The Right Way to Do “Value-Add” Real Estate in 2024

Dave:
Value add investing is popular right now and with good reason. It is probably if not the single best way to make money in real estate right now. If you haven’t heard of this term, value add just basically means taking a property that’s not up to its highest and best use and improving it. That can be during a flip. It could be during a bur or just buying a rental property that you want to fix up and add value to it. And if you look on social media, you see a lot of people doing this right now. I’m sure you’ve seen some of the same Instagram posts that I’ve seen where people show these beautiful before and after pictures showing the purchase price and then the price that they sell it for, or how much they increased rents by renovating a property. And it makes it look super easy, super fun, and there’s no risk. But the reality of these projects is that they are profitable, don’t get me wrong, but if you’re in the industry, if you’ve done these types of projects before, you know that there are risks and it does take a lot of time and it takes a lot of skill to be able to do them correctly. And today, that’s what we’re talking about, how to do value add investing the right way in 2024.
Hey everyone, it’s Dave back with the new investor story on the BiggerPockets Real Estate Podcast. And today we’re speaking with investor Tom Shallcross, who went from operating properties in some of Chicago’s more C class type of neighborhoods to operating 12 month seven figure gut renovation flips in the city’s class A neighborhoods as a full-time career. And I’m excited to talk to Tom because he’s found some really innovative ways to set himself apart in one of the country’s most competitive markets. And he’s finding great ways to do all sorts of kinds of deals here in 2024. And I really want to dig into on his creativity and how he is designing deals to boost cash flow on his rental properties and how he’s mitigating risks on these house flips that he is doing that take nine to 12 months to complete. And he honestly doesn’t really know what macroeconomic conditions are going to look like when he goes to sell these deals. This and a lot more in my conversation with investor Tom Shallcross. Let’s get into it. Tom, welcome to the BiggerPockets podcast. Thanks for joining us.

Tom:
It is an honor to be here. I’m pumped, Dave.

Dave:
Yeah, me too. Let’s start at the beginning. Tom, take us back to when you started in real estate. First of all, when was it and what were you doing at the time?

Tom:
Yeah, so I have what I’ll call an accidental house hack. So this is right out of college. I was working probably about 50 miles outside the city. I’m from Chicago, live in the city, so it’s long commute there and back. And at the time you can get a town home pretty cheap and anyone can get a loan, right?

Dave:
Well, what year was this?

Tom:
This is oh seven.
So this is right before everything crashes. It’s easy to get a loan. I end up getting a place down there just to stop traveling every single day. And then I had buddies who were doing the same thing. They were traveling back and forth, so they started living with me and each one of ’em paying me whatever, four or 500 bucks in rent. And all of a sudden it’s like, well, I’m living for free. This is pretty cool. And traveling back to the city on the weekends and it was a good experience. It opened my eyes to real estate and I didn’t hit the ground running though. After that I sat out the best time to buy real estate. I picked up when my W2 job was doing well and I focused on that. It was always kind of in the back of my head that, wow, this thing works. Other people can pay the debt for you and 10 years from now you have this thing X amount of equity. So that opened my eyes, but then like I said, we did not capitalize on it right away.

Dave:
So what was your job? Anything to do with real estate? Back in 2007?

Tom:
I actually, I did lending for a while, so I was kind of tangent to the game. I got to do lending from oh eight to 2011, probably the toughest time to get anyone approved for mortgage. And I think most of the people who did it during that time with me all went on to have decent careers. Just because you’re young, you don’t know any better how hard it is because you just didn’t have any other experience. But then from there, it took W2 jobs doing sales jobs, kind of white collar sales, traveling tech jobs. So that was going very well. So that was where the focus went. And real estate was kind of just on the back burner there.

Dave:
Were you scared of jumping in 2008 or what was preventing you? If the first deal went well and prices only went down from there, why didn’t you buy more?

Tom:
It was one of those things where other good things happened and I followed them, right? It wasn’t so much like, oh, I don’t know if the market’s going to do this. It wasn’t top of mind. And then what happened was things were going well. So I had a buddy who approached me who was in real estate, who was doing this full time, and he approached me to do some private lending. And I said, okay, I trust him. And to this day, we’re still friends and we still do deals together. But I got into it, I private lent for him, and then we started sharing profits on deals. I started seeing what he was making on these. I was like, all right, we hold on a second. We got to jump in. This is ridiculous. You are no smarter than I am, and you’re making very good profits, very good margins on these things. And that’s really when I, all right, we got to start reading the books, found BiggerPockets and started really diving in at that point.

Dave:
And what year was that?

Tom:
That was probably about 2016 ish, 17, somewhere in that range.

Dave:
So you, you’re out of game for a while, and basically, for lack of a better term, you got fomo. You’re doing this private lending, which does offer great returns, but just generally speaking, I do some private lending myself. You’re getting a good cash on cash return, but you’re funding someone who, if they’re doing their job or making huge chunks of equity from flipping houses and doing value add types of investing. And so basically it sounds like you were a little jealous and wanted to get in there.

Tom:
Yeah, absolutely. This was a guy who’s just like me. It wasn’t like he didn’t go get some fancy MBA, he didn’t go do whatever. It’s the guy I knew and was like, hold on, if you can do this, this is an attainable goal.

Dave:
So to me, being a private lender and being active in flipping houses are two pretty different strategies for real estate investors and might be oriented around different goals. So what was your goal when you moved from being a lender into more active investing?

Tom:
The private lending was never intentional, was I had cash in around, he asked me and I did it. So it was never like, all right, if I keep doing this, I’ll grow my blah, blah, blah. There was never a formula there or any sort of long-term plan. So that was just by chance happened. And then once I saw what he was doing, it was like, alright, this takes some effort, this takes some work. But there’s definitely something here. And then once that trickles down and you start reading the books and you realize, all right, there’s a bunch of normal people living off of real estate, let’s go. There’s an opportunity here. It’s proven that this can be done.

Dave:
You said you started reading the books, you found BiggerPockets, you jumped in. What was your first active deal?

Tom:
So we started, Chicago is a very, very vast market and most people, I started just at the lowest price point, which some people make that work. Some people, it’s a mistake. We really started at, you could buy something for 50 grand, put another 50 into it and have it appraised out at one 50 and either flip it or rent it out for 1500 type of thing. And these were in what I would call C neighborhoods. These, I probably underestimated just the amount of effort and time that these would take. But the original game plan was, alright, there’s a low price point, I can recycle the cash and we’re just going to keep doing these until we get to a very scalable number. So that was the original plan coming out of the passive investing.

Dave:
Okay. So you did, it sounds like a bur, right? You bought something for 50 grand, you put 50 grand into it, and were able to refinance, take some money out of it and rent it out hopefully for some solid profit. What kind of cashflow were you generating?

Tom:
We were producing good cashflow, but it was to a point where this wasn’t going to be a sustainable model for what I wanted to do. We actually totally pivoted and moved up to more of a class areas for several reasons. One, it’s where I’m from. I’ve taken advantage of just my knowledge of the neighborhood, easier to manage, not driving an hour down to a property. And two, we discovered my partner who’s a general contractor, we are good at doing these full gut rehabs. And when you’re doing full gut rehabs, you need to be in a submarket where the RV on the backend can justify spending that much on the rehab. So those are two things that became a turning point for us to say, you know what? This can work. This can work for other people. If we pivot now, this is going to work better for us. And that’s where we kind of made the shift to different submarket within Chicago.

Dave:
Okay, cool. So did you sell off the stuff that you had bought in those C-Class neighborhoods?

Tom:
We did.

Dave:
Okay. And then you basically started doing full gut rehabs. Were those burrs or flips or what was the business plan?

Tom:
Yeah, so I look at it, I’m kind of geo-based. We do both. The flips are my income, that’s how I make a living, that’s how pay the bills. And then I take that money as well, whatever’s surplus and keep buying properties. So the goal is to keep buying units. The flips are still part of it. It’s not like, oh, let’s just flip a property. Like no, we need to intentionally do a couple of these a year because it keeps the lights on. But up here in this neighborhood, it is very hard to rent out a single family home because our price per rent ratio doesn’t work very well here. So almost every single family home is a flip in these areas. For example, if you’re all into something for 500 K and it rents for 2200, you’ll never make money. The market doesn’t justify it. So those are almost all flips. And then anything on the multilevel, we’ll do the heavy rehab and then hold onto it.

Dave:
Yeah, that makes total sense. I hear a lot of people transitioning from buy and hold or burr into flipping right now just because it’s better to live off of if you want to be a full-time investor. Tell me, were there challenges and what were they when you switched neighborhoods? Did it make everything easier or did you have some lessons that you had to learn?

Tom:
This neighborhood’s actually better suited for us. We have more knowledge up here. We have more connections up here. This was a better experience. But yeah, you invested in all these different wholesalers, all these different brokers, you feel like there’s a sunk cost there of this time and effort that you’ve put in. You thought you’d hold these buildings for a long time, so you did a lot of CapEx on the front end. You get a little bit of that back when you sell it, but no one really cares that you did brand new windows or some of the stuff that you don’t get that full. So there’s a little bit of that, but for the most part, coming up here was definitely the right move for us.

Dave:
That could be a painful lesson And an important one that you just mentioned, Tom, that you often make your business plan assuming that you’re going to do something that winds up changing. I think the CapEx is a perfect example. You buy a house, you’re like, Hey, I’m going to put 10 grand into this thing because I don’t want to worry about my windows leaking. But then you sort of have to continuously reevaluate your strategy and see if it’s working. Although putting in new windows might’ve been the right decision at the time. Things change, dynamics change, and you have to make sometimes painful decisions that with new information you have to pivot a little bit. And it sounds like you did a good job doing that, but I’m sure it hurt a little bit at the same time.

Tom:
Yeah, it just feels like a sunk cost. It feels like all that time invested of like, oh man, what? And also you’re walking into the unknown. Everything has worked out, right. It’s easy to look back and be like, oh yeah, that was a really good move in a time though. You’re walking into the unknown, it doesn’t feel awesome.

Dave:
Yeah, I’m sure. But it sounds like at least it’s improved your lifestyle. You said that investing in this first neighborhood was keeping you up at night, and do you feel the same way in this new neighborhood?

Tom:
No, this was absolutely the right move for us. We’ve found our niche here and this is ripping off the bandaid has been the right move for sure.

Dave:
All right. It’s time for a break, but stick with us and we’ll be back with more of this week’s investor story. Welcome back to the BiggerPockets Real Estate podcast. We’re here with Tom Shallcross. So you mentioned you have a partner who is a general contractor, great partner to have. What part of the business do you run?

Tom:
I’ll just take an example. If we’re we’re looking for acquisitions, I have the relationships, I do the marketing as well. I’ll do a plug for deal machine. I know they sponsor your guys’ show. I’m a huge fan of them. We’ll try to get direct to seller, we’ll deal with wholesalers, we’ll deal with agents, et cetera. I’m doing everything on the acquisition side and before we start a project’s, probably 80% me, 20% him getting his intake on construction costs, getting his intake on how we’re going to do the layouts, but I’m in charge of the acquisition, the funding. And then once we’re into, I’ll call it that rehab mode where we’re going, we have our permits. It flips almost 80 20 to him. He’s running the show. He’s there day to day where I’m there twice a week type of thing. And then once we get back to disposition, it kind of circles back to me whether that be we got to lease up the place or we’re going to sell it.

Dave:
That seems like almost a perfect partnership. Can we dig into that a little bit? I’m sure there are a lot of people listening who would love to create a similar type of situation and just learn more about your deal flow and number of deals you do.

Tom:
Sure. Let’s do it.

Dave:
You mentioned you do a couple flips a year in 2024. What are you on track for

Tom:
Total? With the rentals that we’re rehabbing right now, we have five projects going on, which is about as much as we can do at one given time. Two of them are coming to an end here, so if the number’s going to become three in the next 45 days type of thing, they’re concurrent, but on all different stages.

Dave:
Alright, cool. And so you found all five of those deals, I assume, and were they all off market?

Tom:
One was on the private listing network, which was like the pre-market here on the MLS, but yes, all them either through broker relations, wholesalers, et cetera.

Dave:
You mentioned deal machine, but just what’s your go-to source for deals in today’s day and age?

Tom:
So deal machine plays a part of it, man, it’s not a sexy answer, but it’s reality is the last seven years I have just been every single broker. Every single wholesaler, Hey, do you got anything? They post something, Hey, congratulations. Good job. We have built up the reputation where we’re going to get our at bats, right? And then when we get the at bat and we like it, we’re going to close. I haven’t reneged on anything. So they know that it’s going to be there. I’d say another one that’s been a good help for us is with agents as well, especially with flips. We’ll give them the deal on the backend.

Dave:
Oh, nice.

Tom:
Meaning they bring us something, we pump 500 K of rehab into it. They know nine months from now, 12 months from now, they can go list that thing for 1.5 mil or whatever, and they have this big shiny listing and a big shiny commission. So when they hear in their office that something’s going to the market the next week or two, I’m the first phone call.

Dave:
That’s such a good example of relationship building and networking and real estate. Everyone wants a good off market deal, but the reality is if you want a steady of off market deals, it’s really about relationships. At least in my experience, it’s about connecting with real estate agents. And what Tom has done here is really understanding the mindset of the people he’s working with because an agent could go sell that pocket listing to pretty much anyone, but the biggest prize that you can give them, the reason they’re going to want to work with Tom is because he understands that the resale of this property is what really is going to get that seller motivated to work with him. And he’s finding mutually beneficial win-win situations where people are going to want to be excited to sell Tom a deal versus anyone else that they might be working with.

Tom:
Just put yourself in their shoes. Why would they bring a deal to you? What can I do to make this worth their while?

Dave:
And the commission is good, but also just being a person of your word, as you said, also matters. I’ve found, at least with pocket listings too. Just being quick and responsive is also really helpful. These people want to move stuff quickly. They don’t want to wait around for two days, for three days for you to look at it. And honestly, at least with me, I don’t know if you do the same thing, but if someone sends me a pocket listing and I’m traveling, I’ll be like, thank you. I really appreciate this. I don’t have the energy or the time right now to give this proper attention. You should go give this to someone else. Even though I would love to probably look at that deal, but it just shows I’m thinking of them and I understand their business and I’m not going to take advantage of their time or the fact that they brought this deal to me first.

Tom:
Yeah, absolutely. You can provide a lot of value by just telling them on a similar note, why it doesn’t work. Hey, this one doesn’t work for me. I know you’re saying the rehab’s 200, I’m at three 20. I’m not saying I’m right. You’re right. I can’t do this deal. My numbers are here. If you have someone else to do it, great. Or if it is not in my geo, like, Hey, like you said, you should call X, Y, Z.

Dave:
Yep, exactly. Yeah. Just help people out. They’re going to come help you out. And I know like Tom said, it’s not the sexy thing, but real estate’s a long game. It is and always will be a long game. And you’ve got to just start building those relationships now. And then Tom’s seven years into this, but I’m sure he is got a pretty big Rolodex of people calling him and people he can call what he needs a favor. And if you don’t have that now, that’s okay. That’s how literally everyone starts. But if you just start doing it now, two, three years from now, you’re going to have a great network. Seven years from now, you’re going to be firing on all cylinders and you could carry your business as far forward as you want to.

Tom:
The other thing too is if you don’t have those relationships, then you got to turn up the level of how much you got to grind. And any business. If you’re going to start and you don’t have the relationships, okay, well then you got to double down on those efforts to get direct with seller or do whatever you have to do to get out there. It is what it is. You have to work your way until you have those. And if you’re interested, you just do what’s convenient. You just go on Redfin, you do whatever. But if you are truly committed to this, then you will go be an animal. You will go find a deal.

Dave:
Absolutely. That’s absolutely what it takes to be successful in these types of deals. You can be a successful investor doing on market deals. So you could be successful doing buy and hold long-term rentals. But if you’re in Tom’s game, if you’re trying to do these gut rehabs, trying to get these best deals and getting them at the lowest possible price is a huge part of your business model. So can we just talk about an average deal, these five deals you’re doing in 2024, pick one if you want. What’s the entry point look like in Chicago?

Tom:
Yeah, so do you want to flip? Do you want to a rental? What do you want here?

Dave:
Let’s do flip. We’re talking a lot about flips, so let’s talk about flips.

Tom:
Sure. So again, we focus in higher end neighborhoods because like I said, the RV’s got to justify how much money we’re going to spend on the rehab. So a good example, one we just recently finished is we got this at 7 25, 7 50, and this was a 404 20 K rehab that we then sold at 1 6 4. So just hard costs, like hard costs. Now there’s holding costs, there’s permits, there’s a lot. You pay the agents that’s not profit, there’s a lot more that goes into it. But the three hard cost numbers are the ones I just listed.

Dave:
That’s pretty darn good. And how long did it take you to complete

Tom:
On a four or 500 K rehab? We can be done with construction depending on permits with the city. Chicago’s a little tough, but we can usually be done with construction nine to 10 months. And then if we’re lucky, we have a buyer lined up once we’re drywalled once the finishes are in and you can get in and out in under 12 months, but you kind of got to underwrite these things for 15 months, 18 months, model out when things don’t go according to plan.

Dave:
And what’s the market like right now? Are you able to sell these pretty quickly?

Tom:
Yeah, we’ve been fortunate. Two things. One, we’re disciplined. We say no to a lot of deals. So when we get one, we feel very confident in it. In those rehab numbers too, we are going to push limits, meaning we are going to do things that you’re not going to see in other houses. We’re at a point where it’s almost competing with new construction because in my opinion, new construction is pretty sterile. It might be brand new and all great, but if I can keep some of that charm from the 150 year old home or 120 year old home, there’s almost another value there to someone, especially someone born and raised here like, oh yeah, I see they kept a stained glass, they did this. That’s the original door that they refurbished. There’s a lot of value there I feel, and a lot of perceived value from the buyer’s end.

Dave:
I’m totally with you. If I was buying a home, I would love that the combination of historical architecture and a little bit of character combined with a renovated interior that’s super comfortable and up to modern standards, to me at least, that’s the best of both worlds.

Tom:
Yeah, absolutely. And I joke about this, but we spend a lot of time and effort to incorporate that, which is good. And I do feel it helps us, but we are almost over indexed that way. We will spend too much money on some things that we find really

Dave:
Cool. Yeah, I feel like you sort of get that way, but it just shows that you care that you’re into the craftsmanship element and you obviously want to do the house justice and really put it to its highest and best use

Tom:
More times than not, that’s why these things sell. There’s been a few times, there was one good example, different home, but we sold it before we were done, right? We’re at drywall, it’s probably got tile and some finishes, but we go under contract at a number. They didn’t even realize that we were taking this little cellar area and making it a wine room under the porch.

Dave:
Oh, cool.

Tom:
And we were doing stained glass with grapes and rests and all about 12 grand expense. They didn’t even realize it when we were under contract. It’s like, oh crap.

Dave:
Yeah. I mean, is that an instance of renovating that something you didn’t need to do? Clearly, but I guess it depends on the buyer. Some buyer might’ve loved it.

Tom:
Yeah, we probably could have gotten more automated. We articulated better this is going to happen. But no, you just plug in like, oh, if I do this, then why happens? There’s no straight formula for it.

Dave:
Alright, well those sounds like great deals. You, you’re getting them flipped and under a year, all the hard costs are pretty good. Obviously permit costs, soft costs, like hard. I don’t know how you finance these. Well, how do you find that some, why don’t we go into that?

Tom:
A lot of them, we have a acquisition line here, Chicago based company, Renovo. I’ll give ’em a shout out. They’re awesome. They’ve been with me since I was nobody doing my first couple deals in the south side, so been very loyal with them. We do have private investors as well. And on some of these, if we’re taking down a four unit or a six unit and gutting it a lot of times there, I can go to community banks here in the area as well.

Dave:
So at least on the flip side, you have hard money costs, you have some lending costs, you have insurance costs. I’m sure you have to pay taxes. But at the end of the day, just those high level numbers make it seem like a pretty good margin. Do you have any data on what your average profit is?

Tom:
Yeah, so we kind of have two different categories on those big, big ones right there. If you’re selling at 1.6, this is back of the knack and 1% rule type of thing.

Dave:
Sure.

Tom:
If you’re selling at one six in this market, if you can still get 10% of that rv, that’s what you’re aiming for. Some go well above, some go below. Everyone wants the answer of, okay, if I put in this and this happens, then this will be my number I sell at. The reality of the situation is they’re all moving pieces and you’re selling something a year from now. You could look at comps today, it can go in your favor or against your favor there, but those are the high end ones. And then same thing on the lower end. We have a lot of bungalows here, so we’ll buy, so we have a good example now buy something at two 20, put another two 20 into it, get out at like six 50, and those are really good numbers. That two 20 usually got to pay like two 60. That’s kind of where the numbers are. And then you add all the other costs in there. The way we look at it is floor and ceiling, and then my degree of confidence because on these bigger ones, and I think it’s important to stress this, it sounds great how much money you’re making, you need to make that amount of money.

Dave:
Totally.

Tom:
You were taking on all the risk. If that home doesn’t sell, you’re not renting it out, you are taking on all that 500 k. Rehab goes 20% over budget, that’s a hundred K out of your pocket. You have to start with these margins. These things will happen. So it’s not being greedy. It’s not like, oh look, it’s just reality. You have to have that much buffer for when, if and when it does happen.

Dave:
I completely agree, and I think it’s so important for everyone to pay attention to this. The deals that have the highest potential for return are almost always the ones that have the most risk. And as an investor, you just have to decide if that’s worth it for you. It sounds like, Tom, you’re very good at this, and so you’re willing to say, Hey, I could dispose something for 1.6 million. Hopefully my profit’s going to be 160,000, but I understand there’s a scenario where I break even on this or potentially I even lose money on it. But that’s what you get when you take big swings and hopefully you hit a lot more often than you miss. But every once in a while when you take on these big projects that have a lot of variables and a lot of things that are out of your control that sometimes they’re just not going to go as planned.

Tom:
Yeah, absolutely. One other metric we’ll look at too in the front end is just the liquidity required to do the deal. How much am I putting it on the front end? How much do I got to front too? Yes, you’re getting draws and you’re getting reimbursements, but at the lowest point of the game here, how much money am I going to be out of pocket and is that going to affect anything else I’m doing? Is the potential return on the backend going to be worth it? Is this the best use of my money? Right. That’s the question we’re answering.

Dave:
Yes, exactly. I think that’s such a good way to think about it. Just the resource allocation piece. I always give these silly examples, but if you could earn 8% with no risk or earn 15% with a ton of risk, there’s no right answer there, but that’s how you should be thinking about it. It’s not just the total return. If you’ve never heard of this term before, people listening, it’s the idea of a risk adjusted return. You can’t consider the upside without also thinking about what things could go wrong and how much volatility there is in the type of investment and the type of deal that you’re trying to do.

Tom:
Yeah, just because you ignore the downside doesn’t mean it doesn’t exist. It’s there. It’s there,

Dave:
Dude. And honestly, it’s like the more you ignore it, the more likely it’s going to come and bite you in the ass, I think. Right? Because I find at least that if you think about the downside, if you’re cognizant of the risk, then you’re going to be better at mitigating that risk. If you’re like, no, no, no, it’s going to be great. You’re just admitting you have a huge blind spot and you’re not going to be able to identify things that you could do to reduce potential downsides.

Speaker 3:
Yes.

Dave:
We have to take a final break, but we’ll be back with more from the BiggerPockets Real Estate podcast after a few ads. Let’s jump back in with Tom. All right, Tom. So yeah, you mentioned this is flips, they sound great. Tell me a little bit about the rentals that you’re doing in Chicago today.

Tom:
Yeah, it’s gotten extremely competitive. So we had to keep creating, I think you guys have used the term designing deals. So whether that’s adding units, we’ve built a coach house recently. We have started, alright, how can I continue to get more income out of this property? If you have a property, whether it’s four units, six units, five units, whatever it is, but if you have that property, the property taxes, the insurance, the water besides the mortgage, all those expenses are roughly the same. So what can you do to jack up the income there? And whether that be legalizing a unit, gutting the units, there’s costs associated with that. But more times than not, because you have those set costs on the front end, putting in all that effort is usually justified, especially when you’re in the true multifamily space where they’re doing it on NOI, what can I do to just jack up the gross rent coming through the

Dave:
Door? Yeah, because I mean, for better or worse right now, prices aren’t really coming down, especially in small multifamily and big multifamily prices in some cases are going down, but the biggest way that we as investors can impact the value of a property, as Tom said, especially in commercial deals where they’re looking at net operating income is boosting rent, and there is some elements of macroeconomics there. Rents go up and down based on things that are out of our control. But you can control the things that Tom was talking about and getting creative. So I’m curious, Tom, if you’re doing these things like adding a unit, permitting something, it frankly sounds like a bunch of work. Why is it worth it to you to do that versus just flipping?

Tom:
You want to hold deals, you want to have wealth? That’s the name of the game. Flipping is so I can do this part of the game, right? Flipping is the job. It’s fun, it’s cool, but you can pull your Instagram pictures, but at the end of the day, we all want to own real estate. That’s the whole reason we’re doing this. So that’s the end game. Why is it worth it? Especially when you’re in higher end neighborhoods. If you had a unit and that unit’s paying three grand a month, that’s a big number. So yeah, it might’ve cost you 120, 150 K to get there, and it might’ve been a ton of headaches. And that return on investment is insane.

Dave:
Yeah. You’re paying that off in five years when if you’re buying something at a 5% cap rate, you’re paying that off in 20 years. Right? That’s a four times faster return on your investment just by doing that.

Tom:
Not only that, but then you’re taking that number and put a cap rate on it, take it and divide it by 0.06 or whatever the cap rate in the given area is, and your value has just multiplied exponentially.

Dave:
Yep, exactly.

Tom:
And when you go for your refi, it’s like, all right, this is great.

Dave:
Yeah, absolutely. And just to make sure everyone understands what we’re talking about here, if you’re not familiar, typically in commercial real estate, the value of the properties is driven by two things, the net operating income and the cap rate in the area. Net operating income is just a measurement of income. It’s basically all of your income. So your rents minus your operating expenses. It does not include CapEx or capital expenditures or your financing costs, your debt service. So that’s your net operating income. And then there’s the cap rate in the area, which is kind of complicated, but it’s basically how much an investor is willing to pay for a certain type of asset in your area. And this varies pretty dramatically based on what region you’re in, what neighborhood you’re in, what type of asset you’re looking at, the quality of the asset you’re looking at. But the example Tom gave is if you had a cap rate of 6%, what you need to do is divide the net operating income by the cap rate, and you can calculate how much more the property would be worth. So I’m just going to do this right now. You said $36,000 basically in new income, right?

Speaker 3:
Yep.

Dave:
So if you did $36,000 divided by a 6% cap rate, you just added $600,000 of value to your property, and what’d you say? It cost you 150 grand.

Tom:
You paid 150 K to do it.

Dave:
Boom. Yeah. Beautiful.

Tom:
So that deal didn’t pencil at all, but now all of a sudden you’re able to pull your money out if you’re able to finagle this and make this all happen.

Dave:
Oh, that’s such a good example. Thank you for doing that. I’m, I’m glad we got into the details of these numbers. I think it helps people understand, yeah, you’re putting 150 grand in, but you’re improving your cashflow and you’re improving the value of the property. So you could either choose to just enjoy that cashflow or you can refinance now that you have the higher valuation and do something else with that capital.

Tom:
Yeah. I think one other thing with these low cap rate markets, it works the other way against you too. Your taxes go up, everything goes up, your value can diminish. Everyone thinks like, oh, real estate, no, it can, right? The cap rate, whether you’re going the right way or the wrong way, it’s going to amplify that.

Dave:
Absolutely. Yeah. Yeah. I think you have to be, again, cognizant of those risks. So it sounds really cool. Tom, I mean, I totally get this. I think that your approach to your portfolio makes a lot of sense to me. It’s similar to what I do. I don’t flip houses, but I like to have active income, working a full-time job to fuel my passive investing, buying long-term rentals. You’re doing the same thing, but you’ve gotten really good at flipping, which is a very lucrative way to earn money actively as you’re doing, and then putting it into rentals. It’s a similar idea for everyone out there. I just want people to recognize that you don’t need to flip houses if you want to buy rentals, but it is a good way to do it. It’s just a different job. Or would you agree with that, Tom?

Tom:
Absolutely. I like it. I enjoy it. It also, it’s tangent to the other stuff. It keeps me in the game. But yes, it’s the same concept of this keeps the lights on. This keeps me liquid. This allows me to go make offers on multifamily deals.

Dave:
Absolutely. So what’s next for you, Tom, as you go into 2025? What’s the plan for the portfolio?

Tom:
I don’t want this to sound like a lack of ambition, but it’s a lot of the same. There’s a bunch of shiny objects out there, right? We’re going to do this, that and the other. No real estate works. Just keep going. The stuff I’ve owned, I’ve seen it work firsthand. It’s worked hundreds of years for other people. Just stay on the track man and kind of think of things in 10 year chunks as opposed to what’s going to happen in the next three months.

Dave:
I completely agree with that. I think you come up with a goal and you just figure out what you need to do each and every year with real estate. You don’t need to be changing your strategy all the time. I think you should change your tactics based on what’s going on in the market. Similar to what you’re saying, you’re changing and becoming more creative. You’re probably changing your acquisition tactics, like the things you’re doing each and every day. You might be changing the tactics with each and every flip, but your strategy of using flipping to fund your long-term investments, does it need to change each every year? If it’s working, why would you change it?

Tom:
Yeah. You evaluate it and you make the adjustments, but you don’t need to go, you know what? I’m going to be a short-term rental guy in 2025. Nothing wrong with that, but this is working, so let’s keep growing with

Dave:
It. Absolutely. You don’t need to be chasing every little shiny object. Well, Tom, thank you so much for being here. Appreciate it. Congratulations on all your success. It sounds like you found a really great business and a way to continue to grow your portfolio and make a solid income and improve your financial position, even here in 2024. Sounds like you’ll be doing the same exact thing in 2025. If people want to connect with Tom. We’ll absolutely put all of his contact information in the show notes below. Tom, thanks again for joining us.

Tom:
Alright, awesome. Thanks, Dave. Been a pleasure.

Dave:
And thank you all so much for listening to this episode of the BiggerPockets podcast for BiggerPockets. I’m Dave Meyer. We’ll see you next time.