All Forum Posts by: David Lutz

@Dan H. Love that you're taking a nuanced view of CA coast vs inland. I'd just point out that it holds for other states as well.

Los Angeles has certainly done well. But the ranking's in Neighborhood scout don't give any scale. You could be appreciating 10% higher or 0.2% higher than other states, you'd still be ranked above them. The hard numbers listed next to them are more telling. You mentioned Fresno, it's average appreciation since 2020 is <1% lower than Los Angeles (5.39% vs 6.26%). Phenoix is 5.66%, Atlanta is 4.14%, Nashville is 5.49%. Bakersfield is 5.2% since 2000 but has actually outperformed Los Angeles over the last 10 years.

Not sure the interstate variance is as much as you're implying. Plus, population/housing density is also going to mean that the major urban area's of a state are going to skew the state's averages. 

And what you lose in appreciation in those other markets you tend to make up in cashflow since the rents are higher compared to home value. Obviously that starts down a whole different conversation about preferred investing strategies which all have their merits.

My only point here is that I don't think investing in other markets means you're going to miss out on the opportunity to ever buy in Los Angeles.

@Kevin L.   Regarding your fear of getting priced out, please check out this infographic https://advisor.visualcapitalist.com/growth-in-u-s-house-pri... (make sure to use the arrows in the graphic to change the timelines)

I love visual capitalist. As you can see CA isn't outstripping the rest of the country as a percentage, it just feels that way in absolute terms because a 300% increase is a lot more when your starting point is $800K vs $200K. But if you buy four $200K houses then it's apples to apples and you're not going to fall behind.

For what it's worth, I'd be concerned that if you over extend yourself buying a primary home you'll create a larger scale issue than just being house poor. A few folks have talked about leveraging a HELOC in the future, but if you don't have other assets to back up that play and things go south it could force you to sell your primary home - that gets real dark real quick. And you already noted the high mortgage is also going to make it really hard to get your investing going.

Would you buy a C8 Corvette today and then try to bootstrap your way to being able to comfortable afford it after the fact? Owning a $850K home as your primary residence isn't much different. As a side note I live in the Valley, so I get that that's just what starter homes cost but the comment still holds.

If you really feel the need to buy here, could you buy here and rent it out for a few years? Or Househack? That way you could get a property in CA and still have some money coming in to start looking at investing somewhere else.   Best of luck, I feel for you.

@Steven DeMarco

You purchased a property that needed a lot of work to turn it into what you wanted it to be. And like any remodel you got pennies on the dollar in increased market value. If you sell, the percentage of spending that didn't generate a gain in market value is a sunk cost. The only way to maximize the value of what you've already spent is to use it up yourself. Consider selling in +10 years when there's deferred maintenance you can pass on to someone else, per @Jay Hinrichs insights.  Switching properties doesn't change what's already spent, incurs transactional costs, and the initial costs to stabilize the new property. Plus you lose whatever interest rate you got in 2022.

I'm repeating what @Mike Dymski said with a bit more flavor. Whether you hold on or sell should be based on what's going to generate the most net profit on a go forward basis. It sounded like you've turned a corner on this unit's performance. Do you think you can find a better performing option (inclusive of the switching costs)?

Just curiously did you feel like the learning/information you got from the Mastermind class was worth it? I know you already said it was great for motivation, but was the actual content valuable?

@Jeremy H.

The title of the post was to grab eyeballs, a more accurate title would have been “myth of cashflow in the early years for OOS investors who are not handymen doing their own repairs on lower class properties” but that’s not nearly as catchy. You’re clearly right that long term you can cashflow huge amounts if you deleverage.

Why do you think $1000 per door as a minimum to use a PM is nonsense? Many PM have a minimum per door which you can hit if the rents are too low. And if you’re paying a $100 minimum on $800 rent, property management is suddenly costing 12.5%. There may be plenty of specific scenarios where rents hiring property managers for rents under $1000 per door works, but as a general guide I think it gets a lot harder to make the numbers work below that because repairs etc. become proportionally larger too.

In line with that, what part of my RE financial modeling did you think was poor? If there’s something I’ve missed I’d appreciate the heads up so I can fix it. 

All of the homes I bought were inspected, and I had a good sense that many of the issues I've had were coming. I just didn't know exactly when. That's part of why I was reserving 10% of the rent for repairs and another 10% for CapX. Unfortunately, I don't think everyone is as detailed and going so far as to request a photo of the water heater serial number so they can check the units age, and have unrealistic assumptions about their coming costs. That's the whole reason I created this post. The foundation issue got me a $17K credit on the purchase price of the house and was immediately addressed. One roof was storm damage and covered by insurance. The other roof had a partial roof repair 7 years prior my purchase, I knew was going to need attention within 5 years of buying, it just hit sooner than I expected. Fundamentally the point I was trying to get across in my original post wasn't about my due diligence, its that the cost of known and unknown repairs when you first acquire a REI is way higher than people seem to anticipate.

The way my tax person explained it is the 25K limit you’re talking about is the limit to losses you can claim per property per year, I haven’t hit that for any property individually so it works out. Also that aggregate losses can exceed 25K over multiple years and carry forward indefinitely to protect future “passive” income. If any RE CPA see this and that’s wrong please let me know. She did tell me I need to get licensed this year for some of the other benefits it would create.

Best,

David

@V.G Jason I’ve been rereading some of the comments people have made, and yours was one of the more strategic. What makes you think better quality houses will likely prevail in a high(er) rate environment? I could see an argument that reduced affordability would cause the inverse.

I really like your idea of buying asset backed debt. Anywhere you’d recommend to go to learn more?

Your comments about down payment size in a hard vs soft market make complete sense. I view it as overall portfolio leverage instead of individual house, but it’s the same concept. When rates are high taking out more leverage starts to create a lot more operational risk.

There’s been a good discussion of house quality in the thread, but it has largely related to portfolio management over time, not the type of economic market. If you were going to put 25% down on one $600K home or on four $150K homes, why would you be more interested in low quality houses in a low interest rate environment? (removing the down payment variance since you could apply that change in approach to either option as rates go up)

Best,
David

@Mike Robb

Mike,  if you don't mind me asking,  where is the thousand oaks meet up? I'm in the San fernando Valley near the Simi Valley border and wouldn't mind driving. 

Best 

David

@Becca F.

*** there’s a math error in a prior post 5% x 4 = 20% return, not 15% :P I was going too fast while the kids were busy. No idea how I did that, or why the update function isn’t working so I can’t correct it.

You comment helped me clarify my thinking. I try to buy houses with an immediate rent to purchase ratio of 0.65%-0.85% range because I feel like that's where my money gets the best mix of appreciation and cashflow, and then I try and keep the current rent to market value in the 0.65%-0.85% range (obviously dependent on what rents are doing) because that supports being able to do cash out refi and still have the house cashflow. If market rent to market value falls below ~0.65% then I'd consider selling to get the equity out, since a cashout refi to a LTV of 80% would probably be cashflow negative. It would depend on what was going on with the rest of my portfolio. But my attitude is specific to wanting the highest possible growth I can get while still maintaining some positive cashflow. I could see people with different goals having radically different opinions.

In line with that statement, I tend to keep my properties slightly below market rent, but keeping pace with increases. I’m not sure that being even farther below market rent would increase my tenant longevity. And there’s a significant cost to falling behind.

Let’s say a hypothetical $200K home has a market rent of $1,500 (0.75% rent to price) and is actually being rented out for $1400 (0.7%). That’s a pretty good incentive for the tenants to stay.

And let’s say that the market home value and market rent both tend to go up at 3% a year. If you freeze the rent, then over 10 years the rent stays at $1,400 instead of going up to $1,881 [$1400 x (1.03^10)]. You’re giving up a 34.4% increase in rent. And at $1,881 you’d still be well below the ten year out market rent of $2,015 [$1500 x (1.03^10)].

Over ten years if the rent is frozen you collect $168K vs $192.5 if you stay below market rent but keep up with annual 3% increases. That’s $24.5K you’re giving up. If you bought the house with $50K down, that would be a missed return of 5% a year (24.5/10/50 = 5%) on your initial investment. And to your point, operating costs are going up that whole time.

I get it that there’s also a cost to tenant turn over. But how much more likely is it that a good tenant stays or leaves in year ten if Market rent is $2,015 and you’re charging $1,881 vs $1,400? Even if you averaged $6K in costs per turn you’d still need to turn over more than 4 times in 10 years to end up worse off.

Plus, with the frozen rent you are way below market and end up cashflow negative if you try an pull money out of the house. Connected to that, your debt to income is worse so borrowing is harder. Selling the house with the tenants in place is more difficult too, because you have leased tenants at well below market and have to discount your sales price slightly to get someone else to deal with it.

With all of that in mind I think you’re a lot better off pacing market rent and not falling too far behind. In your specific scenario I still think it sounds like Indy #1 is performing well, I would just push to increase the rent. If you want to be generous about it you could tell the tenants your operating costs are consistently going up (which is true), share the current comps with the tenant, and ask them what kind of increase they would be comfortable with.

What are peoples’ thoughts on where rent’s should be set or the best way to get them up if you fall behind?

@Becca F.     First things first, you’re awesome 😊

Also, I’m happy to give you the “guy on the internet who you don’t know and now has advice about your financial future opinion”, but just remember that’s what you’re getting.

It sounds like you’re going through the right mental arithmetic. When you say the rent to price ratio on Indy#1 is 1.17, is that to purchase or current market price? I tie all of my analysis to current market because that’s what determines how it’s performing vs other possible investments. (i.e. a house purchased for $150K, now worth $200K and renting for $1,400 is at 0.7%, which means it’s well positioned to support D/I ratio in the future if I want to do a cash out refi. The fact it was purchased for $150K just effects how quickly I’ll have enough equity to make a cash out refi worth doing.

Your index funds are pre-capital gains (assuming they aren’t tax advantaged) which mean’s you’ll probably owe 15% on returns. That means you only need a return greater than 8.24% to make investing a better option (assuming its post tax money being used to invest or pay down debt). That’s all complicated by investment returns being active and the debt write-off being passive and how that effects your tax picture, etc. But it does make a compelling case for investing, plus that keeps your cash more liquid and gives you more options. So completely agree with the other advice you were given on that.

I had the same issue with stagnant equity in my primary, but you have the regular options of doing a cashout refi or a HELOC to get at it. BTW, if you have 5 or less mortgages you can get a HELOC with Third Fed for 1% below prime, no origination fee, and a $65 annual fee.

Regarding consolidating properties. It all comes down to how the numbers work out and what your goals are. If you’re still trying to grow your portfolio then the rent to market price of the property you buy in 1031 exchange maters a lot, if you’re just looking for stable income and less headache it doesn’t. Regardless, I am a big proponent of buying where property taxes are low, since that’s a variable cost you can control. I have a lot of concerns about CA due to the growing problems with insurance costs (those aren’t going away), tenant rights, rent control, etc. NV and AZ could be good, I know the AZ market has been running pretty hot. But honestly, I don’t know those markets as well. I guess whether you should sell comes down to how well the three properties are performing as a whole and if you could find one or two properties which would better meet your goals and are worth the transactional costs. Maybe just the two class c? Sounds like the first property is treating you pretty well.

Not sure the normal advice of paying down mortgages applies to folks like us that are building RE portfolios. What you're getting at is that when you lose your W2 it significantly worsens your debt to income ratio – which would make getting traditional loans harder. But that doesn't impact DSCR loans if you still want to grow. Anyway, as long as you have enough rent coming in monthly to cover the costs of owning the rental properties I don't think that creates a lot of risk, you would just want to increase the size of your reserves since you won't have the W2 to depend on. Regarding the amount of leverage itself I see that as a function of Debt to Equity. If you have 3 million in property, and are carrying 2 million in debt, plus have 1 million in 401K you'd have 2 million in combined equity and be at a ratio of 1. In that scenario you have enough assets that you could sell part of your portfolio or liquidate 401K to easily have no debt and be left with 2 mill in assets. That wouldn't make me lose any sleep. So the only concern about losing your w2 would be if that was going to make your D/I ratio so bad that you were burning through your 401K faster than you feel comfortable with. With that in mind you probably want to be more conservative as you get toward retirement, but I don't think that means you need to actively pay down your mortgages faster, you could just take your foot off the gas on re-leveraging as quickly.

Love your post though. And congrats on your RE success. Please let me know what you decide to do and how it goes. Hope it works out really well !!!

@Sastry Srini

Per the post I just made, I would question if you need to reposition yourself every few years. If you can't find other sources of capital and the only way you can re-leverage is by selling and buying into something larger, than you're right.  But if you're able to find other sources of capital to make a down payment with, then having some properties with less leverage gives you the ability to buy new properties with more leverage and keep your overall portfolio balanced. And you can avoid the large transactional costs of having to sell your existing properties.

Since you can cashout refi up to ~80% LTV, you're not going to get that much more capital to upscale by selling and doing a 1031. It might still make more sense to do that based on what you're selling and what you're buying. I'm just not sure it's a necessity.

Agree with your comment on the importance of a stable portfolio.

Hey @Nicholas L. 

I’ve been thinking a lot about your question, regarding my future plans, in context of some of the discussion here. Fundamentally I think I just have a very different approach to thinking about RE than some folks. My view is that I never want to outright own any RE.

Most annual returns look roughly like: Market Value x 2% equity gain (mortgage paydown) x 2% cash flow x 3% appreciation for a total annual return of ~7% vs market value. Those numbers shift depending on the property, but because you tend to trade cash flow for appreciation, but I think it tends to balance. If you own the property outright there’s no equity gain, but your cashflow would go up.

Anyway, on a $100K home that would give you a nominal return of 7%... but the S&P averages a nominal return of 11%. So you’re having to put in all the effort to deal with you “passive” RE to get a smaller return than just sitting back and sipping margaritas. I get that there are tax advantages, diversification benefits, reduced risk, etc., but still. Conversely, if I only have 25% equity and the performance of the house stays the same my nominal return is 4x on 7%, or 28%. Which blows the S&P out of the water,… and part of the increased return is for dealing with the extra complexity and risk of the financing.

I know I just explained the value of leverage, but the point I’m making is that without the leverage life would be a lot simpler and easier to just invest in the stock market, and probably more profitable. So if anyone out there wants a guaranteed return of 7% and wants to do seller financing let me know 😊 I’ll be happy to take care of all the headaches and set you up with a stable income.

When I retire, instead of owning my homes outright I plan to cycle taking cash-out refi on them to re-leverage, live tax free on the loans, and let the tenants pay them down again.

Regarding debt, If it's at the same interest rate and terms (and ignoring different potential tax treatment) all debt is the same. So, except for the mortgage deduction, there's no difference between owing a $50K mortgage vs a personal loan, or a draw on a HELOC, or any other source of cash. If the interest rate and loan terms are the same, so is the monthly payment. Now obviously those don't tend to be the same, but it does mean that when I'm looking to optimize my returns I care about the overall cost of the financing, not the source.

I monitor my overall debt to equity ratio to make sure I don’t end up over leveraged. Most companies are considered in good shape if it’s less than 1.5. RE companies can operate over 2, but they’ve got scale to defray risk. This approach lets me look at all of my debt vs all of my equity across all my obligations. I combine that with my Debt to Income ratio, which tells me how healthy my cashflow is. Between the two I have a very good sense of how comfortably I can take on more debt.

My experience has been that my money works the hardest in $200K to $350K SFH, and I believe that would extend next to $450K to $700K duplex or triplex. In that range I think I get the best general mix of cashflow and some appreciation in C+ to B neighborhoods. That can probably be better expressed as RE that rents for 0.65% to 0.85% of the purchase price, where the lower range only works on newer homes that don't have delayed maintenance.

As you start looking at more expensive homes which rent for a smaller fraction of the purchase price you become dependent on appreciation. You can always cash-out refi to get access to that equity, but the real challenge it creates is to your debt to income ratio. The rent you can get for the property is not going to support pulling out as much equity since the property is skewed toward land/location (appreciation) not usage (cashflow). So some of the strategies others have expressed here have their advantages, but they do slow down your ability to grow. And on the flip side buying properties which cashflow really strongly might look good on paper for supporting a strong debt to income ratio, but you get all the headaches discussed previously around real life performance of houses that are too cheap.

So I don’t really care what interest rates are as a stand alone statement. I care about what kind of payment I would have to make, how that affects my debt to income ratio, and if I can generate enough of a return to make it more worthwhile than paying down debt or investing in the stock market. But given my prior statements,… even if the current interest rates mean that my cashflow is 0%, my leveraged return is still a 2% equity gain and 3% appreciation at x4 for a 15% return. That beats any of my alternatives and will improve if I’m able to refinance to a lower rate in the future.

So as long as my D/E and D/I ratios are healthy I think I should continue to expand my portfolio. When they get weaker I will look to consolidate and pay down debt. Even though some of my debt is variable and that’s weakened my D/I slightly, I’m still in a very good spot. So I want to buy another house, although that’s obviously dependent on finding the right deal. It’s a whole other conversation, but pretty clear that the axiom “you make most of your money when you purchase” is true. Getting a good deal is huge.

In terms of how to go about doing it, I want to keep my current RE at their current really low locked-in rates, since that protects my D/I. Also since my current homes are all in that 0.65 to 0.85 ~ish range, and I know them, I wouldn’t sell any of them to trade up unless it was for a very compelling multi-family opportunity.

Instead I’m starting to look for alternate sources of financing and using my very strong RE portfolio performance to support borrowing in other ways. Even though my current cashflow has been weak (per my original post) it’s pretty clear that I’ve been catching up on delayed maintenance and that the fundamentals are really good. (D/I looks at monthly obligations, it doesn’t care about my cap ex woes since those pass as you catch up on them).

Anyway, that’s what I’m thinking about next. What are all of your thoughts/plans?