All Forum Posts by: David Lutz

@Steve Smith Congrats that you’ve got a system that works for you and it’s finding success.

One of the challenges of living in California is that buying local doesn’t make sense. The properties are so expensive due to the land that if you need a mortgage you’re going to be cashflow negative, and the laws are so anti-landlord that I’m not sure it would be smart to buy here regardless.

How are you going about finding your seller financed and subject too opportunities?

@Rajagopalarao Paidi

Raj, And even if it looks like it will be cash flow positive on paper that's not necessarily accurate.  https://www.biggerpockets.com/forums/12/topics/1171104-the-m...

Agree with all the other posts regarding cashflow essentially being a function of how much equity you put down,  and leverage is more expensive now. And the fed is making it pretty clear they're not dropping rates any time soon. Plus rents have gone up so much recently I'd be conservative and assume they're going to go up much for the next few years. So quickly growing or refinancing your way out of your starting situation is a lot less likely.

apparently it would cause the world to break if too many of us agreed.   I live in LA as well, but after spending close to two years evaluating the SoCal markets I decided to go out of state and am very happy with the decision. I put up a long post that covers my experience https://www.biggerpockets.com/forums/12/topics/1171104-the-m...

Per that post I would agree with @Glen Wiley. Never ever overextend yourself. Leaving yourself with no reserves is asking for trouble. If the LA opportunity is so good, take on a minority partner. Someone with a small stake, that will let you run the show, but gives you some operating capital.

What I'd add here is that no one is talking about the landlord environment in CA. This has to be one of the least friendly states to be a landlord, and the taxes are high. I understand that the average tax is low, due to prop 13, but not on a newly purchased investment property. Given that you're not talking about buying a class A or B property (assumption based on your post) I would be very worried about they type of tenants you're going to have and the headaches they create. Regarding OOS purchases,... how often are you planning to drive out to the property anyway. If I bought in Fresno I wouldn't have been driving out there often, and it's the same if you're buying out of state.  As long as you're not buying something that needs a lot of work to get it rent ready, I don't think it's a big deal.

@V.G Jason

First, I appreciate you taking the time to reply. I know we're all busy.

Second, I think this is an issue where it's just hard to have detailed/accurate conversations via forum chats.

I promise you, I do understand the difference between a high and a low interest rate environment. To your point about "if you have a $1M do you pay down debt at 8%, or investing it",.. the answer depends on if you have access to a tax adjusted real return which produces more than 8%, and enough more to be worth whatever risk comes with it.

Honestly, the only place I’m not sure I’m on board with your thinking is the deleveraging. I can only see three reasons to deleverage, if:

• 1) You are retiring and prioritizing the establishment of a stable income stream. (which you said is not your thought)
• 2) If you’re already overextended and need to put yourself in a more secure cash position. (I’m not, per my original post I’m pretty conservative in my modeling and safety nets, I don’t get the feeling you’re swimming naked either)
• 3) You can get a better return investing the money somewhere else, even accounting for the transactional costs

The last is the most interesting. You’re implying that you can get a better return paying down your debt rather than leaving it where it is or increase leverage buying something new/bigger. I think that’s where I’m having trouble.

What’s the scenario where you sell home “A” that’s generating strong returns (I.E. the leverage is working for you) in order to pay down the leverage on home “B” (that’s also working for you)?

In Europe where you only have 5 year loans, or in the US with commercial property I could see this happening because your levered costs can change on you. But with a 30 year fixed you’d just leave the money where it is, and continue to get the benefits of a locked in leveraged return …….

To your questions:

• My timeline is generational wealth. I’ll probably switch from pure growth to a mix of growth and yearly returns in 10-20 years.
• I really don’t care how many doors I have, I just want to increase my portfolio market value and run it efficiently.
• You’re spot on regarding defraying fixed operating costs with better properties. But I think that’s an always thing, not just the current market. There is a limit to how much benefit you get pushing for nicer homes, at some point the spread between rents and home value starts to accelerate.

Final note, I do really appreciate the discussion. Always a good opportunity to learn something new 😊

Quote from @V.G Jason:

A lot of what you said here is what a lot of (experienced and/or intelligent) investors have driven home. With that said, I'd still say your sample size is just too small. Let's see how it fairs Year 8 and ideally closer to year 12-14. 

The description of prices & events that took place for what areas you bought neighborhood wise are par for the course. It's just a lot of volatility in cash flow for the first years; that's expected. That's why you don't invest on a short-term horizon though.

The right move isn't necessarily to cash-out refi and grow, technically. The move would be to cash out re-fi, then sell and deleverage. You scale originally. I wouldn't scale nowadays with cash out re-fis-- in the low rate era sure. Right now just less houses and better houses. Get up to 6-7 quality houses, sell 1 and re-fi one after 10 years. Sell the re-fi one year 12-15. Take that cash and pay capex/debt downs on the other 5, live debt free.

 @V.G Jason  Appreciate you taking the time to comment. If I follow your second statement, are you saying that instead of continuously pulling equity out of the existing portfolio to fund expansion that you would grow to 6-7 houses and then consciously shrink the portfolio down to 5 with much higher equity levels (potential upscaling the quality of the houses in the process)?

I think what you're saying makes sense when you hit the point you're shifting toward retirement and looking to stabilize and increase your cashflow. But I'm still in growth mode. In order for me to hit my RE goals I need to keep growing my portfolio.

My current challenge is figuring out how to keep growing my portfolio as quickly as possible in a sustainable way. (any suggestions welcome). You said you wouldn't scale using cash-out refi nowadays, given the end of the low rate era. I agree with you.


1) I don't want to do a cash out refi unless I'm getting enough capital to make giving up my current interest rates worthwhile. Because my current rates are so low, it will be 3-4 years before there's enough equity to make that really compelling.

1a) Am I correct that you're suggesting pulling out equity, but doing it through sale and reinvestment instead of cash out refi? As long as you can shift into a property that's better enough to justify the transactional costs (your bigger better houses comment) I think you're spot on. But that still requires having enough capital to make that possible, which puts me on a longer timeline than I would like.

2) I can't find lenders willing to take a second position at even marginally sane rates. (any recommendations?)

3) In long term SFR buy and hold I haven't been able to figure out how to structure a deal that works for both parties in a partnership. (ie. If I borrow a down payment from a friend at 7%, there's no way the deal isn't doing to be cashflow negative, and that puts a ton of pressure on appreciation to make the deal worth doing, and every deal makes me less able to do another in the near term)... Money partners make a lot more sense in forced appreciation deals where there's enough money to go around.

4) Seller financing feels like trying to find a unicorn. I'm not working in RE day-to-day, and I haven't seen these opportunities. I am keeping my eyes open for them, but it doesn't seem like a realistic growth strategy.

Out of everything, if I understand your suggestion 1a properly, I think that might be the most realistic option for growth in the current higher rate environment. As you pointed out. It's slower than I'd like (can't I have a lot of money with no work right now?), but it's practical. 

--- I'm not trying to be negative on any of the options btw, just realistic. I'm going to keep pounding my head on these issues until I find a solution to moving forward. If you have any additional suggestions I'd appreciate it.

Did I understand your original comment correctly?

I had a similar experience and just put up a post about it.    https://www.biggerpockets.com/forums/12/topics/1171104-the-m...

My two cents is that you can get positive cashflow on good properties in the right markets,... but that you shouldn't be counting on it. Bigger concern is making sure you have enough buffer that its not going to be an issue riding the volatility out until the rents go up enough you don't care .

My first purchase has been my biggest headache, because I was looking for better cashflow and got all the issues you expect.  I'd also point out that there are a lot of fixed costs associated with maintenance and CapX.   It costs the same to have a plumber snake a drain regardless of the value of the house. But it takes up a much larger percentage of the rent if you're only pulling in $1000 per month.

I just put up a massive post on all my costs and headaches for 5 properties over the last 3 years, if you're interested.
https://www.biggerpockets.com/forums/12/topics/1171104-the-m...

The advice you're getting on how to use your loan all sounds good to me. I'd double down on buying a property that's going to attract desirable tenants. The paper savings on "cashflow" properties evaporate in reality.

BTW, two of my properties are in Augusta, feel free to PM me if you want to chat about the market.

Let me start by saying I am all in on RE. I have an MBA, spent years learning about RE before I pulled the trigger. And when I did, I bought 5 houses worth over $1M in 18 months with only $100K of my own money. So I feel pretty good about saying I am financially literate, know how to model, and to find deals purchasing out of state.

I’m also embarrassed to admit I was so focused on getting going that I just assumed I could track if I was doing well by watching my bank balance. That was dumb. To be fair, in addition to buying all those houses over the last 3 years I also dealt with an eviction, $47.4K in capital expenses, insurance claims, building teams in my local markets, and all the other nonsense involved in this lovely industry.

Anyway, I finally got around to putting together a complete general ledger and had the horrible realization that over the last two years (bank and credit card record limitation make it harder to go back farther)…

….. between 2022 and 2023 I have been $17.5K cash flow negative on $171K expected rent !!!!!

How the **** did that happen? I budgeted 21.2% of the expected rent toward vacancy, maintenance, and CapX, and in reality I ran at around 27% in the last two years. Also,.. why am I telling you? I figure that I’ve gotten so much from everyone at Bigger Pockets, and there is so little information on the hard numbers of how non-professional investors do, that I should give something back. Because most of the tools you have access to are a figment of imagination pushed by self-aggrandizing gurus and the Real Estate industry … because they only make money when you’re buying.

Again, let me stress I've made a lot of money over the last 3 years. I think you should buy real estate, I just want you to be smart. One of the major dangers is caused by the bizarre reality distortion field people have regarding the term cashflow. It seems like a lot of people use the term cashflow to refer to how much net income they average per month with no (or minimal) reserving or debt servicing. And the per door numbers sound huge, which is great but also meaningless. Because, reality check, if you think you're clearing $500 per month over 3 years ($18K) but you end up with one $5K Cap Ex cost, $4K in vacancy, and $3K in random maintenance then you're really only averaging $166 per month ($6K). And if you borrowed money for your downpayment from a HELOC, personal loan, cash out refi, 401K etc., then your hidden debt servicing can take your cashflow negative in a heartbeat. Rosy assumptions about how much free cash your real estate investment is going to throw off make it really easy to be unrealistic about what it's going to take to make owning rentals actually work.

So, 3 years into my Real Estate journey (5 with planning) I have some learnings I want to share:

• The default assumptions in every calculator you look at are rosy at best and complete lies at worst. Unless you buy a brand new house there is probably deferred maintenance. Your costs are going to be higher than you expect in the first few years. Plus, you’re not a professional. There is a high likelihood that you’re going to end up paying slightly more than you should for repairs, and turning houses when tenants leave is going to take longer than it should.
  • -- I’m sorry. I know you think you’re awesome. You’re not. Bleeding money that a pro wouldn’t is just going to happen. It’s better to anticipate it.
  • -- My recommendation is 25% of rent to cover vacancy, maintenance, and Cap X for older homes (+20 year), 20% for middle age (5 to 20), and 15% for new homes (you’ll need it eventually). I’m running hotter than that, but I honestly believe that I’ve caught up on deferred maintenance and these numbers are good for the long run.

• Have a plan for dealing with getting it wrong. I started with a $20K reserve. In addition to a strong W2, I have a HELOC to lean on. I stopped fed tax withholdings because the penalty is cheaper than borrowing cash, which buys a year (I still pay my taxes in full). In a pinch I can borrow against my 401K. And if things ever went truly sideways I could sell a house.

• Leverage is awesome. I borrowed 90% of the money for the homes I purchased at an average of ~4% interest. But the higher your leverage, the more likely you’re going to be cashflow negative. You’re going to make more money with more leverage, but only if you can handle the debt service. Don’t overextend yourself.

• As insane as it sounds, going all in actually helped. The rent from 4 houses covered the mortgage for 5 over the last 18 months I’ve been dealing with an appealed eviction and the court collecting and holding the rent.

• Everything I bought rented for 1% to 0.65% of the initial purchase price (more now). And the 1% has been the biggest headache. So if you go for cashflow you better be on premises, because there are going to be issue to deal with. And if you go for appreciation/quality houses you need to have a plan for dealing with weak cashflow.

• For pity sake don’t turn on water service on a Friday. My buddy and I have both ended up with minorly flooded houses despite the property managers telling us that all the taps had been turned off.

• If you’re buying out of state, ask potential property managers if they have local staff on site or if they outsource their inspections to a vendor (common for larger PM companies).

• When I model returns, I assume appreciation on B-/C+ properties at 1% above inflation. I did a lot of research, long term that’s a safe assumption. Rent I assume tracks with inflation (which is still great because a lot of your costs are fixed). This is probably a bit conservative, but I think it’s generally accurate, and I only like good surprises.

• You have to be able to get +$1000 per door to use a property manager, less than that and the minimums they charge start screwing up your returns.

• Water heaters, etc. cost roughly the same everywhere - it’s closer to a fixed cost. Buy where taxes are low on rental properties, populations are growing, economies are growing, and there are at least two of the following: Gov spend, Major healthcare, transportation hubs, universities, sports teams, industry concentration, tourism, manufacturing. These drive jobs, the more there are where you buy the better and more stable your investment.
  • -- If you’re as nuts as I am read the local area development plans and research planned corporate and other investments. Building an amazon hub and a zoo to the east of the city along with a new planned transit rail line? Awesome.

• Offer what you have and ask for help (preferably in that order). I did some financial modeling for an RE Agent I wanted to build a relationship with, and a year later he gave me some great recommendations on local tradespeople. During a friendly conversation I asked one of my property managers for recommendations on areas with the most growth potential and ended up buying two homes there.

• LLC get expensive if you're thinking of opening one for every property, plus it's a lot of work to make sure they can't be pierced. Consider just getting an umbrella insurance policy.

• Interest only HELOC are only just interest until you hit the repayment period, so make sure you're ready for the increase when you start paying back principal. Also, some lenders have limits on how many mortgages you can have and qualify for a HELOC. So if you think you might want one, set it up early.

• Current taxes on the property you buy generally lag current market value, and in some cases taxes on rental properties are higher than owner occupied. That’s all going to get corrected when your purchase triggers a reappraisal. So put together some realistic tax estimates before you buy.
  • -- All the info you need is available online from the local assessor, and pay attention to what the local community has tacked on to the mill rate. Taxes for two houses twenty minutes apart can be wildly different.

Major costs over last 3 years on 5 homes:

• $10K in missed rent leading to and waiting for eviction
• $3K Eviction costs (lawyers, travel, writ, etc.)
• $2.5K additional lost rent due to 4 month instead of 2 month property turn
• $3.8K for a new furnace
• $7.4K for a new HVAC
• $700 for a bathroom re-pipe
• $12K turn on large home, included new high quality carpet and full repaint
• $5.5K in unnecessary plumbing issues caused by tenant in eviction (no way to recover costs)
• $1.5K in utility bills during vacancy or owner responsibilities
• $900 for a refrigerator
• $4.8K for concrete piers to shore up a foundation
• $5.6K for a roof (insurance claim)
• $5.2K for another roof
• $1.3K for new AC line set (punctured in second roof replacement)
• $1.6 for a water heater
• $1.3 for a water heater
• $2K for a water heater
• $1.7K for new water line from meter to house
• … this actually isn’t everything but I’m getting depressed.

That’s $70.8K which was money that never made it to me, I didn’t expect to spend, or thought I had more time. And this is separate from regular maintenance my property management companies took care of and deducted from the rental income.

So the moral here is that RE is great but you can’t depend on cashflow. If you buy class C or D properties you are going to have way more issues than you can ever anticipate on paper. And if you buy class A or B you’re banking on appreciation. Either way, buy and hold is a long term play and it’s not going to throw off lots of cash in the short term. I’m guessing my year 4 is going to be pretty good, but it’s taken that long to get everything stabilized.

And If I decide to pull equity out to buy more houses, it extends this issue. I would end up with cash to buy more houses, but my monthly debt load goes up and cashflow goes down. So dream of equity and forget about cashflow,... its just a myth.

* These are just my personal beliefs based on my experience. If you hadn’t guessed I am not a RE professional (you probably aren’t either), and that’s kind of my point. I think it’s way too easy to over estimate investment performance based on how well the pro’s do. So don’t take any of my opinions as anything more than that. Make sure you do your own due diligence on your own deals.

**and if you find this info useful vote the post up. I'd like for folks to be able to find this kind of detailed info more easily.

@Tam Nguyen   The costs in time and money for managing the more complex structure add up. What made you decide the protection/anonymity was worth it?

Also, you have any issues moving the properties into an LLC with notes in your name?
 

@Saika Maeda

I'm in SoCal and hold out of state SFR as well. For what it's worth I decided to go with a large umbrella and skip the LLC for all the reasons Katie mentioned. Loans are also cheaper when you're doing it under your own name.

If you ever want to talk about out of state investing please feel free to give me a shout.