In this Episode Tom, Michael and Emil share their systems that take the headache out of acquisitions and ownership to effectively scale up. 

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Transcript:

Tom:

Greetings and welcome to the remote real estate investor. My name is Tom Schneider, and I'm here with Emil Shour and Michael Albaum. And today we're going to be talking about something that is near and dear to my heart. We're talking about building systems. We're talking about automation. We're talking about scaling. We're going to touch on these topics and a couple of specific strategies as it relates to acquisitions and ownership. All right, let's do it.

Tom:

All right. Welcome back to The Remote Real Estate Investor. Before we get going today, we're going to do a quick introduction from the host a little bit about ourselves and our experience and background and all that good stuff. So, Michael, why don't you go ahead and lead us off?

Michael:

Sure. So I'm Michael Albaum. I used to work in my past life as a professional fire protection engineer in the commercial property insurance industry. So everyone has to bear with me if I speak in math terms, cause I'm a reformed engineer. I've been an investor for the better part of a decade and started very traditionally with single families. And now I've found a, found my stride and niche with multifamily value, add projects out in the Midwest. And I'm also the head coach of the Roofstock Academy program and meal. Can you introduce us to yourself and your mustache?

Emil:

Hey everybody. My name is Emil Shour. I work on the marketing team here at Roofstock. My fun fact is I actually bought a couple properties through Roofstock before I was ever working here. It was a big fan of what the company was doing and now lucky enough to get to help spread the word. And I own a couple single family rentals across the Southeast and Midwest.

Tom:

And my name is Tom Schneider. I am the director of investor education here at Roofstock. My career has been focusing on putting technology process to scale and build systems. So this episode is particularly exciting for me is how I do this personally, with my investing. I've been in real estate investing for over the past 10 years, and I'm also a California broker.

Michael:

Nice.

Emil:

The only one of us who's licensed. Where do you have your license hung somewhere as a broker?

Tom:

You can just hang it right around here.

Michael:

Yeah. Hang it on yourself.

Tom:

Hang it on myself.

Michael:

The broker test. Isn't so much more work than just the agent test, right?

Tom:

It is. They've made it harder when I got my broker's license, it wasn't quite as difficult, but they made the experience requirements a lot more difficult. It was kind of funny. I initially worked in acquisitions for one of the publicly traded rates and literally the day that I passed the broker test, the person who was leading our technology says, Hey Tom, we need a can-do guy to help build out a bunch of systems. And I was like, okay, cool. Let's do it. So I got my broker's license and then proceeded to never use it until I did use it when I bought my own house. So I guess it paid for itself there.

Emil:

What is the difference between an agent and a broker?

Tom:

I'll tell you, I should kind of have an idea on this. So an agent needs their license to be hung underneath the broker. The idea is a broker understands the business a little more and folks who are agents can eventually become a broker. If they wish to, they basically can operate on their own. So within California, you can apply for an agent or a broker. And the broker aspect of the test is a little bit harder and the requirements to get it is a little bit more difficult.

Emil:

Got it. So a broker can do everything an agent can do, but an agent can't do everything a broker can do.

Tom:

Yes. Yes, that's correct. That's a good way to put it.

Michael:

Getting ready for my broker tests.

Emil:

Awesome. I've already learned something on this episode!

Tom:

Early and often, baby early and often. All right. We'll jump into some system stuff. So we have a variety of different things and we're going to have a different one of the hosts take the lead in talking about. So we're going to start with acquisitions. And Emil, why don't you lead us off on some systems, some practical systems that folks can do on their own.

Emil:

It might be a little obvious, but I still think it's worth stating. Set up automated filters and alerts on the places you look for properties. If you're on Roofstock. If you guys are familiar with stock is our marketplace where people can buy and sell single family rental properties. You can go and filter by whatever meets your criteria and save that filter. So you get notifications when new properties hit the site that meet that filter requirement, same thing on other sites like Zillow or Redfin or realtor.com, wherever you're, once you've figured out your buy box. And I'll talk about that in a second. Defining it, plugging it in as a filter so you get automatic notifications cause you want to be on top of those listings, right? When they hit the site, right? It's a lot more effective than just constantly going on them and checking your listings. Even though I do that all the time anyways,

Michael:

I don't know about you guys, but I constantly get notifications from Zillow and Redfin about new properties that have hit the market, but I didn't save a filter even, you know, I searched there twice or three times and now I was like, Oh great. You're super hungry for properties in that market. So I'm just getting blasted by these emails. Yeah.

Emil:

Every time I [email protected], like I was curious the other day about like, what do multifamily in Bakersfield sell for? And now I've just, I've been getting Bakersfield filter notifications from realtor.com. It's like, man,

Tom:

What's cool about these websites and the filters, a little pro tip is you can get really granular with your filters and set up multiple filters. So what I'll do is on my inbox that I have all set up multiple inboxes and I'll set up a filter within my I'm gonna, we're gonna do filters on filters. This is a very layered,

Michael:

Filter-ception

Tom:

Yeah. Very meta. So within my inbox, shout out Gmail, just kidding

Emil:

@Gmail, let us know if you want to sponsor us.

Michael:

Yeah. I've never heard of this Gmail, but this Tom Schneider guy talked about it.

Tom:

Anywho, I set up like a master folder for like incoming property leads. Right. Then within that I'll set up additional folders for each different type of either region or property type. So as new listings that meet my criteria are hitting. I have them in a nice clean folder, so, Oh, great. A new Florida property. That's a duplex in this area and I have a special folder for that. What I'll also do is oftentimes timing can be pretty important and moving quickly, instead of setting up a filter that comes just once a week or once a month, since I have this infrastructure within my Google Gmail, shout out again, I'll have it actually doing real time. So I'm not getting pinged in my main inbox if I'm working on some other stuff, but I have a way to see immediately based on whatever that criteria it's hitting that inbox. So again, the super simple paraphrase, but this isn't that complicated. I have a bunch of different inboxes within my Gmail. And then within the, my buying platforms, I'll set up many filters and many alerts and many immediate alerts. So it'll hit right into my Gmail and I'll know at that time, all right, this one looks pretty good and I can move pretty quickly. And I don't have that issue of, Oh, Property. It's already pending. Like I'm not passively looking for it. It's proactively hitting me as soon as it hits the market and I can act and jumped on it. So that was my extra tidbit on that piece of mill,

Michael:

That description Tom was amazing. It gave me such a visual of kind of how you operate. And it made me reflect about how I operate. And you, I'm picturing this nice, neat cubby with nice section organizers. And mind's like just a fricking melted pizza, but it's just crap everywhere. It's, I'm so jealous. I want to be like you and I grow up and have these systems, but in place, I love that.

Tom:

That's why we make a great team, Michael. That's why we make great team

Michael:

Coffee-man, and melted pizza.

Emil:

Oh yeah. I'm not surprised Tom is like the most organized out of all of us internally. And I'm not surprised when it comes to acquisitions. You're equally as organized with the pick and choose you pick and choose. There's definitely lots of messages. So one thing, if you're going to one of the sites we mentioned, and you're not sure how you should set your criteria, just know that it's okay to start a little wider. And then as you've looked at more and more listings, I think you'll get better at defining your buy box. I know we talk about it a lot and we say, okay, build your buy box. And sometimes it's hard to just like, know what to choose. Right. I kind of started larger. For example, I chose a couple of different markets, couple of different properties, size, like a bigger property size.

Tom:

I like it. You feel that you need to shoot with a sniper. I keep using these weapon analogies, but it's okay if you're not sure to start with like a broader spray and then work your way down as you refine what you're looking for. But I'd say it's better to keep it an open, an open range, and then, then shrink that down.

Michael:

Nick it down.

Emil:

Yup, exactly. And also because sometimes whoever uploaded the listing, sometimes they don't include that information. Right? So if you have like really, really specific defined criteria, you may miss something where whoever listed at the seller or the agent or whatever, just didn't submit that information. It doesn't hit the filter. I've noticed that on a couple of things.

Michael:  

And just a pro tip for everybody listening to, if your budget is a hundred grand on the high end, set your filter up to one 20 to include properties that are listed above that because you might offer a 100K and get it. Versus if you set your filter criteria right at your end budget, you might never have seen those properties.

Emil:

Yeah great tip, go like 10, 20% above what you are actually planning on spending.

Michael: It also gives you an idea of what the next tier of property looks like. So if you did want to ultimately spend more, no. What would that buy you?

Tom:

One last piece of advice on building a bike box is to think about how many properties do you practically want to evaluate at a given time? And yeah, you can control this with your buybacks by how targeted it is. So if I have a lot of time and I want to look at a lot of product properties, I'm going to have a really wide buy box. If I don't have a lot of time right now to evaluate properties, I'm going to tighten my buybacks down a little bit. So one way to think about it is to work backwards about what your kind of capacity is for evaluating effectively.

Emil:

It's also, I think when you're first starting out, I think it's okay to, again, to nail this point of going a little broader, I think with time and experience and having different property types, you'll start to get an idea of like, this is the exact property I want in this exact area.

Tom:

Awesome. Michael, do you wanna jump on your next acquisition system?

Michael:

Yeah, absolutely. So, so much of this, in addition to searching, can be done socially kind of quote unquote. And so just talking to everybody who's willing to listen and maybe even some of those who aren't, about what it is that you're looking for. So just in everyday conversations, talk to friends, family members, people in your network about what it is you're doing and what it is you're looking to do because so many eyes are going to be better than, than just one set. So if someone then comes across a property just in their everyday life and thinks, Oh, well, I remember Tom mentioning that he was kind of looking for something like this. That can be a great deal funnel for you as well. Property managers can also be a fantastic, fantastic source of deals for you, which is pretty automatic. You just tell them, Hey, this is what I'm looking for. You, you set your filter, so to speak with them and any property that comes across their radar. Oh, Hey. Yeah. I remember, you know, Emil, I kind of managed this property for him. And he's looking for something like this. It becomes so easy. And so automatic that it's one of those things you can just kind of say it and continue saying it and then forget it. There's not a whole lot of nurturing that has to be done with those types of things, other than some, you know, reminders. And don't be the person that, Hey, have you found any properties yet? Have you found any properties? Just put it out into the universe and just kind of let it, let it bake for a bit and see.

Tom:

It’s like The Secret. You guys remember that book?

Pierre:

I'm still waiting for that check in the mail.

Tom:

It’s coming! Wasn't it The Secret and then The Answer as a followup or something.

Emil:

Yeah.

Tom:

Incredible. Incredible marketing.

Michael:

I didn't read that one. What's The Secret about?

Pierre:

It's the laws attraction.

Michael:

Uh, okay. Okay.

Pierre:

It's when you focus on something for long enough and eventually it comes to you, essentially.

Emil:

That's right. You don't have to actually do anything. Just think about it every day. Hope for it every morning, but no action required. Just think about it.

Michael:

Million dollars, Million dollars! So it's interesting. So for the Academy book club, we just did Think and Grow Rich. And I thought that, you know, that was such a great title by Napoleon Hill and we read it and I thought it was really awesome and talked about a lot of kind of high level things, mindset type stuff. And it was talked about very similar type stuff. And it was, it was interesting. They're all talking about, you know, if we stand around here and talk about blue cars, we'll probably go out and see a bunch more blue cars. And it's not so much that there are more blue cars on the road. It's just that now we're cognizant of that thing. It's kind of front of mind. So it appears more often for us.

Tom:

Yeah. I love that example, Michael, cause not all systems are digital or not all systems are technology, but it's, it's leveraging the people side of your network of funneling in deals through that. So at the end of the day, like a lot of real estate is a people business and nurturing that and building a system that you want and funneling them in deals is excellent.

Michael:

All the real estate meetups that I went to, um, pre COVID, they all talk about they'll usually start or end with the needs and wants section. So people talk about, okay, this is what I need or is it “have and wants”

Tom:

Maybe it’s a “give and a take”, I think I know what you are talking about.

Michael:

Yeah. You announced to the group, what it is that you have to offer to the group and then what it is that you're looking for from the group or from in general, until people say I have money and I'm looking for a deal or whatever. And so it's that those are great opportunities as well. And so again, just kind of reiterating, put it out to the world, don't be embarrassed by it. Don't be shy about it. Just make it known what it is you're looking for. Cause it's tough to help people if they haven't told you what it is that they're looking for.

Tom:

Awesome. Great example. All right. So I'll touch on the last acquisition related systems slash tip slash ways to scale. And this is a special perk that we have within Roofstock Academy is that members can actually export the listings on Roofstock into Excel. And whenever you can do things evaluating a lot of deals at once, like doing it in Excel, that's a great way to do it. So I guess that the main theme is, you know, try to batch processes together. And in this particular example of being able to download all the listings in Excel, batch that whole evaluation of the whole inventory, you know, in one run where, okay, I'm filtering down to these particular property types or, Oh, I'm filtering down for this particular return. So being able to, if you can get a spreadsheet of what you're evaluating or any kind of way, being able to batch it together, do it saves time.

Michael:

And for anybody that's really intimidated by Excel because I know it can often seem very intimidating. There are some really great free courses on YouTube and there are also paid courses. If you want to get more in depth with it, about how to use Excel and maybe how to do some of that batch sorting because it's a really powerful tool. So I guess we're plugging Excel and Gmail in this episode.

Emil:

Shout to Google and Microsoft!

Tom:

Let's continue on. We're going to go into ownership now and Emil why don't you lead us off.

Emil:

Cool. All right. So the first one we're gonna be talking about is cash flow automation. So the first thing I do and you guys let me know if you do this as well. I set up auto pay on all my mortgages. I don't want to think about, did I pay this mortgage? I have to mail a check. I auto pay everything just to make it super easy. Especially when you have multiple properties automating. It is like, step number one. You guys do that as well.

Michael:

Yeah, definitely. Absolutely.

Tom:

Do you also impound your insurance and property taxes when you pay your mortgage payment?

Emil:

I do. I know a lot of people won't because they want that capital and would rather use it throughout the year versus giving it to your lender, to hold it to whatever you like to be able to use that capital. I just don't want to have to think about like, okay, I need to come up with X amount to pay my property tax and insurance. It's kind of like duping yourself into thinking you're richer than you are.

Michael:

I don't, I don't use the impound accounts. I will, if they'll give me a better rate for the mortgage. And then as soon as the loan closes, I cancel the escrow account and just pay it myself.

Tom:

Sneaky move Michael.

Michael:

It's something I'm considering doing just from like a meal mentioned ease of operations. It's just one less thing to think about. So it can be great either way.

Emil:

Why do you not impound it?

Michael:

For the exact reason you mentioned there are significant funds that are going to be paid to property taxes and insurance on an annual basis. And so I'd rather have that kind of, well, that one time hit is kind of a bummer. I'm able to use that cash. I mean, it's a significant amount such that it's usable on a monthly basis to do other stuff with. And so I just know in the back of my mind that, okay, come this time of year, I've got this big, big property tax bill that's going to be due.

Emil:

Yeah. I wonder if there is something there in terms of like at a certain scale, it's a lot more money to be working with versus like, let's say you have one to five properties just for ease and it's not that much extra capital that you'd be able to do something with.

Michael:

Yeah, no, that's a good point. I mean, I think everyone should think about it for themselves because even at that five property level, one to five, your property tax bill could be, you know, $25,000 if we're talking about.

Emil:

Yeah, that's true. Yeah. Good point.

Tom:

Just to clarify impounding your taxes insurance is if you haven't deduced this or don't already know this, it's when you pay your mortgage payment, the mortgage company will also collect a percentage of the annual taxes.

Michael:

They'll take one 12th of the annual tax bill, one 12th of the annual insurance bill with your mortgage payment on a monthly basis. So that you're paying equal payments every month. You're not getting hit with your tax bill or insurance bill just at one time.

Tom:

And then the mortgage company will just pay it for you. So you don't have to think about it. So, boom, that's another system. So that's a good question about, you know, do you use that money in the meantime, if you don't have to pay it for 12 months, but that could be another potential system. Alright. Emil, I broke your flow.

Emil:

Finishing up there. My favorite thing is when they audit your account and you have an excess balance and they send you like a check for a couple of hundred bucks and you're like, Ooh, it's like a Christmas bonus or something. Hanukkah bonus baby. For me,

Tom:

I think I might've mentioned this on another podcast. I like it, but it pisses me off. Cause I'm like, oh geez, what check am I missing? Yeah, it makes me think like, okay, this is great having this check. But I'm like, like honestly concerned that like I may have missed something in the mail because man, there's just so much junk mail as a real estate investor. The wholesalers that email you all kinds of things and like just general, getting a lot of mail. I just get really concerned that I see a check here. That's awesome. But what checks am I not seeing? Because they're buried in between a Serina and Lilly or whatever, a  catalog, that's like five pounds and 500 pages. Anyways, go ahead, please continue your answer.

Emil:

No, please continue your rant. I want to hear that.

Tom:

I got to build it up a little bit. I got to build it up a little bit.

Michael:

Tell us more about what other junk mail you received.

Tom:

We Buy Ugly Houses Houses. So many of those. Yeah. If there's any wholesalers listening, I want off your mailing lists.

Emil:

Okay. So the next one, this one's probably obvious a lot of people, setting up ACH auto payment from your property manager. So they collect your rent checks. I don't even know if any property managers do this, but like sending you a check in the mail. I imagine most people already set up you raising your hand, Michael. Cause do you do that?

Michael:

I used to get paper checks because my property manager was pretty old school and I said, okay, please, please, please, please, please, please, please. Can we do this and other way? Yeah, this is just not awesome anymore.

Emil:

I mean, so that should be like, even part of your PM property management vetting, right? Like, do you do, do you have an online portal where you ACH payments to me? So just make sure you set that up. If it's an option, most property managers in 2020, you will have that.

Emil:

Maybe Michael went to one that was established in 1925 or something.

Michael:

1833 

Tom:

Is this is the one in Alaska?

Michael:

No, it's actually properties that I've since sold, but out in Missouri kind, of rural Missouri. And so just to expand upon this a little bit is I think we've talked about in another episode, but my property manager, there was only willing to use a certain bank or the local bank branch wasn't anything that we had locally or that I use. So they would go to this bank deposit, the rent check and then would cut me a check to my bank. It was just a whole pain in the butt kind of thing. So what we've automated is now they'll deposit the rent check and then those rent checks we'll get bill paid from that bank to my local bank where I actually do my banking and then from there and get distributed. And so if you can automate as many of those processes as possible, it becomes much easier. So ACH transfer a potentially from multiple bank accounts to multiple bank accounts,

Tom:

Are you're hiding something Michael? I'm just kidding.

Michael:

I don’t know. You ever been to the Cayman islands?

Tom:

That's interesting that a local property manager had a preferred bank that they worked with and yeah, yeah.

Michael:

They're just like no Wells Fargo or B of A or union bank out there. So they're like, this is what we use. It's like cool, pony express it over to me.

Emil:

Carrier pigeon that's right. So the last one in this section, we recommend I do this. I have a separate bank account for all real estate stuff. It just makes things easier, especially come tax time. I also just like having it separate cause I try to treat real estate investing like a business to have its own checking account checking account. I use Chase, it's free to set up another checking account and it's just much easier to track things going in and out and it'll make your CPA's life easier. Do you guys do that as well?

Michael:

I was going to ask if you guys have separate accounts for every property?

Tom:

You know, it’s funny, I just got off a Roofstock Academy coaching session before we started recording this episode and we were just jumping into it with a member exactly on this topic. I don't, I use just one account for all properties. It's just, I don't know, easier. And I don't understand necessarily see the value. Not that it's a lot of overhead to have different bank accounts because you can set them up for free on so many different banks, but I just use one for all the rental properties and yourself, Michael,

Tom:

I have one account per LLC. And so I've got LLCs that own multiple properties. So all that was kind of funnel into that one. Yeah. What about you, Emil?

Emil?

I'm just one checking account where everything funnels into nice. Just for ease. Makes it easy.

Pierre:

What would be one of the benefits of setting up an individual bank account for each property?

Tom:

The benefit of setting up, if you were to set up a different bank account for each property, you know, what I like about it at a portfolio level is I just have a really tight grip on cashflow within that portfolio. If I was to do it at an individual property, man, it would be just so clear if I'm making money or losing money. You know, we have these assumptions that we use when we are acquiring properties, but ultimately, you know, when the rubber hits the road, you hope to hit those or even exceed them. But you know, by having an individual bank account for that property, you have a really immediate, transparent view into, is this property performing to how I was projecting it with the cashflow.

Michael:

I was going to say, it's a really good question Pierre. I'm glad you asked it. So because I only have the one bank account set up, I think I'm echoing Tom's viewpoints and opinions that, yeah, it's very easy to see what the actual numbers are, but I found that I just keep an Excel file, very detailed document of, Hey, anytime there's an expense on a given property, I log it the date, the expense, and then the dollar amount. And so that for me, suffices as a very similar type of scenario without the headache, I would argue of having 10 different property accounts searching through which one has what I've got it all in a file for me, that's worked really, really well over the years.

Emil:

And your property manager, a lot of them you'll have a portal where you'll be able to see all your rent, all the management fees they've taken, they handle a lot of the smaller maintenance. So you'll see those expenses as well. So you also have your property manager, you can lean on, that's going to keep track off a lot of this stuff. The only other thing to track outside of that would be your payments to your lender and then property taxes and insurance.

Michael:

There's all kinds of miscellaneous stuff that you'll likely have to pay outside of that. So like business licenses, if you're required in that state or LLC fees, franchise tax fees in, you know, wherever you live and wherever it's registered, just misc miscellaneous stuff. And I just attach that to each property and whatever it's paid for, you know, even might have to pay a contractor, something if they're that's outside the scope of what your property manager is doing. And so having a place to document all of that, I find it to be very, very, helpful.

Emil:

Yup. I also keep a detailed Excel. I don't do it every month. I do it like bi-annually.

Michael:

Do you do it when you incur the expense or you do it as a reconciliation, every, you know, twice a year,

Emil:

The latter I do reconciliation. It's probably not the best, but I don't know.

Pierre:

Yeah. I mean, we're talking about automation,

Emil:

We're telling you what to aim for. We're not necessarily saying we all do this all the time.

Michael:

Do, as I say, not as I do.

Emil:

Exactly. And you know, you don't have to be perfect in all these areas. We're giving people just different ideas, you know, what makes sense to automate.

Pierre:

Cool

Michael:

It’s one of those too like, we all have bad habits that we've fallen into over the years. And now in hindsight, we'd say, man, I wish I had formed this better habit. So here's what I would do differently. And it's so hard to break those bad habits. Like it's so hard.

Tom:

Getting the grove for sure.

Michael:

Yup. Very true.

Emil:

One other thing, we don't have it here, but I want to talk about it as well. This kind of goes back to acquisition automation, but, it goes back to the concept of paying yourself first. So a lot of us, you know, we have a full time job or we have W2, whatever it is, make sure you set up like an automatic percentage that every paycheck coming in is going towards your investing. So right now, like my process is 20% of every paycheck automatically gets taken out of my checking, put into a separate investing account. And I highly recommend people who are listening, check out a website called I will teach you to be rich by Ramit Satie he has this awesome guide. If you look up, I will teach you to be rich, personal finance guide. It shows you how to automate all this stuff, like having separate accounts for different things you're saving up for. I found that super easy and like a really good way to separate your money and like have kind of different categories and use them for separate things. So I have a separate investing savings account that automatically, you know, income coming in goes into that. So that's another automation thing I do.

Michael:

Piggybacking off that a meal I've also automated paying myself first from the rental amount every month. So when we do our analyses, we see, okay, we've got the mortgage payment, property taxes, all these other expenses that may or may not actually occur on a monthly basis, but we modeled them that way. So it makes the cash flow easier to understand. And so your property is going to collect rent. They're going to take their fee and are going to give you the rest. Well, now that's a huge chunk of change, but we've still got to pay some of these other expenses. And so we all have calculated on a monthly basis what our cash flow should be. And so I will automatically set up that deduction amount from my property bank account, going to my personal bank account, if I'm planning on using that cashflow for everyday life stuff. So if it's a hundred bucks a month, I just receive rent on the 10th or whatever of the month. And then I automatically have a hundred dollars transfer into my personal account. Everything else stays in the property account to then pay all those other expenses for. And at the end of the year, you had a good year. You might have some extra dollars left over and you can pay yourself again. Or if you had a bad year, you might need to put some additional money back into that. But it's a really easy way to just start collecting money from your properties without overdoing it.

Tom:

I like it. So the next operational system I'll jump on, has to do with documentation. So if you're an active investor, you will be regularly buying new properties. You will be regularly refinancing had a good episode, I guess it would be two weeks ago. Once this episode is launched on ways to take out equity, anywho, when you are going through that exercise, you're going to need the same documents again and again and again, you're going to need a copy of the current lease. You're gonna need a certificate of insurance. You're gonna need a sample mortgage payment. And what I like to do with this is to streamline this process is set up a folder structure that is secure. There's a couple of different platforms out there, Dropbox, maybe even Google drive, but you know, in a secure folder online, I'll have my relevant documents in there.And then I can use sharing functionality to give it specifically to my lender or specifically to my CPA. That way I'm not needing to constantly track down these documents that I'm going to need again and again and again, and I can safely share it with whoever needs it. So the main takeaway for this system, I guess you can call it that is, you know, don't sleep on it, just have that document structure set up a do it once and do it right and do it early and then have that available for whenever you go through one of these maneuvers, be it refinancing or taking on a new loan or going through tax time.

Michael:

It's so valuable. I know for my first property, I didn't have these systems really set up in place. I thought I did and then came tax time and I was like, Oh my God. So this is going to take so long to figure this out and go back and collect all these things. So, you know, it's one of those things. It's tough to know what you're looking for until you know what to look for. So ask somebody, ask, you know, ask your CPA, ask your tax professional. Hey, I'm investing in real estate. What things you're going to need from you at the end of the year, they're going to tell you, okay, we need your 1098. We're gonna need all your expenses, property tax, receipts, all these types of things. So that way you can start that ahead of time developing and building these good habits and systems. It makes it so much easier. Come tax time.

Emil:

I don't have anything else that neither does my mustache. Good job guys. Excellent.

Tom:

I actually thought of this while you were talking about it. So I love the concept of paying yourself first, right? And with paying yourself first, when you get your paycheck, it's pretty straight forward, right? You take the first 10%, 20%, whatever, and either save it or spend it. However, I like to think about this with your day. So paying yourself first, the first 10% of your day, how are you guys going to pay yourself first with the first 10% of your day? And you're not allowed to say surfing,

Emil:

I'll go one level up then and just say exercising. I think exercising for me has become as equally as important for my mental wellbeing for the day as it is physical. So for me, that's how I pay myself first to start the day, right?

Tom:

What are you doing for exercise?

Michael:

Surfing!

Emil:

I wish more surfing. Having a small child will put a dent in your surfing ability and it's summer, so the waves were a little slower. I will do. I'll either go for a run or I will do a combination of like pushups pull ups. Or I also use this thing called the seven minute workout app. It's literally a seven minute workout. I don't do long workouts. I don't like, I don't know. I used to spend more time working out, but for me, it's just a matter of like doing it almost daily to just start the day right. Whether it's seven minutes or 30 minutes.

Michael:

Classic Emil fashion, he stole my answer. But that's why I went first because you're going to try to take that out. So not surfing, but I like to do kite surfing and I also work out. Do you exercise in the morning? I find that getting my blood pumping helps kind of burn off that haziness in the morning. But since the meal took that already, I really liked journaling in the morning. Just even for a few minutes, a few paragraphs, just kind of what I'm thinking about. What's going on personally in my life and what my goals are. I read that book think and grow rich. And that reaffirm that journaling is a super powerful tool. I've always known it, but again, it's one of those bad habits that it's hard to break into if you're not used to doing it. So starting slow and just trying to get my thoughts out on paper outside of myself, I find it to be helpful and worthwhile. What about you Tom?

Tom:

So the first 10% of my day has gotten a lot earlier with a small child. So, you know, it's, it's now like the, you know, late five's early 6:00 AM is the first 10% of my day, but excellent partnership with my wife helping out. Well, she has the lion's share for sure, but on the extra early days, all right. I'm digressing. Okay. Going on a walk. So, I mean, I guess this is exercise. Sure. Why not? So getting the baby early morning, throwing him in a little jogger or the stroller walking around the street in the morning when like everything's still quiet and the sun's just creeping up over the Hills and the fog is kind of lifting journal in my head. I dunno. So like walking around in the early morning when nothing else is going on, I know that's a fine first 10% of the day way to pay yourself first.

Michael:

As the only person without a baby, just a PSA, you know, you probably shouldn't throw babies into or at anything whether it be a jogger or cribs.

Tom:

Oh, they're, they're pretty durable, but yeah, for sure,

Emil:

They are very durable.

Pierre:

Antifragile.

Emil:

Antifragile.

Tom:

Antifragile! Yes, they get stronger with it. Yeah. How about yourself Pierre? Your first 10% of the day?

Pierre:

I like to save my working out for the end of the day so I can have a break between my work day and the evening. So the morning is a good time for me to read.

Emil:

I used to read a lot in the morning, baby killed that.

Tom:

Got anything good? Any good books going?

Pierre:

I'm a little bit behind with the book club, but I'm reading the book that Michael chose for the RSA book club, Never Split the Difference.

Emil:

Great book.

Pierre:

And this morning I read the ebook that email sent me and the article on how to write better titles for the podcast.

Emil:

Got to keep the audience clicking.

Michael:

Yeah, that's great. Speaking of our audience, if anybody has any thoughts, suggestions, insights, hot topics they want to hear about. Please feel free to let us know at [email protected], [email protected], or [email protected].

Emil:

Or hit us up on Twitter. I'm @emilshour, Michael you're @albaummichael. and Tom you are.

Tom:

I am not positive… I’m @tscnheido

Michael:

Freaky deaky Tom

Tom:

Yea, created like whatever, 15 years ago, something like that.

Emil:

I like it.

Michael:

Skater dude, 27 with an eight.

Tom:

Exactly. Awesome guys. Well, thank you so much for listening today. To our episode, we hope that you got some value out of it. If you liked it, please don't be shy. Please rate us. Please subscribe as a meal set. And like Michael and Emil said, reach out to us. We love to hear your feedback on future content to do and to keep driving. So, alright, happy investing.

Emil:

Happy, investing.

Michael:

Happy investing.

In this episode we have David Young from RCN Capital tell us all about the world of private lending: what it is, how it works, who might want to use it, where the money comes from and how it differs from traditional lending. 

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Transcript:

Tom:

Greetings and welcome to the remote real estate investor. In this episode, we're going to be talking about what investors should and need to know about private capital. We're connecting today with David Young of RCN capital to answer all of our questions. Alright, let's do it.

-Theme song-

Tom:

Awesome David. Well, first off, thank you so much for joining us. And, why don't we start by telling us a little bit about yourself.

David:

Thanks to Tom and Michael for having me, really appreciate the opportunity. Yeah. My name is David Young. I'm the director of business development with RCN capital. We are a direct private lender headquartered in South Windsor, Connecticut, just outside of Hartford. And we do lend nationwide. I'm actually located personally in Boston, remote to the office as are some of our employees. And my background is pretty diverse, prior to arriving at RCN where I got to RCN in 2014, the company started in 2010 in response to the previous financial crisis. If you will, now, we're certainly going through another challenging period, but if you go back to the 2007/2008/2009 nine meltdown RCN was started in response to that, and I'll get to that a little bit more.

So my background is spreads across a variety of things. I graduated from the United States military Academy. At West point, I was in the army active for about seven and a half years upon leaving the service. I took on a variety of roles, many of which were oriented around sales business development. I had executive level positions as a division vice president as well. I also ran a small business in central Massachusetts as a VP running a outbound and inbound call center and a variety of other roles spread across a lot of different types of skills and levels of experience that cover a lot of different ranges of medical, home improvement financing, and several others as well.

Tom:

All right, that's great David, let's jump right into the meat of questions around private lending. So a lot of remote investors, they like to invest with debt, lot of great benefits to investing with debt. And there's this decision right of private capital versus more traditional loans that you would get in your personal home mortgage. Why don't you break down some of the differences between private capital and a more traditional mortgage?

David:

Sure. So, you know, the more traditional route of a mortgage say going to a bank of America or Wells Fargo and applying for your typical 30 year mortgage is certainly an option and might be the best option for somebody depending on their particular situation. In fact, private lending essentially exists and evolves in response to those that can't be served by the traditional sector. So it's filling a gap that isn't being met in the traditional sense. So, you know, a traditional mortgage may be suitable if there are no issues to consider in terms of, you know, damaged credit, if there's not an extreme or even a high sense of urgency in terms of time and being able to complete a transaction in a very rapid amount of time, perhaps if there is no issues with, you know, citizenship, you know, private lending, a lot of the firms such as ours will work with foreign nationals, you know, with traditional mortgages or other, you know, hoops, if you will, that you have to jump through.

There's a lot more that goes into the underwriting with a traditional mortgage in terms of looking at income verification, tax returns and so forth. So, but again, it may be the right route. Generally, the rates are going to be lower and a traditional mortgage, as you see right now, 30 year mortgages are somewhere in the low to mid threes and on private lending, you're not going to be able to get that low, but that's because you're being represented in a different asset class and there's different variables that come into play. So why would somebody pursue a private loan in terms of making a real estate transaction? That could be a variety of reasons. Let's just look at a typical fix and flip, if you will. Timing might be very critical. Somebody might be analyzing an asset that they want to move on and they need to line up financing on that. There may be competition for that particular asset, perhaps there is perhaps there isn't, but either way investors tend to feel a sense of urgency when they identify something that they want to acquire and then renovate and eventually flip. So private lending, generally speaking is going to give you a much faster response time. In other words, you can link up private lenders, such as RCN capital and fairly quickly get through the process and get approved and actually get funded on that loan. Why? Well, there's generally a lot less that goes into the underwriting and there's general early, a lot less in terms of a regulatory issues and traditional banks, you know, going back to the bank of America in order to administer and process your typical mortgage, there's a lot of regulation involved.

There's a lot of issues that they have to consider. They're not necessarily the ones that are thrusting that upon you. Those are things that they must comply with, private lending, not as much, for example, we're not at least in RCN and many others as well. There's no check on tax returns. There's no check on income verification in terms of you don't necessarily have to have a W2 type wage job in order to be approved. And it certainly wouldn't hurt, but you don't necessarily have to have that private lending, particularly if we look at hard money fix and flip, you know, residential real estate where RCN focuses on non owner occupied residential it's asset based. So the focus is on the asset itself. And then other key factors tend to be the experience of the borrower. So how many transactions have the borrower has the borrower completed? We tend to look at the last, most recent 36 months by verifying if their name is on entity that completed a transaction.

And then there's going to be a look at other things like credit score. But for example, in private lending, there are requirements or expectations on a credit score typically lower. In fact, maybe even much lower than in traditional mortgages case in point right now, just in response to the COVID crisis. In some tightening of lending standards across the board, both traditional and private lending, a lot of your traditional banks have really ratcheted up their standards and expectations. Credit score minimums have gone way up liquidity requirements, et cetera, that in and of itself is going to bump a lot of people over to the private lending space and private lending. Currently at RCN Capital, the minimum FICO is 650. If you look across all of our product categories, you're not going to find that at a Wells Fargo. So speed, credit requirements, the ability to be perhaps a little bit more creative with an approach and how to go about getting something done and being rewarded much, much more so for the asset itself. So is this a good deal that you're going for? You know, that's going to be a very high concern to a private lender. Yeah, nd the experience that you bring to the table. So do you know what you're doing? Do you have the experience, do you have the liquidity to accomplish it? That is what really matters as opposed to what, you know, a Wells Fargo or bank of America is forced to look at.

Michael:

That's a really great point. Yeah, I was just going to ask you, you mentioned it in passing hard money is private capital and hard money. Are those two synonymous or do they really differ?

David:

Yeah, that's a great question. Now again, I've been with RCN since 2014. Initially I wasn't directly on the real estate side, but a lot has changed as RCN originated in 2010. What private money consisted of in hard money was what a lot of people I hear now refer to as you know, kind of the old school where, you know, you know, a guy who might know a guy who could get you alone. And then when we say asset based, I mean, it's, there may, there may not even have been, and this still exists today, by the way, we compete with this and RCN where leverage, LTVs loan to values. If you will, to keep it simple, tend to be lower and you're more old school had money, maybe even no doc may not have require barely any documentation. And certainly not necessarily an appraisal or even running a credit score and for the purposes of just adding it to a file. So now when you kind of, it's almost, you know, a point of contention or even something that people joke with each other about in the industry where, you know, hard money has really evolved into a much bigger and more sophisticated ecosystem where more money comes in, where there's more requirements like just looking at the FICO, FICO requirements, FICO minimums. A lot of that is tied to where the capital is originating from to fund these loans.

So there's institutional capital that helps. And not in all cases, there are funds. Well, there are private investors that buy loans directly, but institutional capital tends to come with certain expectations. The FICO is one of those where you have to check the box. If you will, the old school, if you will hide money, probably shrug their shoulders at that. Um, they're not concerned with that. They're not necessarily concerned with an appraisal. They want to see the asset and they're going to protect themselves by, in all likelihood having a lower level of leverage, lower LTV we had prior to COVID essentially the whole private lending, hard money space fix and flip space was getting, you know, leverages, you know, up to 90% or even higher with some particular vendors out there where you were getting 90% of LTV, plus a hundred percent of the rehab funding to close a loan on a flip, as an example, someone doing your so-called old school, hard money. I mean, I haven't heard of anybody doing that high of leverage in that space, but it's still out there. There's those people that, whether it's a lot of times it's speed, somebody will close alone very, very quickly with minimal underwriting work done aside from looking at the asset itself. So there's still a market for that, but there's a lot to your question, a lot of crossover or kind of a lot of blending they're one and the same in some ways. And then they separate from each other as well in different segments of the marketplace, depending on who you ask, different people have different interpretations as well.

Tom:

One piece you touched on is room for, I don’t know is creativity is the right word, but there's a little bit more variability in the different products in that it's just, there's way less regulation I'd say on it. Would you mind touching on that on some of the different products that, and maybe one of the more popular products specifically as a remote investor that you guys originate?

David:

Yeah. One of the ones that really took off, uh, heading into COVID and we've now just activated it again is our 30 year long term rental. Okay. So this is a 30 year fixed, fully amortized loan, much like what many people are familiar with with your traditional 30 year mortgage that we talked about a couple of minutes ago. So 30 year fixed non owner occupied residential. We have that available on one to four units. This really came into play. It. This really took off like a rocket, uh, in March of roughly in the spring of 2019. I don't remember the exact date when we launched it, to be honest with you up to COVID. This thing was already approaching 40% of our originations at that point. And it gives people a lot of flexibility.

We could look at portfolios of assets, so you'd have investors out there with say they had 10 single family residences and they had 10 different financing situations on each one. Maybe two of them were with a particular guy. I know a guy who knows a guy who gave them a bridge loan a couple of years ago. Maybe one of them was with someone else. And there was just all spread out everywhere. The 30 year longterm rental, you could take a whole portfolio and roll it into one transaction and get that entire portfolio into a 30 year fixed fully amortized mortgage. At that time, back in February, you know, rates were getting as low as four 449 on that, which is very low for non owner occupied resi. So you had that, you had the ability to look at those assets. So you may have one particular, if we stick with that example, one house perhaps was not cash flowing as strongly as the others. You weren't necessarily penalized for that. You weren't necessarily told that that one couldn't join the party, so to speak. That one was weighed against the portfolio as a whole. So we could look at the whole portfolio, also look at the investors level of experience, their level of liquidity and take all of that into account to make a decision. We have an executive committee at RCN Capital that looks in each and every transaction and they can exhibit, you know, a certain amount of creativity, if you will, at any point in time to see if the transaction truly makes sense, as opposed to trying to run that through a large bank, traditional bank could potentially be an entirely different experience.

Michael:

That's so cool. David, it's something I talk a lot about with students in the Academy about portfolio loans. It's something that I've used on the commercial side of things, and I think it's the best thing since sliced bread. So I've always thought that they existed for single families, but that's great to hear that they do indeed. So anybody listening that have spoken to me within the Academy about getting, go for portfolio loan, go call David Young at RCN Capital.

Tom:

in coming up with what the rates are. Is there a little bit of a discount for larger pools, larger portfolios, or how does that typically work?

David:

Yeah, that's a great question. So we have generally, you'll see, uh, and right now, as listeners are hearing this, uh, allow me to emphasize if I can, that things are changing very quickly. So in terms of pricing as a whole rates points and whatnot, we saw a very high level of liquidity is kind of sloshing around the system, heading into a COVID and then things really tightening up seizing up even, and then starting to now loosen up. We've seen changes on almost a daily basis over the last couple of weeks here at RCN capital. So the way those rates are determined, you know, in terms of the price at anything is which is, you know, in large part driven by supply and demand as things seized up and there was less or no liquidity for this paper and the secondary market, it became very difficult to price it, you know, because we didn't know what it was trading at when there was a lot more trading volume and activity on this paper and the secondary. Then you could determine pricing a lot more clearly.

Furthermore, you had a lot more of the competitors actually active and lending in the last couple of months, people have pulled back. So we don't necessarily know what this company over here is doing because they've completely ceased lending at this current time. So a lot of that is supply and demand driven, how much volume and activity is there for this paper behind the scenes. And then that results in, you know, subsequent pricing that the retail sees factors that we look at from an underwriting standpoint, and to determine kind of how to bracket that again, back to experience and also the size of the loan. So generally speaking again, pre and post and kind of while we're still with COVID here for the time being, it's a little different, but generally speaking, more experience and a higher loan value dollar absolute dollar value would generally lead to better pricing to the retail client. And through our wholesale channels. My role primarily is with our correspondents that work on our private lending platform, other hard money lenders, private lenders out there in the community that are looking to leverage our infrastructure to grow. We also work in that capacity as well, but the pricing, the borrower's experience and the size of the loan, we have systems in place. Whereas the loan exceeds a certain amount in dollar terms, you may get some relief in terms of the yield. There may be some relief in terms of the origination, but those would be the two main things experienced in the loan size.

Tom:

Got it. And for the kind of ongoing ownership, you know, so there's a secondary market where you guys are selling the mortgages that you guys originate from the experience of the person who was getting their loan originated, or do you guys ongoing service them after you, it, of the loan,

David:

Yeah, depending on the product, but actually RCN Capital. What we have here is, is pretty unique in the industry. And I leveraged this a lot with our wholesale partners when they're looking to find somebody to work with in terms of a capital partners that we have essentially everything in house now, right now, a lot of folks are remote. In fact, almost everybody is given the scenario, but if you'd look past that for the current situation, when we talk about servicing the loans, yes, we have our own servicing team at RCN capital. A lot of lenders in this space are set up with a situation where they're outsourcing that, which is fine. That's a decision. A lot of people make. We actually did that ourselves for a certain amount of time and decided to internalize that and make that organic to RCN, to place that amount of value on the customer experience.

So yes, we're doing that, not all do that, that also holds true for another good example is our legal team. A lot of these transactions involve, you know, somebody originating and kind of setting the table if you will. And then the actual closing of the loan document prep and so forth, working with attorneys, which that can be intimidating and frustrating as a whole to a lot of people that is sent out to some other entity to conduct that business where we have that internally. So we have that an entire legal staff. That's all they do all day long is work on legal issues, closing stock preps, et cetera. We have our accounting team, our marketing team and everything actually in house in RCN. And that really helps as well. Not only does that help the retail client by providing them, they get a loan from us that they're to get an exceptional level of service, everything under our control. If there's a problem, we identify it, we fix it. But also with our, you know, our B to B or our wholesale partners, if you will, other lenders brokers, when they choose to work with us, they have that entire team, all organic to RCN capital to support them and help them grow their business by using our infrastructure and platform.

Michael:

Great. David kind of a specific question for you around some of our CMS product, but anytime someone's using hard money, they want to get out of it as soon as possible because it's typically more expensive than traditional lending. So do you guys have any type of prepayment penalties that would prevent someone from getting out or is that really too specific of a question it's kind of on an ad hoc basis based on the product?

David:

No, that's a great question. It depends on the product. I'll walk you through each of them here briefly. So on our long-term rental. Yes, we do encourage investors to be, you know, fully aware and committed to the asset for that exact purpose. You know, long-term rental and holding of that asset. There is a five, four, three, two, one step down. In other words, you can choose, you know, at what level you are, what time period and what penalty would be associated with that if you were to try and refinance out of that loan. So, you know, obviously that's a big decision to make that you have to be aware of that on our midterm product, which actually now is presenting all kinds of interesting opportunities for investors. It's a two years of interest only we call it a two plus one and already has built in an option to extend for a year. We have this available on one to four units, multifamily five-plus and mixed use, as long as it's at least 51% residential by square footage. On that product, there's a six month prepay penalty.

So if you think it through, if you were to enter into that product to interest only for two years, perhaps you have an asset that you do want to rent, but you're not entirely sure you could change your mind. You may try to sell it. You make, you know, you may rent it for a year. And then at that point, you may want the flexibility to see if you want to do something different with it. The two plus one with only a six month prepay gives you that exact flexibility because after six months you could theoretically enter into a new transaction to get out of that one without a penalty applying. So there's that on the short term, I won't get into specifics on that. It can be on a case by case basis, but there's nothing to dissuade you from completing your project as quickly as possible. You know, as a lender in particularly with the yield component, you know, there's origination, which are the economics kind of front loaded to the front of the transaction.

And then there's the yield component in terms of collecting the actual payments as each month goes by. So there can be challenges that a lender or a transaction ends up being very short. There wasn't much time to collect yield, but again, we don't want transactions that drag out for long periods of time and have to ultimately potentially approach modification as well. So on a 12 month, you know, a flip, if you will, our transactions show that, you know, investors are not penalized for, you know, being expeditious and efficient with their work. And we also have incentives to, you know, not, uh, enable them or make them feel like they should consider trying to extend it or go past a certain point. We try and we want to position them so that the project is done efficiently. According to the data that we have that shows, you know, what success looks like.

Michael:

Awesome. Kind of taking a step back and looking more high level at private lenders. I mean, you touched on it briefly, but who where's this money coming from to fund some of these loans?

David:

That's a great question. When you let's compare it to conventional, you know, just here in COVID, this, this could go in a lot of different directions, but in COVID what we saw was the federal reserve came in and really just threw the kitchen sink at everything essentially. I mean, they've, they've done things that are truly unprecedented that that's cannot be overstated, but one of the things they did is something they've done before. They certainly did it as part of so-called QE, quantitative easing since the 2009 crisis, which was to come in and provide a backstop to mortgage backed securities MBS. Now, even just saying that they're going to do that can have a huge effect regardless of how many they ultimately buy, but those are the traditional mortgages that are originated from, you know, you know, Fannie Freddie type stuff from a bank of America type of transaction that are sliced and diced into exotic securities, and then sold the fed comes in and says, look, we'll back up those, you know, we're gonna, we got your back on that, that helped that particular sector kind of spring back from the depths of the COVID crisis, if you will.

And private lending, you know, we don't have such a backstop from the government. So this money is coming from, you know, private capital sources. However, there's been a big evolution, you know, for a period of time, a lot of this was from a private, you know, private investors, private investors would form funds. So you might form a fund with a group of investors that has, you know, I don't know, $20 million together. And then that funds purposes to invest in these various private lending transactions in whatever area that they choose to focus on. So they're out there lending and recycling that cash and doing their thing. And that's with, you know, that amount of money that they've been able to put together. There's also one off transactions that occur when an originator may take a loan and say, look, here's a loan. We have, do you want to fund this? So they take this loan, it's a 500 K transaction. They present it to that particular investor and they get a yes or no answer. And it's funded that way. RCN can help in those scenarios where you run out of capital and then you can come and jump on our platform. If you happen to be in one of those positions, any of the listeners out there. And then as the industry grew, you know, you have yields here that are pretty juicy compared to traditional. You look right now. Uh, if I pulled it up, I know from looking recently, uh, the 10 year note is what around 0.7%. So you're lining the government money for 10 years, for .7% annualized.

A lot of institutions are, you know, they have to do that, but if you can lend as an institution into the private lending sector for loans that are collateralized by real estate and get five, I don't know, I'm just throwing these numbers out there. A lot of pricing is bounced around, I don't know, five, 6% versus less than one on government notes, government bonds. Then that's certainly a decision that you might want to take a look at. So a lot of that, I think yield differential investor demands for yield, the thirst for yield. You've had interest rates just being destroyed down to nothing. You have negative interest rates in some parts of the world. A lot of folks speculate, you know, rates could even be driven negative here in the United States. So pension funds, you know, other people that manage money institutions, there's no yield. It's very difficult to get yield secured and then incomes private lending, where you have these loans that are backed by hard assets. And as the ecosystem grows, becomes more mature. You have more underwriting standards, you have more eyes looking at it. You have more ability theoretically to, uh, make better loans, uh, minimize the faults and kind of feed the whole beast, if you will. Institutions look and they say, Hey, that's pretty juicy yield. I wouldn't mind getting some of that. And then you have that type of money coming in institutional level. So say, you know, you have funds, people put funds together, you have private investors to do one off transactions and then institutional capital.

Michael:

Super great description.

Tom:

That's a great overview. I'd love to learn a little bit more about the different types of customers and the different flavors of customers that use private capital. So there's individual investors, perhaps there's syndications, I'd love just to learn a little bit more of the different kinds of avatars or profiles of people that use private capital.

David:

Right, yeah. So back to our discussion on experience. So when RCN creates products and underwriting standards, generally speaking, that experience factor is huge. So we do lend to people that have no experience. In many cases, those are, you know, kind of a mom and pop, maybe, you know, an individual that's looking to get involved with their first flip transaction. And that person might be someone that could come from a variety of backgrounds. It may be somebody that was working with someone else on these transactions actually executing the labor, the work, you know, watching a project, go from A to Z with their own eyes, and then deciding that they want to dive in on their own. Maybe it's a husband and wife, couple that are, you know, have a little side hustle going on. So you've got that. You certainly have the mom and pops. Then you have the call it a small business. If you will, maybe that tends to have multiple projects going on at one time, they may have their own crew in terms of contractors and a more sophisticated setup in terms of having a, you know, a playbook on exactly how to execute a transaction and already having the resources lined up or even on their own staff, you have that.

And then you have even bigger organizations that are doing this in big numbers. You know, maybe they may have 20, 30, 40 transactions going on at any given time. They may, you know, they talk in terms of flips. In many cases, they may flip a couple of hundred houses in a given year. You have that as well. We're also seeing, you know, more activity and more interest in the multifamily space. So multifamily five-plus units, you know, these are small balance apartments. Generally. I know in Boston and other areas on the East, you see these spread throughout the communities, a building that may have eight, 10, 12, 16 units. You know, there's estimates, there's about 10 million of these out there in the country. And those are starting to get more activity as well. And for those, you know, that's probably a project that's going to require more than just a couple of guys working together on a side gig and some more sophistication. So you see a variety of different flavors out there. You see people that have made this, their, their living. This is how they make a living. This is their job. This is their career. This is everything. So we've seen different variations.

Tom:

Awesome David, I think people hear private capital or private money tossed around a lot, like we were saying before, and you've given us such a great overview and background of kind of the institutional side of things, if you will, but from a private lending perspective, if I'm looking for money and I happen to know someone that has some extra, could I just go ask them to lend it to me and I think work out some kind of agreement with them, or do I have to go through maybe the more traditional channels of private money?

David:

Yeah. I mean, we have actually specific to my role. We have investors lenders, if you will, that were doing exactly that. Or maybe they may even still do that, where they are providing kind of one off direct transactions between themselves and an individual investor out there looking to flip a house or what have you. So to your question, can you do that? I mean, there's nothing that I could say that's could literally stop somebody from doing that. There may be other things to take into consideration in terms of making sure everything is within compliance. I mean, the compliance is certainly looser on the private lending side than it is on traditional, but you want to make sure that you're working with, you know, it may be worth considering to take a look at working with an established organization or entity. That's been doing this to ensure that all documentation is done correctly, to ensure that all procedures are done.

They'd probably be, it's in their vested interest to help you, help you to look at the project and make sure it makes sense. And there's ROI available there for you to capture, obviously to be able to pay back, pay them back and make the monthly payments. So I, yes, you can still, you know, there's nothing stopping someone from, I suppose, from approaching an individual saying, Hey, do you think you could give me X amount of flip this house? And that's kind of how it all got going, you know, looking at, you know, maintain a certain leverage level minimum or no doc, you know, obviously securing with a lien, putting that money out, collecting interest, only getting it paid off and then getting the balance back, you know, your principal balance back. So there's nothing per se stopping you. I think there's other things to consider in terms of, you know, working with an established entity that, you know, has a strong reputation has done this before, and they may have a lot more options. You know, you're kind of guy on the corner of the street, if you will, may have certain options that might fit certain people, but you go to a lender such as RCN Capital, and there may be more choices there for you that might be a better fit to your situation after you take a complete and thorough look.

Michael:

Okay, great.

Tom:

That's awesome. I think we're, we're getting close to covering all the questions we have. I guess another question, practical question is geographic footprint. So do you guys have any limitations on where you originate loans?

David:

Yeah, that's an excellent question. Anyone that's curious, it's a better description than here in me, you know, yap about it would be to go to rcncapital.com and see if I can get some traffic to our website. Here are capital.com and scroll down to the bottom. You'll see the map and that will show, but yeah, we can originate and close loans in the entire country everywhere except for a few States, Alaska, Oregon, Nevada, the Dakotas, Minnesota, Vermont. So the bulk of where the business is and where the volume is not nothing against those other locations where we're not currently able to do that. We have that covered. So any investor that is looking to do whether it's activity locally, or perhaps even dabble in other areas, you know, another benefit of an established entity such as RCN capital is the fact that we have that footprint nationally already. So we're already established in those areas. If you have something in Tennessee, great, but you may also have something in Oklahoma, we can do both of them. So we've got a pretty well covered.

Tom:

My last question has to do with a product that I'm not that familiar with, but very interested. I'm just not sure I'm interested. If you guys carry it like a revolving credit where you can add properties in and out of a facility, do you guys offer any type of products like that? And this is a self serving question. Just something that I've heard about and just interested in learning more about,

David:

Yeah. I mean, what I can say on that and thank you for that. It is a great question for investors with a certain level of experience, you know, a strong level of experience. If they get connected to RCN Capital and a loan officer, they can certainly take a look at pursuing what we would call a line of line of credit in the precise definition of that is probably not the best description, but we, it comes up a lot in the, in that, in those terms. And people use that to describe it. It's not exactly what it is, but we could potentially consider and look at that for someone with a certain amount of experience in the sector and has that documented and demonstrated. And what that could look at like is just use a million bucks to keep it simple. Perhaps someone being granted exposure of a million dollars every 12 month period, every annual designated period at certain terms. And in that case, they're, you know, why would it benefit them? Why would they care about that? It could be improvements in terms of speed and efficiency. If the borrower's already underwritten, ie. the entity, you know, on these short term loans in particular can only lend to a legal entity. So if that entity and the owners of it are already underwritten, then that's all locked and loaded. And now you're presenting each asset as you identify it and decide to move on it into the mix from an underwriting standpoint. So you still have to follow procedure, you know, appraisals and whatnot, but you've got some of the things out of the way to expedite the process and make it more efficient and make it a cleaner experience for your high volume, high experience clients. And that also would take into account. You may be able to add more fuel to the more logs on the fire in terms of supporting your own case, by adding in, like, if you have other things that contribute to your liquid net worth, you could provide that to perhaps support your case. If you're trying to obtain a certain amount of exposure that you're granted annually, you could look at doing things like that on.

Michael:

Tom you gotta get on that.

Tom:

I know. Yeah, definitely.

David:

It sounds like, Tom was thinking about that one,

Tom:

For sure. Yeah. Okay Michael, do you have any other questions?

Michael:

I think that's it for me that this has been awesome.

Tom:

David, this is great. Yeah. So we're going to end this David with a couple of what we call quick fire questions, and these are just general investing philosophy. It's great having smart guests, such as yourself, come on the show and just love your thoughts on this either or type of question. So are you ready to do it?

David:

I'm ready unless you got a bunch of trick ones in there.

Tom:

All straight forward ones. All right. So consolidation or diversification.

David:

You want me to give a quick answer?

Speaker 4:

All quick answers, all quick answers. Yes. You can say both. I'll always...

Speaker 1:

I’ll say both, I always tend to, when I, if I may, when I identify a trend, I tend to favor something. If it depended on my belief in it, I tend to consolidate, I'll give you an example, crypto. I can consolidate Bitcoin. I don't need to mess around with the others, but in other scenarios, I might favor diversification.

Tom

I think a good way to say that is either shallow and wide or deep and narrow.

David:

Yeah.

Tom:

Deep and narrow, I like it. High property taxes or high income taxes?

David:

Neither

Michael:

That’s the best answer we’ve had yet.

Tom:

High rent growth or low vacancy?

David:

Probably say low vacancy. On that type of thing, I like to play it more safe.

Tom:

Yup. Yup. Cashflow or appreciation?

David:

I'm going to say cashflow. Cause I look at real estate as the primary benefit to me is a hedge against the inevitable destruction of your purchasing power over time. So I feel like that will happen when a hired asset, if it's chosen properly. So I'll go for the cashflow. If you pinned the two against each other.

Tom:

Debt or equity?

David:  

From the standpoint of real estate, debt.

Tom:

Love it. Single family or multifamily?

David:

Tough to go against SFR right now.

Tom:

I like it. Alright. Last couple of questions. Turn key or massive project?

David:

How cheap did you get it? Being realistic, turnkey. You know, assessing my own situation.

Tom:

Yeah. Midnight oil or early bird worm?

David:

Early bird worm

Tom:

Text message or email?

David:

Neither. No, I'm kidding. I'm either, probably either.

Tom:

Alright. And the last one kind of an off the wall, olive oil or butter?

David:

Well, I do like that butter that is allegedly made with olive oil. Tried that on a steak and that worked out pretty well, but..

Tom:

I know what you're talking about.

David:

Yeah. It's olive oil or butter with olive oil. I'm not sure what brand it was, but I tend to use olive oil fairly consistently. So I have to be true to myself and to you and this excellent show we’re on.

Tom:

Awesome. Well, well, that's it. You made it through the quickfire questions. Want to give you a chance to yeah. Where can people find you get a hold of you and get ahold of RCN?

David:

Folks can find the company at rcncapital.com, blue and white colors there. If you're Googling around looking for it, usually you'll find it. You can link up to myself. You could certainly shoot me an email if you'd like a first initial, last name [email protected]. You can hunt me down on LinkedIn as well. Love to make connections with folks and expand the network and learn from people. So those are probably the best ways to get ahold of me and the company.

Tom:

Awesome. David. Well, thank you so much for coming on.

Michael:

David. Thanks so much. This was great.

David:

Thanks guys. Really appreciate you having me and I'd love to do it again. Appreciate it. Thanks.  

Speaker 1:

Thanks again to David Young for answering our questions. Today's episode was brought to you by Roofstock Academy and we're running a special promotion right now. For a limited time you can receive a $100 discount with the promo code JULY4. With Roofstock Academy we have all these benefits: coaching, on demand lectures, the tools, the SFR paybook, on and on, but the Roofstock Marketplace credits just got that much sweeter. So initially it was a $750 credit when you buy, now it is a $2500 credit. So you buy Roofstock Academy and for your next 5 transactions you will $500 back at the close of your transaction. Happy Investing!   

In this Episode Emil, Michael and Tom discuss the pros and cons of the HELOC, cash-out-refi, 1031 exchange and buy and sell strategies.

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Transcript:

Emil:

Hey everyone. Welcome back to another episode of The Remote Real Estate Investor. My name is Emil Shour, and today I am joined by my lovely co-hosts Michael Albaum and Tom Schneider. And today we're going to be talking about how you can use trapped equity to actually help you scale your portfolio. So let's dive into this one.

Tom:

Before we get into it, I want to give you a heads up on a promotion that we're running right now. So with Roofstock Academy, we have always benefits coaching on demand lectures, the tools, our SFR playbook, on and on, but the Roofstock marketplace credit's just got that much sweeter. So initially it was a $750 credit when you buy now it's a $2,500 credit. So you buy Roofstock Academy and for your next five transactions with no time limit, you're going to get $500 back at the close of your transaction.

Michael:

That's right, Tom. Thanks so much for sharing. And for all of our listeners, we're actually giving out a hundred dollar off coupon for an enrollment into the Rootstock Academy. So go ahead and use JULY4 at checkout and that's JULY and the number 4, at check out for a hundred dollars off every sock Academy enrollment. And that coupon code is good through July 4th of 2020.

Tom:

Take advantage of today. Happy investing. Awesome.

Emil:

Thanks Tom. All right, guys. So we're going to be talking about how to tap into trap equity to help you scale your portfolio before we get into the different ways. Why do you guys even think this is an important topic for investors to know about?

Tom:

This is gasoline to growing your portfolio? You know, buying a rental property is expensive, right? You know, it's not as expensive of buying an apartment complex, but once you start appreciating, having these properties appreciate and building equity, to being able to flip that appreciation into new rentals, honestly like that's really like a catalyst for growing your portfolio so much faster than needing to, you know, come up with all the new cash all at once.

Michael:

Totally, totally agree, Tom, just to echo and piggyback off that if you're taking a hundred dollars a month cashflow, just for sake of discussion from a property that's 1200 bucks a year, that's several years of saving that cash flow before you're ready for your next down payment.So being able to tap into the appreciation side of things, which tends to grow a lot faster and appreciating markets than the cashflow does, can be a really great way to just leverage into additional rentals. Just like Tom said. So hopefully I added some value there and didn't just say the same thing in different words, but I totally agree.

Emil:

It's funny because we're all I think in the same boat of we're all cashflow investors and we don't want to bank on appreciation, but when it does happen, there's all these benefits you can take advantage of to help you grow, right? Like most people probably think, Oh, I have to keep saving from my W2 or whatever you're doing to save up for properties. But there's actually a lot of different ways you can come up with the funds to keep acquiring new rental properties.

Michael:

Absolutely. It can come from a number of different buckets.

Emil:

Yep.

Tom:

Something that's, similar to us three is where we're not necessarily need to use the returns we're making on our investment properties right now where I think we both think of it, of the cashflow reinvest that dividends into new properties, as well as the appreciation reinvest that appreciation is new properties. And today's episode is just about that ladder of return and how to actually actualize that to investing in new properties with the appreciation.

Emil:

Yep. All right. So now let's get into the specifics of how you can actually tap into that trapped equity. And we're going to be highlighting four different strategies. You can use first one being HELOC or home equity line of credit. Second one is a cash out refinance. Third is a 10 31 exchange and the last one is selling a property and using those funds to buy a new property.

Michael:

Yeah, absolutely Emil. So, a HELOC, like you said, as a home equity line of credit and it's something that I'm super excited about. It's something I've used a lot. It's a very, very powerful tool in the real estate arena. So basically what it is is it's a line of credit. Think of it like a credit card that gets established on the equity in your home. So if you've got a primary mortgage, call it a hundred thousand dollars and you've got a hundred thousand dollars of equity in the property, a lender might give you 80% or 70% of the equity in a line of credit, which means they might give you a 70,000 or an $80,000 line of credit. And what it is, it's basically just like I said, a credit card. And so you actually get a check book in the mail and if you need access to that $70,000, you can write yourself a check and you'll have $70,000 as soon as that check, clears your bank. So this can be really great. That can be used as a down payment that can be used to go buy a new car that can be used for home improvements. I definitely wouldn't recommend the car thing because that's a depreciating asset. It doesn't give you any kind of return on your money, but it's just a really, really, really flexible way to have access to quick cash. And then really nice thing about a HELOC is that you're only paying on the balance if it's outstanding. So let's say I set up this HELOC for $70,000 day one. I don't use any, I just have the line sitting there. There's a closing cost associated with setting that lineup, but it's usually pretty minimal, but so now I have access to that $70,000 and I can use it in any increment that I'd like. So let's say next week I want to buy a property. And $20,000 is my down payment. I'll write myself a self, a check for 20 grand close on that new property. Now I'm off to the races. And now let's say a month from now, I get a bonus for $20,000 at my job. And I decide that I want to pay back that line of credit. I can make a $20,000 payment back to the line of credit. And now my outstanding balance is zero, which means I have no monthly payments on that line of credit. The other nice thing about HELOCs is that they're typically interest only payments. So on that $20,000 example, I just gave that I had outstanding. I'd be making interest only payments, which as we all know are going to be significantly smaller than a fully amortized principle and interest payments, some important things to note about HELOCs and their interest only payments, typically they are going to be variable interest rates, which means they're going to fluctuate from month to month. So if I have a 5% interest rate this month, I might be at five and a half or six or 7% month next month. So we just need to be aware of that. But again, if we look at the math and just go back to our $20,000 example, the difference between a 5% interest rate and a 7% interest rate in terms of interest, only payments on a monthly basis is pretty negligible. So I, you know, when I first started using a HELOC and I'll get into it at the end, I thought, wow, the interest rate is 6%. That's crazy. I can go borrow money at 4%. Why would anyone use this, this HELOC thing at 6%? But again, as it comes back to the interest only payment, it's a so much, it's often a much more affordable and digestible payment amount to be allowing you to do things with that money that you might not ordinarily be able to do. So that was a super long winded answer. I know Tom thoughts, feedbacks opinion, additions?

Tom :

Love a HELOC. It's like basically a bazooka in your back pocket. Like if you need to like a bunch of cash real quick, like let's say a great deal comes up and you're like cash of like actual, you know, liquid position is low. If you have an open HELOC, you can quickly tap into that and use it. Like for opportunistically, the rates that are available now are pretty incredible. I have one through right now from third federal. Yep. That's the name of it? And it is like hovering like mid two per two point somewhere in the middle. Holy smokes. I'm looking at my app right now and it's unreal and it's, you know, I jumped into it without knowing a little bit about it, but kind of just Guinea pig my way through and setting the line of credit up on my personal residence. And it's as wonderful as it sounds, but just having this huge cash, I'm using the capital right now, doing some improvements to the house that I live at, but what's, what's great is there is no HELOC police. You can use the funds to on whatever you want to use it on. You can use it for buying rental property. You can use it for buying a car. As Michael said, I think you said it was a good investment to get a car. Anyways. I don't remember.

Michael:

Yeah a Lamborghini is the best.

Tom:

Yeah, HELOC really powerful way to dip into your appreciation that you have. Something that I'm thinking about on the risk side is I don't, who knows what's going to happen with rates? I think into 2021, it could potentially go either way, but I don't want to leave. Myself on the hook for if there is a spike up, just because like Michael said, they are variable rates. I don't want to leave too big of a balance that I can't get out of, but it's a really great resource to have. If you're able to set one up.

Michael:

Such a great point, talking about risk Tom. One thing that's really important to note is that a locked is actually a second position mortgage. And so if you've got an outstanding balance that you don't pay on your house or the property that the HELOC is established on could be foreclosed on via that he locked. Even if your primary mortgage or your first mortgage is up to date. So it's gotta be treated with respect. It's it's still a mortgage. It has all the ramifications of a mortgage. So just be aware of that, but they are such, such a flexible tool.

Emil:

Nice job guys. You guys covered this one. Well, I have a couple questions for you as someone who's never done a HELOC, never used a HELOC, Michael, you mentioned there's some closing costs. How do those compare to a cash out refinance or just, you know, when you're regular, when you're getting financing, those closing costs, how do they compare to that?

Michael:

Super, super minimal? I think I set up my line for like 500 bucks. It was the cost of the appraisal. And then like some miscellaneous minor fees. It was super, super cheap.

Tom:

That's right. And on the appraisal, they didn't even send someone out to appraise the property.

Michael:

Someone did a desktop appraisal.

Tom:

I think they may have even waive that fee on that  one, the one that I did, but yeah, it's marginal costs.

Emil:

Okay. I was going to ask you guys about appraisals as well. How do they do that? Do they send somebody out? Do they do desktop?

Michael:

So depending on the size of the property, they might send somebody out. But yeah, for mine, it was just as on a single family home.

Emil:

Got it.

Tom:

Another piece about HELOCs is, as Michael said, you know, it's a delta between the value of the home and the, your first mortgage, different companies. That issue HELOCs may have a different percentage that they go up to, to the value. So the one that I'm in right now, it's the balance of my mortgage, excuse me, 80% of the value of my home that the appraiser comes up with minus the balance of my mortgage. So the point that I'm making is for this particular lender, it's 80%, but I've seen HELOC companies, I believe the San Francisco Fireman's credit union or something, they go up to 90%. Don't quote me on that. But there are some HELOCs that go up to 90% of the value of the home, which, you know, if you're trying to build a, a big arsenal of having HELOC funds, going up to 90% of the value is pretty, pretty incredible. But this was a while ago when I looked at this. So I'm not sure if it's still available, but the point is it's not a one size fits all. Just like mortgages are not one size fits all.

Emil:

Nice, good job guys. Well covered. Alright. So any, anything else before we move on to cash out, refinance?

Tom:

Might as well do it, go get a HELOC

Michael:

Yeah, I was gonna say one last point is it's one of those things that there is very little consequence to doing it and not using it. So I would so much rather have it and not need it than need it and not have it. And so for the $500 expense, I mean, these typically have a five to 10 year drought period. So they'll reevaluate in five or 10 years. If they still want to grant you this line, if you don't use it for five years, okay. Not a big deal. It cost you 500 bucks, but if you do use it, you are going to be so, so, so thankful. I promise you that you establish your future self will thank your past self for having set this up on a property, especially when values seem to be quite high at this moment in time, kind of throughout the markets.

Tom:

I’ll come in with one last question. Michael, do you have. On your rental property? Cause I know a lot of lenders don't like doing HELOCs on rental properties,

Tom:

Like I have it on my personal house. What I'd love to, for you to riff on that real quick.

Michael:

Yeah. I've got it on a rental property that I own free and clear. So it was much easier to do because most lenders don't like to come in and a second position lien. Uh, so if you have a free and clear property, you have a primary with some equity in it. Those can both be really great candidates for, although I was talking with a student within the Academy and they were saying that they found a headlock provider that would come in and second position behind a mortgage company on an investment property. So those, you know, everything exists under the sun. So you've just got to go out and find it.

Emil:

I don't know if you guys answered this or mentioned it, what's the period on a HELOC usually when is that payment due? Is it five years, 10 years down the road.

Michael:

So typically it's it's between five and 10 years, depending on what the HELOC stipulates, but it's, again, it's an interest only payment. And so if you're paying it back slowly over 10 years, and then you still have a balance, usually it'll just convert to a standard mortgage at that point, whatever interest rate is, and that all be stipulated by the lender specifically.

Emil:

Got it. Okay. Thanks for clarifying. All right. Let's move on to the cash out refinance now. So basically a cash out refinance replaces your current home loan with a new mortgage that's higher than your outstanding loan balance. And what you're doing is that difference. You're pulling that back out as cash. And what's awesome about this. Just like the HELOC is that this is money you're getting and it's not taxed your, your home appreciates. You're redoing the loan and taking out that difference. And it's untaxed, which is really, really nice as an investor.

Michael:

Can you give us some like math, some, some number of breakdowns in meal about what that might look like for an investor?

Emil:

Yeah. So let's say you let's make it simple. You purchase a property at a hundred thousand dollars and you put 20% down. So you have a outstanding loan of 80,000, your home appreciates to 150,000. So your equity has gone up 50K. So now you basically redo the loan at an 80%. Some lenders only can go up to 75% loan to value. So you're making, what is that? What does that difference? The 50 K times 75%, Michael's doing the math 112. Okay. So your original loan was 80 and now your new loan is for 112. So the difference is $32,000. So minus some closing costs, let's call it 3000 bucks. You're able to pull out around $29,000 in your cash out refinance. And now your new mortgage is for 112,000 instead of that original 80,000. So some of the things to be conscious of here, you might, let's say you, your home appreciates like the example we just gave. And before you had a cash flowing property, you may, you want to be careful to not over leverage yourself. So now you have a property that's not cash flowing. Maybe you were making a hundred, $150 of cashflow a month before with very conservative estimates. Now your new loan you're basically breaking even each month or maybe even paying into the property. So that's when I think of some of the cons with a cash out refinance, I think some people may over leverage themselves to get that extra cash, create, turn a cash flowing property into one that's negative cash flow.

Tom:

An alligator

Emil:

An alligator as our friend Michael Zuber a likes to call it.

Michael:

So I've, I've got an opinion on this. And so I always say, especially within the Academy with a lot of people I coach consult with that, we have to look at cash out refi is as really a two step process. Step one is getting the cash. And step two is what are you doing with that cash? Because if we can go then buy a second property that will yield us $250 in cashflow a month, as opposed to are just single at one 50, as long as our cumulative sum is greater than its parts. I think that's a good move. Even if I have to have a negative cash flowing property in order to obtain a better one, I'm willing to do that. Tom, what do you think? Whose side are you on?

Tom:

It really depends on what your situation is. If you are not needing the cash flow. Now, you know the scale I would advise if you build your portfolio, there's a lot of value in that. As long as you're cognizant of your LTV as a whole, cause you know, with doing a cash out refi, your loan to value is going to go up. So being conservative with that, but if you have the opportunity to scale your portfolio and you don't need the cashflow now, I think you're going to have two lines in the pond with multiple properties of doing that cash out refi and buying another unit with that would be what I would recommend. Does that answer it?

Michael:

Yeah, totally. You're on team Michael. That's awesome. Team michael for the win.

Emil:

You guys are being silly, don’t have negative cash flow on properties. Come on, rule number 1.

Michael:

But if your cumulative cashflow is now greater than your single positive cashflow, does that carry any water for you?

Emil:

Okay. In our example, what do we pull out? Like 30 K you'd have to use that 30 K as a new down-payment.

Michael:

Correct.

Emil:

Let's say your, your old property was cashflowing a hundred bucks and now it's at zero. So your 30 K would have to go find a new property. That's going to cashflow. I mean, yeah, at least a hundred bucks, 150 to make it worth it.

Michael:

I would argue that it would need, yeah, we need to need to cash flow significantly more than what you were previously making because you could have done nothing and ended up with the same cashflow. So I need, in my opinion, should cash out at least 200. Yeah.

Emil:

I mean, it sounds good on paper. Is that possible? Can you take that and go steamroll into more cashflow?

Michael:

Watch me, challenge accepted. No, I have, of course I think the numbers have to work and we're, we're just using examples numbers for the sake of discussion to illustrate a point. But I guess the point that that I would take is that if I'm comfortable and again, like Tom said, it's a very personal decision and you've got to evaluate everyone at their own specific point in life and what their, what their properties look like and what their business looks like. But I'm comfortable killing the cashflow on property a to have a increased cashflow on property B that is cumulatively greater than just a alone.

Emil:

Yeah. You're more of a risk taker than me. I'm a little more conservative, but to each their own.

Michael:

To each his own!

Emil:

All right. Cool. Anything else on cash out refinance we should cover. When do you guys think the cash out refinance is better than the HELOC and vice versa?

Tom:

Well, the nice thing about the cash out refinance is if rates, as they are now are at a very low number. When you do a cash out refinance, you're going to lock that rate in for 30 years or, or whatever the terms are versus the HELOC. You know, you're still on the rollercoaster on where rates are going. So for me right now, just basically cash out refi the majority of my portfolio to tap into these super low rates that we have. So thinking longterm, looking at the rate.

Michael:

I totally agree. I think it all comes back down to what your plan or what the individual's plan is for that cash. If they know that they're going to be buying something in the next three to six months, you know, cash out refi could be a great way to go if they don't know what they're going to do with the cash, but they know that they want cash, HELOC can be a great way to go because you're not paying on that cash to just sit in your bank account, like you are with it with a cash out refi. So, and there's nothing to say that you can't do a hybrid approach, take a little bit of cash out and also set up a HELOC for that remaining equity balance. That can be a really, really great way to go and a really powerful tool. It's something else that just keep in mind is that your rate is going to change from your original mortgage when you do a cash out refi. So you're basically wiping that first mortgage clean and getting a brand new, totally new mortgage. So whatever the rates in terms are of that new one, that's what you've got to come to terms with. And then the last thing to think about is I've heard this said from a number of different people, is that if you're a, towards the end of your mortgage, when go do a refinance that resets the clock back to year one on a 30 year payback for a single family home conventional mortgage. So if you're at the end of your mortgage cycle, you're paying this significant balance towards the principal. You are just gobbling away at that principal balance, which is really, really nice. Versus if you resetting the clock. Now we're paying the vast majority of that payment is going to the interest. So the balance is going to be decreasing at a slower rate than if we're towards the end of our, of the life of our mortgage. So again, just something to consider, to keep in mind, to be cognizant of, as you're looking at considering doing our cash out refi,

Tom:

Great point. Hybrid, and it's not a one size fits all you can, if you could use both, have both guns and missiles.But that example, I would say that the HELOC would be the gun and the cashout refi would be the missile, like the kind of a bigger, you know, locked in.

Michael:

I thought that HELOC was the bazooka man. Now you're changing it up

Emil:

So destructive today Tom.

Michael:

Someone played command and conquer as a kid.

Tom:

Too much coffee.

Emil:

Man, you guys are making my job easy. Like I don't have anything to add on top of like your final notes. Cool. Let's let's move on to the next one, 1031 exchange. Tom, you want to take the lead on this one?

Tom:

Yeah. So we'll hit this one pretty quickly. We had an episode earlier episode, I think four or five somewhere in there. Anyway. So at 1031 exchange is deferral. So it is selling a property, not paying any taxes on the proceeds from that sale and rolling all of those proceeds into buying a new property. So with a 1031, there are some rules that you need to adhere to. And a high level example of those rules is you need to identify properties within a specific period. There is rules around the value that you're selling to what you can buy. And we recommend talking to a 10 31 professional company to understand those rules, but the big shtick for a 10 31 exchange is you're selling your property. You're making a bunch of money and you're not paying any taxes on those. You're deferring those now eventually when you do sell and do not use the proceeds to buy another property, which we'll talk about.

Michael:

The thing that you're getting at Tom, is that you can continue rolling that deferment via 1031 exchanging every property that you then buy and then subsequently sell. So if you sell property via 10 31 exchange to buy property B, when you're ready to sell property, be 10 31, exchange that into property C and so on and so forth, such that you're deferring, deferring, deferring your capital gains tax until the point at which you might not be around anymore. And then whoever you leave that building to gets a step up in basis. And that basically wipes away the capital gains tax that they would have to pay. So, yeah, echoing what you said, go talk to a 1031 professional before attempting this go to the episode that we did on 1031 exchanges, it's really, really informative, but it's a really, really great way to sell properties and not have to worry about paying the capital gains tax.

Emil:

Yeah. And I looked it up. It was episode 15 was a 1031 episode.

Tom:

Awesome, reasons that you would want to do a 10 31 is perhaps you're moving your portfolio, moving geographies. Perhaps you're changing to more of an appreciation asset to more of a cash flowing assets. Perhaps you want to take one property and use the proceeds to buy multiple properties or the other way around. There's so many different use cases for doing a 1031 exchange and the mechanics of it, of deferring the tax payment are available for all of them.

Emil:

Yeah.

Michael:

So what would be a con, why wouldn't you want to do it today?

Tom:

You wouldn't want to do a 1031. I mean, you're, you're selling the property. So if it's an asset that you like, like, you know, you are changing assets, you know what other ones cons are?

Emil:

Oh, the, the timeline you have, right? So sometimes I think it's like a 45 day or 60 day timeline to identify the next property that you're going to re 1031 into. And so sometimes I think you could feel like it's forcing your hand into maybe a so so deal versus something where you wait, you know, maybe you pay the capital gains on it, but you finding a better property cause you, you're not restricted to this short time window.

Michael:

Mhm

Tom:

Other con I would put is versus those initial two with the HELOC and the cash out refinance, you have a very good idea on how much money you're going to have available from that maneuver. But with a 1031 exchange, you're selling the property. So there are just a lot more variables on what you're going to get when you for when you sell the property versus like knowing what the, what the rates are and whatnot with a, with a HELOC and a cash out refi.

Michael:

Yep. And one additional point to add on top of that time, I always seem to be picking piggybacking off you cause you've got such great points. Is your back tired yet from carrying me?

Tom:

I’ll call you Jansport. Go ahead

Michael:

Is, you know, in the first that we talked about, we're tapping into the equity and now have a usable cash. In addition to still controlling the asset. When we go to sell as with the 10 31 and selling a property straight up as we're going to talk on in a minute, we now no longer own the asset. And in the example of a 1031, we don't have the cash because we need to use all of that cash to buy a new property. Now, of course, if we don't use all the cash, that's called boot and that can be taxed at capital gains rate, whatever. But if the idea is to pay as little capital gains possible, we want to be using all of that gain into a new property. There's going to be nothing left over for us and usable cash.

Emil:

Talk about boot a little bit. You mentioned it briefly. Michael, do you know that? I think it's the boot is, let's say you sold your property at 200,000. You go and find another property for 150 K you still have $50,000 that isn't used in the 1031 exchange. And so if you don't use that within your 1031 timeline, you're still taxed on that $50,000 capital gain or whatever.

Michael:

Exactly whatever that Delta is, whatever is not used up is leftover and that's called boot,

Tom:

Yeah. And that's a con example, you know, you're, you're fitting a little bit more of a piece of a puzzle and you can't fit it just right. You're going to have some taxes. Sorry Emil, go ahead.

Emil:

All right. Michael, do you want to close us out on selling a property straight up without a 1031 exchange?

Michael:

Yeah. So last and final way to tap into the trapped equity is just sell a property straight up. So instead of doing a HELOC or a cash out refi or temporary one, just sell the property. If you bought it for a hundred, now you can sell it for 120, sell it for 120. You'll walk away with 20 K and you'll have to pay uncle Sam, the capital gains on that. And depending on what your personal financial situation looks like, that's going to dictate what that game might look like. So if we call it a cool and easy 25%, you'll walk away with 15 grand in your pocket, not a bad payday at the end of the day. So I think a lot of people get hung up in, Oh, I've got to do 10 31. So I've got to do cash. Every fire, I've got to do a HELOC. If you just need the cash quick and you just want to be done with the property, for whatever reason, you just want the cash, you don't want to have to worry about it. Just sell the property. It can be a really, really great option. And again, depending on your personal financial situation, that's going to dictate how much tax you may or may not have to pay on that gain. So Emil, do you have any pros cons to this type of thing? Okay.

Emil:

Yeah. So I have a personal example of this recently. So I bought a property about two years ago and recently decided to sell it, ended up selling it for the same price I bought it for, for me. So I didn't have to worry about a 1031. I didn't have any capital gains to worry about. I basically ended up a little bit below break even. I lost $1,200 you factor in cashflow and selling and all that stuff. But for me, I wanted, I wanted this down payment back, right. I put 25% down on this property. I wanted my down payment back to be able to go use it on something better that that property was okay. Cashflow property, but I'm pursuing a little bit different of a strategy right now. And there's, again, there's all these different ways you can tap into money. This, this property hadn't appreciated. So cash out refi hayloft weren't really options for me, but I wanted to get a nice chunk of cash right now. And so I just decided to sell this property at basically no gain. So this is something I used recently.

Michael:

So that's a massive pro. Okay.

Emil:

Right, exactly.

Tom:

I like that example because you know, you got you, you dipped your toe and you know, maybe it wasn't like the property you wanted, but I think that the takeaway that I hear from it is, you know, when you do these maneuvers and nothing is locked in stone and you know, these are all, some excellent tools that you have in your back when you are investing in real estate. And there is some appreciation, some extra equity, but ultimately, you know, doing, you have a lot more options within this type of investment and to have these options available, you got to get in, you know? Yeah,

Michael:

Absolutely. And Emil is something too that I don't think we touched on yet is, is the tax advantages that you've had for the last two years as a result of owning that property. So if we looked at the total total, total return factoring in loan, pay down appreciation, tax benefits, all this kind of thing, my guess is you're, you're gonna end, you're still gonna end up in net positive. So even though you didn't see any true dollars gained in your pocket, if we turn the clock back and look, two years in reverse, you probably did better on this than you would have had otherwise.

Emil:

Right. And, and to echo Tom's point, it's a learning experience. I didn't lose that much. Right? Like obviously there's an opportunity cost of that money making money over the last two years versus losing. But I think that's part of it, right? I think a lot of real estate investors only talk about the big wins and sometimes it's not always rosy, there are some things that happen that were isn't what you expected. But the important thing is you learn something from each, each maneuver each step

Michael:

Nicely said, Tom, do you have any good examples of any instances where you've maybe used one or multiple of these strategies to grab some tap equity, some trapped equity?

Tom:

Yep. So HELOC on my personal house, have that line of credit, uh, did a cash out refinance. It was two years ago on some properties and actually going through a couple of them right now getting a lot of dry powder available if using a lot of, yeah. Of a weapon analogies,

Michael:

A lot of pirate puns today,

Tom:

A lot of pirate puns, dry powder anyway, and then did a 1031, a couple of years ago, getting out of a specific geography or I guess a better way to say it is concentrating into a different market than that current, that property was in. And just like we were talking about earlier in doing these exercises, you get experience and kind of understand them that much better

Michael:

Love that.

Emil:

How about you, Michael? Any stories you want to call out on using these strategies?

Michael:

Yeah, sure. So I bought a property, all cash awhile back and then day one cash out refi, 80% of the sale price, which the lender was gracious enough to give me and then basically took all of that cash and put it into the rehabbing of that property. And now that property is worth a whole lot more. And so I intend to go cash out refi again. Now at the higher value after the rehabs all said and done, everything's leased up. So some important things to think about are the refinance costs that I incurred now twice. Thankfully the lender that I work with, the refinance costs, it's the same lender I use for my, HELOC their refinance costs are pretty minimal. So it's not a big deal as far as the costs are concerned, but it's a really great way recycle that cash and only needing to have that initial chunk of change to buy the property, all cash. Obviously we have to make sure that the rehab costs aren't going to exceed the, the 80% refinance of the initial purchase, but that's a really, really, really great tool that I like to use a really great strategy is buying all cash, turning around, refinancing, getting that cash out and then go, go doing it again somewhere else. So then again, I've already spoken about the HELOC I've used. So using those two things in conjunction has been a really, really great way for me to be able to scale pretty rapidly and take advantage of some killer deals that have popped up on the radar over, over the last couple of years.

Tom:

So one more thing I'll add real quick is knowing what your loan to value is. Um, that's just really important with any of these tools. You want to just make sure that you have an appropriate balance between the total mortgages or HELOC value or whatever out on the property versus the value of the property. And I think, you know, at a minimum, you know, 75%, 80% loan devalue, more conservatively, you can get down to 60%. Well, I'd love to hear what you guys think is an appropriate loan to value ratio.

Emil:

I'm probably personally pushing it to like the 75 80% cause I'm in growth mode right now. I think later on at some point, just for peace of mind, it's going to switch to, okay, how do I increase my equity on these properties? Maybe sell properties to own certain other properties free and clear, but right now it's kind of just grow. And then I think it will be switching to how do we make this more efficient.

Michael:

Yeah, anytime I get this question, I think of that song, push it to the limit, push it to them. Cause I totally echoing Emil. I levered up as much as I could when I was in growth mode. And I've talked about this in other episodes. Now I'm looking to really streamline and become super, super lean, super efficient and reduce my loan to value and just being able to do more with less. I also think that depending on the deal itself, I mean, if the, if the value isn't there, but you've got a high loan because it just, the property isn't super valuable, but it cashflows really well. So your debt service coverage ratio, the amount of income that you're bringing in compared to the debt on the property is, is really powerful. Then I'm more okay with that. You know, if I've got the cashflow to cover the debt, even though it might be a very high debt ratio, I'm, I'm comfortable with that. And so everybody's got to reconcile that for themselves and determine what their risk appetite looks like and how comfortable they are with the values that they're working with. But no, I like him he'll have, have levered up as much as I possibly can. What about you, Tom?

Tom:

Yeah. Growth, growth mode. I mean, debt is cheap right now. So keeping it at, you know, 70% I think is a number that I keep in a keep in the back of my head, and not getting, getting beyond that. Cause once you start getting involved that you risk where if there is like a downturn in the, in the market, getting under water where the value of the loan is greater than the cost of the house, I think it's pretty unlikely, but that's how a lot of people got in trouble in that 2008 crisis is the value of the loans greatly exceeded the value of the houses. And that's not a position that you want to get in. So that's why you want to build that buffer. It's kind of, it's similar to the alligator expression, a property that cashflow is negative. The version of that for value is a property that's underwater. So the worst animal in the real estate investing zoo is the underwater alligator.

Emil:

Yes. Don't be an underwater alligator finishing strong.

Michael:

Yeah.

Emil:

I have a question for you guys. Let's say you have a rental property and does go underwater, right? As long as you have a tenant, who's covering rent, your mortgage, all that stuff. Does it matter? Like as you know, real estate goes in, cycles goes up and down. Let's say you temporarily go underwater, but you're still cash flowing. You're still able to pay everything off. Do you guys think that matters?

Tom:

It really depends on your situation. Like if you are an ultra growth mode and you are not at risk of not servicing your debt payments, even if you do have a vacancy or something, I think that's fine, but it's pretty situational. So if you have good other sources of income to be able to cover those shortcomings, I think that's fine, but you need to have a, an end game plan as well as some contingencies, if things go sideways, which sometimes they do.

Michael:

Yeah. You know, it's a great question Emil one that comes up a lot within the Academy. And it's something that I don't pay a whole lot of attention to as far as the value, because I agree that it doesn't really matter. Nothing about that. Snapshot in time has changed. If you have a rental renter paying the rent, your income has not changed. It's totally independent of the value. So as long as you don't need to do anything with that property, either sell it or refinance it or try to get a heat lock on it. It has no impact on the financial picture. In that snapshot of time, of course it'll affect your net worth and all that kind of a thing. But again, it doesn't affect the property's performance. And it's kind of like a stock. If a stock has gone down in value, we don't automatically say, okay, we now we're going to sell it. It's an unrealized gain or loss until we do something with it. Buy, sell refinance.

Emil:

Yeah. Yeah. I think the same thing I think about it a lot, I guess it's just the unknown of will you need to sell for some unknown life events, right? And then it's, you're putting yourself at risk in that way.

Michael:

Exactly. Exactly. But that gets into the bigger discussion of having reserves and not, not ever being in that position because you never want to have to fire sale something.

Emil:

Sure. Cool. I always think about that one. I was curious to get your guys' thoughts on it too.

Michael:

What's your guys's spirit animal and the real estate investing zoo?

Tom:

An Eagle. No.

Michael:

Why?

Tom:

Agile. Peregrine. Falcon. Fastest animal. Next question.

Michael:

Yeah, but you're at the zoo. So you’ve got your wings clipped. Same answer?

Tom:

I’d fix them. I'm like a lizard.

Michael:

Grow new wigs that are better faster stronger. Emil, what's your real estate spirit animal?

Emil:

Oh man. My monkey swinging from property to property. I don't know, man.

Michael:

That's a good one. Eating bananas the whole time, right?

Emil:

Exactly. Yourself. Michael?

Michael:

I'm a duck man. I said it before. I'll say it again. I'm floating. Looking calm on the surface underwater. I'm paddling hardest.

Emil:

Well, thank you as always everybody for tuning into this episode, make sure you go and subscribe wherever you listen to podcasts, you get new episodes. And if you enjoy the show, please leave us a review. We want to know what you think and we'll catch you on the next episode. Happy investing.

Michael:

Happy investing

Tom:

Happy investing

In this episode, Emil and Tom talk with Leandra Figueroa, the Valuations Manager at Roofstock, about what goes into our valuation reports.

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Transcript:

Emil:

Hey everyone. Welcome back to another episode of The Remote Real Estate Investor. My name is Emil Shour, and today I got my co-host Tom Schneider, and we're going to be talking to our valuations manager here at Roofstock. Her name is Leandra Figueroa. We're going to be learning all about what goes into our valuation reports, how Leandra and her team compiled those and what it means for investors. So let's hop in

Emil:

Leandra. Thanks for coming on the show. We're excited to have you guided to be here. So like we do before any episode, anytime we have a guest on I go and I scour their LinkedIn, creep on their LinkedIn just to get a background on them. And I noticed that you've been appraising and running valuations for over a decade now, but can you tell our listeners a little bit about yourself and what you do here at Roofstock?

Leandra:

So here at Roofstock, I started as a pricing analyst, basically looking at the properties that the sellers are looking to list on Roofstock and looking at the sales comps for that specific property, you know, the same size similar condition, and actually seeing what the property could sell for in our marketplace.

Emil:

Nice. And how long have you been at Roofstock

Leandra:

Just made three years last month. Thank you.

Tom:

21 years in dog years as a startup,

Leandra:

It feels that way.

Emil:

So run me through kind of just, you and your team day to day. What are you guys really focusing on?

Leandra:

So we have a couple of variations of tasks that come through their valuation tasks. They could be initial pricing tasks. This is where the sellers first engaging with our account managers and kind of just feeling out to see what we feel the price range could be, what they could sell this property for. And then we have another set of tasks where right before a property gets published, you know, the inspection is completed through the certification team, and then we're actually able to give a more accurate opinion of value because we have an inspection report. So that's another step. Those are another bunch of tasks that we do prior to publishing. And then another one that we look at, I guess, similar to the initial pricing is the seller self service. This is where the seller actually requests the valuations themselves and kind of just try to flow through the roof, that process. And so that's another way that we also value the properties that come through.

Tom:

That's really interesting. How you talking about this funnel? You're talking about, you know, you do this initial pricing and then you get more information with condition. How big of swings do you see? And I'd love to learn a little bit from an appraiser. Like what is the ways that an appraiser thinks about condition? Because I understand there are categories, right?

Leandra:

Correct. Correct. So there's a C1 through C5 and C5 being new construction, never lived in. Though funny enough, some of our sellers, they have a 1960s home and they'll select C1 as the condition.

Tom:

But it’s beautiful. It's beautiful. Just kidding.

Leandra:

What do you mean it’s not C1?

Tom:

That’s literally brand new build, right?

Leandra:

Yes. It's absolutely only for new builds and this is in the appraisal world and then C2, maybe more high end rehab renovation. C3 is average, maybe some updates here and there. C4 no updates like normal wear and tear. C5 and C6 is almost like uninhabitable and, and needs major repairs. So yeah,

Tom:

How big of a swing do you get in valuation based on condition? You know, if you had to do it like…

Leandra:

From our initial pricing?

Tom:

Yeah, just kind of a curious question

Leandra:

I wouldn't say there's too much of a difference. I think if anything, like I said, some sellers will say, it's the one and then the inspection report comes back and it's more like C3. So we know when sellers say C1, it's just, it's just telling us that they've done some rehab work. And so we kind of try to value it as a C3. And then if it turns out that, you know, after reviewing the inspection report that they did do these high end upgrades, then we're actually going to look for the right comparable and not just stick it at C3. We're going to look for the C2 comps. So it's rare that there's a large variance, I would say maybe five to 7% of the time. It's completely out of range from where we were initially

Tom  (04:47):

Trust, but verify, trust, but verify. I got it.

Leandra:

Yep.

Emil:

Some people who are listening, they're not even sure where, so we publish these valuation reports with each listing that goes on our site. Can you tell the listeners where they can access that with each property?

Leandra:

In the analysis tab for each listing, you'll be able to see the valuation report. Initially when you first look at the listing, you'll see the range, you'll see the value range, you'll see the rent range, but clicking on the analysis tab would actually show you the PDF of the report.

Tom:

And in that PDF, it's pretty much all the homework, right? You can see the actual comps and the sale date and the square footage.

Leandra:

Correct. And if you wanted to see photos of the comparable to kind of just for your own knowledge and how we're comparing it to the subject, you know, just a quick Google search on those comps would be able to show you some photos of the comps we use.

Emil:

Got it. Yeah. I was going to ask what's in there besides, I mean, valuation range, obviously you guys pull comps as well. I think neighborhood score is in there. Is there anything else that we add in there?

Leandra:

I believe just the subjects data, just your bill bed back, count footage, lot size neighborhood score. I believe school score that's in that as well. And sales comps are going to be in there. Perfect.

Emil:

Awesome. Okay. Can you run us through someone who's never done evaluation? Just what does that even look like? Where do you start? What are the processes you go through to get all these comps and come up with the evaluation report?  

Leandra:

Well, at Roofstock, I mean, the first thing is like, that's verify the data. You know, the seller comes to us with a three bedroom, two bath with 700 square feet and it's like, Ooh, something seems off here. So then we want to look at County records. We want to just see what other data we can find. Funny enough, I have a situation that I ran into this morning where it's a 900 square foot triplex with four bedrooms and three bathrooms. What we found was there was a finished basement that actually has two units. And so what you want to do in those situations, so first verify the data. You want to make sure that we are going to value this properly and you wouldn't be able to use in that situation that I had this morning, priplex comps were all the square footage is above grade. You really want to find one where, you know, there's a main floor and then there's a finished basement with a unit down there. Like that's going to be your best comparable sales. So going back to just the process itself, it's verifying the data before you actually can find what you're looking for, find the right comps, because you want to make sure that you're looking at sales that are recent, especially with market changes. And you want to look at sales that are similar in size, similar in bed bath, count your build location and condition.

Emil:

Where are you looking for those comps? Is it Zillow? Is it somewhere else?

Leandra:

So we actually have a couple of third party vendors that we use that generate data, sales data, probably from the local MLS or just County record data for prior sales. And so we're taking all that data and actually looking at the ones closest in proximity to the subject. That's really going to define the neighborhood and what that property could sell for. Cause like we know values can differ from one block to another. You see that a lot in Chicago or neighborhoods that are vastly different from blocks of blocks. So we look at third party sources sometimes we'll look at Zillow, but for the most part to sales, we see on Zillow, we've also seen from the data that we pull.

Tom:

I think there's this interesting art and science to an appraisal. And you know, you're talking about finding properties that are close in proximity and recent sale. And ideally, you know, you find something that was sold right next door, exact make model. At what point do you put, you know that, Oh, that's too old of a sale that, that shouldn't count in my analysis or, Oh, that's too much square footage. I'd be curious. It's just some general that you, as a longtime appraiser, think about as not valid in comparing.

Leandra:

I mean, if the house right next door sold within 12 months, I would still use that as a comp because you have to do this side by side comparison to even see if there was an adjustment in value for that market, for that property. So you have to take more than one comp to figure out what the adjustment is for size, what the adjustment is, if any, for bed bath count and what it is for time, you know, if any, from what the value is today versus where it was last year. So you have to do that analysis with at least three properties. And that's why appraisals tend to have at least three sold comps. So you can really dial it down and figure out what the adjustments are for the different features of the subject.

Tom:

Yeah. So that makes sense in that appraisal, it will be much more difficult in areas or more subjective if there isn't a lot of sales. Am I understanding that right?

Leandra:

Yeah, that is correct. It's really just based on, and lenders tend to give the most weight to sales comps just because it's kind of like insurance for them. We know we can sell it for this price, should the borrower default or you know, something along those lines. So in areas where there's less sales happening within 12 months, it tends to be difficult. Sometimes we'll have to expand further, go back 18 months and actually apply a time adjustment for those comps that we're using. And even then, it's kind of still just hard to figure out we're having to expand outside the subjects, immediate neighborhood to try to find at least three solid comparables.

Emil:

That makes sense. I wrote down a question, I forgot to ask you, as you were going through how we do the evaluations, you mentioned there was a finished basement in that triplex, I'm curious are finished basements included in square footage on a home, or it has to be above ground or whatever you would call it.

Leandra:

Correct. On the standard appraisal form. Basements are separated from the above grade square footage. So although this property has two units that are clearly generating income for the owner, that value would be in line on the sales comp grid with the basement and not that above grade level. So it's super important that we find a comp with a similar unit in the basement, which can sometimes be a needle in a haystack, but, but we'll keep expanding and we'll keep doing those time adjustments. If we need to just to find that one, that's really going to help us figure out what this could sell for. So, yeah, you're right. It's not included in the above grade square footage

Tom:

Leandra. I know a lot of investors both on the buy and the sell side. They look at Zillow, right? It's super easy. It's kind of tasty, just a single number. What would you have to say to investors who are really banking on that number either as a seller, as a buyer, as that is the truth about what the valuation is on the property?

Leandra:

I would say, don't. No, I mean on the surface, it's nice to see, but I wouldn't just stick with one, right? Like [email protected]. Look at Redfin, look at Zillow. And more importantly, Zillow has a really nice tool where you can actually dial it down to properties that are more similar in size, kind of how we look for comparable properties when we're valuing our listings, you could do the same thing in Zillow. There's a filter section where you can filter out the small stuff, the big stuff, the stuff different in size. I mean, I'm different in age, different in size and kind of like narrow your search radius to really get a good idea of what your property could be worth. But definitely don't be fixated on that zestimate or that Redfin estimate. Do your own research and do your own comp polls super easy. Zillow has that nifty tool. And I would definitely start there.

Tom:

That's great. So get into it. Look at the actual sales comps before leaning so heavily just on that one number they pull up. That's great.

Emil:

I want to second that actually. So I track my Zestimate pretty regularly and the first property I bought, it's been about three years since I bought it. And it looked like on paper, according to the Zestimate that it had appreciated like $40,000. So I went to do a cash out refi and it was significantly less just because I think this is just not knowing any better. You really, really have to take into account the quality, like you mentioned, right? Like they're just probably doing it more so based off size, square footage and the surrounding area, but off all the homes in the area where they're coming up with that, or the kitchens are brand new, the bathrooms are brand new in your home. It's a little more dated. You're not going to get in that range.

Leandra:

Right. You're right.

Tom:

You think you're a C2 Emil, you're a C3 Emil.

Emil:

I'm a total C3.

Leandra:

No, you hit it right on the nose with that. I mean, Zillow takes all the sales and Zillow doesn't know what the condition is of your property or the property, the other properties that have sold. So that's where really takes that human touch to really figure out and dig deeper. Like, you know, is this actually a good comp.

Emil:

Right

Tom:

My other question that I have is, so you look at tons of comps all the time. I'd be interested if you've noticed any trends we're roughly, I don't know, two, three months going into a pandemic. Have you noticed any things with the sales price or do you think it's still too early to notice any adjustments and I'd love your thoughts on it?

Leandra:

Yeah. I mean, still valuing properties today. Honestly, I have not seen yet any big price drops to where it's significant. What I have seen is a slowdown in actual sales. So a lot of sales data is more from like March, December, January. There's really not too many recent transactions. And then rightly so, right. People may are a little nervous, but I haven't seen a decline in crisis yet.

Tom:

It's the function of doing transactions have been stalled up with shelter in place and not being able to go out and do appraisals and counties shutting down. That makes a lot of sense.

Leandra:

Yeah, definitely.

Emil:

One of the last things I wanted to ask you, so these valuation ranges we have on our reports, what percent of the time is the appraisal coming back in that range? How often are we basically missing? Do we have any data around that

Leandra:

we do. It's a small percentage that we're missing. I would say less than 10% of the time. We might have an appraisal that comes in below our value range, but nine times out of 10, almost the appraisal or the actual sell price is within our value range.

Emil:

I'm curious, have there been any scenarios where the appraisal comes in lower and someone uses our valuation report to go back to the bank or the appraiser to actually rebut it and it comes in higher?

Leandra:

Yes. Whenever that happens, the transaction team reaches out to my team and we review the appraisal report. We review our report and the sales comps we use versus the comps the appraiser used and just see what type of adjustments the appraiser will used in their reports. I had one recently where the appraiser didn't even review the purchase contract. So they don't even know how much this property is being purchased for. And a lot of people just see this as a non MLS sale. So they think there's a discount applied to our properties when there's not. So in those cases, him, I will prepare a rebuttal and send it to the lender. And then the lender would send it back to the appraiser just to kind of review. We might give them additional comps to consider or comment on why it wasn't used in their report.

Emil:

Nice. Okay. That's awesome. I didn't even know he provided that. That's great.

Tom:

Another question into the crystal ball of appraisals and valuations. So I know right now for originating loans, right? You'd get your appraisal done. And they've always been very particular about doing the full shebang, like an appraiser going to the site. And my understanding is they're getting a little bit looser, at least on the refinance where they're allowing what's called a desktop appraisal. I'd love for you to touch on your thoughts on, you know, where this is going and maybe touch on a little bit about kind of like a desktop appraisal. Like how is that different? And then also, where do you think the, uh, the crystal ball going? I like it, how my voice gets higher as I'm at the end of my sentence. It's like aggressively like full off. Okay, go ahead.

Leandra:

You know, even pre COVID Fannie Mae was already working on some sort of desktop reports to help lenders kind of speed up the appraisal process. There's markets today where it takes two weeks to get an appraisal done, maybe even longer, because there's not a lot of appraisers in that area. So in an effort to try to speed up the process, that transaction process or the processing of alone, they were already working on what the industry calls a 1004 P and it's basically a desktop report for appraisers, but an inspector goes and does the inspection. And somehow this was supposed to speed up the process because then appraisers are not having to go out and do the inspection themselves. There's someone else doing it, doing that part of the work, and then giving that information to the appraiser. And the appraiser is just sitting at home, cranking out these desktop reports.

Leandra:

So now with COVID-19, I've seen a lot of lenders lean towards, and this is great for everyone's safety is using desktop reports. The only setback to a desktop report is if you had like a brand new remodel done on your house and you're refinancing the, appraiser's not going to know that, um, the appraiser's going to do just based on exterior or what I've seen. There's a company that a couple colleagues work for where they're doing this inspection report. Having the owners actually take photos of their interior and send that to the appraiser. So there's ways around it without, you know, having to expose anyone to anything, you know, for the safety of inspectors and appraisers and for the safety of the homeowners and the people that live there. I have seen more desktops being ordered right now, which is great. I think we could still do an accurate appraisal without having to go inside the property.

Tom:

That's great. Yeah. I want to get credit for that C2.

Leandra:

You really do. I'm seeing like a $500,000 difference. One of my colleagues did an appraisal in Montclair and it was valued at 1.2 million. And then the borrower's like, hold on. I did all this work. Like I know my house is worth more. And then my friend went back and actually was like, Oh my gosh, this is nothing like the prior MLS photos. Like I was completely wrong. And the value came back at 1.7M. So it's important to actually see if you've done any remodeling for an interior, some sort of interior inspection to be done, whether it's the borrower taking the photos or, or the appraiser just doing the inspection.

Tom:

Makes sense. All right. Time for some quick fire questions. Hope you're ready. I hope you're ready. So we do this with some guests. It's a quick either or decision some real estate related some not really real estate related, but all right. So are you ready for this Leandra?

Leandra:

Okay.

Tom:

High rent growth or low vacancy.

Leandra:

Wow. That's tough. No vacancy.

Tom:

Good choice. Safe play. I liked that one too. Yeah.

Leandra:

Yeah. Slow and steady wins the race. I mean, at least it's consistent.

Tom:

Yeah. Flow or appreciation cash flow.

Leandra:

Cash flow

Tom:

Ooh. Is surprising from an appraiser. Not thinking about that appreciation, but yeah. Debt or equity?

Leandra:

Equity

Tom:

Equity, love it. Local or remote investing?

Leandra:

Ooh. I mean, if I was local in Memphis, then I might say local, but remote. Definitely

Tom:

Single family or multifamily?

Leandra:

Ooh, that's a good one. I actually have a lot of people ask me about that. Multifamily.

Tom:

Ooh. Do you notice a big difference in appreciation between the two, like over the last several years?

Leandra:

No. No, not at all. Not really. I think why I would choose multifamily is just a higher cash flow. You know, more rents coming in and again, with the low vacancy, you know, it just sounds like a win for me.

Tom:

Turnkey or massive project?

Leandra:

Turn key.

Tom:

All right. My last three questions, midnight oil or early bird worm?

Leandra:

Early bird worm.

Tom:

Love it. Text message or email?

Leandra:

Text

Tom:

And the last question. Olive oil or butter?

Leandra:

Olive oil

Tom:

Love it. All right. You did it. You made it through. Excellent.

Emil:

Well done.

Leandra:

Oh my God. That was so fun.

Tom:

Well, thank you so much for coming on Leandra. This was enlightening. I love to talk about valuations with you and always learning a little bit. This is fantastic.

Leandra:

Thanks for having me. This is great.

Emil:

Thanks again to Leandra for coming on our show. This week learned a lot. I hope you did as well before you guys go, wanted to tell you about some new we have going on at Roofstock. It is our referral program. So if you invite your friends and they buy or sell a rental property on Roofstock, you get $250. And so does your friends. So just head over to [inaudible] dot com slash my dash referrals, and you'll be able to invite your friends with a simple link. And again, if they end up buying a property or selling a property through the Roofstock marketplace, they'll get $250 and you'll get $250 for every friend. You refer to check that out and we'll check you out on next week's episode. See you later. Happy investing.

Tom:

Happy investing