What would you do in my shoes?

[Jason Striker]

Hi All,

I am posting this in hopes of getting some advice on what other investors would do to grow if they were in my shoes.

I started investing in real estate in 2009. We grew rapidly at first, but for the last few years have been a bit stagnant and are not sure what the best next steps are to continue growing.

Here is our current portfolio:

-8-plex in HCL area. Currently paid off. Purchased for 625K, current value 1.25M. NOI = 68k annually.

-Tri-Plex in HCL area. Loan of 325K at 2.85%. Purchased for 725K. Current value 950K. NOI (pre-loan payment) 59K.

-Duplex in HCL area. Currently paid off. Purchased for 435K. Current value 625K. NOI 35K

-Duplex in HCL area. Currently paid off. Purchased for 450K. Current value 650K. NOI 36K.

We have an additional 300K liquid and available to invest at this time and are looking to grow. We also expect to generate an additional 300K from outside investments to dedicate to real estate, but that could be a year out. We could use the 300K we have now, then invest the other 300K when it's liquid, or wait and have 600K to dedicate to real estate in another year-ish.

As you can see I have been risk and debt adverse over the years. It has worked out well, but with this base we are willing to take on more risk/leverage in order to find more opportunity.

I am open to any and all advice, and would love to hear how others would grow from this position. We have considered doing what we have always done, finding a nice multi-unit building and purchasing it with a small amount of leverage. That said I know there is a lot I do not know, and I am wonder if I am leaving some value on the table not exploring other avenues for growth. I have considered 1031 exchanging, but as our buildings cash flow and are appreciating well so I have not seen much value in doing so.

Thanks in advance for any insight and advice.

[Greg Scott]

Congratulations on your success so far.  Just from your real estate, it appears you have built a substantial net worth.  This gives you a lot of options.  I was in a somewhat similar position a decade ago when I had 14 SF rentals. From my perspective, you definitely need start managing debt differently. 

I understand you are very conservative with debt, but having so much equity in these deals has ruined your returns. We call this "dead equity" or "lazy equity".  Currently a "risk-free" 10-year Treasury yields 4.3%. In contrast, any investment that requires management effort should yield much higher returns.  Your return on equity is less than 6% in every case. To make matters worse, you have very little depreciation to shield your income. 

Here is a simple thought experiment.  What if you took each one of these properties and put on 50% leverage and bought an identical set of properties.  Odds are good your cashflow would go up.  More importantly, your taxes would go down because you have 2x the depreciation (even more if using accelerated depreciation). Also, you would then get to experience 2x the appreciation, and 2x the loan paydown benefits.  In addition, if you bought any of these below market, you might capture some equity upon purchase.

My wife and I do a mix of syndicating and limited partner investing in apartments and have had great returns.  We are part of a group that has a structure and rules governing syndications within the group. The general partner is not allowed to take excessive fees (like most syndications) and the profit sharing arrangement aligns general partner and limited partner goals. The beauty of that arrangement is that I make MUCH better passive investment returns than I would if I invested in a typical syndication.  As a syndicator, I make less money, but the group makes it easy for me to raise money, so I can take down bigger deals than I otherwise would.

My wife are owner / operators of 3 apartments, totaling 830 units and are passively invested in over 5,000 units across 8 landlord-friendly, lower-cost, higher cashflow states.