All Forum Posts by: Shane Pearlman

@Mark Ferguson I've been following the same pattern and have seen our net worth go up nearly 1.5M in the last 3 years. It has been a genuine boon to our family and makes the possibility of retirement real. 

That said, I am really not a fan of negative cash flows unless you have a clear short term plan to remediate. The risk simply is not worth it. I saw too many people get wiped out in 09/10. The key here is to actually know what your cashflow is an be able to project it accurately. I've met with a few new investors this year and when I look at their pro-formas, I get nauseous. But, once we are truly positive, then I'm pretty happy. 

Honestly, even if we miss an upswing and have to camp out, as long as I bought in a reasonable community and have good tenants (part of our strategy), then they can buy me the property over time and I will at least beat appreciation. 

@Manch Hon you have nailed (among a handful of other reasons) why I find all those % rules are basically deceiving. Each area has its own cost basis, its own nuances, and each owner has their own strategy. Julie & I like what she calls rental chic. Better tenants, more stability, but more cost. The expense of replacing a fridge in a C class apartment where you buy a refurbished white freezer top small sized fridge ($300-400) Vs replacing a side by side stainless steel fridge in a top line vacation rental ($2k+) is not apples to apples. I just trust my spreadsheets and my reserve studies and take the time to put the math in place.

@everyone

What an awesome dialog! I will address many of you individually in separate comments tomorrow / monday but wanted to see if I could consolidate my thoughts. A number of you mentioned scale. I think many of us are in agreement that in the SFR business, appreciation can be a completely independent factor from cashflow, and we can debate the merits of one or the other all day long (and we all will). Where the waters get either muddier (or perhaps clearer) is the point in which the two begin to correlate in multifamily. Its why I chose this forum. =)

My current (and first) hunt for apartments has been quite educational. Market cap rates in the core Seattle area float about 5% +/- 1% and have stayed there for nearly 2 decades. Appreciation of the property is defined by the growth in rents. Many of the baseline key economic drivers that propel SFR appreciation should also affect rents. Jobs, availability, immigration, culture… prosperity for all (sorta). Historically, I wonder how intimately they are associated. 

I’ve watched West Seattle (where my parents live) turn from a pleasant middle class to community to a hipster hub of happenings and the rents nearly double in recent history. New high end apartments built out, gastro pubs and a thriving economic boom near the junction.

There is no question about the power of sitting in the path of progress. You could theoretically do nothing and by strategy or sheer dumb luck (like @Louis Leone artists) make profits well in excess of inflation. Most of the real success in our portfolio so far has been the byproduct of adding value compounded by appreciation. We have brought to life broken properties. We have repositioned properties. We have nurtured teams and systematized the business. These types of efforts happen in any and all markets and are the foundational building blocks we all work with. They don’t need appreciation. So you can buy well, make your money through improvement and careful management, then hold or repeat, and aim to put yourself in the path of progress but when you miss, the profits are there to collect.

What is unclear to me is if this changes in the higher $ acquisitions? I am hoping this month to close on an Apt between 1.3 - 2M (leads in SF Bay or Seattle anyone) and I can easily imagine the next 2-3M purchase. My experience puts me strongly in the equity / appreciation camp, but as I start looking at the bigger complexes, does the difference between cashflow camp and the equity camp vanish? I still find myself far more attracted to a solid 10 unit apt for 1.7M @ 5cap in downtown seattle over a 50 unit apt for 1.7M @ 10cap in rural indiana. I still feel (but don’t have the numbers to prove it) that if purchased with the right timing, would lead to much stronger long-term gains with greater stability and less risk.

While cashflow is key to keep the property safely under control, I seem to find that the larger returns for our portfolio to date come from strategic growth of equity. My wife and I are still fairly small in our investing business and I want to ask if the long-term seasoned investors have found the same to be true, especially in the larger multi families, where value is more closely tied.

Example: A Current Deal We Are Wrapping Up:

My partners and I bought a home in Santa Cruz, CA in May 2011 for 389k and remodeled it. After a cash out refi where we had 108k of our investment left in the deal. Rented the pre-tax profits were $6,840 annually. That is a 6.3% return cash on cash, which in our area is basically a freaking miracle of the crash. I was only expecting 2.8% in my original performa. Haven't seen any deals like that since 2012. The property is being sold and closes in 5 days. For the three+ years we owned it, we basically accumulated $22,550 in rental profits.

In those three years, we saw some serious appreciation. You could call me a speculator, but the indicators were there. A strong job market (thank you silicon valley), a major university, over 3 million tourist annually (to a town of 50k residents), major agricultural center, amazing natural resources / extreme sports meca, a world famous brand and limited room for growth. Houses in a good neighborhood were being sold below replacement cost. I'd call that a strategic acquisition with strong potential for growth. Forcing equity through a remodel provided a nice bit of padding.

We are selling the house for the equivalent of 640k. Net proceeds of the sale minus cash invested is 168k. That is 155% return on investment (37% compounded annualized return). 

Even if I had ended up with a 0% cash on cash, I would still be doing a happy dance. I don't see cashflow deals offering anything in the range of that return

I imagine there may be a day when we need to convert our equity into cashflow. At that point, we will probably pivot again. 

So What Do You Think?

Brandon / Josh often seem to call equity investors gamblers on the BP podcast (although they mostly seem to be warning newbies not to buy stupid), but for those of us looking to build wealth, who are willing to do careful homework, learn the markets, do the deal analysis and make careful strategic plays, make sure we are not upside down or outside our fiscal means, my experience to date says investing in strong equity growth markets, perhaps despite their poor cashflows, seems like the strong play.

Alright, bring on the arguments and tell me where I might be right or wrong (especially as we are moving our portfolio into the larger apartment complexes)!

@Mark Mosch I've been asking myself that same question for the last month. At the Santa Cruz BP investor meetup last week I ended up in a debate with @Troy Fisher regarding cashflow Vs equity investing. Cashflow being somewhat hard to come by in the SF bay area.

I have been investing in microloans since 2008 through lending club and have a solid track record of net annualized returns between 7.8 - 8.9%. I feel the odds of getting these returns in the future to be fairly certain, although nothing is for sure. If we are simply talking cash-on-cash, considering that real estate has both higher risk and more work involved, I'd need to see a higher return, probably near 10-12%.

With that said, I have the personal blessings of a solid career I truly enjoy, so cashflow alone is not my primary driver. I really care about the net returns of the deal over its lifecycle. My wife and I are trying to build wealth. 

We are just wrapping up selling a property where the CoC was 6.3% and the net annualized return on the actual sale (forced equity from a remodel / reposition + appreciation) was 37% compounded. While cash if key to keep the property safely under control, I seem to find that the larger returns for our portfolio to date come from strategic growth of equity.

Hope that helps!

@Matt Liu You have my sympathy. These situations are so stressful.

#1. Document, Document, Document

If you have not been, this is the time to begin track all correspondence with them in written fashion, and take meticulous notes.

#2. Talk to your lawyer if you have not yet.

We have a similar situation right now with a troll trying to extort a payday. They have submitted at small-claims court and we have a trial date. Ultimately, I decided the safest approach was to be as distanced as possible when it comes to communication. I had a conversation with my lawyer to get the lay of the land, after which we decided together that we were not at fault and could make a strong case. I then gave permission for my lawyer to put the fear of god in them and take over all communications. Which he did with an amazing amount of professionalism. He clearly explained to them how the law plays into the situation and that we will ask for a judgment to have them reimburse legal preparation fees. The plaintiff has just replied Friday that they plan to dismiss ($1k in legal fees well spent).

#3. Chat it out with your insurance agent.

So I haven't gone this route, but I have a great relationship with my agent and often run scenarios by her. Your agent may not have a crystal ball, but they do know what usually happens and can give you a better understanding of how insurance would handle it as well as the impact on your fees.

We have a general liability policy at 1M / 2M for our software business. For years clients have requested 2M / 4M and we have fought back saying it was unnecessary due to the structure of our business (totally true). Today a substantial new client wouldn't budge, so I called insurance to find out what the damage was of upgrading. The quote: $7.02 and I feel like an idiot. 14 years of fighting with procurement departments because I had assumed it was a significant cost. Some times, the unknown bites us in the ***.

#4. Trade dollars for a departure?

If you need to settle, I'd consider mutually breaking the lease and aim for a departure on good terms. If you are going to spend the money, you probably don't want to keep dealing with them.

Let us all know how it pans out. Vote it up if this helps. =)

@Troy Fisher have you actually done that on a single family? I could see that for a multifamily. Curious how your tenants / prospects reacted?

@Chris K. the tenant is a middle aged single lady who works from home and is quite well to do. She is fantastic. She started dating a gentleman and he moved in with her (it is a 2br). I know all the neighbors and they make small comments about his personal look and casual pot usage (which alone is not terrible as long as he doesn't cause trouble). His carriage and demeanor make me apprehensive and when I had the chance to meet him and asked questions about income / profession he was a touch evasive and contradicted himself (mentioning an engineering career, then being retired, then working in retail all in the same window). Last time I came through to do repairs, he actually avoided me because he "was sick". As in, he went out of the house when I was inside and then back in when I went outside and into the garage. I'm not looking for a buddy, but little behaviors stack to make me suspicious of some misbehavior.

It is a 2yr lease and the core tenant has been totally responsible.

I'm with you on the walkthroughs @Terri Lewis . I do them 2-3x a year and last time didn't check the basement since I have it padlocked to keep our repair equipment for the properties we own in the neighborhood. The next walkthrough is almost due and I delayed as we have a new baby.

With the last house, they actually took the whole system apart before each walkthrough and got away with it almost a full year. I have no idea where the heck they put it all. The only reason I found out about it was that I was doing a refinance and was only able to get the appraiser in on short notice. I left a note on the door the night before and they must not have seen it.

That is a good suggestion @Steve Babiak and I will do so. 

In the last grow house I dealt with, they had a giant bank of batteries that they trickle charged in order to spread out the usage impact. I checked power history afterwards out of personal curiosity, and while it was higher, it wasn't so much that I would have been able to call it out for sure and there were no huge spikes. #tricky =)

@Jassem A. I shared your position until I had the experience personally and paid over 8k in remediation. And I was lucky. They didn't tweak on my electrical panel, reroute my water system and the moisture didn't make it into the house. If you just google a bit, you will see that a grow house can severely damage your property.

I have a buddy who had tenants growing in all the bedrooms and the humidity was so high that mold sprouted from all the walls and the floors buckled. They had to gut the entire house (I think he paid nearly 45k) to repair it and remediate the damage.