What if my market is just too hot?

[Zach Vaught]

Hey Guys! I'm just dipping my toes into the waters of Real Estate Investing and I'm interested in buy and hold rental property. 

However, the more I look and analyze deals in my area, I'm seeing that there aren't any deals (atleast not ones i'm finding) that just make a lot of sense. Yes, they could cash flow, but I feel like I need something that is a "GREAT" deal to get my feet off the ground and for this to take off in the right direction. I couldn't do this and it cash flow $100 a month and it create enough momentum financially for it to snowball into the next deal anytime soon. If that makes sense? I listen to the BP podcasts and I hear about all these 2% deals and I struggle to find a 1% deal in my local area. To be honest, I don't have a huge savings to pull from at this point, so if i invest, it needs to offer good enough cash flow for me to convince my wife that this is worth doing! haha. 

I'm scouring Zillow & Realtor.com for these deals. Am I missing it? Is it imperative that I find a connection to the MLS because the good deals are gone before they make it to those sites?

I'm just trying to connect the dots here and find if I'm missing it. And if I'm NOT missing it, and my market is too hot and oversaturated, how do you confidently invest in a foreign market? Really just looking for feedback and ppl to share their experiences with dealing with situations like this and overcoming them. Thanks!! 

[Ryland Taniguchi]

Originally posted by @Llewelyn A.:

I'd like to chime in on investing in Hot Areas. I have 2 Decades of experience in the Hottest City currently, Brooklyn, NY.

First, if I used the 1% or 2% rules, I would never have bought here. Those rules are really for Cashflowing properties, not really properties which will take time to Cashflow as the Rent and Value appreciates.

Second, to invest in a Hot Area, you will need a different kind of Analysis. One that is much more extensive. I have seen some of it done here, and there is a really good analytical tool that BP offers called the BRRRR Calculator.

Unfortunately, the BRRRR Calculator hides all the Calculations from you which is why it's easy to use, but then you really don't learn anything other than using the Calculator and hoping that the numbers are correct.

FORTUNATELY, I'm an expert in these calculations and I have been utilizing it for the last 15 years in my own Investment Property Purchases in Brooklyn.

The bottom line of the BRRRR Calculator is that it calculates your Internal Rate of Return (IRR) for the next 30 years.

Why is this the most important Calculation you will need to know? Because it helps you to Drive your Investment Vehicle by looking through the windshield.

Here is the Analogy.

Treat every Investment like a Vehicle. So we call it an Investment Vehicle.

You are Driving your Investment Vehicle like you drive your Car.

If you only look at the Rear View Mirror and NEVER through the Windshield... you have a good potential to Crash your Vehicle.

If you only look at the Side View Mirror and NEVER through the Windshield... you have a good potential to Crash your Vehicle.

If you ALWAYS look through the Windshield and occasionally through the Side View and Rear View Mirror... you have the BEST chance to succeed. 

Let's define the 3 ways you can look.

The first is the Rear View Mirror. This represents the Past. That's the History of the Investment Property which would include past Sales Data, past Rents, past Renovations, past Economics of the Area, etc.

The second is the Side View. This represents the Current situation. This is exactly your 1% and 2% rules, your Cap Rate, your Cash on Cash Return, etc.

The third, AND MOST Important..... is the Windshield. This is the FUTURE. It forces you to think of things like "What will be the future worth of my Investment Property in the future?" That question implies the following:

- What will the Future Rents and Future Expenses be? 

- What are the Economic Factors that will be affecting my Investment?

- What can will the Appreciation Rate?

The Calculations you would use here is Discounted Cashflow, Rate of Returns (RoR), Internal Rate of Return (IRR), Appreciation Rate, Future Value, Present Value, etc.

Many beginning Investors are taught only about Rules for the Current View, the Side View of your Investment Vehicle. Hardly is there a mentioning of the Windshield view, the Future View. In fact, you are generally told you cannot depend on the Future like Appreciation.

HOWEVER, that is FAR from the truth and it's critical that you think of the Future.

Let's say you bought your Investment Property in Detroit in the year 2000. The only View you had for this Investment Vehicle was the Side View, the Current situation. You calculated the 1%, the 2%, the Cap Rate, etc. It meets your entire Criteria. You then purchase your Investment Vehicle.

Years later, what was a good Investment Vehicle, was laid wasted because it went over a cliff. The reason why was because you did not look through the Windshield of your Investment Vehicle to see the warning signs that the Bridge was out. You did not notice that you should have taken a different route.

The interpretation of this is that what you should have paid attention to when you bought your Investment Property was the Big Three Domestic Automotive companies that 90% of the Economics of Detroit was dependent on. Had you followed their economics, you would have seen the warning signs and veered off in a different direction.

ANYWAY.... I'm trying to make this short, but it seems I cannot really write a posting short these days!

To invest in a Hot Area like Brooklyn, NY.... you cannot use just the Side View which is the Cash on Cash Return, the Current Cap Rate, etc. You need to anticipate the rising rents and expenses, the migration of people, the potential for good and bad economics, otherwise, it doesn't make sense at all.

The BRRRR Calculator gives you some of that. However, I did not subscribe to it to see if it had the things I normally use.

For instance, NYC will have a vastly different appreciation rate than nationally. In an area that conforms to National Averages, you will use somethings like 3% to 5%. NYC, depending on the area and the local economics of the neighborhood, it can be something like 7% to 15%.

An example would be a property that I purchased in 2014 for $900k. I put in approximately $300k for renovations, but this year, 2016, it was valued at $1.85 Million. This was the Bed-Stuy neighborhood which is a highly Gentrifying neighborhood.

Another example, in 1999 I bought a 2 Family house for $140k. in 2013, I sold it for $675k. There was no significant Renovations. Rents in that property tripled. If you calculated the appreciation rate, it was 11.89% per year for 14 years. Some would call that amazing... but it's fairly typical in the last 2 decades all over Brooklyn and NYC in general. I'm sure it was even better in many places in SF as well. This property was a negative cashflow in 1999.... but by 2013, I was Cashflowing more than $2k per month.

If you applied the Side View rules to any of my several Investment Properties.... or should I say, Investment Vehicles...... you would never have invested in them.

Now, YEARS later.... decades later I should say.... I am reaping the rewards of looking through the Windshield while I have seen lots of other Investment Vehicles which crashed during the financial crisis.

The theme here is to understand as much of the more sophisticated calculations and how to apply it to your potential investments. If you do, you will begin to see that you should not exclude ANY place.... whether your Goal is Cashflow, Appreciation or Both.

I hope the readers of this post can be inspired to learn beyond simple rule of thumb calculations.

Investor Llew

This is a beautiful analogy with the Front view, the Side view and the Rear view. I also agree that IRR is the way to look at any investments as it factors in cash flow, leverage and appreciation.

The only issue I have with your analogy is that it is not for newbie investors. What you are talking about should only be attempted by very experienced, battle-tested sophisticated investors. 

On an IRR T-Table, there is the cash flow component and an appreciation component. Calculating for the future requires an advanced Financial IQ of understanding where we are in the real estate cycle and what factors drive that. It is really dangerous to take a "my market goes up 9.5% per year" approach to arriving at a future net proceeds. Historically, cash flow has more future predictive value and is easier to access for a new investors.

What I would tell a new investor in a hot market (like my market here in Seattle where even the Pros are finding less and less deals) is to diversify their approach. Take a hedged portfolio approach to real estate investing. 

Put a 1/3 in a conservative wealth preservation strategy with a minimum 6% target return and make sure this investment value does well in a 2008 like market crash. Buy something like a tax lien certificate or a performing note at 50% LTV.

Put a 1/3 into a moderate cash flow strategy with a minimum 18% IRR and plan to hold on to it through a market crash as the main risk is selling where investors panic. You can find 18% IRR locally through a strategy like BRRRR or out of state. I generally do what I think has the highest return with the least amount of risk. For a newbie investor with limited capital, you may only want to look in the Front View mirror only if you at least get a 1% rule property.

How you invest may depend on your access to capital. In 2009 to 2013, I went all in in buying $80 k to $95 k newer cash flow turnkey properties in Phoenix. It was a historic opportunity with very high returns with virtually no risk. At the time, I had only access to a little over a million dollars and so this limited my opportunities. Nowadays, I have access to over $35 million (and hope to have access to over $200 million through our hedge fund by the next crash). With more capital after a 2008-like market crash, I would go all in buying cash flow AND appreciation in hot areas like San Jose, Santa Monica, San Francisco, Seattle, Honolulu, Williamsburg Brookyn, and/or Boston. In the last cycle, I stuck to cash flow because that was the limits of capital that I had access to. With more capital, I could look into buying more in Hot Areas.

And only after having solid conservative and moderate investments where 75% of your money can survive a 2008 crash, then and only then full blown look into the Front and Rear view mirror that have more aggressive returns based on appreciation. The conservative and moderate approaches are your safety nets that allow you to create wealth through appreciation. The truth is that you aren't going to get wealthy off cash flow alone. Appreciation makes you wealthy and then you preserve your wealth by rolling over your appreciation into cash flow. However, cash flow though gives you the safety net and securitization to play in the appreciation wealth game.