Why Investors MUST Change The Way They Buy Real Estate in 2022

Dave:
Welcome to On the Market, everyone. Today, we have certified deal junkie, James Dainard, joining us to talk about a super important topic that is on most people’s mind right now, which is what does a good deal even look like in 2022. But before we jump into that super interesting topic, James and I are going to be talking about some confusing and often contradictory data coming from the housing market right now.
Hey everyone, welcome to On the Market. I’m Dave Meyer, real estate investor and VP of Data and Analytics at BiggerPockets. Joining me today from Seattle, we have James Dainard. James, how are you?

James:
I’m doing well, man. Just try to keep up with this market right now.

Dave:
Yeah, it is a little confusing, and we are definitely going to get into that today. But before we do, I’m sure everyone who’s been listening to this podcast for the last couple weeks knows who you are. But if we have any newcomers with us today, could you just give us a quick explanation of your experience as a real estate investor?

James:
Yeah, of course. Like you said, I’m a certified deal junkie. I’ve been an active investor now for, and I can’t even believe it, like almost 20 years. I started when I was 23 years old as a wholesaler knocking doors in Seattle, Washington. We only buy in the Pacific Northwest, King, Snohomish, Pierce County. And we’ve gone from wholesaling. We used to wholesale 5 to 10 deals a month, and now we’re buying about 5 to 10 deals a month, and we’re a very active flipping company developer up in Washington. We usually flip about a hundred homes a year, build about 30 to 40, and then we lend money up there. And then we’re very active buying whole departments indicators where we’re doing a lot of value-add construction on the multifamily side.

Dave:
Yeah, James is a super experienced investor, and you should see his face when we talk about deal analysis. He just lights up. He gets so excited about it. So we are lucky to have him on the show today to talk about how to underwrite deals right now in 2022.
But before, James, we’re going to jump into some of our headlines. And as you said, we have some really confusing headlines. So I want to play a new game. I made it up. It’s just called Market Forces. I’m going to read you two market forces that seem to be opposites, but are existing at the same time right now, and I’d love to hear your opinion on which one is more important or which one’s going to win out. There seems to be these tug of war between opposing market forces, and I’d love to hear your opinion.

James:
I would love to hear what these questions are. That is the truth. Everything’s being contradictory right now. One thing says this, the other says this, and it makes it very confusing.

Dave:
It absolutely does. Okay, so let’s start first with demand versus supply. This is classic economic question. For anyone who hasn’t been paying attention to this, demand has been dropping off. You see that mostly reflected in… The data I like to look at is the Mortgage Banker Association Survey. I’m not sure if you follow this, James, but they actually just came out yesterday and said that mortgage demand reached a… I think it was like a 22 month or since 2019, it hasn’t been this low. So we’re seeing demand really fall off. But at the same time, so demand is low, we are also seeing supply remain pretty constrained. And as of this recording in early June, we still only have housing market data, really reliable data from back in April. But at that point, active listings were also down 10%. So we’re seeing lower demand and lower supply. So it’s unclear, in that kind of condition, where prices are going to go. So which one do you see winning out, lower demand or lower supply, in the battle for housing prices right now?

James:
I mean, demand is always key in anything that is moving in the market, whether it’s housing or… If demand is at an all time high or low, the transactions just don’t move in general. I believe demand is more important than inventory, because inventory can change with seasons, it can change with what people are actually doing right now. I think there’s a lot of things as we go into a different type of economy, and we possibly could be going into a recession, those are things that are still forecast down the road. So I do believe that the inventory is going to adjust up as demand starts to fall.
Cost of money, it gives people that reason to really slow down and think about things now, where if it’s really cheap, you always make that impulse buy or whatever it is, right? If something really pops up on Amazon, I’m going to be like, “Oh,” and it’s that impulse click buy. I do it a lot quicker. But if it costs more and I have to think about it, it just causes everything to slow down.

Dave:
Yeah, I think that’s a really good point that especially with inventory, demand, it’s not just like… Inventory is not a reflection purely of supply, like long-term supply. Inventory is a reflection of both new listings, how many new listings are coming on the market, and how many people want to actually buy that. So as demand declines, and I did misspeak, it’s a 22 year low for mortgage demand, not a 22 month low, that the mortgage bankers just announced. Yeah, it’s pretty big difference. That could mean inventory is on the rise.
That brings me to my second question, which is a little bit confusing to me. So Redfin came out with some data that on June 2nd, so it’s pretty recent here, that shows that as of June 2nd, the number of listings that had price dropped had doubled since February. So back in February, it was about 2.5% of listings were seeing price drops. Now it’s at 5%. Which historically, let’s be honest, is still not super high, but doubling is pretty significant.
But at the same time, 57% of properties are still selling for above list price, and the average list to price ratio is still 103%. So we’re still seeing most things go over asking, but at the same time, we’re seeing price drops. Super confusing market dynamics. What do you make of this? And which one do you think is going to be more important over the rest of 2022, let’s say?

James:
Well, the first thing, I think the data’s just a little bit behind right now. And part of that data that’s been recorded actually was on a lower interest rate. Because the rates were about four and a half to four and three-quarters when that data started recording. And when we started seeing the transition with a lot of our fix and flip… Because we get a very good basis of what’s going on in our market. We’re in affordable markets, we’re in expensive markets. And as we saw the transition, we were still getting a lot of movement. Because I think the buyers in that market were so beat up and they were so trained mentally that if anything popped up on market, it was going over list.
Because we’d have brokers… We would list a property and we’d have a review period. And we would miss our review period in that transition, and we would still have brokers call us saying, “How many offers do you have?” And we are like two or three days out past a review period, so that means we have no offers. And the next phone call will be from a broker, going, “How many offers do you have on the table? Do you have a pre-inspection? Do we need to waive? Do you take escalators?” And we’re going, “Wait, but we missed our review period.” So I think it’s just buyers in the market were getting trained, so it started recording more.
What I’ve seen recently in the last week or so is I have seen a lot of price drops. I’ve been seeing that, and so I do think that that 103% data point is going to change next month, when it all records out.
And the pending sales, they are selling. The properties are selling. They’re selling quickly, but we’ve seen a couple things. Either people are pricing about 5% to 10% lower off peak right out the gate, because they kind of have FOMO right now. They just want to make sure their house gets sold. Or I’m seeing these 7 to 10 day price drops, which, in my opinion, as a real estate broker, doesn’t make any sense. If you price your home and you run your analytics and you come up with your comparable value, you need to feel good about that number. And if they’re not selling in the first 7 to 10 days, brokers and sellers are getting a little bit of panic and they’re cutting price pretty aggressively because they’re just not used to these market conditions. They’re used to seeing 40, 50 people come through their house on a weekend, and now we have four to five, and they’re getting concerned. It’s causing a little bit of market irrationality and it’s causing the whole market to kind of cut, because everyone’s starting to chase each other, which is going to affect these data points.
But I do think price drops are going to be, as people try to figure out where the magic sweet spot for affordability in the market is, we’re going to see it a little bit at irrational, which is going to throw all these data points off. That’s why it’s really important for any listener is look at the data and hear the information out of it, but take a step back and always look at the big picture. Like if I hear inventory doubles, I’m not that concerned, because that means we went from two weeks to four weeks, and four weeks is still four months lower than the normal amount of inventory in the market. So don’t get caught up on these crazy little headlines, because the headlines can freak you out, but then you really have to take a step back and go, “Okay, what does that really mean?”

Dave:
Well, that’s why we brought you here for, Between the Headlines segment every week, James. Thank you. That’s super helpful.
One question before we move on is can you help ground us? You’re saying that a 7 to 10 days price drop is crazy. Back in 2014, 2015, whenever there was a more balanced market, what would you expect, as a broker, for the amount of time for a home to sell? Or how long would you wait before dropping price?

James:
We always factored in at least 45 to 60 days on the sell back in 2000… I would say from 2009 to ’12, we would actually factor in 90 days. And then from ’12 to ’16, we were really factoring about 30. We got our craft pretty dialed in at that time to where we were coming out as the nicest product in the market, so we would factor about 30 to 45 days, maybe 60 in a slower market. But that’s a normal amount of time. I think over the history of real estate, the average market time is like four and a half to five months. That’s normal, right? And it really should be, right? Buying a home is a huge decision for somebody. This could be a house that they’d live in for the rest of their life or raise their kids.
People started rushing so much because they had more FOMO rather than looking at what their long-term goals were. They had the FOMO of, “I’m going to miss out on the cheapest money that’s ever been out there in the world. I’m going to never have a house because there’s no inventory for sale.” And then they came off the pandemic and they were going stir crazy, so they wanted their own place to have to be more settled. So this mindset has really caused the market and the rules of the market to change, and you have to be patient.
So when we go out on a price, no matter what, unless I get zero showings or one showings, I’m not making a price adjustment. I have to run a very in-depth CMA on the property, go through the comparables, feel good about my price, mark it at that price, and then judge inventory. But I’m not going to cut price for at least three to four weeks, unless I dramatically overprice out the gate.

Dave:
Okay, thank you. That’s super helpful because I think when you see people… This increase in price drops, it’s not necessarily because they’ve been sitting on the market. Days on market is still 15 days right now. It’s still incredibly low. Some of the lowest that we’ve ever seen. So as James said, you see these headlines, it’s tempting to get sucked into this and be fearful, but do your due diligence, understand what the data is actually saying before you make any decisions about this.
Before we go into our due diligence part of the show, I do want to just ask you, it seems, in the last couple shows and today, you’re… Would it be fair to say that you are a little bit bearish in the short term about the housing market right now?

James:
I think everyone should be bearish on all investments, to be perfectly honest. I think the amount of money that got pumped into our market and the amount of assets they got inflated is just concerning. And it didn’t inflate just gradually. It hockey sticked up everywhere. So anytime there’s a hockey stick, I’m a little bit more bearish.
But at the same time, when I think the market is bearish and people are getting a little bit of caution and there’s some… There’s definitely investor fatigue out there right now. People have had this wild 24 months, and people are starting to pull back. That is also when I’m trying to buy the most, because there’s always this over-dip in correction, where everyone’s trying to figure out what’s going on, everyone wants to sit on the sideline. Well, if everyone’s on the sideline, that allows me to run the run on the field pretty freely. And yes, we’re being bearish in our underwriting, but we are still being aggressive on our purchasing. I think we did… I mean, we’ve closed like $5 million or $6 million in real estate in the last 45 days. So we’re still actively buying, we’re just buying under a new mindset.

Dave:
Well, that is a perfect segue to our due diligence topic for today, which is what is a good deal in 2022. Very excited to hear what you have to say about this, James. We’ll be right back after this.
All right, James, let’s get into your favorite topic. Let’s talk about deal analysis and what deals you’re doing right now. I’d like to break this down, because I think for different strategies, deals obviously look differently. What’s a good buy and hold versus what’s a good flip or a good wholesale or maybe even a syndication or passive deal. So let’s just start with buy and hold investing. Are you doing buy and hold investments right now? And what are some of the key metrics that you’re looking at or rates of return that you’re targeting in your deals, given this confusing market we were just talking about?

James:
Yeah, I’m definitely still looking at purchasing property and keeping them in the long… I mean, we just closed a nine unit in Renton, Washington. I just closed a triplex in Issaquah, Washington. And for me, I’m aggressively looking for rentals right now, because I do believe that rent is going to still go up. I know it had a huge jump the last 12 to 24 months. But with the cost of housing, I think rents are naturally going to get pulled up. And for me, I always like to know where is the upside, where’s the opportunity. So buying real estate right now, even with rates high, is a great idea for people. It’s a heads against inflation. It gives you a place to park your money, so you’re not losing money on your dollar right now.
And when we’re looking at these rental properties though, because we have that big inflation factor, we are looking for… For me personally, I won’t buy any deal unless the cash flow is higher than the inflation rate by two points. So if I think the inflation… For me, I don’t believe the national reported inflation rate. I think it’s right now around 8%, based on what I’m paying for things. So I’m targeting everything at least at 10% to 11% on my cash-on-cash return.
If I don’t have that, I don’t want to be cash flowing less than what the dollar could be going down at, because I just don’t think… You’re not getting ahead of the market. And for me, as a… I’ve been doing this now almost 20 years, so I feel like I’m getting old. But I still have a lot of runway, I think, and I want to stay ahead of the market and keep growing rapidly, because I’m not at that kind of, I would say, stabilization phase as an investor where I can passively just kind of invest and live off that. I’m still trying to grow. So for me, it’s really important to be ahead of the inflation rate.
I’m also looking at what kind of finance am I having. Commercial banks right now are being pretty aggressive, and so we are still able to get very good lending out of our local banks and they’re cheaper rates. So right now, as we’re looking at properties too, we’re going towards those 5 to 10 unit buildings, because the bigger players aren’t really aggressively looking at those, and the small mom-and-pops investors, they’re kind of getting locked up a little bit and they’re afraid because… They’re so used to this mindset of, “Hey, this property’s for sale for this price, and it’s going to sell because the market’s so hot, so I’m just going to sit off the sidelines.” Whereas what we’re doing is we’re looking at what’s not selling and we’re going to aggressively go after that with the right metrics in play. And because there’s no demand, we’re able to actually get these properties under contract right now at numbers that we haven’t been able to do for the last 24 months.
So we’re making sure that we are above the inflation rate and we’re going where our banks are being loose with the money that gives us the best financial performance. Those assets that we can get the cheapest money on with the lowest demand is going to be the best possible deal.

Dave:
There’s so much to unpack there. Let’s start with the inflation rate. How did you come up with the 2% above the rate of inflation as your metric? Is that because you expect inflation to go up another 2%? Or is that just sort of like a bare minimum you’re looking for because you need some real cash-on-cash return?

James:
I’m a cash-on-cash return junkie. That is my main metric. And a lot of people don’t use it as heavy as I do, but I mean, for me, as a simple investor, is I have this much capital, how much is it going to make me every year? I just like keeping things simple on that route. That’s done really well for me over the last 15 to 16 years. But yes, I want to be ahead of the inflation. I want to be making that cash-on-cash return.
Also, I think at some point, we could see a hockey stick in inflation too, with all the supply chain issues. I mean, we could have food shortages. There’s some other impacts that we’re reading in the market that could make it jump again. Again, I don’t want to underestimate the jump. So if I core believe that, then I need to plan accordingly for that and really put it inside my metrics. So it gives me a little bit of padding on the 2% in addition to… I just want to make sure I’m beating inflation. I don’t want inflation pushing me around. If I can outsmart inflation and out-return it, then I’m okay.

Dave:
Yeah. But I think that there’s probably… I’m thinking one, if you’re finding 10% cash-on-cash return deals, give me one, and I’m curious how you’re finding those. But two, is that a good return? Would that have been a good return for you in a less inflationary environment, or is this an adaptation that you’ve made based on what you’re seeing in the market?

James:
I constantly… Every quarter that I was… Even every six months or so, I really look at what I’m doing with my holdings. The most important thing any investor can do, including myself, because it helps keep me focused, is narrowing my buy box. What is my expected returns in certain areas? So in areas that were more B2C rated, I was always going for 10 to 12, because I think it comes with more of a hassle. It requires more management, there’s more expenses. So I always want that extra padding in there.
In better neighborhoods… For example, I purchased this triplex in Issaquah, Washington, or I have one in Queen Anne, Washington I recently purchased as well. They’re really good neighborhoods. So I dropped my cash-on-cash return down to like 6%, because I had such a high appreciation factor in there, and I was buying in the neighborhoods that were moving the most. These are also neighborhoods that aren’t going to have as much movement on the drop either. This is where people want to live. But right now, if I’m buying that same deal that I bought five months ago at a 6% return, I’m going to be… In my opinion, I’m losing money, because the inflation’s beating it out at that point.
So I’ve adjusted even in the good neighborhoods. Now I’m at more 10% on the good neighborhoods, and in my B2C rated neighborhoods, I’m actually dealing with more 15%. The reason that’s even higher for me is because in those neighborhoods, I’ve had more wear and tear on my properties in general, and construction costs are also a lot higher. So my maintenance repair costs have jumped up quite a bit as well. So I factored in the extra return there also to offset costs that I have to keep up with in the inflation.

Dave:
That’s fascinating because I have typically taken a similar approach where if you’re in a good neighborhood where there’s a good prospect of appreciation, willing to take less cash-on-cash return, because your maintenance is probably going to be less. You probably might have less turnover between tenants, and there’s costs associated with that. But does that mean that you’re… Are you able to find deals in good neighborhoods with a 10% cash-on-cash return now? Or are you focusing more on different neighborhoods that have higher cash-on-cash return, but may be less desirable to live?

James:
No, we are definitely seeing the transition over… Right now, I would say the buy and hold hasn’t quite, quite got there, but we’re seeing it on the fix and flip for sure. But again, it comes down to that perception of what the market is. So everybody is getting… They’re pulling back a little bit. It’s like they’re getting all the bad media. They’re paying more at the pump. They’re paying more at their grocery store. And everyone’s seeing the signs. I think a lot of people that were investing in the last 5, 10 years also went through 2008, whether they were growing up and they had a bad experience at their own household, or they were an investor or homeowner that it maybe didn’t go so well, and there’s that whiplash in the market.
So as people are pulling back, we are definitely seeing more opportunity. Because the thing is construction’s gotten way more difficult, things are harder, it’s harder to find guys, things cost more and it’s became a pain point for a lot of investors. So value-add has already had this pain point where people are like, “I don’t really want to deal with this. It’s giving me that floating target. The construction’s hard. It’s just such a headache for me. I don’t want to do it.” So that was already in the market.
Now the money makes all list prices look bad too. When you really put the numbers on most stuff that’s listed, it does not make sense at all. But as those days on market start to accumulate, that’s where sellers start really fluxing. And we have contracted some fairly good buys recent… I mean, we just got one in Everett, Washington for $50,000 a door. We haven’t been able to buy at that price range. It was a nine unit. It needs a lot of work, but stabilized, it’s going to be a 9.9 cap. The cash-on-cash return is going to be over 20. Those things usually trade at about 150 to 175 a door. We’re at 50. That was stuff that we would get back in 2012 to ’14. Heavy fixers didn’t people want to do with it. Higher rates back then, so people didn’t really want to mess with it. But we were able to get that deal now. And it really comes down to, again, just cost of construction, the processes behind it, and then a little bit of fear in the back of the mind where people now are not pulling the trigger.

Dave:
So was that sitting on the market? Is that where you attribute the… Is that why you got the deal for such a good price?

James:
Well, that one was actually an investor bought that one six months ago, couldn’t figure it out, and then now they are like, “I just want to get rid of this.” Because they’re in the planning process and because they’re nervous, they were willing just to kind of cash the deal out and call it good. They’re taking a little bit of a haircut too.
And that’s the thing. When people get nervous… I think for the last 24 months, people thought they… Or not thought. They’ve obtained a lot of wealth through equity, and in their brains, they feel like they’re way wealthier than they actually are. Equity is only good when you realize it. And then what happens is as people are seeing their bank accounts go up with this equity and they’re feeling better and better, they’re spending money. They have real wealth. And once it starts coming down, people start really freaking out, and they want to capture that wealth right now. They don’t want to go back to not having as much money again. So it kind of makes people be a little bit irrational. But I would say we’ve been able to do this in the last two weeks. It’s really on these current transactions.

Dave:
Wow. That recent.

James:
It’s very recent.

Dave:
Are you getting deals on the market too? Like that nine-plex was an investor deal, but are you finding things on the MLS too where people are selling for under that list price? Because you just said that with the list price on a lot of these doesn’t make sense. So how are you making them make sense?

James:
We are actually getting more on market deals done than off market, because-

Dave:
Really?

James:
Yeah, because here’s what’s going on right now is these wholesalers, for the last 24 months, they’ve been… I mean, they’ve been getting paid.

Dave:
They’re having good times. Good times for wholesalers.

James:
They have been crushing it. And every investor, wholesaler, it’s like you’re courting them every time. How do I get in bed with you so you bring me that deal first? What do I need to do? I mean, that’s what we do a lot in Seattle. We help wholesalers because we just want them to bring us the deal first, because we don’t want to miss out.
So these wholesalers have also been trained that if they get anything under contract, they can sell it to anybody. But what’s happening now is they’re turning around to these investors and there’s nobody taking it, because the margins aren’t there anymore. And a lot of wholesalers are also newer to the market, so they haven’t been through any kind of life cycle of real estate, and so they don’t understand that people buy differently at the time.
So the wholesale deals are actually still pretty heavy. Also, these sellers have been getting harassed for 24 months, so they haven’t… And the transition’s so recent, they haven’t really caught on either. We have been getting more calls from off market sellers re-engaging. Those leads are up probably four times of what they used to be.

Dave:
Wow.

James:
We use a room called Call Magic. They call out… They do mass amounts of contacts. We used to get about five to six leads a day, or I would say every two days. We’re up to like 15 leads in those two days. So people are definitely calling more, but they’re getting a gauge really on what it is.
The on market’s beautiful because a seller gets it listed. They see how many people are coming through, right? They get the reports. They get to see what’s happening in real estate today. They know that homes were selling in five days, 90 days ago and selling way over list. And then they roll their house out on market, and nobody wants it and no one’s even looking at it. They get real very quickly. I like doing transactions with people that are real on their numbers. So we’re able to use a lot more logic on the market based on days on market, showings, inspections, and data points, and we actually get a better margin on market than we do off market right now. Substantially better margin, to be honest.

Dave:
That’s fascinating. I mean, you are ahead of the data right now. As you were saying, most real estate data comes a month, six weeks in arrear. So we’re sitting here in the beginning of June, we’re looking at a last full month of data in April. But what you’re saying is just in the last two weeks, things are already starting to shift. So this is super valuable for our listeners, so thank you for sharing all this with us.
So you basically said cash-on-cash return in terms of a buy and hold is your main metric. Do you ever factor in appreciation into a buy and hold deal? And if you do normally, are you doing it right now?

James:
Any property I buy, and I’ve always trained myself this way, I look at it on a 10 year basis. So in our rental pro forma… Because we want to see how well does this deal do over 10 years. If it’s commercial, what’s your principal buy down. What’s your accumulated cash flow over the 10 years?
And then we always put in two standard metrics, but we don’t use the high ones. Appreciation. For the last 30 to 40 years, real estate has appreciated, I think, an average of like 3.5%. It’s been crazy the last two. So that’s what we put into our appreciation box. We use the average over the last 20 to 30 years. So we factor in a 2% to 3% appreciation over 10 years. I don’t think I’m going to get that over the next two, but I will get it over the time. So I just use a normal metric.
Same with rent increases. I think rents will pop even higher over the next 12 months, but we do a standard 3% rent. It depends on what your market is. We kind of just put in 3%. 5% is kind of standard right now. So we pro forma that over a 10 year basis. A 3% rent increase on the growth as well. So we just use standard. We won’t factor in short term.

Dave:
Got it. Okay. So one rule of thumb in the buy and hold world that a lot of people are familiar with is the 1% rule. Which if you’re not familiar, or the rent-to-price ratio, basically it says, if you divide your monthly rent by the purchase price of a property, it should equal 1%. So as an example, you buy a place for a hundred grand. The monthly rent should be at least a thousand dollars a month. The theory is that this is a good proxy for cash flow. If you hit that 1% rule, you’re going to have a good cash flow.
I’ve actually done some data analysis into this, and there’s truth to that. There’s about a 0.85 correlation between the rent-to-price ratio and your cash flow. So that’s pretty good. Pretty strong relationship.
I’ve written extensively about the 1% rule and my own opinions about that. But I don’t know if you know my opinion about it, so I’m going to ask you first. Do you think the 1% rule is a good rule of thumb or represents a good metric that people should be using in today’s day and age when they’re looking for buy and hold deals?

James:
I think on a general, I think it could be usable. And I think your numbers at around 85, that’s about dead on, because your cost of mortgage on that is going to be about, let’s say… That’s going to be about 0.65% of that. Roughly in there. And then your other expenses is going to get you around that 85%. I think it’s a safe way to look at things on a broad basis to help you get through that first step of underwriting.
Would I ever buy a deal based on that? Absolutely not, because each market is so… There’s so many variances in each market, depending on where you’re investing or I’m investing, it can have a lot of variance in it. But as a quick rule of thumb, I do think it works fairly… It’s like my first set of scrubbing. Does this work real quick? Okay, let’s take it to the next phase. Because also as an investor, your time management is such a… I’m a huge deal junkie. I’m looking at 40, 50 deals a week, minimum.

Dave:
That’s crazy. That’s awesome though.

James:
That’s why I was emailing you so late last night. I was just crunching… And there’s so many more to look at right now too. So it’s like a kid in a candy store. But it’s a good first way to do it. And I think as a general, it has enough padding in there, and it also doesn’t have too much padding to where you’re going to get frozen up every time. So it’s a reasonable rule to use.

Dave:
All right, I like it. My general thinking is that it’s a good way to screen neighborhoods. Like if you wanted to pick a whole market, like if you wanted to say, “I’m interested in finding a neighborhood in Texas,” it’s a good way to sort of zero down. But when you get to the actual deal level, I think it really kind of falls apart.
So what I’ve recommended to people is if you see a rent-to-price ratio that’s like at 0.75 or even 0.8, that’s worth considering. Again, you might not want to pull the trigger on a deal that has a rent-to-price ratio that low. But it’s not worth writing off a deal just based off of the 1% rule until you fully underwrite a deal. Because I’ve seen deals as low as 0.75 rent-to-price ratio deliver really strong cash flow depending on taxes and insurance and maintenance. There’s just so many variables that rent-to-price ratio doesn’t account for.
So I generally think that these rules of thumb are helpful, but a lot of times, it frightens people because they can’t find that 1% rule. But they’re not fully even underwriting these deals and don’t actually know what the cash-on-cash return would be at the end of the day.

James:
Yeah, and there’s so many things that factor in that too, like how much work do you have to put into it, what kind of… If it’s turnkey, move-in ready, then it’s probably going to work fairly well. But you have to factor in your time, your money, and your resources in there. Those are the things that that’s not going to capture very well.

Dave:
So if you had a rule of thumb to use for buying in 2022, would it be 2% above inflation? Is that sort of your north star right now?

James:
Well, a combo, because I’m still that walk-in equity guy. A great equity position is a great equity position. But yes, that’s my general rule on cash flow. I want to be at least at 2% above inflation, and that’s minimum too. I do shoot for higher, but I’m also prepared to do a lot of construction work and heavy lifting to get me in a better position too. So the more work you get, the more cash flow you get too.

Dave:
Yeah, makes sense. All right, great. James, this has been super helpful. So for everyone listening to this, seems like according to James, at least in your market, James, there seems to be some buying opportunity right now. And even on market, there’s opportunities to find the kind of returns that James, as a deal junkie, is looking for. So that’s encouraging. I’d like to switch now to flipping. Because you also are doing a ton of… How many flips do you do in a year?

James:
Too many. I think we-

Dave:
You can’t count.

James:
… do about 150 with our clients a year, where we help them design them, find them, source them, put the plan, implement the plan. And then we do about 50 this… We were doing about a hundred, but now we do about 50, but they’re bigger projects. So it’s about 50 a year. Right now, I think we have like $15 million to $20 million in projects going.

Dave:
Wow.

James:
In flips. But they’re expensive. They’re just more expensive ones. So it’s definitely the most… It’s the fewest amount of deals I’ve been doing, but the most amount of capital for sure that we’ve had out.

Dave:
Interesting.

James:
We’re trying to work smart and not get us spread out.

Dave:
Well, that raises a good question. Well, raises my next question. I’ll just call my own questions good. But raises my next question, which is what is a good flip look like to you in this kind of market?

James:
There’s three major things that we’ve done to transition, and it’s been a pretty rapid transition. We’ve only take these steps about four to five weeks ago. The less people I’m seeing look at houses, the more we’re padding our margins.
The first thing that we’re doing is we’re adding contingencies to all of our construction costs and costs in general. The cost of fuel, the shortage of materials and labor are real things that are not improving. They’re getting worse. So any deal that we’re looking at, we look at our rehab numbers and we add 10% to 20% on. That’s the first thing we do, because that’s our middle core cost.

Dave:
How do you come up with a 10% to 20%? Are you basically taking numbers and comps from your last deal? And then how did you settle on 10% to 20% as your padding?

James:
For the last 12 months, we’ve used 5% to 10%, because it was a little bit less variance. Plus, there was a little bit more appreciation… The market was doing well, so you’re going to be a little bit more aggressive.
As it starts to flat line out… And by all means, I don’t think the market is going to go into a total, total spin, but I do think there’s great opportunities coming. As it flattens out, there’s just more risk. You’re not getting that extra upside that we’ve seen that’s going to pay for those overages. So we wanted to double up our contingencies because also things are just soaring so quickly. So it gives us more padding in our deal.
We use a construction calculator that we built internally that just really calculates per square foot install rates and allowances all the way through our project. So we know exactly what materials we have in our estimates. We know what people are installing them for. So because we have our core… That’s the beginning part of our budget. The budget’s set up right. Usually, we’re going to be within a couple percent of that out the gate, unless we miss something on our scope of work. So by adding that contingency, 10 to 20% on, it just pads in our numbers.
How we get the numbers is we interview contractors in our trades, and we just get the install rates directly from them. And then if we’re putting our own allowances on, we’re controlling what the materials are. So we just add the 10 to 20% on top of that.

Dave:
Okay, so that’s one rule of thumb that you’re following, which is just padding your construction and-

James:
Pad. Pad, pad, pad.

Dave:
Pad as much as you can. What about on the acquisition side? Have you changed anything about the kind of deals you’re looking for or the price point you’re looking at?

James:
We definitely are. We made major adjustments on what our expected returns are. So typically what we’ve been buying for the last 12 months is in really good neighborhoods of Seattle, or the east side. We’ve been buying at a 10% to 12% cash-on-cash return, not including leverage factored in that. That’s just on a cash basis. That typically turns into about a 30% to 35% cash-on-cash return with leverage. Maybe even a little bit higher.
We were kind of in that 30% range at that point. And that we were getting that kind of appreciation factor in there. I’ve never factored appreciation to any one of my deals on a fix and flip. I don’t think it’s a smart thing to do. You’re banking on the market. What I will do is go in with a slimmer walk-in margin. I like the area, so I’ll buy it if it’s a little bit riskier.
In sub-markets, we were buying them at 13% to 15%, which was going to be about a 35% to 42% cash-on-cash return. So what we’ve done is we’ve added about 4% to 5% to each one of those areas. So it’s a huge jump. So if we were buying at 12%, now we’re buying at 17, because it gives us a much bigger padding.
Because as you go through a transitional market, you just don’t know where it’s going to fall, so you have to pad things more. So we’re padding it with 5% on the buy. So we’re going from 12 to 17, roughly. And then we’re adding 20% to that contingency on the construction budget. So we’re just adding in buffers of time.
In addition to, we’ve been able to flip all these homes… What we’ve tracked, all of our clients flips, all of our flips, we average out about 6.9 months for a normal fix and flip for the last year. It would take our clients and ourselves on average 6.9 months to buy it, renovate it, sell it, close it. We’ve added three more months to that now.

Dave:
Wow.

James:
Because as we know, that was also in a market where we were only on market for five days and things were closing quick. So as we go into longer hold times, we’ve just got to account for it. So instead of running our flip calculations at a six month to seven month hold, we’re running them at a 7 to 10 month. So we’re adding more leverage costs, we’re adding more construction costs, and we’re adding a bigger margin, and that’s what protects us all the way through.

Dave:
Okay, I have a lot of questions. The first one is based on that additional time… You said you added three months, and you said that’s because you’re expecting days on market to go up, longer sale time. Are you also anticipating longer construction time with some of the supply chain issues? Or have you been mostly able to mitigate that?

James:
Well, how we’re mitigating that is we’re really staying on top of our budgets and just increasing them dramatically. The more money you have in the budget, the easier you can move. That’s actually why I’m doing a lot more luxury flips is because I can bring out trades that show up, they’re quality workmanship, and they’re more professional. It allows us to systemize it out a little bit more. So if you have the money in the budget, you can pay people a lot better, and they can move a lot faster.
But yes, delays are still happening in cities and permits. Things are starting to fall. I think that’s going to be an issue for another three to five months, kind of in that range. I do think as rates get up, the economy is going to slow down, and I have a feeling… Well, also, investors are getting out of the market a little bit. They’re sitting on the sidelines. There’s general contractors and tradesmen that are calling me right now that haven’t called me in a while.

Dave:
Really? That’s a big change based on where we’ve been the last couple years.

James:
It’s been a huge change. And to be honest, I kind of put them on the sideline right now. I said, “Hey, look, you kind of left working.” So we kind of ice them out a little bit longer too.

Dave:
We’ve got to play hard to get now. They’ve been ignoring you.

James:
The things I’ve had to do for these contractors for these last 12 months, I feel abused. It’s like you just have to be so… So I have a feeling as things slow down, the trades are going to show back up a little bit more. So I do see that… And that’s why I’m a buyer right now. Things are going to improve in certain segments. And as long as I have those big pad in, walk-in margins, and I think they’re going to improve, then it’s almost like I can pick it up on my construction cost and timing, and put that back in my pocket from the padding. So instead of getting appreciation, I could pick up extra costs based on efficiencies.

Dave:
Got it. That makes a lot of sense. But in general, so it sounds like over the last two years, you were targeting an unleveraged cash-on-cash return of, you said, about 12%.

James:
Correct.

Dave:
Which would net you a levered return of mid 30s. And now in order to protect yourself, be a little bit more conservative, you’re looking at 17% unlevered in… You said it was in the mid 40s on a levered return?

James:
Yeah, it’s, I would say, 38 to 45 on average.

Dave:
Okay. Just out of curiosity… So that’s super helpful for anyone listening to that, is that’s what you’re targeting. What were you getting on a leverage return basis over the last two years on some of your flips?

James:
Oh man. Some deals, we were making 100% to 150% returns. I mean, there’s that expensive flip we did where we pro forma-ed the deal at 3.95 mill as our exit. We sold it for 6.5.

Dave:
No.

James:
I’m sorry. 4.95. 4.75 to 4.95. We sold it for 6.5, and that was in a five month period.

Dave:
50% over what you pro forma-ed it.

James:
It was unreal. But we were seeing that. Our clients, we were getting offers 200, 300 grand over list. Bellevue appreciated 50%, 60%. So we saw these huge swings, and they’re unrealistic returns.

Dave:
So that’s exactly why I asked you this question, because one thing I hear continuously is the deals aren’t as good as what they were a year ago or two years ago or 10 years ago, whatever it is. But you’re still buying deals. So how mentally do you handle that? You were getting maybe 50% cash-on-cash, 100% cash-on-cash. Now you’re saying, “All right, I’m okay with 38%.” How do you rationalize that to yourself, and why are you doing that and why do you think listeners should consider sort of readjusting their expectations in the way that you’re doing that?

James:
The first thing that I would always tell people is if you were getting those kind of returns, that is not normal. Like for me, I’ve been doing this for a while and I’ve seen ups and downs. I’ve taken pretty major losses, and I’ve done very well. So I just know at the end of the day, it’s going to balance out. A great year could lead to a flat year the next one. And if I look at a two year basis, it usually kind of levels itself out.
What I like to do is I look at my pro forma and how well did I execute if I would’ve hit my pro forma numbers. How well did our construction do? What was our carry cost time? Because that tells me the efficiency of my business. And when I underwrote that deal, the numbers were probably right. The market dictated the return in the upside. So I have to remember that I am not… The most important factor in this is economic conditions and market conditions. And no matter what I do, I can’t beat the market. The market will always beat me. I have to plan accordingly for the market, but I also have to set my expectations that way. At no point did I ever think in my pro forma that I was going to hit a hundred percent return on any of those deals.

Dave:
You’d be insane to think that, right?

James:
I would never get a deal.

Dave:
Yeah, you can’t go in… Yeah, exactly. You would never do anything. But I think that’s sort of what happens to some people, at least, is it’s sort of paralyzing, because you hear these stories about these incredible returns or buying in 2010 and these amazing opportunities. But in some way, at least this is my opinion, a good deal in 2022 is anything that’s better than doing nothing, right? In the simplest way of looking at it, you have an option of losing money to inflation. You can invest in the stock market if you want. Or you can go and find what the market is giving you right now, which what you’re saying is maybe an 8% to 10% cash-on-cash return on a buy and hold, or a 40% levered cash-on-cash return on a flip. Both, to me, sound considerably better than doing nothing or any alternative asset classes.

James:
Yeah, and that’s the thing. People just need to remember what’s normal. I have to always remember that we did very well the last two years. All of our businesses did. But I think any business that was operating well was doing well. It wasn’t just because of what we were doing, it was the market and the economy helped us do that. But you have to always remember what’s normal.
That’s what I was telling my clients for the last two years. You guys, this isn’t normal. Just remember. They call me, they’re all excited because we just sold their home for a quarter million dollars more than we thought. And I’m like, “But remember, that’s not normal. What that should be is a reminder to stay as a consistent investor,” because those people were not making the same amount of money 24 months ago to 36 months ago. But if they would’ve never started in a market where they were making average returns, they would’ve never been in this position in the first place.
So the more you go in and out of the market, the less opportunities you’re going to have. That’s why I’m always consistently buying. Some years, it’s going to be better. Some years, it’s going to be worse. And some years, we’re going to absolutely crush it. But you have to consistently stay in the market. If you’re jumping in and out and trying to time everything, you’re going to miss all the opportunity. So you just have to be realistic.
And then one thing that I like to do too is I look at myself on a 24 to 36 month basis with all of our numbers. How did our flipping business do over a two year basis, not just the last six months? The historical numbers are going to really tell you what to forecast correctly, because that shows you different market conditions and cycles.

Dave:
Yeah. What you said, I think, is super important because there is a distinction between timing the market, which is what you’re cautioning against doing, which is like jumping in and jumping out and adjusting to the market and trying to make the most of what the market is giving you at this time. And as you said, you are making adjustments to the market, and that’s wise and you’re being conservative. Because I agree with you. No one knows what’s going to exactly happen to the housing market on a national basis, but there is a good deal of market risk right now, far more than I think we’ve seen in 15 years or whatever. So you’re being conservative, which makes sense. But that doesn’t mean you’re trying to time the market and saying, “I’m going to completely stop. And then once there’s a crash, I’m going to get back in.” You’re taking a much more consistent approach, similar to like dollar cost averaging in the stock market, right?

James:
Correct. Yeah, right now, we have a certain amount of inventory going. We could take a step back and go, “Well, if the market’s going to be flat, do we want to refi it and keep it?” No, we have a certain goal that… We know what we’re doing with that asset already. It’s going to sell for what it’s going to sell for, or it’s going to rent for what it’s going to rent for. It’s going to cash flow for what it’s going to cash flow. If it doesn’t meet my expectations after I’m all done, then I need to sell it off or move on to a next asset. But consistency is key. The more irrational I’m pulling in and out, the less money I’m going to make.
And just adjust and pad your numbers, and then you can… As long as you have that padding in there, you’re mitigating your risk and you’re still going to keep yourself at the returns that you want to be. And if you don’t get those numbers, then wait or ask more people. You’ll find it if you ask enough people.

Dave:
That’s great advice, James. Is there anything else that you think our audience should know about what constitutes a good deal in this type of market condition?

James:
I mean, the biggest thing is just padding the pro forma, making sure everything’s good. One thing I like to do too, and if people are really worried about risk or when I get worried about risk, I like to buy cheaper deals that can cash flow or flip.
When you have multiple exit plans that you can put on a specific house, that’s your safest investment. And that’s going to be tell me… When we were doing this in 2009, that’s what we were buying, because A, we just got our… It was not a fun 2008. We got smacked good. We had lost most of our liquidity. So we couldn’t just put it into the market, we had to kind of build it back up. So every deal that we were buying, because we were so shell-shocked from that, it was a very risky market where it was falling extremely fast, is we were targeting properties that we knew, no matter what, if it didn’t flip and we couldn’t make our minimum return, we could refi it and rent it out and put it into our portfolio. Some of those houses that we couldn’t flip turned into some of the biggest profit-makers that we’ve had over the last 15 years. So just having a multipurpose, multiple exit strategies on your deal, that would be another way you can mitigate risk.

Dave:
All right. Thank you, James, so much. This has been enlightening. I’ve had a lot of fun learning a little bit about flipping. I’ve never flipped a house, and so I’m very interested in learning from you. This is really helpful. We will be right back after this for our crowdsource segment.
Welcome back, everyone, to our last segment of the day, where we interact with our crowd. James, for today, I would love to hear from you about your clients and some of the people you’ve been working with, specifically about 1031s. There’s a lot of chatter about selling now when it’s high, and what do you trade into. So can you tell us a little bit about how you’re advising your clients and the people you work with?

James:
Yeah, it’s kind of confusing right now because a lot of our clients and ourselves, we’ve been buying properties for the last two years and we’re obtaining money at very low rates. So you buy these properties, you have very low debt on them. Typically on commercial, it’s going to be a 5 to 10 year note anyways. But they’ve got a lot of equity in them, they have good money on them, and they’re happy with their cash flow. But they have worked through some of the depreciation schedule, like the cost segregation. They’ve gotten a lot of the benefit out of it. They’re also worried that their rates might reset in three to four years at a higher rate at that point. In addition to, they might just want to move into a different asset class too.
So as markets transition, the question always is, “What do I do with my investment money and portfolio before it goes through that transition?” Because once you fully go into the transition, it’s harder to move things around. So a lot of the question right now is, “What is my current portfolio doing?” And then also what we’re telling everybody to look at is, “Is it beating the inflation rate?” If it’s not, you might want to look at trading some things around. Look at what your true equity position is. And then we can look at how to increase your cash flow to beat that inflation rate or to increase it naturally at that point.
Where people get hung up, or I even can get hung up on, is being so obsessed with their rate. They’re like, “Well, yeah, I have all this equity, but I’m only paying 3.5% on this rate,” and they don’t want to move. But they might only be making a 6% cash flow position, and they have all this equity in the building. What we’ve done is we’ve actually audited our whole portfolio. We saw what deals we’re looking at that were lower than the rates, and that’s what we do for our clients. Where is your cashflow dragging the most with the most amount of equity? And then trading it. And it doesn’t matter what the interest rate is down the road. It could be double. But our cash flow position is going to double up at that point.
So right now, a lot of the question is, “Do I make that trade, and what would I trade it for?” Now, for me, I will only make the trade if I can double up cash flow right now. I do have low rates. I’ve got good stabilized buildings. You’re going into kind of a more transitional market in general. But with the amount of equity that we’ve made, I can double my cash flow on almost every apartment building and house that I own if I 1031 them out correctly.

Dave:
Wow. So are you seeing clients do that right now? And if so, is there a limited window in which you can keep doing this before the market shifts even further?

James:
Yeah, to be honest, I do think the two to four units, you might have missed your window. Because those rates are 6.5%, and it dramatically affects the cash flow. So if you have all this equity in your property, or you might have lost some because of rates, when you run that true, true cash flow position, it’s going to naturally bring your price down.
What recommendation I would have is because rates are high, affordability is in high demand, is if you are going to sell your two to four unit, get one unit vacant, because the owner-occupied buyer is still out there, because they’re looking for a way to cut their expenses, especially with the inflation right now. So that’s the best way for you to trade it.

Dave:
That’s great advice. To basically make it appealing to someone who wants to house hack.

James:
Yes. And there’s so many people out there. I mean, BiggerPockets has done a really good job teaching people that that’s a very effective way to reduce your expenses and grow wealth. Investors are only looking at the cash-on-cash return and how that building’s going to perform. If your rate and your money’s really high, you’re not going to perform that well. But an owner-occupied owner, I mean, they can move in and they can go, “Hey, I can cut my mortgage cost by half by buying this unit instead.” So I would say leave one open.
There’s still a really good opportunity to trade your five units at above right now, because the money’s still cheap and it’s… Or it’s not cheap, but it’s four and a half. It’s cheaper than the alternative. It’s 4.5% to 5%. And I think there’s more qualified investors in that realm too. A lot of times, two to four is your mom-and-pops that are a little bit newer in the industry. Not always, by any means. I still own two and four unit buildings. But a lot of that’s what it trades.
The guys that are selling the bigger stuff have gone through more market conditions, and so they’ll sell and they’ll trade things around a lot better. But you can still trade those out. Right now, there’s still demand to buy those if it’s stabilizing good, because people do want to park their money, beat inflation. The rates are a little bit lower, so it’s not affecting that equity position as much. And then you can trade into more of a value-add.
So just you’ve got to be careful about what you’re trading in money. Just see how liquid can that product be traded around, and then make sure you’re maxing out. There’s certain properties that I’m looking at selling right now, but we have that bottom line number that if it goes below that, we’re keeping it for another five to 10 years. Because we’ve already done all the hard work. It’s not worth trading at that point. So we’re listing four of our buildings very shortly, and I know we’ve listed like six units for our clients recently as well.

Dave:
Because you believe you can double up your cash flow.

James:
Yeah, double up the cash flow, especially for our investors that are more passive. Their cash flow has been hit dramatically with inflation. Their cost of living, things that they’re living off of. So right now, it’s the perfect opportunity to realize the equity before it could possibly get reduced, and then go get more cash flow to offset your cost.

Dave:
All right. James, you have been dropping some knowledge on us today. Thank you so much. If our listeners want to hear more from you or interact with you, which I’m sure they do, where can they do that?

James:
You can do that… So on Instagram, check us out on jdainflips. We talk about all this stuff daily in the field. And then also on YouTube, at ProjectRE. We’re constantly putting out free education for everybody. So make sure you check us out.

Dave:
All right. And I’m Dave Meyer. You can find me on Instagram, @thedatadeli.
And just a reminder before we go, if you want to interact with James, myself, Kathy, Jamil, Henry, or any of the On the Market crew, you can do that on YouTube. James has been putting out some great videos there. We have a lot of really good YouTube videos that don’t make it to the podcast feeds. So if you want more information like that, check out YouTube, subscribe there.
And if you are listening to this right now, please, if you like this kind of information, leave us a five star review. It really helps us out. Thank you all so much for listening. We’ll see you all again next.
On the Market is created by me, Dave Meyer, and Kailyn Bennett. Produced by Kailyn Bennett. Editing by Joel Esparza and Onyx Media. Copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team.
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