All Forum Posts by: Austin Fowler

Hmmm... turnkey rental properties purchased at full retail value, with 100% leverage, at the peak of the market cycle, owned remotely, under management, with no value add or upside other than potential natural appreciation, with accelerated depreciation, very little budgeted to fix anything or in case anything goes wrong... expected to somehow spin off enough profit to provide a guranteed percentage return to investors whose money is held in "savings accounts" with no bank charter or FDIC insurance, and only backed (partially) by personal funds... What could possibly go wrong here? This sounds like the same deluded justification that the iBuyers have been using over the past few years: "Too bad we lost $100k on that one property, but don't worry stockholders, we'll make up for it with scale!"

1) Tax assessed value going up from last year has no direct bearing on current market value, especially because the market turned just a few months ago but also in normal times. It's not a data point people use. 

2) Cap rate is not used for single family rentals, only multifamily.

3) Depreciation needs to be recaptured when you sell.

4) 3.7% for maintenance and repairs is unrealistic

5) 4% vacancy loss is extremely wishful thinking

6) An average tenant stays 2.5-3 years, not 6 and turnovers can easily cost $5-10k (which would take you many years to recover from with your budget, even if everything else goes perfectly)

7) Always take the operating costs given to you by the seller/ turnkey provider and double them for a more accurate estimate

 I’m not seeing enough profit here to have it be a worthwhile use of time or worth the risk for even an individual investor, and definitely not enough to share with outside investors. Hopefully these properties have wonderful appreciation and nothing ever goes wrong with them! Even if your cashflow projections were realistic (aside from whoever sold you these properties, no one believes they are), I still don't see the point. I get the banking side and the investing side, it's not complicated but just doesn't add up due to there being no profit-driver. All this just for accelerated depreciation, very nominal equity gain through principle pay-down, very nominal if any positive cashflow, and maybe enough appreciation to make it all worth the effort in 20 years? By overcomplicating things and over-leveraging yourself in the way that you have, you've opened yourself up to more personal risk than the best-case returns could ever justify. You're doing all the work and taking all the risk while relying on getting really lucky for very little, if any, potential return (maybe appreciation will save you?). 

If you want to "be the bank", you'd get better returns with less work and less risk as a private lender. Why not just do that and use your own funds to invest since you already have the capital, and avoid having to deal with the hassle and risk of combining the two? There's got to be a lot of admin, paperwork, financial reporting, legal fees, customer service/sales/ account management/ explaining, software, client portal management/IT, new lead generation/marketing and other overhead involved in this business, and there's real risk of potential lawsuits, audits, criminal charges etc. If your projections turn out to be mere wishful thinking and not actual underwriting (which my experience tells me they are), you could actually even risk being sued or facing federal criminal charges because the rosy predictions you made to investors could end up being deemed as false and misleading statements. Obtaining money from investors by means of false or fraudulent pretenses, representations, or promises is called bank fraud. Your underwriting and financial statements could easily be seen as misleading, because you keep calling them very conservative when anyone with a basic understanding of what a realistic SFR operating budget looks like will agree that's not the case. These cashflow projections are simply unrealistic. Every property has vacancy, needs repairs and maintenance, and requires capital expenditures well beyond what you have budgeted for. You will end up needing to pay investors out from your personal funds to cover operating costs in the near future, unless your plan is to continue raising new capital to cover your losses, Ponzi style. I don't see the point unless this is some sort of fund-raising pump and dump scheme, but I can't see how a savvy accredited investor would participate in this anyway. Why wouldn't they just go directly to the turnkey provider, buy the asset and reap all the benefits themselves? What value do you bring to the deal? I understand how it's a tool for them like a high interest savings account, but why settle for 8% when they could just invest directly in turnkeys themselves?

 Literally one garbage disposal going bad, not even a water heater replacement/plumbing leak/fallen tree/ driveway replacement/ sewer line collapse/ anything happening that costs more than your tiny maintenance, repairs and cap ex budget, or a single bad tenant/ eviction/ mishap that creates a few months of vacancy loss causes this model to lose money…. even a minor market correction for that matter considering you have zero equity/ zero margin for error… you’re probably underwater on these properties now with what is happening in the market. It’s unlikely you’d be able to sell them for what you paid never mind factoring in transaction costs and depreciation recapture since you're accelerating depreciation... 

Don’t quit your day job as they say. Hold on to your high-paying W2 for dear life now because you will need it to fund this money-losing endeavor. You may hit these extremely optimistic numbers in the very best year, but over time there’s no chance you’ll have positive cashflow. Sorry but I just don’t see it happening. Anyway, this model doesn’t make sense to me. Maybe for an apartment syndication or $100M development, but buying one-off turnkey rentals is an asset class that is notoriously difficult to derive profit from and impossible to scale (scaling will just magnify your losses here anyway). This seems like a lot of work and a lot of risk for not enough benefit and a potential recipe for disaster IMHO. Good luck, I hope you take this feedback as tough love and not a personal attack, and that you do well for yourself and your investors.   

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Quote from @V.G Jason:

Quote from @Matthew Failor:

@Austin Fowler very creative. I don't see how the property in question cash flows even taking out the numbers questioned above.

I like how you essentially are a case study on how a bank works and people's first thought is fraud and jail time. Note, life insurance companies do the same thing. Do you think they have 1 to 1 reserves on every policy? No! You might say what about the re-insurance companies? Neither do they! Just ask an actuary.

Insurance companies operate on a different set of rules. We all state we know how a bank works. You think proprietary investor here operates on the same set of rules as them?

 It's really not that complicated, raise capital, keep 20% in reserve, rest in illiquid assets that provide a return on the entire raised capital. Make sure the contract specifies what happens if the reserve runs dry (investor gets penalty interest). In 20 years of operation, I've never needed to pay penalty interest. The math behind fractional reserve banking is sound. Many clients, small balances, smooth operation.

 The concept is simple. We all already know what it is.

The execution though doesn't come at an amateur level without issues. 20 years without hiccups is great, I genuinely hope you don't falter for the sake of your investors. But the entirety of the situation doesn't add up math wise. You still hold collateral in stocks, houses that don't have equity, credit lines. That's just a bad recipe.

Quote from @Austin Fowler:

I'd also mention that I received a $190k tax return this year which is double the total interest owed to clients for the year, so very strongly no, I don't routinely need to replace withdrawals with explicit capital raises. I have enough depreciation banked to get the same next year, and likely the next as well. Also, please well note, that under normal operation deposits and withdrawals balance out.

 A cashflow of one month does not equal cashflow over a long period of time (month to month varies to due a number of factors, more important to look at this annually, in my opinion). Debt paydown - especially for the first 5-10 years is so little I'd argue it's a moot point especially if the house is 100% financed. There's nothing you can do with that money other than sell the house to recoup it. Understood though. 

You may have the right to return capital and close accounts - but how would you do this? You don't have access to liquid money for all investors. You have access to 20%. So yea you could close a couple accounts - but then you'd have to raise new funds to pay back investors if you chose to close more than 20% of the investors balance. This is the same as if investors chose to close out their account - you'd have to raise new capital to pay them back. These houses are all so new they have no equity - so I'd argue this isn't a source of revenue - in 10+ years ok now you have so equity to liquidate if you needed to. 

The equity buffer? What is it exactly? 

The tax return and likely CSS bonus depreciation is great - the key is you can essentially never sell and you have to keep buying in order to get the depreciation. I understand it has worked so far. But with higher interest rates and your strategy to wait for them to come back down - you won't be getting the same depreciation every year. Nevertheless, I do understand this, and if you can keep it going indefinitely that's great, but you have to buy continually. 

I think your big W2 job (Mine is roughly 1/3rd-1/2 of what yours is and I wouldn't feel comfortable playing bank) gives you a big security. 

Saying withdrawls and deposits balance out under normal operation - what's the definition of normal operation? Chase bank? State Farm? You? I think this varies too widely to assume they would always balance out - hence why you need reserves - because operation is not normal. If evertyhing always went normal, we'd never run into any issues. 

This concept is still somewhat intriguing even while highly leveraged, unique to your individual finances, and full of risk. 

Quote from @Austin Fowler:

I would argue that most banks make money in many more ways and are also regulated, but I understand the concept.  

The epitome if your business is to raise private funds from investors - use their money as the downpayment on SFH, and offer them a 8% savings account. If an investor wants to cash out you simply raise new to funds to pay them (you don't actually pay anyone interest until they cash out, so the money to pay them doesn't exist without raising new funds)  - and the idea is that no more than 20% will ever cash out at one time. This is a highly leveraged strategy and even the money that you have access to isn't liquid - so you would essentially have to raise new funds to pay investors. As the investors account balances increase (due to interest) it becomes even more risky, so you have so raise new capital or increase reserves (in order to keep their percentage of the reserves low or penalize them for having an account balance too high). You have to ensure no one's account reaches over some arbitrary percentage (5%-10%) of your reserves, or you could risk liquidity problems.  

The thing is there is absolutely no exit strategy, you literally can't exit - the houses don't substantially cashflow, the tax deductions have been taken up front, they are 80-100% financed, they can't be refinanced for many many years (because they have no equity and the interest rate will go up), they can't be sold for many years because they were bought at market price (and we are seeing the beginning of a downturn, even without a downturn it would be an L to sell). 

You say you have a solid equity buffer before buying more assets...What is the equity buffer?

See the other kicker is that there is no profit here (the only profit is 20 years out when you start getting some equity paid down and appreciation). The profit would be buying under market value, OR having substantial cashflow - neither of which I see. How do the investors make a profit? By putting their money in an account which you pay 8% on. How do you pay someone 8% when they cash out? You raise new capital because the money to pay them doesn't exist. Rinse and repeat. The only thing keeping this going is raising more capital than the amount of withdraws made. If you stopped raising new capital or couldn't raise new capital the entire thing collapses when people slowly start asking for their money (because you cannot pay them so you have to start liquidating assets, and the value of the assets isn't enough to pay back the investors...so you are back to raising new capital). The business model here is raising more private capital than capital that is withdrawn at 8%. The assets being purchased are just icing on the cake for you. 

Quote from @Matthew Failor:

@Austin Fowler very creative. I don't see how the property in question cash flows even taking out the numbers questioned above.

I like how you essentially are a case study on how a bank works and people's first thought is fraud and jail time. Note, life insurance companies do the same thing. Do you think they have 1 to 1 reserves on every policy? No! You might say what about the re-insurance companies? Neither do they! Just ask an actuary.

Insurance companies operate on a different set of rules. We all state we know how a bank works. You think proprietary investor here operates on the same set of rules as them?

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Quote from @Jeremy H.:

Quote from @Austin Fowler:

I don't understand how you have any substantial equity in houses that are financed 100% or even 75% - there's no way to get access to this money other than sell, you can't refi and take anything out either because there is no equity there. You've been doing this with SFH for 2 years - likely everything you bought in from mid 2021 onward will sell for less today than it would have then. That was literally the peak of prices.

So you back your clients investments with your personal assets?

The thing is you are still relatively small - if this got much bigger it could get out of hand really quick. One swing in the economy OR over 20% of people want their money out and you would be getting screwed. I hope these investors don't know each other or speak to each other - if there is any kind of cohesiveness between them it can be a real problem for you. 

 I've been doing this a long time. Not every property I ever bought was bought with 100% finance. I make sure I have a solid equity buffer before raising capital and buying more assets. Regarding current values, I'd prefer to argue that with data. My experience with property tax assessments says these properties have gone up significantly since time of purchase. I have the cash flow to hold on to them indefinitely, so only really need growth over the very long-term. I'm getting an appraisal done at the end of the month and will update this thread with that data. Opinions, are great, and I appreciate yours, but where data can be obtained that should dominate the discussion.

 Did you really just say that you're using tax assessed value as a data point to determine market value? If you don't know even the most basic stuff like the difference between tax assessed value and actual market value, you shouldn't be investing other people's money IMO. This whole thing smells as fishy as Good Friday to me, sorry. 

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Quote from @Steve Vaughan:

Quote from @Austin Fowler:

Account Terms and Conditions

Maximum balance: $1.5M

1) The funds in the account are secured with full recourse to the worldwide assets of the borrower, no matter how indirect the ownership structure is, no exceptions.

2) Deposits and withdrawals can only be made electronically to ensure unambiguous dates of transactions and secure transfers.

3) The lender can initiate a deposit by performing an electronic transfer to the borrower's account.

4) The date of deposit will be the date of receipt of funds listed on the borrower's bank statement.

5) If the received deposit would take the lender's account balance over the maximum balance, this deposit shall be returned in full within 7 days during which no interest will accrue on these funds. Failure to do so will result in the lender's account switching to the penalty interest rate and the deposit posting to the lender's account 7 days after receipt until the excess deposit is returned.

6) The lender can initiate a withdrawal at any time by sending an email requesting funds. Interest shall continue to accrue until these funds are sent. The funds must be sent within 7 days of the email requesting withdrawal. Failure to do so will result in the lender's account switching to the penalty interest rate until the funds are sent.

7) Transactions, interest, and current balance shall be provided via an online portal.

8) There shall be no fees or transaction limits associated with the account.

9) The borrower has the right to close the account at any time by sending all owed funds.

10) Even in the event of death or incapacitation of the borrower, this contract gives the lender full recourse to the borrower's estate, even after transfer to other beneficiaries of the estate, without exception or limitation.

 Interesting.   Thank you for providing capital preservation stage accredited investors an alternative savings option.

Will we know the fund balance or be made aware when it is approaching $1.5M? The risk for us are dollars earning zero above $1.5M. 

That limit is a per account limit. As a client, you can see in your own account if you are approaching that maximum. As a business owner, the limit is determined by your personal income, essentially the maximum balance you could handle sitting in a bank account and paying out-of-pocket. With a $625k W-2, $1.5M is an appropriate balance that I can afford to keep in cash if necessary.

 Gotcha, thanks. 

I assume we'd be issued an annual 1098 or 1099 for interest reporting?

Can we be an entity?  A few of my contracts are in LLCs that owned the buildings.

Quote from @Austin Fowler:

Account Terms and Conditions

Maximum balance: $1.5M

1) The funds in the account are secured with full recourse to the worldwide assets of the borrower, no matter how indirect the ownership structure is, no exceptions.

2) Deposits and withdrawals can only be made electronically to ensure unambiguous dates of transactions and secure transfers.

3) The lender can initiate a deposit by performing an electronic transfer to the borrower's account.

4) The date of deposit will be the date of receipt of funds listed on the borrower's bank statement.

5) If the received deposit would take the lender's account balance over the maximum balance, this deposit shall be returned in full within 7 days during which no interest will accrue on these funds. Failure to do so will result in the lender's account switching to the penalty interest rate and the deposit posting to the lender's account 7 days after receipt until the excess deposit is returned.

6) The lender can initiate a withdrawal at any time by sending an email requesting funds. Interest shall continue to accrue until these funds are sent. The funds must be sent within 7 days of the email requesting withdrawal. Failure to do so will result in the lender's account switching to the penalty interest rate until the funds are sent.

7) Transactions, interest, and current balance shall be provided via an online portal.

8) There shall be no fees or transaction limits associated with the account.

9) The borrower has the right to close the account at any time by sending all owed funds.

10) Even in the event of death or incapacitation of the borrower, this contract gives the lender full recourse to the borrower's estate, even after transfer to other beneficiaries of the estate, without exception or limitation.

 Interesting.   Thank you for providing capital preservation stage accredited investors an alternative savings option.

Will we know the fund balance or be made aware when it is approaching $1.5M? The risk for us are dollars earning zero above $1.5M. 

@Austin Fowler

I think part of the problem with looking at one specific property is, how do we treat the down payment?  Is it borrowed, or is it cash?  If it's treated as borrowed at 8%, then the property doesn't cash flow.

This goes back to my question of whether we look at your portfolio of SFRs in the aggregate or not.