CapEx and Vacancies can cover each other?

Question

I had a wonderful conversation with Linda Labbe from here on BiggerPockets. She explained how they manage CapEx risk together with vacancy risk to cancel each other out, by selling off the bottom 20% performing properties in their portfolio each year and use the funds to purchase properties with better prospects. By constantly pruning off the bottom performers, they minimize vacancies, and by turning over all their properties every five years, they avoid most major Capital Expenditures. This sounds like a home run, and I'd love to get some feedback from people who have been both successful and unsuccessful with this strategy!

Bob E. · Answer

@Samoy Min Hoayin  That is an interesting strategy.  I find that the highest CapEx and vacancies for our portfolio are in the first 1-2 years.  Property usually has deferred maintenance in the form of older roofs and water heaters.  Once we replace those we are good for 15 years.  When we buy property with tenants A lot of those tenants move after the sale when we start insisting they follow the rules and pay on time.  When they leave we turn the unit but usually do some upgrades.

Once we do the CapEx and rehab properties are pretty stable.

When we sell we do a rehab to sell to owner occupants for the best price, basically a flip.

Carlos Ptriawan · Answer

Sorry to say but it's not "innovative" strategy as everyone in real estate professional (such as GP) is doing that by default anyway.
What Joe telling you is very simple ; most of the pros are actively buying and selling property every 4-7 years, in terms of IRR. If market goes up 3 percent every year, even your lousy negative-cash-flow house will have "some appreciation value" at year 5.

What makes the price goes up in this case "is not your property" but your neighbor that's selling houses and more demand from buyer that would like to acquire property.

Curt Smith · Answer

All very interesting IRR etc math here.  And the OP topic is nice theory too.  What intesests me in commenting is to simplify for the OP and others my tactics;

- Yes we sold for cash or on notes to other local investors remote houses that I could not make perform at distance.  IE my business model of rent to own to top tenant/buyers in some lower income areas didn't work.  Where a local face to face investor could make straight rent work if they where face to face.  So those deals I gladly sold off and most now are paying me principal and interest without the hassel of tenants or toilets.   A note is not the best possibile solution, its a middlee ground in that you give up appreciation for convenience (no hassel) and _some_ income for your risk taking buying the place.   Given this middle grouind I still like selling off dogs on notes to other investors vs a cash sale since a true dog is not a likely fix up and sell to retaiil for max $$ there's something wrong with the house that a local investor needs to take it over.  But I agree if the dog could be fixdd up and sold to a retail owner that is a good solution to raiise cash.  But but read below, we NEVER sell for cash.  We sell dogs on notes or cash out REFI...

We did sell off the dogs like the OP, but it was NOT on a 5 yr rotation, which in 2019-beyond the tight inventory just doesn't allow one to so easily buy better deals as the OP's theory suggests.  Its VERY VERY hard to buy performing replacments.  At least in my hot area, Chattanooga and Atlanta.

- Yes we didn't let equity sit forever dragging down your return, we cash out REFI!!!   :)   We love the doors we currently own.  Most of our tenenats are >5 yr stays so I would never sell a house out from under these wonderful renters.  Its their home!

- We believe in buying good houses in decent neighborhoods and keep them forever.  Cash out REFI when equity >= 50%.   The math of cash out REFI needs alot of equity for the lenders LTV max net you decent cash out.

- Just buy good houses that match the needs of your target tenent type.  To read up on what this statement means, go to my BP profilee, read the paper I linked off my 1st paragraph, how to buy a bullet proof portfolio.   It will change your views about what is the asset in buy and hold.

Best to all, curt

Joe Villeneuve · Answer

It is one way of also maximizing profits, and minimizing the losses that automatically are happening as the equity increases past the point where it is greater than twice the down payment.  When the equity is equal to twice what you paid for the property it reaches its maximum value and (the DP), you start losing money exponentially.

Chris Seveney · Answer

@Jacob Trogan

My philosophy is similar to don.

For example in mortgage notes people are paying stupid $ for loans in texas and florida. I will liquidate my portfolio of those states if someone wants to overpay and then go buy a steeper discount in a different state that people do not like. There are many philosophies and what really matters is buying smart and managing smarter.

Jacob Trogan · Answer

To me this makes more sense. It is the equivalent of rebalancing a portfolio in the stock market. Aka selling when sentiment is too high for one stock(selling your winners) and buying when overall sentiment is too low on another stock (dollar cost averaging a stock you believe in). For real estate selling off the equivalent of a bad performing stock that you no longer have belief in seems silly because you have much more control of the asset in real estate than in stocks. You could easily turn a non  or low performing property into a well performing one by making some changes. I would only sell a losing property if the area truly took a turn for the worst. I hope that analogy makes sense. I also like the concept you mentioned at the end with notes. Working as a HML I see a lot a lot of room for opportunities in the note market going forward.

Boruch Vann · Answer

@Don Konipol- wise words! I've apreciated all the input I've gotten from everybody here, but your voice of reason definitely stands out in the crowd, Thank you!

Boruch Vann · Answer

I never knew that! Can you elaborate a bit? It seems like many would benefit from an education in the balance between equity and down payment.

CapEx and Vacancies can cover each other?

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