All Forum Posts by: Eric Fernwood

Hello @Annette Barnett,

Good questions. I have the following comments:

1031 Exchange

We've completed over eighty-1031 exchanges and I have a comment on the 45-day identification period.

While you only need to identify (up to three) replacement properties, you might not be able to secure any of them. Our solution is to coordinate the sale of the relinquished property with the acquisition of the replacement properties.

For instance, one of our clients sold a property and purchased five replacements. We signed contracts for replacement properties once our client had a contract for the relinquished property and all contingencies were past. This method works as long as the replacement properties close after the relinquished property. Typically, we close on the replacement properties within two weeks of the identification period's start.

Using this strategy, if one of the replacement properties has significant issues revealed during the due diligence, we can still have enough time to contract another one and stay within the 45-day identification period.

Location Selection

Financial freedom is not about replacing your current income; it is about maintaining your current lifestyle for the rest of your life. The value of the dollar is constantly being eroded by inflation, so in order to maintain your current lifestyle, rents must keep pace with inflation.

Whether rents keep pace with inflation depends on the rate of population growth in the city where you invest. If the population is rapidly increasing, the current housing supply will not meet demand, and competition will drive up prices. If the population is static or declining, the existing housing supply meets demand, so prices do not rise significantly.

Rents follow prices.

• Higher prices reduce the number of people who can purchase, increasing demand for rental properties and increasing rents.
• Lower prices enable more people to purchase, decreasing demand for rental properties and decreasing rents.

If you buy property in a low-cost city, your rental income will not keep pace with inflation. As a result, your period of financial independence will only last as long as you can continuously decrease your living costs to match the falling buying power of the dollar due to inflation.

It Is Not What You Gross, It Is What You Net That Matters

There is a cost to doing business in every city. What percentage of your rental income is consumed by direct and indirect costs has a huge impact on how much money you will have left to live on. As an example, I compared the state average insurance and property taxes in Arizona, Florida, Georgia, Nevada, North Carolina, and Texas.

To put these rates and costs into perspective, below is the annual operating cost in the six states:

There is a hidden cost that can be larger than any direct cost, and that is rent control. In some cities, you may not have the option to select the tenant with the best financial history. In others, you may not be able to increase the rent fast enough to keep pace with inflation. Other cities make it difficult and expensive to remove non-performing tenants. While these are not direct costs, they can be the most expensive costs of all.

City Selection Criteria

While there are multiple selection criteria for a city where rents are likely to rise fast enough so you can maintain your standard of living for the foreseeable future, below are a few of the more critical ones.

• Cities with a metro population greater than 1M**.** Small towns may rely too much on a single business or market segment. Wikipedia
• Both state and metro populations are increasing. Do not buy anywhere if the state or metro populations are static or decreasing. Wikipedia
• Low crime - High crime and long-term appreciation and rent growth are mutually exclusive. Do not invest in any city on Neighborhood Scouts’ list of the 100 most dangerous US cities.
• Low operating cost - High operating costs can turn what appears to be a profitable property into a money pit. The three most apparent costs are income taxes, property taxes, and insurance. Insurance - ValuePenguin, State Property Tax Rates - Rocket Mortgage
• Rent control - Never invest in any city where there is rent control.

Any city that meets all the above requirements is worth considering.

Property Selection

I believe that deciding on a specific property type as the first step is a mistake. Your ultimate goal is financial independence for the rest of your life, not to own a certain type of property. I recommend focusing on the best properties to meet your financial goal. The type of property is irrelevant.

You want a property that keeps pace with inflation in terms of both rents and prices and that attracts reliable tenants. A reliable tenant is someone who stays for many years, always pays rent on schedule, and takes care of the property. However, such tenants are the exception rather than the norm.

My recommendation:

1. Choose a location based on the criteria specified in the City Selection Criteria section.
2. Through property manager interviews and research, select the tenant segment with the highest concentration of reliable tenants.
3. Buy properties similar to what this tenant segment is renting today.

This approach is effective anywhere and eliminates guessing and luck, making it the most likely method to generate the income you need for sustained financial independence. It is the approach we follow. How have our clients' 480+ properties performed over the last 15+ years? Between 2013 and the first quarter of 2022:

• Average annual appreciation >15%
• Average annual rent growth: >8%

Like everywhere else, the high-interest rates have reduced appreciation and rent growth.

Summary

Financial freedom requires buying properties in a city that provides the income necessary to maintain your same standard of living for as long as you live.

Hello Basit Siddiqi,

We have many foreign clients. Aside from getting an ITIN number, and working with a US CPA for filing taxes, what else is needed?

Hello @Stacey Michaels,

Some background: Over the last 15+ years, our investment team has successfully delivered over 480 investment properties to more than 180 clients worldwide. Our clients evaluate our performance very positively - over 90% of them purchase two or more properties, and our largest source of new business is referrals from existing clients. My point is that I have a solid understanding of how to find performing investment properties in Las Vegas. I am not just another armchair guru.

The goal of real estate investing is financial freedom. It does not matter what property type or anything else. However, financial freedom depends on keeping a reliable tenant in the property.

A reliable tenant is someone who stays for many years, always pays the rent on time, and takes care of the property. Reliable tenants are the exception, not the norm. And, you will need multiple reliable tenants over the years you own the property.

The best way to always have a reliable tenant occupy your property is to purchase a property that attracts people from a tenant segment with a high concentration of reliable tenants. How do you find such a segment? Through interviews with multiple property managers and additional research. This is what I did in 2005. Once I identified the right segment, I determined where and what they rented. The, we bought similar properties. These are the properties we’ve delivered for 15+ years and our results have been excellent.

• Average tenant stay >5 years
• We’ve had 6 evictions in the last 15 years with a tenant population of over 1,000.
• Our client's income was unaffected during both the 2008 crash and COVID-19 pandemic. Meanwhile, properties that attracted other tenant segments experienced high vacancy rates.

Notice that I did not pre-define a property type or location. The tenants I wanted to occupy our properties defined everything. It is really that simple. And, this method works anywhere. In some cities, the target segment property type might be multi-family, while in others it could be single-family homes or condos. The property type is not what matters. Income reliability is what matters.

It's Not as Simple as Selecting an Area

The map below shows where many of our client’s properties are located.

As you can see, there are areas with a high concentration of properties and areas with few or no properties. How did we know what and where to buy? Because we listened to our target tenant segment.

How Do We Consistently Find Performing Properties?

Below is our process:

1. Using data mining software we developed and exported data from the MLS, we eliminate all properties that do not match our target demographic. Only about 0.4% of all properties pass the data mining software.
2. Next, we compare the characteristics of each remaining property to the financial profile of each client. The ones that appear to match, we manually evaluate. About 60% of properties we manually evaluate are eliminated.
3. Next, we conduct an onsite evaluation of the remaining properties. If we determine that a property is likely to attract our target tenant segment, we take a video and send it to both our client and the property manager we work with.
4. Based only on the MLS number and the video we provide, the manager responds with probable rent, time to rent, pros and cons, and a list of renovation items necessary to attract our target tenant segment and maximize the rent.
5. We next use software we developed to generate an estimated renovation cost based on the list of renovation items provided by the property manager.
6. If the property and renovation costs match the client's profile, we provide actionable analytics and recommendations. We never send MLS data sheets because they contain nothing of value to an investor. If the client is interested, we submit an offer.

How long does it take to complete this process? Typically, it takes between 6 and 10 hours. Good properties tend to stay on the market for only 2 or 3 days, so we have to move quickly. On average, we close 4 to 5 properties every month.

A common question I receive in, “How much does it cost to work with an investment team like ours?” I can’t answer for others (there are no others in Las Vegas to the best of my knowledge) but we’ve only charged a fee 4 or 5 times out of the over 480 properties we’ve delivered. And these few occasions were due to exceptional circumstances. For all other properties, our fees were paid by the seller's listing agent, not our client. This enables you to take advantage of 15+ years of experience and a team of experts, without any additional cost to you.

Summary

I’ve worked almost exclusively with investors for over 15 years and selected hundreds of investment properties. Could I find a good property by driving around or cruising websites? No, there are too many properties and the time they are on the market is too short.

Reach out if I can help.

Hello @Raj Palem

Appreciation is critical for three reasons.

• Compensating for inflation.
• Minimizing total capital required to achieve financial independence.

Compensating for Inflation

Financial freedom is more than just replacing your current income; it's about maintaining your current lifestyle for life. Inflation continually erodes the purchasing power of a fixed amount of money. What you can purchase today for $100 will require $155 in 10 years if the inflation rate is 5%. The only way to sustain your current lifestyle is if rents and prices keep up with inflation.

Prices and rents are determined by supply and demand.

• When population growth is stagnant or declining, the current housing inventory is sufficient and rents and prices rise slowly or not at all. Such locations are characterized by low prices due limited demand for housing of an extended period of time. In such locations, rents will not keep pace with inflation. The first rent check you receive will have the highest buying power for the life of the property.
• When there is sustained and significant population growth, there are more buyers than sellers. In such locations, prices increase until the number of buyers and sellers reach an equilibrium point. Locations with increasing population are characterized by higher prices and rising rents.

Unless prices and rents keep pace with inflation, your financial freedom will be short lived.

Minimizing Total Capital Required

To replace your current income, you will need to acquire multiple properties. How much capital will be required depends on appreciation.

• Low-price location: I will assume each property costs $200,000. I will also assume that you will need 20 properties to generate sufficient monthly income to replace your current income. I will only consider the capital needed for the down payments and ignore all the other costs like renovation, closing costs, etc. I will also assume the downpayment is 25% of the purchase price. The total capital required from savings for down payments: 20 x $200,000 x 25% = $1,000,000
• Higher price location - I will assume that each property costs $400,000. In a high-appreciation location, you can use cash-out refinance when there is sufficient equity to pay the down payment to buy the next property. In this case, the total capital requires from savings to purchase 20 properties will be: First property capital requirement: $400,000 x 25% = $100,000. Each additional property is purchased with accumulated equity from the previous properties. This is what many of our clients did to grow their portfolios. The (BRRRR) process of growing your portfolio is illustrated below.

This method is how successful investors grow their portfolios over time.

In summary, you can’t afford to buy in low-cost locations if you want to achieve financial security with the least total capital possible.

In Summary

Locations with high appreciation:

• Enable you to to achieve permanent financial independence because prices and rents keep pace with inflation.
• Reduces the total capital required to acquire the number of properties you need to replace your current income.

Locations with low appreciation:

• Provide short-term financial freedom because rents and prices will not keep pace with inflation. Sooner or later, you will be forced back onto the daily worker treadmill.
• Requires far more capital to purchase the number of properties needed to replace your current income.

In short, if you want to achieve permanent freedom, you cannot afford to buy in low appreciation locations.

Hello @Raj Palem

Appreciation is critical for three reasons.

• Compensating for inflation.
• Minimizing total capital required to achieve financial independence.

Compensating for Inflation

Financial freedom is more than just replacing your current income; it's about maintaining your current lifestyle for life. Inflation continually erodes the purchasing power of a fixed amount of money. What you can purchase today for $100 will require $155 in 10 years if the inflation rate is 5%. The only way to sustain your current lifestyle is if rents and prices keep up with inflation.

Prices and rents are determined by supply and demand.

• When population growth is stagnant or declining, the current housing inventory is sufficient and rents and prices rise slowly or not at all. Such locations are characterized by low prices due limited demand for housing of an extended period of time. In such locations, rents will not keep pace with inflation. The first rent check you receive will have the highest buying power for the life of the property.
• When there is sustained and significant population growth, there are more buyers than sellers. In such locations, prices increase until the number of buyers and sellers reach an equilibrium point. Locations with increasing population are characterized by higher prices and rising rents.

Unless prices and rents keep pace with inflation, your financial freedom will be short lived.

Minimizing Total Capital Required

To replace your current income, you will need to acquire multiple properties. How much capital will be required depends on appreciation.

• Low-price location: I will assume each property costs $200,000. I will also assume that you will need 20 properties to generate sufficient monthly income to replace your current income. I will only consider the capital needed for the down payments and ignore all the other costs like renovation, closing costs, etc. I will also assume the downpayment is 25% of the purchase price. The total capital required from savings for down payments: 20 x $200,000 x 25% = $1,000,000
• Higher price location - I will assume that each property costs $400,000. In a high-appreciation location, you can use cash-out refinance when there is sufficient equity to pay the down payment to buy the next property. In this case, the total capital requires from savings to purchase 20 properties will be: First property capital requirement: $400,000 x 25% = $100,000. Each additional property is purchased with accumulated equity from the previous properties. This is what many of our clients did to grow their portfolios. The (BRRRR) process of growing your portfolio is illustrated below.

This method is how successful investors grow their portfolios over time.

In summary, you can’t afford to buy in low-cost locations if you want to achieve financial security with the least total capital possible.

In Summary

Locations with high appreciation:

• Enable you to to achieve permanent financial independence because prices and rents keep pace with inflation.
• Reduces the total capital required to acquire the number of properties you need to replace your current income.

Locations with low appreciation:

• Provide short-term financial freedom because rents and prices will not keep pace with inflation. Sooner or later, you will be forced back onto the daily worker treadmill.
• Requires far more capital to purchase the number of properties needed to replace your current income.

In short, if you want to achieve permanent freedom, you cannot afford to buy in low appreciation locations.

Hello @Jordan Futch,

We've operated a one-stop investor services business in Las Vegas for 15+ years and delivered over 480 properties to over 180 clients worldwide. We've also completed over eighty 1031 exchanges with most coming from California followed by Portland, Seattle, Florida, Indiana, Oklahoma, and Texas. My point is that I’ve actively worked deals for several years and been through a few financial cycles.

Today, most of our clients are from California. The most common reasons people choose not to invest in California are:

• Rent control: Rent control laws limit how much landlords can charge their tenants for rent. While this may protect tenants from steep rent increases, it can also make it challenging for landlords to turn a profit. Additionally, evicting tenants who are not paying rent becomes more difficult under such laws.
• Anti-landlord regulations: There are many regulations in California that make it challenging for landlords to operate their businesses. These regulations can include tenant screening requirements, eviction laws, and building codes.
• High property prices: Property prices in California are very high. This can make it difficult for investors to afford to buy properties, and can also make it difficult to sell properties for a profit.
• High taxes: Property taxes in California are notorious for being very high. This can significantly reduce the profits of landlords and make it harder for investors to afford buying properties.

So, the difficult of finding properties that cash flow is not the only reason Californians invest out ot state.

@Jordan Futch - On you comment on real estate crashes.

In 2005 I did extensive research on selecting the right tenant segment to target for income reliability. We've targeted this tenant segment for over 15 years. Our results:

• On average, our tenants stay over five years.
• We've had six evictions in the last 15+ years (over 1,000 tenants).
• 2008 crash - Zero decline in rent and zero vacancies. Properties prices plunged, but our clients buy properties for income replacement, not flipping.
• COVID - Almost no impact
• Eviction moratorium - Almost no impact

So, if you target the right tenant segment, you can achieve income reliability. However, nothing can protect you from national crash events. If your goal is a reliable passive income, you can achieve this with the right tenant segment. If anyone is interested in rental income reliability, reach out.

@Jordan Futch - Airbnb

Short-term rentals rely on vacationers, so occupancy is dependent on the economy since vacations are optional. This is why there is a lot of interest in mid-term rentals. Mid-term rentals solve a business need. For example, traveling nurses.

Another differences between short-term rentals and mid-term rentals is the amount of personal time investment required. One of our team members owned four short-term rentals and described them as, "purchasing another full-time job." She 1031 exchanged some of her properties and converted others to long-term rentals.

With mid-term rentals, there is cost effective property management available. Also, our approach is to purchase excellent long-term rentals and use them as mid-term rentals. This provides a fallback position if the market changes.

Hello @Johann Villalvir,

Congratulations your accomplishment.

Some background: I am an engineer and what I do in our investment services business is primarily data science and software development.

We use data mining software to evaluate thousands of properties based on about 40 behavioral characteristics of our target tenant segment. The software performs the following functions:

• Eliminates all properties that do match our target tenant pool segment.
• Selects sales and rental comps for evaluating rent and return.
• Generates investor analytics. We provide actionable information, not MLS data sheets.

I’ve experimented with increasing the scope of our software. However, despite trying many approaches, I have failed to consistently meet our accuracy and consistency requirements.

Today, we use a hybrid solution. We reduce the number of investment properties to consider by about 99.6% using our data mining software. Then, we match the properties that passed the data mining engine against the specific financial situation and goals of individual clients. Next, we manually evaluate each property. At the manual evaluation step, approximately 60% more are eliminated. Additional software estimates renovation costs and provides actionable analytics. We have never shipped MLS data sheets.

Below are some reasons why taking the next step with software, has not been successful for me.

• There is a lot of inaccurate information in the MLS. A recent example, "How much is the monthly association fee?" Answer in the MLS, "Yes."
• Computers cannot accurately determine whether a property is located in a desirable or undesirable area for a particular tenant pool segment using photos or aerial maps. There are more location considerations. For instance, even if a property has excellent characteristics, it may not rent if there is a significant amount of traffic on the street. This determination can only be made if you know the specific street.
• An onsite evaluation is essential. For example, if there is a barking dog next to a property, it will not rent. How can software determine the presence of a barking dog?
• Zillow and OpenDoor attempted to use software to predict the sale price of properties and their results were/are bad because their software was poor and the inherent limitation of software to deal with subjective data. Zillow lost so much money that they decided to exit the flipping business, while most of the OpenDoor properties we see in Las Vegas are sold at a loss.

In my experience, software can only go so far when humans are involved. Our hybrid approach has worked well. If there is a better approach, I would like to understand what it is.

Thanks for your post.

Some great horror stories on this thread. And, I believe most are true, or at least representative of reality.

I believe there is a common theme: people decided to do everything on their own. Let me ask you a question. If you needed surgery, would you start medical school? Of course not, you would find a surgeon with extensive experience in the procedure you require.

That is why you need to work with an experienced local investment team. To date, we have delivered over 480 investment properties, and none of our clients have ever been involved in the renovation, maintenance, or management of their properties. Managing properties is not their skill set, and they do not have the time. Additionally, there is another need that an individual investor cannot provide. The only way to have a reliable income is to have a tenant who stays in the property for many years, always pays rent on schedule, and takes care of the property. However, finding such a tenant is rare, and out of over 100 property managers in Las Vegas, I have only met two who possess the skills to consistently select such tenants. You cannot afford to manage your own properties. One bad tenant can cost you more than several years' worth of management fees.

For over 15 years, we have provided end-to-end investor services. Our clients focus on what they do best (e.g. doctor, lawyer, engineer, business owner), while we handle everything else. What sets us apart from other realtors? We are engineers who approach finding, validating, renovating, and managing properties as engineering problems. We use proven processes, not luck or gurus. How do our clients evaluate our performance? Over 90% of our clients purchase two or more properties from us, and our largest source of new business is referrals from existing clients.

You might assume that our end-to-end investor services come with a steep fee. However, in delivering over 480 investment properties, we have only charged a fee 4 or 5 times, and only due to exceptional circumstances. For all other properties, our fees were paid by the seller's listing agent, not our client. This enables you to take advantage of 15+ years of experience and a team of experts, without any additional cost to you.

You can either try to do everything yourself or work with a team of experts. By working with an experienced investment team, you also have the option to invest where you can make the most money, not necessarily where you live.

Hello @Javaras Thomas,

We've completed over 80 1031 exchanges from multiple locations and never had an attorney involved. The primary locations where 1031 exchanges came from are California, Portland, Seattle, and the midwest. The most often stated reasons for clients from California, Portland, and Seattle are high costs and anti-landlord regulations. From the midwest, slow rent growth and appreciation. In this post, I will provide a high-level view of the 1031 exchange process and some considerations.

A 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred.The actual 1031 process is simple and illustrated below. The challenging part is the 45-day identification period, which I will discuss later.

Below are some considerations that you should be aware of:You are not allowed to use the proceeds from the relinquished property to pay for renovations. Some of our clients have opted to pay capital gains tax on a portion of the proceeds and use that money for the renovation.Not all purchase contracts include 1031 exchange verbiage. Have your listing agent obtain the correct verbiage from your exchange agent for your state and include it in the agent-to-agent remarks, specifying that the 1031 text must be included in the offer.To fully defer the capital gains tax, you must reinvest all the proceeds from the sale into the replacement property. If there is existing mortgage debt on the relinquished property, it's important to consider how it will be handled during the exchange. Any reduction in debt or cash received may be treated as taxable boot, resulting in potential tax liabilities. Talk to your 1031 exchange agent.Both the relinquished and replacement properties must meet the requirement of being held for investment or used in a trade or business. Personal residences or properties primarily held for personal use do not usually qualify for a 1031 exchange.It's important to understand the state-specific regulations regarding like-kind exchanges. Some states may not recognize or fully conform to the federal provisions. Consult with a tax professional familiar with your state's laws.The Biden Administration's proposed FY 2024 budget includes the creation of “capped deferral” for 1031 exchanges. In this proposal, taxpayers in FY2024 would be able to defer capital gains only up to an aggregated amount of $500,000 for each taxpayer ($1 million for joint filers). Source. If you are considering a 1031 Exchange, 2023 may be the last year to do it

I get a lot of questions on how to handle the proceeds from the sale of the relinquished property (ies). Below is an illustration of the flow of funds during a 1031 exchange. The funds move from the closing escrow agent to the 1031 exchange agent. When you close on the replacement property, the funds go from the 1031 exchange agent to the escrow company handling the closing. The funds must never be in your hands, or the 1031 exchange will be void.

Where things can go wrong is the 45-day identification period. While you only have to identify (up to) three properties as replacement property(ies), I can see a situation where you are unable to close on any of the properties for various reasons. If this happens after the end of the 45-day identification period you would lose the tax exemption.To guard against this situation, we follow a different process. Once your relinquished property is in escrow and all contingencies have passed, we will get the replacement property or properties under contract before the relinquished property closes. This is permissible as long as we close on the replacement properties after escrow closes on the relinquished property. We target to close escrow on the replacement properties within 2-3 weeks after the relinquished property closes.

Using this process, if a replacement property falls out for any reason, we have time to get another property under contract and complete due diligence inspections. Only after due diligence inspections do we know if we want to close on the property.

When people contact me about a potential 1031 exchange, I ask them why they want to do a 1031 instead of a cash-out refinance. Which is the best option depends on whether you want to keep the property. Because this is a frequent discussion, I put together the following decision chart.

Javaras, I hope this helps. Reach out to me if I can help or if you are undecided on the replacement investment location.

Excellent post Nick!