till I'm 59 and a half or older. And then, you know, at the end after that, then I can finally start using this money. But the big benefit here is that even though you pay taxes, you put the money in this account, once it's in that account, it grows completely tax free. If you're a young investor as an example, or you you think you're not going to need this money at all, if you're already into or are close to retirement, this money is hugely important, because the money that grows tax free is about as good of money as it can get.

Right. So Roth retirement accounts are absolutely and considered the third bucket a really important part of a portfolio. And the the considerations there or I should say the different types of accounts, your traditional IRA. So in here you have a Roth IRA, and you can have a Roth 401 K, but depending upon your employer, some employers allow you to have a Roth 401 K, which is one quick note, regardless of what your income that you can contribute to a Roth 401k. There, like I said, there are limitations on Roth IRA accounts. So kind of weird that they forgot to include the Roth 401 k as part of that limitation.

Michael:

But so Zack did, maybe I misunderstood you what you said in the traditional 401 K, the growth is also tax free. So why is one How is that different than a Roth 401k?

Zac:

So officially, that would you would with a traditional retirement account, you would say that it's tax deferred, right? So you put money in there, it's all pre tax money, so you don't pay taxes until you take it out after 59 and a half. Like I said with the first time homebuyer, that, things like that there are a few ways where you can take some money out without paying a penalty before 59 and a half. But the way that we would always like to think about as these retirement accounts are for retirement. So you'd wait till after 50 and a half to start taking distributions and you don't have to pay penalties, but you do still have to pay taxes on this account.

Michael:

Okay?

Zac:

The Roth Ira in sorry, if I was confused in the first go around was really where you pay the taxes on the way in. You don't have to worry about taxes while it's in there. The benefit is afterward when you take those, those funds out after 15 and a half the money comes out tax free.

Michael:

Perfect. All right, what else you got?

Zac:

So the next one is actually if you've got IRA accounts. So and this actually applies to 401 K's also, but it's an borrowing from yourself. In this case, you actually can take money out of an IRA account. And this could be a for a Roth IRA, or traditional IRA, up to $10,000. And if you're married, it can be 10,000. For each of you, if you're buying a new property, essentially, it's a first time homebuyers. And so the rules around this are actually a little bit more flexible than I think a lot of people would imagine. Right? The the definition is that your first time homebuyer is just that you don't have ownership interest in your main home or primary home anytime within the last two years of the new purchase. So it does make it quite a bit more accessible to you than just saying first time homebuyer maybe you bought a house 10 years ago, and you've been renting for a few years or something like that, and you want to go back to buying this gives you a huge opportunity to get a little bit more cash.

So that's one ways you can do this first time homebuyer exception to take money out of retirement accounts before the age of 59 and a half. And for traditional IRA. Well, for both of them, you don't pay penalties for traditional IRAs, you just got to be careful because there are still taxes involved. Right, because all that money is still pre tax. With Roth, it's actually quite a bit easier. There's just they waive the penalty for first time homebuyers. And Roth is after tax money. So you're good there to like I was saying with both traditional IRA accounts and Roth IRA accounts and 401K's for that matter, you can do that $10,000 for each you and, and your spouse, if you're married, to take that money out and use it for the first time home purchase.

The one other way that you have the opportunity to, in a way borrow from yourself, it's a little different than the 401k loan option. But it's actually called the 60 day rollover. And so there are lots of different ways that you can roll your IRA account money to other IRA accounts, maybe at a different firm or move it from a 401k to an IRA, or whatever the case may be. There's lots of different considerations. So you want to understand all those different options. But one that's really interesting is called a 60 day rollover. And what that means is that you're going to take money out of your IRA account or out of your 401k account, borrowing, it's literally a distribution. But you have 60 days to get that money back into the account. And as long as that money's back in that account, within 60 days, you avoid taxes and penalties. And the the reason that is really helpful my opinion, is because let's say you do need to you maybe you want to pay cash for a house. And this kind of pushes you over the top to be able to pay cash, so you can get a better deal.

And then you can go and refinance and assuming it's not the middle of a pandemic, and rates are really low. And all those things that are causing mortgages to take forever to close, aren't around at that point. 60 days hopefully would be enough time for you to close and get that money back into the IRA before you have to pay taxes and penalties on it.

Tom:

It's like a like a vacation. Just want to go out a little bit, see the world. You so you can do that with…

I was gonna say conjugal visit, that's not the right term. Wrong term. The opposite of that. Just so you can even do it. Even if you're moving to a different account. So it can be even be in that same account, jumped out of it and then put it right back into that same account.

Zac:

Yeah, yeah, for sure. Mm hmm.

Michael:

Like how stringent it is like the 60 day Really? 60, 61 62 days?

Zac:

It depends on everyone. The IRS knocking on your door. You know, if you want the IRS knocking on your door, sure. Take it out for however long you want. No, I mean, that the reality is that, from what I understand, and this is where a CPA question because they're the ones that I get actually reported, of course, the IRS, it's 60 days. I wish I could say otherwise. It'd be awesome if you had more time, but I wouldn't push it.

Tom:

 And this is all just in a similar question I had practical tactical, is your you would just manage this with your the company that is you know, what's the right word? The investments holder?

Zac:

Exactly. That's holding that Yeah, yeah. So you can just work with your whatever investment firm you're with. They'll help you with the distribution. And as much as you know, I, you'd like to trust the person that you're working with, I would put a calendar reminder for, you know, 45 days out. And make sure that that money is kind of getting wrapped up with whatever refinance or whatever you're doing to make sure that money gets back in the account on time.

Tom:

Incredible. I'm fired up about both of these magical money.

Michael:

So Zack, what happens if you don't get it back in on time the bank takes too long to refinance done, you know, we can we can tell the IRS Oh, it's the bank's fault. My guess is they're not gonna buy that.

Zac:

Yeah, they don't care at all.

Michael:

If this happens how fingers do you lose?

Zac:

I start with 10. And then each time it happens, I just lose one. So I'm down to four fingers? No, no, the reality of this is that if you don't put that money back in, and it's a it's a, it's a traditional IRA account your tax on it and if you're under 59 and a half, you could be penalized to right. So that penalty right now is that is 10%. So you could be paying depending on your incomes a lot in taxes on that distribution, which is why getting it back in 60 days, is really important. Nobody wants to pay the government any more taxes, and then the CPA tells you to do. And so you want to manage that as best you can.

Michael:

Make total sense. And that's great. Okay, you must be out of ways to get money, or

Zac:

Almost.

Michael:

But wait, there's more?

Zac:

When you get two options, we give you the third for free. Now they. So the cool part is actually with Roth IRA accounts, there's a lot of different options there to where you have, there's a lot that goes into it. So it is something that you really want to be careful. And you can look this up on, there's tons of websites that you can go to, to get the details in your own situation. But the basic idea is that if you have a Roth IRA account, you can actually take, potentially take money out of that account, your contributions specifically. And as long as you've had that account for more than five years, then it's potential where the the earnings would come out tax free as well. So you can get because you already paid taxes on your contribution, right? You don't have to worry about those taxes, but you could potentially take the earnings out on top of that.

And it really just comes down to making sure you have the account for a long enough period of time. And making sure you're not taking too much money out, you're still limited to the reason why you're taking money out in the first place. So first time homebuyer ideas and things like that. So but after 59 and a half, then this matters, right? As long as the money's been in there for more than five years. You're not paying taxes, you're not paying penalties. And you can take as much as you want out. Before that there's a couple complications that that you just want to be careful. But there's definitely ways to access money from your Roth IRA accounts and not have a huge tax bill, at the end of the day.

Mihcael:

So what are some of the other reasons that you could take out the earnings on the Roth IRA?

Zac:

Good question. So there's quite a few. So you could take it out for qualified education expenses, you could take it out for a disability or a death in the family. I believe it's for a family I know, if you pass or as an example, God forbid, then your beneficiaries could take it out at that point, regardless of age. So there's a handful of other factors that can come into play to allow you to take the money out without paying taxes or penalties on that money. You just want to I know it sounds boring, but you just want to check with your CPA. I mean, that's the big thing. These are the CPA is gonna be the one to make that final call, because that's, that's the world they live in.

Michael:

Fortunately, and fortunately for us, unfortunately for them, I don't know how you want to look at it.

Zac:

Yeah. faxes and dealing with the IRS does not sound like the greatest job to me, but there's probably people who hate the idea of being a financial advisor too.

Michael:

So that’s why I leave it to the big dogs.

Zac:

That's right.

Michael:

Perfect. Okay, Tom, any other questions?

Tom:

No questions, just comments. I'm just tickled pink with what I have learned today. I'm like, immediately gonna, like round up me and my wife's retirements house and then go, go make some more. Make some more money with some more money. Anyways, yeah. Incredible, incredible content. This is this is great, Zachary.

Zac:

Yeah. Now, I'm glad that this is helpful. And yeah, I think that big thing is just creating, making sure that everybody has a team around them. Like just like as a real estate investor, you want to have your property manager, you want to have, you know, your contractors or, you know, whoever creates that full team around you. The same idea for financial planning and financial advising specifically, it's like, you want to have your financial advisor, want to have your CPA, you want to have your state attorney kind of get make sure everything's in line. I think after that, ever, collectively, everybody can help make sure that you're successful in your investments.

Michael:

Right on and speaking of Zach if people have other questions, questions about financial planning or financial advising would love to utilize you for your services? How what's the best way folks get in touch with you?

Zac:

Yeah, they can send me an email the email for long one but it's we can maybe post it in description or something like that for here totally. But it's [email protected].

Michael:

Right on. And Zac, when the world opens back up, the pandemic is over. We can go eat at restaurants again. Where's the first place you're headed to?

Zac:

That's a tough question. Good. Potsie fancy. Yeah, this is oily water. Honestly, this is the most nervous I've been. Quite honestly, I've actually been okay with eating takeout more often.

Michael:

Okay.

Zac:

It's just easy. You know, you don't have to get all dressed up and do anything fancy.

Michael:

Well, that's not a fun answer tells me to go sit down and eat.

Zac:

Quite honestly the one thing that I right now I really miss is having a really good steak, like from a high end steak restaurant.

Tom:

Zac:

It is tough. It is tough. And I can try and make a steak as much as I can. And it just don't ever come out. Not like Michaels the least.

Michael:

Yeah, it’s because you use a microwave. Of course it doesn't.

Zac:

Yeah. Well, you know, I always mess up the timing. So it’s problematic.

Michael:

Right on. Well, Zac, thank you so much for hanging out with us. This was super super insightful, as all of our conversations are. I really appreciate you taking the time today.

Zac:

Thanks for having me. I appreciate it's been fun.

Michael:

Okay, everybody that was our episode a big big, big thank you to Zac Breverman for coming on the show was such a pleasure to have you, looking forward to doing it again in the future. We talked about a lot of things in that episode. So go back and give it another listen if you didn't get all of it. Use it as a jumping off point to go research and have additional conversations with financial advisors in your world. Looking forward to seeing you on the next one. Happy investing.

In this Episode Emil, Tom & Michael cut through the noise and explain how to calculate cash flow properly. 

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Transcript

Emil:

Hey everyone, welcome back for this week's episode of The Remote Real Estate Investor. My name is Emil Shour. And I'm joined by my co host,

Tom:

Tom Schneider.

Michael:

Michael Albaum.

Emil:

And today we're going to be talking about how should you actually calculate cash flow. There's a lot of different formulas out there. And we want to clear the air and give you a we believe is the best way to calculate what your projected cash flow should be as you're analyzing a property. So let's get into this episode.

Theme Song

Emil:

Alright, guys, so this was actually a topic that I thought would be interesting to cover, because I feel like there's a lot of misinformation out there. And I feel like it's really easy to read case studies and blogs and go on YouTube or on social media. And you'll see people talking about their cash flow. And the numbers seem outrageous, right? It's like a property renting for 1100 dollars. And they're talking about $400 of cash flow a month. And obviously, it seems like there's a lot of things missing from the way their, their expected cash flow should actually look like. And so I thought it'd be good for us to dive into this on this episode. Have you guys seen the same thing? Like a lot of people?

Michael:

Yeah, I have a property that rents for 1100 cash flows 400 bucks a month, so this is gonna be interesting.

Emil:

Oh, do you

Michael:

No just kidding.

Emil:

Do you guys see this a lot? Do you guys like get this kind of feeling like being prevalent out there that a lot of people maybe aren't calculating cash flow the right way?

Tom:

Or they just inflate it a little bit to feel good about yourself.

Emil:

Sound cool?

Michael:

Yeah, he's a bit of an ego thing.

Tom:

Yeah, the thing with returns and what I like about this episode is man assumptions are just so important. And two people can be looking at the same deal, analyzing it and come up with completely different returns based on the way that they're calculating these, you know, what's in the sausage factory of those calculations is just so critical.

Emil:

Yep.

Michael:

I agree. I think that's kind of where deals often get made or broken is in the assumptions. And if you make a bad assumption, you can very easily buy a bad deal. And you could just as easily lose out on a good deal. So getting good at making assumptions is huge. But I totally see this regularly, where people aren't including the things that I would include in their cash flow calculation to determine what it is, I think it's it's too often to light.

Emil:

Yeah, I agree. I've actually seen examples of this of properties that I've analyzed, like someone posted on Twitter, a property they just purchased. And I remember that exact property, and I had underwrote it as well. And my cash on cash was like half of what, you know, they said their cash on cash was going to be so I've seen it on like, on property, like specific properties, I've underwritten, too. So hopefully, it's a good episode for people to just have like a little bit more of like realistic expectations of what their cash flow could look like after they really account for everything and peanut butter spread all the expenses that come up throughout the year, right, Tom?

Tom:

Jiffy, that Oh, yeah.

Michael:

Jiffy on the spot?

Emil:

All right, let's start out by talking about like, what is the formula? What expenses should you be considering as you're calculating this number?

Michael:

The PITI is an acronym for your principal, interest, taxes and insurance. So the principal and interest is just determined by whatever the mortgage looks like, whatever the interest rate, whatever the amortization period is, and then your property taxes, if you are escrowing, these, the lender will often pay them for you. And so you pay monthly into this account. And you don't have to have this big property tax bill once or twice a year. And so I would always call the county assessor to determine what the after sale property tax looks like for an investor, and then obviously, divide that number by 12, to get a monthly cash flow amount.

And then your insurance, I use a very ballpark estimate of point eight 1.2% of the purchase price for properties under 150 K. And for properties over 150 K, you're probably looking closer to one half - .8% of the purchase price, one half percent to .8% of the purchase price. And so I'll use that number divided by 12. And again, apply that to my monthly cash flow. So you've got your principal interest, taxes and insurance, and then your property management on top of that, Tom, what are some other expenses that I want to hog the mic here that you would include in your monthly cash flow?

Tom:

Ohh, vacancy, so an often assumption used is half of a percent of the annual rent or perhaps a month, depending on what that term time is, like, like a more conservative would be doing it a month, but hopefully that would be shorter than that. Another one is within that property management fee, or I guess this would be separate but they would be managing that process. If you're using professional property management would be turned costs would be repairs and maintenance costs and to define the term cost. That's the cost You're paying after your tenant moves out, and you have to get the property rent ready again. So that's typically more static stuff, some paints and carpet, perhaps if there's some older deferred maintenance that was there when the tenant was living there that kicked down a line that would be addressing any of those issues. So turn costs, what do you typically budget for your? I'd love to hear what you guys typically budget around turn costs.

Michael:

1 million dollars. I've seen this inverse relationship between monthly rent, amount of the property and turn costs. So if I've got a $2500 a month rental, my turn reserved that I'm escrowing is going to be a lot less than a $500 a month apartment. So can I have a bigger security?

Emil:

Do you guys have a separate turn reserve? Yes, don't just leave it as a repair and maintenance and it kind of just gets lumped in there.

Michael:

I mean, it can, I just am mentally bucketing money for when the turn comes, that's totally independent of the regular repair and maintenance and the regular capex that I'm anticipating and also reserving for a page back the roof, exterior paint that kind of stuff.

Tom:

You have a mental escrow account.

Michael:

Yeah, mental escrow account, but also I put it into my calculator, it is a separate line item. But yeah, mentally, I'm thinking about like, Okay, this money is going towards the eventual turn inevitable term for kind of middle of the road rental, I put a couple hundred bucks. Yeah, on it, depending on when the last time that the unit was turned. If you did a big turn at the beginning, your subsequent turns are probably going to be a lot less. And you can also do things on the front end, like tenant proof properties, put in vinyl flooring, laminate flooring, as opposed to carpet, you never have to worry about that, again, you know, maybe tougher cabinets, builder grade cabinets, you can put into the getting into get less banged up. So there are things you can do on the front end to make your turn reserves down the road, your turns less expensive.

Tom:

I’m going through a turn right now on one of the properties. And thankfully, the property manager which just did their move out inspection in the properties in great shape. So this is going to be a fairly inexpensive turn, it's like 400 bucks or something like that just to do kind of a deep cleaning. But in my experience, turn costs have ranged anywhere from 400 to like 10,000 bucks if there's a lot of deferred maintenance. And where you see those big deferred maintenance is oftentimes if you have a tenant that's been living in the property for a super long time, then stuff builds up over time. Sneaky stuff sneaks up like fences and any kind of like loose decks and stuff like that is the one that always surprised me that I'm like, dang, that's expensive. So in budgeting, kind of depending on the condition of the home, my kind of down the middle of the line, say we're talking about a 1700 square foot three bedroom, two bath, I typically budget around 2000 bucks or something like that for the turn if it's occupied. And it's, you know, been so for 12 months.

Michael:

Wow. $2,000 you budget for the return? I mean, for the for the turn,

Tom:

I'd say anywhere between 1000 and 2000 bucks. I mean, I don't know you don't necessarily and be overly cautious, but then optimistic.

Emil:

So how, at this point, how are you even making any money on these with all those assumptions? I'm kidding, we don't have to get into that. But I think the only other one we're missing is utilities. So if you're buying a single family home, most of the time, water and electric are going to be even lawn service, all that stuff is going to be covered by the tenant. So you don't have a ton of utilities to pay for. If you're buying multifamily. A lot of times you as the owner, you're on the hook for water heat, sometimes depending on where you're buying a couple other different things. So I've noticed with multifamily, you have to account for a lot more utility versus single family, the tenant is covering a lot of those.

Michael:

And also depending on how the property is metered, you may not be able to push utilities onto the tenant for multifamily and a lot of multifamily also have what's called a house meter, which is a common area usually just electric meter. That's good for common area lights, exterior lights, that kind of thing. So you'll as the owner will likely be responsible for that. Let's say again, just check how the property is metered. And that'll give you some indication of whether or not you as the owner are going to be paying utilities whether or not you're going to submeter it or check some of that expense back to the tenants in the form of a utility bill back or just included on the rent. Again, check how it's metered.

Emil:

Yep. So okay, so I think those are all the different line items It was interesting to do because you guys have a couple more line items than I do so that may be some homework for me to start being a little more conservative. I thought I was being conservative here I am looking at you guys like dang

Tom:

Looking back at my bottle I I estimate typically like 1000 bucks not 2000 bucks in that like catbacks turn costs but a lot of that is dependent on what I'm seeing like within the inspection if it's like in pretty good shape your point to Tom How do you ever cash flow on your on your property with that turning cost is is right and so yes, a little bit less overzealous with my Yeah, not 2000 roughly you know 750 to 1000 bucks is is more where I target that turn costs the once a tenant moves out. So within that cash flow assumptions,

Michael:

And is that inclusive of like cap x reserves to for HVAC roof? Or is that a separate line item?

Tom

Two separate line items. So one of them would be for R&M for costs that I'm incurring? Well, the tenant is in the property. So roughly 75 bucks a month, maybe 100 bucks a month, and hopefully a lot of the months that doesn't happen, and you don't do that, but then a separate line item for reserve for capital expenditures.

Michael:

And so is your turn reserve considered cap x?

Tom:

Yes, that is that. Am I thinking about this the same way that you are? What? Go ahead, Michael.

Michael:

Yeah, I mean, I just have a separate, I break it out, separate I call it, you know, turn reserve versus capex. My turn reserve I expect to spend every year or every tenant turn versus the cap x is more, I think 10. Instead of that a little going into this bucket, that's going to be a piggy bank to draw on when I need to replace the roof replace the fat. But at the end of the day, I mean, the money is going into the account anyhow. So I just mentally earmark it for certain purposes.

Tom:

I like it. So just to paraphrase the three buckets that you have within these type of costs is R&M tenant occupied, right. Yeah. And then one would be turned costs just bread and butter, cleaning paint. And then the third one would be more specific for like, roof or like, you know, major property system? Ah, back. Yeah,

Michael:

Big ticket systems.Yeah, exactly.

Tom:

I like it. Nice. Nice.

Emil:

You got a lot of very detailed Michael, I like it.

Michael:

I'm a reformed engineer. I don't have a choice.

Emil:

All right. So we've gone over, like, what's the formula world of things we consider, we've kind of like sprinkled in some of our assumptions, but maybe we should just go through each line item and give what we think maybe are some good assumptions for people. Would that be helpful?

Michael:

Totally. Let's do it.

Emil:

Okay. All right. So mortgage, I don't think we need to get into how you can go online, use a mortgage calculator, figure out your mortgage payment. That one's pretty, pretty simple. Insurance. Michael, I really liked your, your kind of formula, I use something pretty close. Can you describe that again?

Michael:

Yeah, so I like to use and this holds fairly true for properties. 150,000 purchase price or less. So I like using point eight to 1.2% of the purchase price. So let's just take an example a property's 100,000. on the low end, we're talking $800 a year on the high end, probably around 1200. And what's going to make the difference on that sliding scale is one, how conservative how much insurance? Are you looking to get? What type of policies that are replacement cost versus actual cash value? Is it really a comprehensive policy? Or is it named peril? So I am a very conservative person, I come from the insurance industry, I grew up in the insurance industry, so I get a more expensive policy than is available for that same hundred thousand dollar property, you know, my guess is you could go get insurance for 400 500 bucks annually, it is available is out there.

But it's probably not going to be the type of coverage that I'm comfortable with. And so to help me sleep at night, I'm going to up the coverages, I'm going to add some additional layers to it probably get some additional liability coverage. And so the additional coverages just have additional cost. So for the extra $300 a year, or $600, or whatever it is, that's often worth it to me. So I've just over the years and purchasing properties and helping other people purchase properties, that point eight to 1.2% of the purchase price tends to be fairly reasonable. And I'm confident that getting that type of coverage, you shouldn't be paying much more than that, that's going to be on the high end, being very conservative.

So if that ends up being your biggest expense on the property, you know, of course, we might want to go back and take a second look at things and say, oh, maybe we were too conservative. But I find that typically the $300 that we might be too overly conservative isn't going to push something from a no go into a go category. There are typically going to be other expenses that are significantly larger as a percentage of the income that we want to take a second look at and see if we can't refine those a little bit more. So that was a super long winded rant. Hope that answers the question Emil.

Emil:

No, that was good. That was great. Okay, so that's insurance. Tom, anything you want to add there anything you kind of like to use for an assumption that's made different from what Michael mentioned,

Tom

If you look at the Roofstock calculator, really helpful tool, you log in to Roofstock and look at an individual listing. And then you click on financials. Just below that financials tab, you can click on cashflow, you can see kind of a rundown of all these different costs. The Roofstock calculator is pretty handy in that you can see all these assumptions. One thing I like about Michael's example for insurance is he does it as a percentage of the purchase price. It's just kind of general guidance. And a lot of values in the risk calculator does it a percentage of income. So I think in some cases, a percentage of income makes sense. And in some cases, a percentage of the value makes sense. So just as kind of like an FYI, you can see these assumptions in here and looking at a property that's $110,000 we can see this insurance value is pretty close to Michael's assumption of point zero Point 8% point oh 8%.

Michael:

Yeah, yeah,

Tom

Where that would be $800. This example is a little bit less than that at $110,000. Home is around $600. But within rootstocks calculation for insurance, they'll actually get a value that a insurance company will, will bind again. So part of the Roofstock’s operations team, they'll go out and work with one of our insurance partners, insurance costs can change based on what kind of deductible you have. So depending on what value you have, it could either the price go up or down. But that's my two cents is I'll just touch on Roofstock as a platform and their calculator, the value they have and where it comes from.

Emil:

Cool. So next one is property tax. I don't think you should estimate anything for this one, I think Michael mentioned called the property assessor, some cities, they have a like part of their website, you can literally just go put in the value that you're going to be buying at you and put in the address, and it'll spit out what the new property tax will be. So this one's probably no one you kind of estimate based on percentages or whatever. This is something, it varies from state to state, city to city, you should probably just go figure out what it is for your market. So you can accurately estimate it.

Tom:

There's a lot of landmines and trying to calculate property taxes, one of them being if you're looking at last year's taxes, the current owner might be an owner occupied, so they get a homeowner's exemption. So I would be conservative in that property tax assumption.

Emil:

Cool. Alright, so next one is property management, property management. This one's usually pretty easy to figure out, you know, as you're interviewing different property managers, you find out what their property management fee is, whether it's flat fee or percentage of monthly rents, like Tom and Michael were talking about, and this isn't something I should I do but I should be doing in that property management or you can have it as a different line item, adding it make sure you add in whatever you think for lease or releasing fee, right, so releasing fee will usually be a smaller percentage than a completely new lease, but factoring in every year that the property manager is going to charge either a release fee or if it's a new tenant, a leasing fee. So adding that up there, Tom, you want to add something

Tom:

Yeah, just specific to roof stocks calculator that it has or any calculator that you're building perhaps in Excel with rootstocks calculator, It defaults at 8%, I remember something that we wanted to do on the product side was make it like updated dynamically based on picking a property manager if you use one of Rootstock’s preferred property managers to automatically update, but whatever the case is, when you know what that property manager fee is going to be for rent collection, you should update your calculator accordingly, within rootstocks calculator, it defaulted. 8%, but you should keep that updated.

Emil:

All right, give me on. Okay, so after property management, we have utilities. And so for utilities for anything, two units, plus, I use $1,000 per year per unit. So if I'm looking at, let's say, a four unit building, and I want to figure it out monthly, it's just $1,000 times forums 4000, divided by 12, to find the monthly for single family, I don't have a more cookie cutter approach. Again, it's it's a lot of the times utilities are going to be covered by the tenant. But sometimes depending on some cities, like I own a property in St. Louis, a single family home in St. Louis, the water bill and the sewer bill are separate. Whereas most other cities, it's all on one bill. And so the tenant pays the water bill. But the sewer bill comes to me as the owner. So that's something I have to factor in as part of my utilities. Are you guys any kind of formula you use to estimate utilities?

Tom:

I think on every lease that I have the tenant pays for utilities, I don't even have that in my, in my model, I guess it's more common with multifamily and bigger stuff. But utility isn't even something that we'll have. Perhaps during the turn, you know, I might spend like $10, or whatnot, just during the turn time where the utilities will be on me as the landlord, but for the most part, yeah, I don't consider that. In my cash flow.

Michael:

I was gonna say for me for multifamily, it's, it's similar, I think 1000 bucks a year per unit is fairly reasonable, depending on what utilities are being paid by the owner. And usually the listing will say on or paid heat, water or whatever. And that can give get pretty good insight into all tenant paid utilities. Okay, that's gonna be a whole lot less than a grand a unit a year,

Emil:

Like 12 months of expense, prior expenses from the seller. And so you can kind of see like, how much are they paying for all these different expenses and see if it lines up with what you have and if you need to adjust up or down but as I have no information, I just put $1,000 a year per unit.

Michael:

Yeah. And I would say don't hope that you get those t twelves. Go demand those in the due diligence. I would say that's something that you really need to get a handle on before you close the property because you could find out that you were way off on your estimate and really buy yourself an alligator.

Emil:

As our good friend Michael Zuber likes to call it absolutely. Next one is repair and maintenance and capex some people separate those out. Most people separate them out. I have them as one line item now and for multifamily, I'm using hundred dollars a month per unit is what I do for repair, maintenance and capex just kind of all together. for single family I've usually used 120 550 per month on single family is the amount I've used for repair and maintenance and capex as one line item. How about you guys?

Michael:

like Tom for my repair and maintenance, I break it out into those three that we talked about. So for repair and maintenance, I'll use 75 $200 a month depending on the property size, and location and tenant class. So in a milder climate with a good tenant, that's not a massive property, I'll use 75 bucks a month, all the way up to the size of 100 bucks a month. And then for capex, I really let the inspection report dictate what that looks like. So if you've got that in advance, like on a roof stock property, you can get a decent handle on what that might look like. versus just looking at the photos or plugging something in for a run of the mill single family home that seems to be in decent shape 750 bucks a year, between 750 to 1000 bucks a year for capex usually should do it, that's, you know, in three years time, you'll have 2000 plus dollars set aside.

And also, depending on if I'm going to get a home warranty or not, for that property is going to also determine what type of capex budget I'm looking at. And capex is kind of one of those tough ones too, because it's a bit of a living, breathing, moving target. If I just replaced the H fac this year, well, now I'm going to put less money set aside for that each of that going forward because I know I got another 10 to 15 years out of it. So depending on the life of the systems, I call it the property will dictate what that budget what that number should be.

Tom:

Ditto to Michael and I like that concept of kind of trade off, you know, you might not what you might be spending more on one year on the turn or or catbacks you know, major property systems that's going to take away for future costs related to to R&M. So similar to Michael and structuring that and if you really wanted to geek out and get really sophisticated on building a crystal ball to estimate some variables that we used when I was working on one of the REIT the vintage of the property was the size of the property just because oftentimes these costs, especially on the turn are directly related to how big the property is and square footage, and perhaps certain vintage, you might expect more or less on those turn costs. Those are some important variables to consider.

Michael:

The one thing I would say on vintage is just look to find out what's been done on the property. I've got a 4-Plex that was built in like 1892. And we did a total gut rehab on it down to the studs, we put in brand new electrical brand new plumbing, brand new roof. I mean, everything is brand new. So the year of construction is at 92. So if someone attacks record, that's what they would see. But as far as the insurance is concerned, the effective year of construction in 2019. So I would say you know, with a take it with a grain of salt look just a little bit beyond the year of construction to determine Okay, what was done? Absolutely, if something was built in the 50s it's going to have more maintenance and something that was built in 2000s. But if that 1950s has all new electrical plumbing, I would say they might be comparable or that might could even be more updated.

Tom:

before we run out of time. I'd love to hear your guys's thoughts, more multifamily dudes on like in ciliary and silivri income like perhaps having a laundry machine or having like storage sales. How do you guys underwrite that when you're thinking about cash flow on your multifamily? Because there's also the costs of like up keeping those type of amenities?

Michael:

Absolutely. So for me, I'll just jump in here Emil for I gotta hop off. It's something that I think about, and we'll calculate if it's like a reasonable assumption. And so for me, I just have laundry, the vast majority of multifamily on site coin laundry, it's not a big moneymaker by any means. I mean, 15 to 20 bucks a month, maybe. But there's cost associated. so there's costs associated with that T rex and paying the water and electric bill for those machines because those are on house meters. So the big ones that I like that I use is storage, digital storage or parking. I know pretty darn sure what I can get for those on a monthly basis is for rent comps talking to property managers and also it has zero expense. So those are ones that I really like adding into the pro forma or using to drive value and increase the NOI.

Emil:

For me I am newer to multifamily so I don't have like the confidence Michael does and knowing Okay, we have a garage we have some spaces how much we can get for it. So I don't even account for any of that and laundry. Even if you have a bigger building maybe you account for it, but I haven't been when I'm looking at stuff I just those to me are are extras, but I haven't really been accounting for those is that extra income because like Michael mentioned, they do come with some extra expense as well. So unless it's parking, parking and storage, that's that's on the property, but laundry, it's you know, you're paying for that as a landlord potentially. Okay, so you guys had mentioned turn that you guys actually have it as a separate line item. I think we already were to talk about kind of what you guys set aside for that. So Tom, you mentioned like $1,000 every year every other year, how do you set that term budget aside?

Tom:

Yeah, I would set it as an annual You will amount 750 to 1000 bucks. And again, if the property's been occupied for a long period of time, I would expect that eventually be a little bit north of that value. But you know, be happily surprised when you get back in your turn cost is 400 bucks, 300 bucks, and that that you can roll around in that extra money.

Emil:

Yeah. And you know, it also, I think it depends on property type, right, with multifamily, you're just gonna typically see higher turnover. So you're gonna have more turns where a single family I don't know about you, Tom. But like, single family, a lot of my tenants stay really long term like I've had of the four single family homes I've owned over the last couple years, I've had one turn, the rest of them have stayed even with rent increases, like single family tenants just seem to stay a lot longer.

Tom:

I totally agree. I mean, I was saying I had a turn right now, but it's like, it's pretty far and few between. I think you're right, though. And there are studies around SFR having longer duration. And it makes sense. I don't modify my cash flow assumptions. I'll still assume you know, based on whatever is on the lease like expect, the worse that they're going to move out. But generally speaking, like you said, oftentimes be surprised. happily surprised. Roll around that extra dough.

Emil:

Awesome. All right. So then the last one, I think we should cover here that we mentioned in the different expenses, you should be considering his vacancy. What's funny is for single family, I always do 5%. I feel like that's like the industry standard. But again, if I'm looking at my actual vacancy across my portfolio, it is way below that I think it's just good to be conservative, because I don't know, maybe you're in a city or an area where your tenant does leave once a year, whatever that may be. And it kind of equates to 5%. But honestly, I've heard so many people who have seen my family and they're like, you know, they're good landlords, they have the same tenants for five to 10 years. So your vacancy becomes real tiny.

Tom

Especially Emil, I think if you are getting in really nice school districts, it's a hassle. Like if you have a rental in a nice school district, and you have good tenants with kids, like no reason to move out, you know, I think it's an upside to including that in your acquisition strategy a little bit.

Emil:

Totally. So that 5% for single family for multifamily, I do seven and a half 8%, usually just depending on where I'm investing in. But I feel like that's a solid level, like seven and a half percent. A lot of these things also, especially as you're learning a new market, every market I think is different. And you're estimating these expenses, but I imagine in five to 10 years, I'm going to be much better at like being able to look back at all my expenses for five years and say, Okay, here's what it actually averaged out to be. And here's how my pro forma should change. So you know, I think right now, it's like, especially in the early goings, you're kind of just taking some different assumptions, either talking to people who are in that market, or figuring it out. And then I think over time, you're just gonna get really good at knowing, alright, my expenses are basically this amount every single year per unit. This is my vacancy over the last five years. So I think, just with time, you'll get really, really good at these pro forma. Yeah,

Tom:

Yeah. And when you're setting that budget, and thinking about your cash flow, that's goal setting, right? And to be successful, and to make money as a real estate investor is to, you know, spend less and make more. And once you identify those numbers, those are specific values that you're working against. So when you get to the end of the year, it's like, Okay, how do we do against these values, and hopefully beat them. And if you don't, you know, reasons why and how to improve upon it. And if you don't beat those value goals, hopefully you put enough of a cushion, that you can still be fine. And then get back at it next year and work with your property manager if you're working with a property manager. So it's fun.

One other line item for you Emil is HOA fees. So if you're buying a property, and there's a homeowner's association fee, and those can be super high in some areas, especially if you're buying like condos, or they can be really, really low. So that's a really important consideration because that's money in money out.

Emil:

Yeah. And like you mentioned, some of them are high and some of them are low. Like I have one property, I only have one property that's in an HOA, and it's $21 a month so as I was looking at it, everything else I really didn't want a property with an HOA but at $21 it wasn't really affecting my monthly cash flow. And so yeah, I went with that. But yeah, be careful sometimes it can be $100 plus, so that can really really you know, mess with your cash flow number. So good call Tom.

Tom:

And kind of back to that exercise of comparing your pro forma assumptions for cash flow to actual you have some actions that you can do to try to improve them specifically around shopping. for insurance costs, that's something that I need to do right now, to revamp the insurance costs, looking at mortgage rates, interest rates have never been lower. So you can beat those values. And then looking at that trade off between taking care of items on the turn or just repair replace. So there's a lot of places that you as an investor, in working with your property manager and some of your other partners that you have, there's actionable item, actionable items to improve on those values.

Emil:

Yep. You know, there's other small things, right? Like if you are again, buying, let's say, a four unit building, and you're on the hook for water, installing low flow toilets, right, not expensive, but over the course of a year, it can add up to some decent savings that probably more than paid for the toilet in the first year. So like there's, you know, little things you can do to also try to decrease your expenses along the way.

Tom:

Yeah. And rent growth versus vacancy. You know,

Emil:

There you go.

Tom:

Have we done a debate on that rent growth versus vacancy?

Emil:

We haven't we should

Tom:

That's coming up in the pipeline, for sure.

Emil:

Yeah.

Tom:

I like the question of you know, do you are raising rates at the risks of vacancy? Right, I got a feeling I think I know where we're gonna land. But it'll be fun to just switch back and forth in that debate.

Emil:

Yeah. I also think it's depending on what you invest in, I think dictates how you do it. Right? If you're investing in something that's valued on cap rate makes a lot more sense. Because it's all based on income versus a home or up to four units based on sales comps. You know, you're less incentivized

Tom:

Very astute point, Emil makes a lot of sense.

Emil:

But we can get into all that in a debate.

Tom:

Yeah, it'll be a good episode.

Emil:

With that. I think it's probably a good spot for us and this episode. Thank you again, everyone for lending us your ears, and we will check you out in next week's episode. Happy investing.

Tom:

Happy investing.