From 0 to 140 houses in 2 years. Now what?

Question

It's been a hell of a ride during the past 2 years. I started my real estate investor back in June 2012. Bought 12 Class B townhouses and started learning being a landlord, 3 months later bought 37 class D apartments. Another 6 later acquired another 56 units class D. Experienced first hand the challenges and drama of managing almost 100 units class D properties. Have seen it all. Now moving back to class B townhouses just closed 20 more townhouses all rented to Sec 8 tenants. Currently have under contract 30 more townhouses in affluent area of Wellington, FL. This year I plan to partner with a contractor to build 8 more townhouses and plan to sell the portfolio of class D properties for a 70% profit and now I'm thinking to buy commercial retail plaza or medical offices. Can anyone give me advice what I should do now with a budget of $4M cash? What are the advantages of owing residential townhomes vs comercial retails or medical offices?

Joel Owens · Answer

Hi Will,

That's a common occurrence I see.

Someone bought Class D stuff and the market cycle is frothy now. I would be dumping off and shedding that class D product while it is frothy. Class D should not be held long term due to the constant problems.

Medical offices are currently are more risk due to constant Obamacare changes and medicare billing on what items they will cover and how much will be paid. You tend to have just  a few tenants so break even occupancy isn't good.

Commercial retail if purchase right is a good investment. Now that you have millions many slow down and want more quality. The B properties if you want to hold you could refinance up to 75% and then invest that way or 1031. The class D shed those and 1031 exchange 100% tax deferred into other investments.

Commercial you might achieve 15% cash on cash after your down payment which doesn't include principal pay down. It's less that headache SFR but you aren't working as hard either.

25% return on 100,000 for a headache is 25,000. Not enough for most to live on. 2 million getting 15% back each year is 300,000. More than enough for most to live very well and have more leftover to keep investing.

Don Konipol · Answer

Here's what I do.  Put 50% into a portfolio of private mortgage notes and discounted trust deeds, earn an average annual return (interest) of 15%.  Than buy property that will hedge inflation best, I currently own high end high rise condos, investing the other 50% and leveraging with mortgages at 50% of purchase price.  this has the following effects

1. Owning twice as much (though subject to the 50% mortgage) real estate as notes should theoretically fully hedge your total portfolio should we enter another 1975-1982 period of inflation

2. Using a 50% leverage with interest cost of 4.5% against total cap rate of 6.5% will increase cash on cash yield of the real property portion of portfolio to 8.5%.  This will produce a blended yield on the total portfolio of 11.75% annually, fully protected for inflation (theoretically).

3. Residential property is subject to short term leases, so can be adjusted for inflation much more readily than commercial leases, which will typically run 5 years or more.

4. Using conservative leverage of 50% will allow the investor to get through problem times as vs higher leverage of 75-80%.

5. For ultra conservatives, hold cash reserves equal to 10% of total portfolio.  Assuming no return on the cash, this would reduce yield for overall portfolio to 10.575%, reduce inflation protection from 100% protected to 90% protected, but decrease possibility of loss due to economic depression significantly, in other words insurance like protection.

6. Any non inflationary increase in real estate values are still collected in the portfolio at the same rate as if the entire portfolio was invested in real estate without leverage, but the significantly higher yield of the debt investments are obtained with little if any additional risk.

7. For very passive investors, the same could be achieved using a variety of passive vehicles ranging from REITs to real estate crowdfundng investments, albeit at likely lower returns.

Joel Owens · Answer

Hi Will,

Actually my clients are getting 8 caps.

Your comment I hear it all the time but it is a misconception on retail. It depends on the demographics of the areas you are buying. National average median income is 54,000. Those areas when the economy is good might have a few extra grand a year to blow. When the economy is bad they have no additional income and money is tight. Mom and pop commercial tenants in those areas mortgaged the house to start a business. They are not very liquid and depend on business sales to survive.

Higher median income areas of 100k or more the people's idea of roughing it is eating steak 1 time a week instead of 3. They have a lot more discretionary income to weather an economy down cycle. National tenants also on leases have under performing stores, middle performing, and top performing. If the lease is a national guarantee then even if the store is losing 40k a year they have to keep honoring and paying in full the primary term of the lease.

No asset class is perfect even multifamily. There is talk of a rent ceiling because 49% of SFR renters the rent payment now takes up over 30% of their checks. So a correction is slated in the future years on rent growth for many parts of multifamily.

Looking at retail there are too many metrics for me to cover in this post. People not in the space day in and day out do not fully understand it. When you have a deep level of knowledge about what to buy and how to analyze risk it is not the systemic risk people talk about.

These days I look for DESTINATION type tenants. Karate school, green dry cleaners, hair salon, restaurant, doctor's office, etc. These are physical spaces where people have to go somewhere and drop money. They can't go in the store and then buy cheaper online.

Will Wu · Answer

Joel, Thanks you for your input. I learned a lot. Specially your preference to look for Destination type tenants make a lot of sense.

Cal C. · Answer

Obviously I don't do Class F, since I had to look up the definition of a Tweaker.  Learn something new everyday!

Jay Hinrichs · Answer

@Will Wu  Class A or B  MHP can be a nice alternative I have owned a few of these over the years... and done very well with them.

I just bought a Class F  one and am repositioning.... full of Tweakers and criminals  LOL.

Will Wu · Answer

Thanks Joel,

Thank you for your suggestions. I'm seeing some interested Commercial deals that generates 7% cap rate. My concerns about commercial are that these products are more vulnerable to the economy. If the economy goes bad more business will struggle and the risk of having empty units will be higher. While residential especially for middle to low class properties the demand will be there no matter how the economy goes as people needs to have a place to live.

From 0 to 140 houses in 2 years. Now what?

Most Popular Reply