All Forum Posts by: Eric Fernwood

Hello @Sean Haran,

The most reliable way to achieve a goal is to start at your destination and work backward to where you are today. That is what I will do in this post.

I believe the goal of real estate investing is to create a reliable passive income that meets the following requirements:

• Inflation compensating: Rental income keeps pace with inflation, enabling you to pay inflated prices to maintain your standard of living.
• Persistent income: Your income will last so you will not run out of money.
• Reliable income: Your income continues even in difficult economic times.

Before I continue I want to explain why inflation compensation is the most important factor.

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 to buy in 10 years if the inflation rate is 5%. The only way to sustain your current lifestyle is if rents keep up with inflation. If rents don't keep up with inflation, your financial independence will be short-lived.

Why Location Is the Most Important Investment Decision

Unless rents keep pace with inflation, you will not have financial security. So, what is the first and most important investment decision you will make? The city where you will invest.

In real estate, prices are dictated by supply and demand. Population growth is the heartbeat of demand.

• When the population rapidly increases, the existing housing inventory is not sufficient, creating a mismatch between the number of buyers and sellers. The result is rising prices. If the population continues to increase, prices will continue to rise.
• When the population is static or declining, the existing inventory is sufficient to meet housing requirements and prices stagnate or fall, relative to inflation.

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.

So, when it comes to selecting an investment location, the critical factor is population growth. Do not invest in any city where the population is static or falling if you want rents to keep pace with inflation.

What are some other location selection criteria? I listed a few below.

• 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 locations almost always have declining populations. Do not invest in any city on Neighborhood Scouts’ list of the 100 most dangerous US cities.
• Rent control - Cities and states with rent control may prevent you from increasing rent fast enough to keep pace with inflation. This can limit your ability to select the best tenant and can make evictions of non-performing tenants difficult or impossible. Never invest in any location with rent control.
• Low operating cost - It's not how much your gross what matters is how much you net. Choose a location where operating costs consume as little of your gross rent as possible. Below is a comparison of property tax and insurance costs in three popular investment states.

To show the impact of taxes and insurance on net cash flow, I compared overhead costs on a $400,000 property in those three states.

So, if you buy a property in Texas, it must generate a $5,700 ($9,194-$3,494) higher annual cash flow than a property in Nevada to compensate for the higher overhead cost in Texas. (Sources: Insurance - ValuePenguin, State Property Tax Rates - Rocket Mortgage)

Property Selection

Rather than following popular dogma, I recommend focusing on your goal of achieving a reliable income. To have a reliable income, your property must be occupied continuously by a reliable tenant. A reliable tenant is someone who stays for many years, pays all the rent on schedule, and takes care of the property.

Reliable tenants are the exception, not the norm. And, because you will likely hold the property for as long as you live, you will need multiple reliable tenants over the years. The way you achieve this is to buy properties that attract people from a tenant segment with a high concentration of reliable tenants.

You can identify this tenant segment through multiple property manager interviews and research.

Once you identify the tenant segment you want to occupy your property, determine what and where they rent today. It could be multi-family, single-family, condos, or whatever. Your goal is to have a reliable income, so purchase properties that are attractive to the tenant segment with the highest percentage of reliable individuals who are willing and able to rent.

This approach works anywhere because you are making property selection decisions based on your financial goal; the type of property is irrelevant. You just want a reliable income.

The Skills You Need to Succeed

Everything you learn in podcasts, seminars, books, and on real estate websites is general information. It is valuable information but tells you nothing about how to invest in any specific location. What you need is an experienced local investment team. And this is true whether you invest across the country or next door.

An experienced investment team has years of experience doing what you need to succeed. For example, our investment team has delivered close to 500 investment properties to clients worldwide. There is no way you can replicate the years of experience a team of experts already has.

And, there is no reason not to work with an investment team. For example, out of almost 500 properties, we have charged a fee only 4 or 5 times, and all were unusual situations. Other than these 4 or 5 properties, we’ve never charged clients for our investor services. I assume that most experienced investment teams are like us, not charging a fee. So, I ask you this: if you could gain the experience of a team of experts at no cost than working with a realtor, why would you attempt to do it all yourself? For example, if you needed surgery, would you start medical school? No, you would find a surgeon who specializes in the type of surgery you need.

Finding a good investment team is another story. Let me know if you’d like to know how to find and vet a good team. This post is already long.

Summary

Always start at your goal and build a plan back to where you are today. And, always stay focused on your financial goal, not dogma.

It’s August and time for another Las Vegas update. For a more in-depth view of the Las Vegas investment market, DM me for a link to our blog site which contains more information on investing in general and investing in Las Vegas in particular.

Before I continue, note that the charts only include properties that match the following profile, unless otherwise noted.

• Type: Single-family
• Configuration: 1,000 SF to 3,000 SF, 2+ bedrooms, 2+ baths, 2+ garage, minimum lot size is 3,000 SF.
• Price range: $320,000 to $475,000
• Location: All zip codes marked in green below have one or more of our client’s investment properties.

What we are seeing:

Overall inventory continues falling in Las Vegas. The chart below is from the MLS and includes all property types and price ranges.

The Charts

The charts below are only relevant to the property profile that we target.

Rentals - Median $/SF by Month

Rents held sturdy from April through July. YoY is flat.

Rentals - Availability by Month

The number of homes for rent continued to drop (since January).

Rentals - Median Time to Rent

The median time to rent is at 20 days, a very reasonable time on the market.

Rentals - Months of Supply

Only about 0.8 months of supply for our target rental property profile. Demand is greater than supply. This will push up the rent.

We saw a similar tight supply in sales as well. Now only about 0.6 months of supply. This will push up the prices.

Sales - Months of Supply

Sales - Median $/SF by Month

Despite increasing interest rates, $/SF is climbing up.

What is driving long-term demand for rental properties in Las Vegas?

Las Vegas Fundamentals

Supply and demand determine prices and rents. What is the supply situation in Las Vegas?

Supply

Las Vegas is unique in that it is a tiny island of privately owned land in an ocean of federal land. See the 2020 aerial view below.

There is little undeveloped private land remaining in the Las Vegas Valley. Any available land in desirable areas costs more than $1 million per acre. Due to the high cost of land, new homes in our targeted locations start at $550,000. The homes that appeal to our target tenant segment are priced between $320,000 and $475,000. Therefore, no matter how many new homes are built, our target housing segment remains almost constant.

Demand

Demand for housing is driven by population growth. Las Vegas is a rapidly growing city.

• The average population growth is between 2% and 3% per year.
• According to CNBC, Las Vegas is the top destination that people want to move to.
• Penske truck rental announces 2022 top moving destinations: Houston is #1, and Las Vegas is #2.

What brings people to Las Vegas? Jobs.

• At the spring job fair, there were over 20,000 open positions.
• According to the Bureau of Labor Statistics, Nevada is the #1 state in the nation for job growth
• Where are California companies moving? Henderson and Las Vegas are adjacent so the total for Las Vegas metro is 3,603 companies moving from California to Las Vegas.

More jobs are coming: there are over $30 billion of large projects currently under construction or in the planning stages, which will create thousands of additional jobs.

Everyone Must Have a Place to Live

No one has to take a vacation, buy a new car, or use self-storage. However, everyone must have a place to live. That is why rental property income is so reliable. Las Vegas is an ideal location for real estate investment because of the combination of land shortage and population growth. This combination almost guarantees appreciation and rental growth for the foreseeable future.

Thanks for reading my post. Reach out if you have questions or would like to discuss investing in Las Vegas.

Hello @Carlos Silva,

Great question! My views on both:

Commercial

I mainly deal with residential investment properties, but I also do commercial properties. However, I do not generally recommend commercial properties due to their cyclical nature and the increasing competition in any profitable sector. For example, ten years ago, when I moved to my home, there was only one self-storage facility in the area. Today, as shown on the map below, there are 18. The area population has not increased anywhere near 18 x so the 18 are splitting nearly the same amount of business. Commercial real estate is usually a zero-sum game.

Another concern I have with most commercial properties is that most are not a requirement. For example, while everyone requires a place to live, no one requires self-storage. The same scenario is true with warehouses. There was a shortage three or four years ago and now they're being built everywhere.

Residential

Residential investments can offer a dependable source of passive income if you invest in the right city and buy properties that attract the right tenant segment. While I won't delve into the process of selecting a location for income reliability, I will briefly describe why I relocated to Las Vegas to establish my investor services business.

Why Invest in Las Vegas?

Prices and rents are a function of demand. Where there are more sellers and buyers, prices are low, and rents and prices increase slowly or not at all. Where there are more buyers and sellers, prices are higher, and rents and prices increase rapidly. What is the supply and demand situation in Las Vegas?

Supply

Las Vegas is unique in that it is a tiny island of privately owned land in an ocean of federal land. See the 2020 aerial view below.

Available land in desirable areas costs more than $1 million per acre. Due to the high cost of land, new homes in such locations start at $550,000. The homes that attract our target tenant segment cost between $320,000 and $475,000. Therefore, no matter how many new homes are built, our target housing segment inventory remains almost constant. This differs from metropolitan areas with unlimited expansion potential, where the construction of new homes limits the growth of rent and home prices of existing properties.

In summary, the supply in the $320,000 to $475,000 range is almost fixed and will not increase.

Demand

The driver for housing demand is population growth. The average Las Vegas annual population growth is between 2% and 3%. What is attracting so many people to move to Las Vegas? Jobs.

At the last job fair, there were over 20,000 open jobs available. The average annual income for these jobs is $65,000, which falls within our target tenant segment. Moreover, the number of available jobs is expected to increase in the future due to new developments.

Depending on which study you read, there is between $18B and $26B worth of new construction under development. As these projects come online, they will create even more jobs and attract more people to Las Vegas further increasing demand for the segment we target.

The combination of a fixed supply in our target price range and increasing demand almost guarantees that prices will continue to rise in the foreseeable future.

Summary

No one has to buy a new refrigerator, store things in a warehouse, or have an office. So these are more discretionary than having a place to live. Also, replication is very simple with commercial properties but may not even be possible with residential.

Commercial and residential investments are very different in my opinion.

Hello @Allen Duan,

Last year, we conducted a study with a few clients and produced a white paper. If you would like a free copy of this white paper, please DM me.

Below are some of the results of our study:

• Short-term rentals and mid-term rentals are fundamentally different. Short-term rentals mainly cater to vacationers. During difficult economic times, fewer people tend to take vacations. This is why many short-term rentals in Las Vegas were sold during the COVID-19 pandemic. In contrast, mid-term rentals are primarily driven by business necessity. For instance, there is currently a nursing shortage across the US, and traveling nurses help to alleviate it. Our research shows that traveling nurses usually start with a 13-week contract that may be extended. They require a place to live, which is why mid-term rentals are driven by necessity.

• The primary consumers are traveling nurses. Hospitals with trauma care levels one and two and neonatal intensive care typically have the most traveling nurses. Properties should be within about 5 miles of such hospitals. However, the property must be in a safe location, which is sometimes further than 5 miles from the hospital. See the map below for trauma and neonatal intensive care hospitals.

• There are two primary places to market furnished rentals, the MLS and sites like Furnished Finder. Our research showed that furnished properties rented through the MLS have a $.60/SF to $.70/SF incremental rent above non-furnished long-term rentals. On Furnished Finder, the incremental rent appears to be about $1.20/SF.

• Having a property manager to handle mid-term rentals is crucial. The property manager we work with offers reasonable rates for this service and will take care of inventory management, leasing, maintenance, and overall property management.

• Always buy a property that would also be a good long-term rental. You need the backup option in case the mid-term rental market changes.

• Minimizing turn costs and downtime is critical. This requires the right renovation components and speedy make-ready after a tenant departs. A renovation company that has already completed over 350 renovations for us will quickly do whatever touchups/repairs are necessary so we can get the property back on the market.

• Use electronics to control access and reduce turnover time. For example, the garage door must be remotely controlled so:

  • The property manager can remotely open it to allow delivery and service people access.
  • Access to the garage will be through an app on the tenant’s phone, no clickers or digital keypads to reprogram. Also, immediately after the tenant leaves, the access can be changed.

• Minimizing vacancy is critical. We believe the best way to do this is:

  • To ensure sustained occupancy, positive tenant reviews are crucial. Providing a simple and easy move-in process can help create the best experience for new tenants. The gateway to tenant resources will be accessible through their phones via a QR code, which will give them access to a property-specific website. This website will include links to download the necessary apps to control the house, QR codes for food delivery and other services, maps to locations of interest, requests for repairs, and more.
  • Attractive furnishings. There are multiple companies that, given the dimensions and such, will provide a list of everything you need, down to spoons and salt shakers.
  • High-quality photos. The photos must show a bright, attractive, friendly property. For several years we've worked with a commercial photographer so we can get quality photos at a reasonable price.
  • Currently, properties are marketed solely with photos. We will create a unique website for each property which will increase its desirability. This website would include a walk-through video, more photos, information on what to do in the area, shopping recommendations, places to go, and things to see. By providing an overall guide to the area, potential tenants will realize that there are many things to do and places to go, increasing the desirability of the property.

  This is a summary of the study. If anyone is interested, DM me for the complete study.

Hello Joshua,

To date, we have successfully completed over eighty 1031 exchanges. In this post, I will discuss the basics of a 1031 exchange and the process we follow. Also, some proposed 2024 legislation that could end/limit 1031 exchanges.

What is a 1031 Exchange?

A 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred.

The actual process is simple and illustrated below:

Be aware of the 45-day identification period. Although you only need to list up to three potential replacement properties, there is no guarantee that you will be able to acquire any of them. If you fail to do so, you will lose your tax deferment.

Movement of Funds

Another frequent question I receive is regarding how the proceeds from the sale of the relinquished property must be handled.

The following diagram illustrates the flow of funds in a 1031 exchange: The funds are transferred from the closing escrow agent to the 1031 exchange agent. Once you close on the replacement property, the funds flow from the 1031 exchange agent to the escrow company handling the closing. It's important to note that the funds must never be in your hands, as this will void the 1031 exchange.

Our Process

The risk of losing the 1031 tax deferment due to being unable to close on the identified properties is a significant risk. We created a process that minimizes or eliminates this risk.

Once your relinquished property is in escrow and all contingencies have passed, we get the replacement property or properties under contract before the relinquishing 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 approach, if the 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 replacement property.

Some Considerations

• Renovations cannot be paid for using the proceeds from the relinquished property. Some clients choose to pay capital gains tax on a portion of the proceeds and use that money for renovation.
• Verbiage related to 1031 exchange may not be included in all purchase contracts. Ensure that your listing agent obtains the correct verbiage from your exchange agent and includes it in the agent-to-agent remarks, specifying that the 1031 text must be included in offers.
• To fully defer capital gains tax, you must reinvest all proceeds from the sale into the replacement property. Any cash or non-like-kind property received during the exchange will be subject to capital gains tax.
• If there is existing mortgage debt on the relinquished property, it is important to consider how it will be handled during the exchange. Any reduction in debt or cash received may be considered taxable boot, resulting in potential tax liabilities.
• Qualified Use Requirement: 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 qualify for a 1031 exchange.
• State Tax Considerations: While 1031 exchanges are allowed under federal tax law, not all states conform to these rules. It is crucial to understand state-specific regulations regarding like-kind exchanges, as some states may not recognize or fully conform to 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. Under this proposal, taxpayers in FY2024 will only be able to defer capital gains 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.

If you would like to investigate moving your investments to Las Vegas, DM me.

Hello @Jeanie D.

If you're seeking financial independence, Las Vegas is one of the best places in the US to invest. In this post, I will explain why this is the case. But first, let me define financial freedom: it means that you are permanently off the daily worker treadmill. In order to achieve this goal, you need a passive income that meets three requirements:

• Inflation compensating: Rental income keeps pace with inflation, enabling you to maintain your standard of living by providing additional dollars needed to pay inflated prices today and in the future.
• Persistent income: Your income will last so you will not run out of money.
• Reliable income: Your income continues even in difficult economic times.

Maintaining your living standard depends on being able to buy the same goods and services in the future as you do today. Inflation erodes your buying power, so buying the same things takes more and more dollars over time. The only way to have the additional dollars you need to pay inflated prices is for your rents to increase faster than inflation.

What Drives Rents and Prices?

Prices are driven by supply and demand.

• When there are more sellers than buyers, prices either remain static or fall until a relative balance is achieved between the number of buyers and sellers.
• When there are more buyers than sellers, prices rise until there is a relative balance between the number of buyers and sellers.

Rents are primarily driven by property 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.

Rents follow prices, but the impact of price changes on rents is delayed by 1 to 5 years. This delay is primarily due to leases, which typically last for one year or more. Therefore, an increase in prices will likely result in a change in rent in 1 to 5 years. As a general rule, where prices go, rents will follow.

What is the supply and demand situation in Las Vegas?

Supply

Las Vegas is unique in that it is a tiny island of privately owned land in an ocean of federal land. See the 2020 aerial view below

There is little undeveloped private land remaining in the Las Vegas Valley. Any available land in desirable areas costs more than $1 million per acre. Due to the high cost of land, new homes in our targeted locations start at $550,000. The homes that appeal to our target tenant segment are priced between $320,000 and $475,000. Therefore, no matter how many new homes are built, our target housing segment remains almost constant. This differs from metropolitan areas with unlimited expansion potential, where the construction of new homes limits the growth of rent and home prices of existing properties.

Demand

Population growth is the driving force for appreciation and rent growth. What is the population growth situation in Las Vegas? The average annual population growth in Las Vegas ranges between 2% and 3%. And, this is likely to increase. According to CNBC, Las Vegas is the #1 move destination in the US. According to a Penske Truck study, Las Vegas is the #2 move destination in the US. Every person that moves to Las Vegas will either rent or buy a place to live.

What is drawing so many people to move to Las Vegas? Jobs.

At the last job fair there were over 20,000 open positions. Nevada is also #1 in the US for job growth, (Source: Bureau of Labor Statistics. Note: Growth for the trailing 12-months ending January 2023.) According to a study by the Rose Institute of State and Local Government, Las Vegas is also the #1 destination for companies leaving California. When you add Henderson, the total is 3,603 companies moving to the Las Vegas Valley.

And, the number of jobs will continue to increase. Today, there are over $30B in major projects either under construction or planned. As these projects come online, they will create even more jobs attracting more people to move to Las Vegas, further increasing demand.

Moreover, the number of jobs is expected to continue increasing. According to a report by Applied Analysis, there is currently over $30 billion worth of major projects either under construction or planned in Las Vegas. As these projects come online, they are expected to create even more jobs, attracting more people to move to the city and further increasing demand.

What Does All This Mean?

To replace your current income, you will need to acquire multiple properties. Purchasing these properties in Las Vegas requires less total capital to achieve financial independence than buying in a low-cost location. I will explain using two example locations. For the purpose of this example, I assume that you need 20 properties to replace your current income and that you will put a 25% down payment for each property. For simplicity, I will only consider the cost of the down payment and ignore all other costs.

• Low-price location - Where prices are low, there has been little demand for housing for many years. The result is that prices failed to keep pace with inflation. Rents follow prices, so there has been little increase in rent. So I have some numbers to work with, I will assume each property costs $200,000. Because there is limited appreciation in low-cost locations, all the down payments must come from your savings. So, the total capital from savings required for down payments is 20 x $200,000 x 25% = $1,000,000.
• Higher price location - Suppose you purchased in a high appreciation location and each property costs $400,000. In a high-appreciation location, you will do a cash-out refinance when there is sufficient equity to pay the down payment on the next property. In this case, the total capital required from your savings to purchase 20 properties will be $400,000 x 25% = $100,000. To purchase additional properties, you can use cash-out refinance (BRRRR) from the equity of previous properties for the down payments. This is how many of our clients grew their portfolios. Many people would be unable to purchase all of the properties they have without using a cash-out refinance. Below is an illustration of how our clients grew their portfolios using cash-out refinancing.

Because of the high appreciation rate in Las Vegas, you can grow your portfolio through cash-out refinance instead of relying solely on your savings.

Summary

Las Vegas has unique features that enable you to achieve permanent financial independence with the least capital.

Hello Mohan,

You are wise to focus on the investment location. The location determines all the long-term income characteristics including:

• Whether rents will keep pace with inflation
• How long your income stream will last
• How reliable your income stream will be
• How much of your rental income is lost to overhead
• Whether you or the government control your property.

You want to invest in the city which is best for long-term investment. Fortunately, there is a straightforward process for selecting a city that provides the best combination of characteristics to provide a reliable passive income.

You don’t have infinite time to explore every possible location so below is the process I followed to select the city where I set up my investor services business.

I started with metro areas with A population greater than 1M**.** Small towns may rely too much on a single business or market segment. Wikipedia

I then eliminated any city that failed any of the following metrics.

• 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, Metro Property Taxes - LendingTree, State Property Tax Rates - Rocket Mortgage

  Below is an overhead cost comparison between California, Texas, Florida, and Nevada..

  

  To put the above costs into perspective, below is the annual overhead cost for a $400,000 investment. To keep things simple, I will ignore California's state income tax.

  

  These numbers do not include all operating costs. For example, rent control in California may prevent you from increasing rent rapidly enough to keep pace with inflation. So, while rent control is not a direct cost, rent control can cost you a lot of money. So, you have to look beyond just the numbers, but the numbers are a good indicator of overhead costs. For example, a property in Florida will have to generate a $2,223 higher cash flow per year to have the same cash flow as a property in Nevada due to the higher overhead cost.

• Low disaster risk - Natural disasters, such as tornadoes, can destroy entire communities, including jobs, shopping, and housing. If a tenant loses their home, they will immediately move to a new location with jobs and a place to live, instead of waiting one year or more for the property to be rebuilt. Even if your insurance covers the cost of rebuilding, it may be difficult to find new tenants because people have already moved away. Communities hit by natural disasters may take years or never fully recover. Meanwhile, your expenses, such as mortgage, taxes, insurance, and maintenance, will continue. To avoid this, choose a location with low-cost homeowners' insurance, which indicates a lower risk of natural disasters. Insurance - ValuePenguin

• Rent control - Some states and metro areas have implemented various kinds of rent control. Rent control may prevent you from increasing the rent fast enough to keep pace with inflation. It may limit your property manager's ability to select the best tenant. It may make evictions of non-performing tenants difficult or impossible. Never invest in any location with rent control.

• Inflation compensating - Every time you go to the store, the same basket of goods costs more and more dollars. In order to have the additional dollars needed to pay inflated prices, rents must rise faster than inflation. Therefore, a critical location selection metric is that rents and prices are rising faster than inflation. Rents tend to lag behind prices, so you can use the appreciation rate if you do not have historical rental data. Zillow Research

Once you apply all the elimination filters to the initial list of cities, you will have only a few remaining for additional consideration.

Another important consideration when selecting a city is whether you can find an experienced investment team in the area that interests you. While podcasts, books, seminars, and websites provide general information, only an experienced local investment team can offer the necessary local resources, processes, and expertise to help you make a sound investment decision.

If you want a process for finding and qualifying a local investment team, let me know.

There is a straightforward process for determining what type of property to buy. You should elect the property based on financial objectives, rather than an opinion from someone who may be on the other side of the country. Always beware of blanket advice, as one size does not fit all in real estate.

The goal of real estate investing is a reliable income that you will not outlive. To have a reliable income, you need the property continuously occupied by what I call a reliable tenant. A reliable tenant is someone who stays many years, always pays the rent on schedule, and takes care of the property.

Reliable tenants are the exception, not the norm. However, there is typically a single segment with the highest percentage of reliable tenants, which can be identified through property manager interviews. Once this segment is identified, determine where they currently rent and what they rent. Then, purchase similar properties.

This method can be applied in any location. Essentially, you should identify the tenant segment that is most likely to provide reliable income and buy the type of property that they are willing and able to rent. By letting the segment decide the property type and other factors, you can maximize your cash flow and income reliability. Moreover, by doing so, you eliminate opinions and luck from your investment decisions.

Excellent comments on this thread. I decided to add my 2¢’s.

Return Calculation Limitations

Return calculations only predict how a property is likely to perform on day one under ideal conditions. Return calculations tell you nothing about the future. Because you will hold a property for many years, what happens after the first day is far more important than what happens on day one.

Financial Independence

In order to have financial independence you need a income replacement equal to your current income that also meets three requirements:

• Inflation compensating: Rental income keeps pace with inflation, enabling you to pay inflated prices to maintain your standard of living.
• Persistent income: Your income will last so you will not run out of money.
• Reliable income: Your income continues even in difficult economic times.

Unless rents keep pace with inflation, your time off the daily worker treadmill will be short. This is because inflation will continue to increase prices, and you will not have the additional dollars you need. Regardless of how many “Property A’s” you own, your buying power will decrease each month, and you will be forced back onto the treadmill of daily work.

Rent Follows Prices

Property prices are driven by supply and demand.

• If there are more sellers than buyers, prices will fall.
• If there are more buyers than sellers, prices will rise.

Rental rates are driven by property prices.

• If prices rise, fewer people can afford to buy and will be forced to rent. Demand for rental properties increases as will rents.
• If prices fall, more people will be able to buy so fewer people will rent. Demand for rental properties decreases as will rents.

In short, where prices go, rents follow. However, rents typically take 2 to 5 years to catch up with changes in property prices. This lag is primarily due to leases, which are usually for one year or longer.

What Drives Demand?

Population change is what drives housing demand.

In cities where the population is increasing, the demand for housing exceeds the current supply. This causes prices to rise until a balance is reached between the number of sellers and the number of people who can afford to buy.

In cities where the population is static or declining, there are more sellers than buyers. This results in a decrease or stagnation of property prices. This trend continues until there is a balance between sellers and buyers. Low property prices are the result of years of low demand for housing. In other words, housing prices have not kept pace with inflation, resulting in lower property prices when compared to cities with increasing populations. Rents follow property prices, so if prices have not kept pace with inflation, neither will rents. If you buy in such a location, rent increases will not keep pace with inflation, and your buying power will continue to decline over time. No matter how many low-cost properties you own, your days of financial freedom are limited by how long you can continuously decrease your living costs.

If you purchase property in a city with higher demand, prices will be higher, but rent increases are likely to keep pace with inflation. If they do, you will achieve permanent financial freedom.

Your financial independence is tied to the city's ability to quickly grow its economy, create jobs, and increase its population. Do you want to risk your financial independence by betting that cities like Detroit, Cleveland, and many others with declining populations will somehow turn around and become economic powerhouses?

Do You Make the Most Money With Cash Flow or Appreciation?

An example will explain far better than text.

Suppose you have two properties. Property A has a 7% appreciation rate with no cash flow. Property B has a 7% cash flow but no appreciation. To keep the example simple, I ignored all other variables except for personal income taxes, which I assumed to be 30%.

Why Low-Cost Properties Are the Most Expensive

To replace your current income, you will likely need to acquire multiple properties. The total amount of capital required to acquire multiple properties depends on the city's appreciation rate. In the following examples, I will assume you need 20 properties to replace your current income. I will also assume the downpayment is 25% of the purchase price.

In a low-priced location, I will assume each property costs $200,000. To keep things simple, I will only consider the capital needed for down payments and ignore all the other costs like renovation, closing costs, etc., and no inflation.

Total capital from savings required for 20 down payments: 20 x $200,000 x 25% = $1,000,000 in after-tax dollars. The fact that all capital will come from after-tax dollars means that if your marginal tax rate is 35%, you will need to earn (gross) 1,428,571 to have $1,000,000 after taxes. $1.4M will take a lot of years to accumulate. And, if there is inflation you will need a lot more capital.

Higher price location - Suppose you purchased in a high appreciation market and each property costs $400,000. In a high-appreciation location, you use cash-out refinance when there is sufficient equity for the down payment on the next property. In this case, the total capital required for down payments 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 how many of our clients grew their portfolios. The process is illustrated below.

In summary, if you buy in low-cost locations, every investment dollar must come from your after-tax savings. If you buy in a high-appreciation location, even though prices are higher, you will need significantly less capital because the majority of the capital required can be obtained from cash-out refinance.

Summary

Low-cost locations may seem alluring initially, but it's important to look beyond the first-day returns and consider the long-term performance of the property over the next 20 to 40 years.

Hello @Allen Berrebbi,

The cap rate is only useful for comparing properties. It does not indicate what your ROI and cash flow will be, because it does not include debt service. That is why I find ROI and cash flow more useful. In this document, I will share the formulas we use for ROI and cash flow and how we are dealing with the high-interest rates. But first, I want to highlight the limitations of return calculations.

Return Calculation Limitations

Return calculations only predict how a property is likely to perform on the first day under ideal conditions. They do not provide any information about its future performance. Since most people hold their properties for many years, it is more important to consider how the property will likely perform in the long term rather than on the first day, month, or even year. Real estate is a long-term investment, so taking a long-term view is crucial.

For example, suppose there are two properties that have the same initial return. One has a rent growth rate of 2% annually and the other has a 6% annual growth rate. Assuming an inflation rate of 4%, suppose you buy the same set of groceries every week that currently costs $100. The table below shows what you can buy for the next 20 years. With Property A, the amount of groceries declines each year. With Property B, rents rise faster than inflation so you can buy more groceries each year. So, no matter how many “Property A”s you own, your time off the daily worker treadmill will be short because the rents are not keeping pace with inflation.

How can you choose between Property A and Property B, only considering ROI and cash flow? The answer is that you cannot. You need to take a long-term view of the economic future of the city.

The Formulas We Use

When calculating return, we include all known recurring costs. We do not include any unrealized gains, such as principal paydown or appreciation. Put simply, if it does not appear in the bank account it does not exist.

Also, calculated ROI and cash flow are not what you will actually experience. Your actual cash flow and ROI are heavily influenced by your tax situation. For example, depreciation typically will increase the effective return by 3% to 6%. However, in some situations, the benefit from depreciation may be much less.

The formulas we use for cash flow and ROI.

• Cash Flow = (Rent - DebtService - ManagementFee - Insurance - RealEstateTax - PeriodicFees - MaintenanceCost - VacancyCost) x (1 - StateIncomeTax)
• ROI = (Rent - DebtService - ManagementFee - Insurance - RealEstateTax - PeriodicFees - MaintenanceCost - VacancyCost) x (1 - StateIncomeTax) / ( DownPayment + ClosingCosts + RenovationCosts)

Or,

• ROI = CashFow / ( DownPayment + ClosingCosts)

We leave out what we do not know. For example, when we first consider a property, we have little knowledge of the property. This means we have no basis for estimating maintenance cost, vacancy cost, or renovation cost. So, the formulas simplify to:

• Cash Flow = (Rent - DebtService - ManagementFee - Insurance - RealEstateTax - PeriodicFees) x (1 - StateIncomeTax)
• ROI = (Rent - DebtService - ManagementFee - Insurance - RealEstateTax - PeriodicFees) x (1 - StateIncomeTax) / ( DownPayment + ClosingCosts)

We perform a multi-step validation process for each property, adding more cost elements as we gather more information about the property.

Comments:

• We do not include depreciation because the amount people actually benefit from tax deductions depends on their unique tax situation.
• We do not include unrealized gains, such as principal paydown or appreciation, as they are only recognized when the property is sold. For most people, the goal is to generate a passive income stream that will last the rest of their lives, so they will hold the property for many years. As for myself, I have no intention of ever selling my properties.
• We do not include what we do not know, specifically renovation, maintenance, and vacancy costs. Once we know more about the property, we add an estimate of the renovation cost.

How We Are Dealing With High-Interest Rates

The purchase process has changed. In the past, clients obtained pre-approval, which we submitted with offers. Once an offer is accepted, we proceed to close using the same lender. The process is illustrated below.

With interest rates over 7%, this no longer works. Now, once we get a property under contract, we obtain interest-rate buy-downs from multiple lenders, as illustrated below.

We compile the best interest rate buy-down options on a spreadsheet and present them to the client during a Zoom meeting. Together, we select the best option and move the loan to that lender. Below is the most recent buy-down comparison sheet. As you can see, the rates are all over the place. The name at the top is the lender.

Comments:

• Shopping for the best interest rate buy-down rate after the property is under contract has been effective. Through a combination of buy-down and in some cases, increased down payment, we are getting neutral or positive cash flows. This method is reasonable because Las Vegas has a unique situation (land shortage plus population growth: source, [source](https://www.macrotrends.net/cities/23043/las-vegas/population#:~:text=The current metro area population,a 2.7%25 increase from 2020.), source) so rents and prices are almost guaranteed to increase significantly over time.
• The downside of this approach is that we cannot accurately estimate ROI and cash flow until we get the property under contract, since we do not know the interest rate.

Allen, this was a lengthy response, but I hope it answers your question.

Hello @Geoff Anfuso

Spot on about cash flow, Geoff. Getting initial positive cash flow is difficult. We’ve had to change our process.

In the past, clients would obtain pre-approval, which we submitted with offers. Once an offer was accepted, we would proceed to close using the same lender. This process is illustrated below.

With interest rates now over 7%, our previous process no longer works. Therefore, we have changed our approach. After getting a property under contract, we get interest-rate buy-downs from multiple lenders, as shown below.

We then compile the best interest rate buy-down options on a spreadsheet and present them to our client during a Zoom meeting. Together, we select the best option and move the loan to that lender. Below is an example of what we work through with clients.

[The name at the top of each column is the name of the lender who provided the buy-down quote.]

Some considerations

• The buy-down rates change frequently so we do not know the actual interest rate until property under contract.
• We always consider the buy-down payback period. For the column in green, the payback period is 22 months or just under 2 years. This is geat If the payback period were over 5 years and you believe interest rates will fall in four years, then it would not be as good an investment.
• Friction - We’ve delivered close to 500 investment properties and we’ve worked on our processes for many years to remove friction points our client’s experience. Switching lenders after we get a propertyunder contract is an unwanted additional step. However, the results are well worth it.

It is important to note that return calculations only predict how a property will perform on day one under ideal conditions. How the property performs during the first year is not very relevant if you plan to hold it for 30 years or more. Therefore, it is necessary to keep the long-video in mind.

Geoff, pingback if I did answer your questions.

…Eric