Quitting the Police Force, Wholesaling, & Buying Notes with David Greene

David:
What’s going on everybody? I will be your host of today’s show, David Green. You guys have asked questions, and I’ve got answers. Normally, you guys are used to seeing me sitting next to a seven foot bearded giant. But today, the beard is away and I’m here to play. We’re going to be doing this show solo with just me and you and your questions regarding real estate.

Intro:
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David:
All right. Have you wondered more about how you’re going to succeed in today’s market? Maybe you have questions about strategies that you can use in specific scenarios that don’t always apply to the podcast. We are going to be seeing green where I get my perspective and give my advice on just what people should do in different scenarios when it comes to building wealth through real estate. Before we get to today’s episode, let’s hear from me on today’s quick tip. Today’s quick tip is go to biggerpockets.com/david and follow the instructions to submit your questions to get it answered live on the BiggerPockets Podcast.

David:
As long as it’s about real estate and wealth building, we want to hear from you. Without further ado, let’s get to the show. We’re going to be hearing from BiggerPockets members asking their questions, and I’m going to do my best to answer them. Let’s go to the Facebook forums and see what questions we’ve got first. Today’s first question comes from [Ret M. 00:01:35] Ret asks, “Purchasing an assignment from a wholesaler, what do I need to know? They have their own attorneys and title company doing all the work. Should I have an attorney look over the contract on my side?”

David:
All right, this is a good question because more and more people are actually buying deals from wholesalers right now. You should expect to see more of this the hotter the market gets. When there’s plenty of deals on the MLS, obviously people would rather go to the MLS in order to find properties. They get to use an agent, they don’t have to worry about as much of the due diligence being done on their own without guidance. But as wholesaling is becoming more and more popular, these type of questions come up a lot more. There’s two ways that I’ve seen wholesale deals go bad, and those are the two things that you want to focus on.

David:
The first one is that you don’t have a fiduciary representing you in this transaction because there’s no realtor involved, which means the due diligence is all on you. I’ve bought a wholesale deal before where I was told it was 1,400 square feet. The property ended up being 1,100 square feet. I took the wholesalers word for it and I didn’t do my own due diligence. Now, the problem is it appraised for exactly the price per square foot that I thought. My BRRRR would have went perfect, but because there was 300 square feet, I actually didn’t have any equity in the deal, and I ended up paying market value for that 1,100 square foot house thinking it was 1,400 square feet.

David:
What am I getting at? Make sure that you’re doing the due diligence and you’re getting a home inspection on a property that’s coming from a wholesaler. Now, a lot of wholesalers want you to pay cash for a property. You can pay cash and still get an inspection contingency. You need to talk to the wholesaler and see, has inspections been done on this property, and what is my timeline to back out after I’m doing inspections? Now, they probably won’t call it an inspection contingency because you’re not getting the same type of a purchase agreement that you get with a realtor.

David:
The question you need to ask the wholesaler is, A, if I have to put a deposit down, how long do I have to get that deposit back? Or B, If I move forward with this house, can I just not put a deposit down so I can get some inspections done, and if it doesn’t look good, I’ll get out? Now this is why we don’t recommend people buying properties from wholesalers that are not experienced real estate investors because most wholesalers are going to tell you, “No, the property is as is.” Your problem is you don’t know what as is is, you don’t know what kind of condition it’s in. A good wholesaler will have already got an inspection on their property.

David:
If I was wholesaling, that’s what I would do it. I would have inspections already done and give them to you. You would then call the home inspector and go over that with them. You’d ask the questions you have, and then you could talk to a contractor and figure out, well, exactly how much is it going to cost to get these repairs made? The other side of the question here was that they have their own attorneys and title company doing the work. Should I have my attorney look over the contract on my side? Well, I can’t give you legal advice, and it’s probably never a bad idea to have an attorney look over the contract. But it really depends on how complicated the contract is.

David:
The wholesale deals that I bought were one page. There was not really anything for attorney to review. It was pretty cut and dry. In those circumstances, if you understand what’s at stake there, you don’t have to have an attorney look over the deal. But I also bought these properties without a deposit. There was an understanding that we would have a 30-day escrow and I would pay cash for the property at the end of the day. In situations like that, it’s pretty cut and dry. Now, the second way that I see people getting into trouble with wholesaling is when the property doesn’t appraise for what they thought it would.

David:
When you normally have an appraisal contingency in your deal, if you paid way too much for that property, your appraisal is going to come in low and you’re going to be able to back out of the deal and get your deposit back. This is when you’re buying houses traditionally off of the MLS. When you’re buying from a wholesaler, you’re sort of flying blind here. It’s your own gut and maybe an appraiser or an agent that you talk to. The problem is appraisals themselves are more of an art than a science. You never can really nail down exactly what a property is going to appraise for, and that is a big risk that you take when you buy from a wholesaler.

David:
I would say be very, very careful that you feel very confident that this property is going to appraise for what you believe it will after you buy it. Now, many times this is a value add play. That’s often the case, is you’re buying a property that is in bad shape, needs to be repaired. You’re looking at an after repair value, not just the appraised value of what it’s worth in its current condition. In fact, sometimes you can pay what it is worth in its current condition, but the value add is so big that the deal makes sense to you because you’re adding more value than what your rehab cost actually was.

David:
My final piece of advice that I’ll leave you with is if this is your first property, I would probably caution you against going with a wholesaler in the first place. I didn’t buy anything from a wholesaler until I had bought several deals from an agent. I do buy properties from wholesalers now, but I still prefer going the MLS route. If you feel really experienced, if you have plenty of money in reserves, if you make a bad decision and you can weather that storm and come back again, then sure, go after it. But this is your first property or you don’t have a lot of wiggle room, I would probably have second thoughts about buying directly from a wholesaler.

David:
All right, Ret. Thank you for that question. I love that one. Okay, next question comes from Mantis R., and they ask, “How do I place properties under newly acquired LLC?” LLC stands for a limited liability corporation. In a sense, when you place a property under an LLC, you’re not holding title in your own name. You are holding title in the name of the business entity. In terms of how the law would understand this, the business owns the property, not you yourself. Now, if you own the business, that’s how you control the property, and this is really the reason that most people purchase properties in the name of an LLC. When you own the property yourself, if for some reason you get sued, common understanding would be they can come after you and they can take your personal assets.

David:
If the judgment is $500,000 against you, and the property is only worth 200,000, well, they could go after you for the other 300,000 of this hypothetical judgment. People have the understanding that if it’s an LLC, well, they can only go after what’s in the LLC. Now again, I’m not a lawyer, but I will tell you, I’ve seen cases where judges did what is called pierce the veil of an LLC. The judge looked at the circumstances and found the property owner to be negligent, found in favor of the person who is making the complaint, and they said, “We’re not just going to take what’s in the LLC. We’re going to go after the landlord’s personal property.”

David:
Now, this doesn’t happen all the time, and I don’t want to scare anybody because in most cases, if you don’t do anything grossly negligent, you’re not going to be found guilty of a lawsuit like this. In fact, I know hardly any landlords that have ever actually successfully been sued. But what I want to say is don’t assume that just because you put your property in the name of an LLC that that means you’re covered. It is by far not … It is far from a foolproof way of holding title to avoid the lawsuit. That’s the first thing I want to share. The next thing I want to share is that sometimes when you hold property in the name of an LLC, getting financing is very difficult.

David:
You see, the lender wants to lend money to you as a person because if you don’t pay, they can get money back from you. You’re on the hook for that. It’s called a recourse loan. They don’t want to make a loan to a company that only has one asset in its entire sheet, which is this exact property. It’s also much easier to do things like use bankruptcy to avoid having to pay back your debts when you borrow from a bank in the name of an LLC. They don’t like that, and a lot of the best loans that we look for these Fannie Mae Freddie Mac programs won’t lend to an LLC at all. When you’re talking about how do I place properties in my LLC, that’s relatively straightforward.

David:
You just have the title company take property in the name of the LLC. You just say it’s the company that’s buying this, here is my articles of incorporation and all my paperwork that shows that I am the president of this company, and I have the authority to buy something in this company’s name. Here’s the money that’s in the company’s name that you’re putting into escrow. At the end of the year, you declare in your taxes that this company, this LLC, is one that actually owns this property. Putting properties in LLC is not difficult at all. A title company can do that for you very easily. What makes it tricky is when there’s a loan on the property itself, okay?

David:
My advice to you, just personally speaking, is that you don’t put properties in the LLC unless there’s a compelling reason to do so because you’re going to make it much more difficult for yourself to be able to get financing for it. This is speaking to mostly new people. When you buy it in your own name, that doesn’t mean you don’t have protection. Your homeowners insurance policy will almost always have a certain amount to protect you in case you’re sued by a tenant for something and you settle, or if the judgment is found against you for a certain number. What I recommend is that you look over your homeowner’s insurance policy and see how much you’re covered for, and if you’re really worried about this, pump up your coverage on your insurance as opposed to thinking that the LLC will protect you.

David:
Your insurance can protect you, and you’ll still get the better financing that most people don’t want to let go of. Now, I do own property in my own name, and Ia own property in the name of LLC. It all depends on the type of loan I got. When I’m getting commercial loans, I put the name of the property in an LLC, because commercial lenders really just care about the cash flow of the property in almost every single case. As long as the business that owns the property is cash flowing and making money, which it will be if the property that’s in the LLC is cash flowing, I can get commercial loans in the name of an LLC, and I’m fine. When I’m buying residential property, it’s usually better to put it in my own name.

David:
When you’re putting it in your own name, the lender’s going to look at your personal credit score, your personal debt to income ratio, and that’s what they’re going to make their lending decision based on what is David’s ability to repay, as opposed to what is this LLC that David owns ability to repay? Just to sum that up, when they want to look at what David can repay, they’re going to look at my taxes, and they’re going to say, “Well, how much did David make? How much debt does David have? How much money does he have leftover at the end of the month to be able to make this payment? What other properties is David on the hook for that he has to pay for?”

David:
When there’s a commercial lender looking at me, they’re going to say, “What is the property or what is the company that owns the property cashflow? What is that business making, and are we going to lend to that?” They’re not even going to ask about my personal credit score or my personal debt to income ratio. All right. I hope that answers your question there, Mantis R.. That is asked by a lot of people, and I appreciate you bringing that one up. Next question comes from Michael N.. “What contingencies do you often elect when placing an offer for land purchases? I’m submitting my first offer to purchase land and trying to learn the key differences between property and land contracts.”

David:
Okay, Michael. Disclaimer, I don’t actually purchase raw land. I’ve always purchased things that were already improved, meaning that they already had property on it. But I have represented clients that wanted to purchase land, and I know other people that do purchase land. A few things that you didn’t ask that I think the listeners need to know that we’re going to cover first. First off, when you’re buying land, usually you can’t get a loan, and you definitely aren’t going to get a 30-year fixed rate loan like you do when you buy a property. A lot of people assume I can go buy raw land with a 30-year fixed rate loan.

David:
The land’s only 100 grand, my mortgage payment would be really small, let’s go buy the land and then I’ll build a house on it. Not the case. You almost always have to pay cash for land, or you have to get a very special loan from a bank where there’s a commitment to improve that land, and here’s the reason why. If a bank gives you a loan on land that has an improvement like a property on it, if you default on that loan, they can go sell that parcel with a house on it fairly easily. Now, they may not get all their money back, but they can still unload that asset and recover their capital, and it really reduces their risk and how much time they have to spend to do it.

David:
If you default on land, what are they going to do with it? How do they know how to go sell land? Now the bank is in the responsibility of having to find a person that wants to buy raw land, which there’s not a lot of people looking to do that, develop that land and sell it to a home builder, or develop that land, build a home on it theirself and then finally sell it. Now, banks are not in the interest of doing that. They’re not in the business of doing that kind of work. They don’t really want to give loans on raw land, nearly as much as they want to give it on land that has been improved.

David:
That might shoot your idea down right there. You might realize I have to go pay cash for this land, and so I don’t have enough money to make it work. The other thing when you buy land is usually it’s not generating income. Now, if you’re buying land that already has like crops growing on it or something like that, sure, you might be able to generate income if you know what to do with it. But in many cases, that’s not the case. You’re still having to pay for that land though, because you owe the property taxes that are on it. I know a lot of people that bought land, planned to develop it, got stuck with the city or the county or the state trying to get their plans approved.

David:
Couldn’t do anything to move things forward any faster than they were, got very frustrated and had to continue to pay the interest on the loan or they lost the interest they could have been making on the money they put on the land and had to pay property taxes all while waiting for something that was beyond their control. Simply put, if you’re looking to buy land because you’re trying to escape the route of, well, houses are really expensive so I’ll build my own, it is not that simple. I highly recommend that unless you have experience with the development, construction, you have contacts within the city, or you have a mentor that has done this before, you don’t venture into this and just try to figure it out.

David:
This gets very complicated and very messy very quickly. It’s not a good alternative to a hot market to just buy land and build your own house. Now, let’s say that you know what you’re doing, and you’re going into it. A little bit of advice, because your question was how do I have contingencies in place with the contract, you still want contingencies because you still need to figure out certain things about that land. Let’s say that you buy land and your purpose for that land is to build a triplex on it. Well, what if it’s not zoned for that, but you think it could be? You need to contingency in place in that contract to back out in case the city says, “We won’t let you build a triplex here. This is only zoned for single family homes.”

David:
I was in a situation, maybe five or six years ago, where I was looking to buy a really big chunk of land in Jacksonville, Florida. Now, the land had a couple trailers on it that were generating some cash flow, so the idea was I buy the land, it comes with the trailers, the cash flow from the trailers pay me what my holding fees to hold the land were, and I was going to build 24 plexes on this thing. Now, I started to move forward and I put a purchase contract together, I put it under contract, I had contingencies in place, and then I found out that the city wasn’t going to let me build 24 plexes. There was actually a zoning issue where I was only allowed to build one door per square mile.

David:
I was only going to be able to build five houses on this … It was like one door per acre, something like that. I was only able to build five single family houses, not 24 plexes. Obviously, that killed the deal and I didn’t move forward with it. Because in my purchase contract I had a contingency to back out after an inspection period, I was all good. If you have an agent representing you on this, you need to have a very clear conversation with them that says, how long do I have to back out of this deal, so that you can go do your due diligence.

David:
Now, most of that due diligence is going to be zoning issues, talking to the city, or the governing authority that controls what can or can’t be done to that land and making sure that the plans that you have for it are actually going to be allowed by that authority. Now, some of you have actually submitted video questions, and I want to get to those. Let’s go take a look at what questions were submitted via video and see what you guys have for me there.

Andy:
Hey, David. My name’s Andy. I’m a buy and hold investor from Southeast Wisconsin. I’ve been buying small multifamily properties for the last few years now. My wife and I are also realtors and recently opened our own brokerage. I’m also a full time police officer. I’ve been doing this for the past six years. At this point, though, I am financially free because of real estate and I’m looking to leave law enforcement for real estate. My question to you, David, is how do you get out of that mindset of the full time W-2 where you have that security in the job, and get into the mindset of the full time real estate entrepreneur? Having some issues making that leap, and hoping you can help me out knowing you’ve done it before. Thanks, David.

David:
All right. Andy, what a great question. Let’s dig into this one. Andy here is a full time police officer, same profession that I came from, became a real estate agent, same thing as I did, got his broker’s license, same thing as I did, started a brokerage, much like me starting a team, and now wants to know how do I transition out of the security of knowing I have a paycheck coming in to the uncertainty of not knowing where my next paycheck is coming from? All right. Let’s analyze this, let’s break this down a little bit and unpack it.

David:
The first thing we all have to understand is that life operates on a spectrum and there’s give and take with everything. Many people are unhappy with the ceiling that gets put on them, with the rules they get put on them, with a lack of freedom they have at their job, and they come to resent that. They look to real estate to be their heroes so that they don’t have to deal with those things anymore, and it can work that way. It does work that way when it works well. What you have to realize, when you have ceilings put on you, when you’re in that prison of a cubicle, there’s also some safety there.

David:
The reason that you are expected to show up every day and do what you want to do is that your employer is expected to keep paying you, okay? When you own a business, you understand this definitely than when you work at a job. But the business owners are just as scared that they’re going to be on the hook to pay people who aren’t being productive, as the productive people are scared that they’re going to have a ceiling put on them so that they can’t get higher, and this is really why the mind has a hard time letting go of that W-2 job because it doesn’t want the restrictions, but it loves the safety that comes from the money.

David:
If you want to make that step from W-2 world to 1099 or entrepreneur world, there’s a few things you have to do to shut up the part of your brain that keeps wanting to tell you you’re scared you’re not going to make it. The first is put yourself in a position where you don’t need the benefits that a W-2 job offers, which is security. Can you get your bills paid from the investment realtor you already own? If you own real estate that will pay your bills, and you’re not making a ton of money but you make enough that you’re not going to go hungry or broke if you don’t have a paycheck coming in, your mind will give you permission to leave that job a lot easier.

David:
That’s one of the things I did, is I bought enough rentals that my living expenses, my rent, my food, my gas, my insurance, my gym membership, all of that was covered by rent. Now, I wanted a job, but I didn’t need a job. That was the first thing I did to break the chains and break the shackle that ties you to your job. The next thing is to get used to the fact that when we work a W-2 job, we’ve put the responsibility of finding revenue and finding business on our employer. Very few of us work at a company where we are responsible for finding our own clients, almost all the time. We are cleaning the fish that somebody else caught. Your job, your boss went and caught a bunch of fish, and now you’re cleaning them.

David:
When you step into the 1099 world, when you become an entrepreneur, which it will be if you go full time into this real estate business, you’re responsible for catching the fish, and you’re responsible for cleaning it. Now, you can hire people to clean your fish. That’s what leverage is. This is what being a business owner is, is you start with the I’m going to catch fish and then I’m going to removing and cleaning them, and you start backwards at the cleaning fish section with hiring. You hire people to clean fish you caught, then you hire to get them out of the boat and get them to the people that are going to clean the fish.

David:
Then you hire people to gas up your boat for you and look at the fishing chart so that you know where you’re going to go fishing the next day, but you’re still catching the fish, right? You slowly move yourself from the end back to the beginning. Now, if you’re trying to figure out, well, how do I know when to make the jump? Do both as long as you can. That’s what I’m going to say. Now, there’s certain people like Brandon that will say, “Hey, burn the ships and just make it happen,” and for some personalities, that works. But that’s not really my personality. What I did was I kept working my W-2 job while I started to build my real estate business.

David:
I went out there, I found a bunch of leads, which I did when I was at work. You’re a police officer, talk to the guy sitting in the car next to you, talk to the other officers you work with, talk to their family members, find clients, find fish to catch for your company while you’re at work. You’re really making money twice, if you think about that. Are you a healthcare provider and you want to be a loan officer? Or you want to be a real estate agent or you want to have a construction business? Well, start finding leads, start finding fish to catch when you’re already at your job. You’re getting paid to be there, you might as well work your other job too.

David:
Then I started showing houses to my cop friends and representing them when they were selling, and I did both of it for a while. Once I had enough money saved up that I knew, okay, my bills are paid from real estate and I’ve got a nice healthy nest egg sitting right here, I took some of that nest egg money and I hired my first assistant. Now, the assistant job was what? It was to clean the fish that I caught. I would go get the client, I would go put them in contract and I would hand them to [Krista 00:22:53] and she would handle all the stuff that goes after that. I would go get the listing agreement signed, I would bring it back and give to Krista, and Krista would get the house ready for market.

David:
Krista didn’t have to catch any fish, and I didn’t have to clean any or as many fish. I had more time to stay at the W-2 job because I had Krista. All right? At a certain point, I didn’t have enough time to keep catching fish and work the W-2 job, and that’s when I knew it was time for me to make the jump. But it was very systematic. By the time I made the jump, I had my bills covered by my rental property, I had a really strong nest egg saved up, I had an assistant that was highly trained in exactly what to do, I had a steady stream of business that was coming in, and I had so much work to do that I couldn’t do both jobs anymore.

David:
That’s the way that I went about it, and that’s just because your brain will keep telling you of all the reasons why you don’t want to make the jump. Now, you can just say, “Screw it. I’m just going to quit my job and jump in with both feet,” and for some people, you can make that work. My guess is that that’s not you, Andy. I think you and your wife are much more purposeful based on the route that you’ve described here. You’ve talked about getting your real estate license, getting a broker’s license, starting a brokerage all while you’re still working the job. You’re very purposeful about the stuff that you’re doing.

David:
What I would recommend for you specifically is to get a couple agents working in your brokerage and use them to clean your fish. Have some of these agents function as your transaction coordinator, have some of them function as showing assistants to show houses to your buyers, have some of them function as listing assistants that you pay hourly or per file to get your listings ready to go. You can probably stay working at your W-2 job if you want to, and have a lot of the work done that you actually go and gather by the people that you have working in your brokerage, and then you’re leaving your W-2 when you want to, not when you have to.

David:
Now, if the question is how soon can I get out of my job, take that passion, that desire that you have to get out of the environment you don’t like and let it fuel you to get into the one you do. When Brandon and I interviewed Patrick Bet-David, this was a really big piece of what he talked about. He said never let pain go to waste. If you’re in pain in your life in some way, you want more money, you’re tired of being broke, you’re tired of sitting and commute traffic, that one can be tough, you’re tired of watching other people succeed around you, you’re tired of working this job that takes up all your time and you can’t get anywhere, you’re tired of being in debt, that’s a good one, don’t just complain about being in debt.

David:
Take that pain and let it fuel you to work more hours, save more money, spend less money, and pay off that debt. Let it feel you to get out of the situation you’re in. If you’re just tired of law enforcement, I don’t think anyone could blame you at this point, and you’re ready to move into something differently, don’t waste that pain. Grab that pain, harness that pain, take that pain and really internalize it, and everyday wake up knowing what you don’t like and let that help you make more phone calls. Let that help you interview more people, let that help you grow your brokerage, okay?

David:
When you do a great job and you grow your brokerage to 20 agents and 10 of them leave and go somewhere else, don’t quit. Let that pain fuel you to go get another 10 and get back in there. Let that pain make you learn faster, learn quicker, learn harder, learn deeper, but it make you more resilient than everyone else. What will happen is you will grow yourself out of the job. At a certain point, you won’t be able to stay there even if you want to, right? Now the alternative is you let pain make you quit. Man, this is really hard. I shouldn’t go be a broker because somebody left me, somebody quit, I can’t recruit agents, I didn’t get that client, somebody else got him, I’m just going to be in this situation forever.

David:
That’s when you let pain beat you. Don’t let pain beat you. Harness pain, make pain work for you, and you’ll find yourself getting much further ahead. That’s the best advice that I can offer you. There’s really two forms of … The advice I gave you took two forms. There’s the practical side, systematically how to put yourself in the position to excel or succeed. That’s the path that I laid out for you, and then there’s the emotional side where you’re going to tap into that pain and let it drive you along that path that I just made for you. You got to draw out the path and then you got to run it as fast as you can.

David:
I think not everyone here is a police officer that wants to be a real estate agent, but many of you are in a position that you don’t like and you’re trying to get into a position that you do. To me, that’s the formula. You draw out a systematic path of step after step after step that makes logical sense that will get you where you want to go, and then you have been harness into the pain that you’re feeling at your current job and you let that fuel you to go. The worst person in this scenario is a person who wants more, but likes where they’re at. If you’re not in a lot of pain, it’s going to be very hard for you to take the action that’s required to get yourself out of the position you’re in.

David:
You hear many people say that the enemy of great is good. If you’re in that spot and you want more, but you like what you have, you have to be intentional about focusing on the areas of pain that you do feel, okay? I don’t know what that is for all of you, but there’s something that makes you want more. Maybe you need to write that down, you need to think about it, you need to talk about it with other people that are in your life and keep it at the front of your mind. But that’s the advice I’m going to give you. If you want more than what you have and you’re content where you are, you’re probably never going to get it. You got to tap into that pain. Let’s see who is up next here.

Luis Arriola:
Hi, David. My name is Luis Arriola. I currently have three rentals, and I have my own primary residence. I started out by doing a cash-out refi and purchasing my first rental property. This was before I found BiggerPockets. Then I ended up getting into more rentals using conventional loans. Now I’m pretty locked up moneywise. The first rental that I purchased cash, that was always been my safety blanket. But do you suggest me keeping it paid off or doing another cash-out refi on it and maybe using some of those funds to buy another property and making my money work for me? Or do you suggest something else? Keeping it there and trying to find other ways of financing more deals? Thanks.

David:
All right. Thank you for that submission, Luis. Now, that’s actually a very good question. There’s a lot of things that we can pull out of this. What I didn’t get from you is what your goal is, and that’s what I really need to answer this question specifically for you. I need to know what game you’re playing. You said should I keep it as a safety net or should I refinance it and use it to buy more properties? Well, I need to know how much you want. Are you looking for more growth? Are you looking for more cash flow? Are you looking for more wealth, or are you looking for less risk and more time? You don’t want to have to work anymore.

David:
I’m going to assume that your question was asked from the perspective of I want more growth, because I’m assuming if you wanted more time, you wouldn’t have necessarily asked that question. What I’m getting from both your tone and your words are that you want to refinance this property but you want to make sure you don’t make a bad decision and lose what you’ve already got. Okay? Now that’s a normal thing to think. If you guys all think about, if I said to you, “Hey, why don’t you go knock on doors and ask someone if you can sell their house or buy their house?” If you knocked on enough doors, you’d absolutely find somebody, and you might be able to make 50 grand wholesaling a deal by just knocking on doors for a month. All right?

David:
If I said you can make 50 grand knocking on doors for a month, that’s probably 10 times more than most people are making, that are listening to this right now. There wouldn’t be a ton of people that rushed into it to go do that. They think about it, but they might not move. Now, let’s say that I said, “Hey, you’ve got $100 in your wallet. I’m going to reach in your pocket, I’m going to take it from you,” how hard would people fight to stop me from taking the $100 that they’ve already got? Now, you can’t compare $100 to $50,000, right? But this is just how human beings think.

David:
We are much more concerned with protecting what we have and going out and getting more, and that’s what makes this question tough, is when we’re in the position of “Hey, my house is already paid off, I’m safe, but I want to grow. How do I go about this?” A few things that we need to make sure are in place. First off, Luis, in order to refinance that property, you have to have money coming in from a job so that you can even get a loan. You have to have a debt to income ratio that will support paying off the loan on the refinance. If you’re not working and you’re living off cash flow, that can make things a little bit trickier for you.

David:
It’s one of the reasons that I don’t recommend that as soon as somebody gets cash flow coming in, they just quit their job right away before they have another way to earn money. Because in real estate, having money coming in is a big piece to getting financing, and financing is a big piece to continuing to grow and expand. Now, most once of us get the bug and we love real estate, we want to grow and we want to expand, we want to keep buying, and it doesn’t make sense to stop once you get good at it, and you need income to do it. I just want to have everybody be aware of that when you quit your job and you want to live off the cash flow, you sort of stop yourself right there in many scenarios on being able to continue to grow.

David:
You’re also going to need money coming in in order to get loans for future properties you’re going to buy. If you cash out on the one that you have paid off, and now you’ve got down payment for three new properties, that doesn’t do any good if you have to pay cash for the next property because you can’t get a loan. Make sure that your personal finances are in order, check out the BiggerPockets Money Podcast, where they’re going to give you some advice to make sure that you’re going to be doing strong in that area of life.

David:
Now let’s assume that Luis here actually has enough money saved up for repairs, for closing costs, and he can pull enough money out of his property for the down payment of the next properties, and he has a strong enough debt to income ratio to support getting loans for future deals. The next question I would ask is, do you have the bandwidth to take on the responsibility of more rentals? I’m assuming you do, because you’ve got what? Three rentals and one primary residence. You already own four houses. You probably have pieces in place that can support adding some months.

David:
I think that you’re good from that perspective. Another perspective to consider is is the return you’re going to get buying the next round of properties more than the interest you’re going to borrow on the money? Now, the answer is almost always yes. Interest rates are so low right now, you’re probably going to pay 4% or so when you refinance that rental. You’re going to get much more than a 4% return on the real estate. The next question to ask is, should you expect that return on real estate to continue growing, or does it look like it’s going to drop? It wouldn’t make sense to do this if you could go get a 6% on real estate and 4% on the loan, but at the next year, you only got 5% in your real estate.

David:
The next year you only got four, the next year you only got three. If we think the market is going to be dropping, that wouldn’t be the best time to refinance and go buy more property. You might want to refinance and just hold some of that money and not go reinvest it until the market drops. Now, if you’re listening to this podcast currently, it doesn’t look like the market is going to be dropping. We have a massive shortage in inventory, we have a very strong economy, we have a ton of inflation. All the objective signs are that we’re going to see prices continue to increase.

David:
In that case, if it is correct that prices are going to continue to go up under this assumption, buying more real estate makes so much more sense. Let me tell you all the benefits of why you want to cash out, refi and buy new deals. First off, let’s say that your property is worth $200,000 and you can pull out 160,000. Okay? You’re going to be borrowing 160,000 which will give you a mortgage of a certain amount. Let’s say that Luis here is going to borrow 160,000 on this $200,000 property at a 4% interest rate, the principal and interest will be 764. I’m going to say that his all together payments probably …

David:
Well, actually, let’s not go with all together payment because he’s already paying taxes, he’s already paying insurance even though the property is paid off. The only extra revenue that’s being added is $760. That’s what he’s going to be paying when he takes out this $160,000 loan, if he gets it at 4%. That payment of 764 will become cheaper every single year in the future as inflation continues to go up, and it will become significantly cheaper if inflation is more significant. $760 today is worth much more than it’s going to be worth in 10 years if inflation keeps going. It’s worth more than it’s going to be worth in three years if inflation keeps going.

David:
If we’re operating under the assumption that we printed a bunch of money and real estate prices are going to rise, then the money that you’re paying back, the 160 grand that you borrowed, is going to be cheaper than the money that you borrowed. That’s a win for you, Luis. Another thing is inflation will likely lead to rents going up in addition to property values. Your cash flow on that property is going to drop initially by $764. You have an additional expense there, okay? But every single year that the rents go up, that cash flow is going to get stronger and stronger and stronger, and eventually, it’s going to get right back to where it was where rents have gone up by 760 bucks.

David:
You take out a loan for 760 bucks, your cash flow is the same as where it was before. Now, those are the small pieces. Let’s look at the big piece. Let’s say you could go buy three more properties with that money, and each of those is going to cash flow 300 bucks, right? In year one, if you bought three properties right off the bat, you’ve got $900 coming in with cash flow. You took on $764 of debt to do this. You’re already up what? 140 bucks, 136 bucks, or whatever the math would be, right off the bat, okay? But you’ve set yourself up to grow exponentially by making wise investments.

David:
That 300 bucks of cash flow that each property is bringing in is going to go up every single year that the rent goes up. Now that $900 of cash flow becomes 1,100, becomes 1,300, becomes 1,500, becomes 1,850, and it’s increasing times three because you own three properties. That $200,000 house that you refied when you pulled over 160, it’s going to keep going up in value, so you’re going to gain more and more equity. But now you’re also getting equity on the three new properties that you theoretically purchased for say $200,000, or whatever the case was. Okay?

David:
Now you’re gaining equity in three new properties, which means that you’re going up times four what you were when you only had one property, because you’ve got four plus … We’re not even counting the other properties that we didn’t refinance. Aren’t really part of this equation. Now, you’re paying back the mortgages on those three new properties that you bought with cheaper dollars than you borrow to buy them, okay? What you guys see is the benefits of real estate become exponentially better as you scale and they become exponentially better with inflation. Scaling, getting more of them, and then inflation is what makes real estate really, really good.

David:
In this scenario, Luis is able to capitalize on both of those, and that’s why his wealth is going to grow significantly faster if he cash out, refis and buys new cash flow in properties in good areas that are going to appreciate under the assumption that the economy continues to grow. I am well aware that none of us have a crystal ball and we don’t know that, which is why I started this off by saying if you think the property values are going to drop, this can become exponentially worse for you. The reality about real estate though is that even when they drop, they come right back up, and rents very rarely ever drop.

David:
If they do, it’s usually only a little bit. My advice to you, Luis, is if you want to grow, which we’re assuming you do, yes, you should cash out, refi, and you should buy new properties. There is a risk to doing this, so let’s focus on mitigating that risk. Keep some of the money from your cash out, refi, set aside in reserves and don’t invest it. Keep it as a rainy day fund to cover this new portfolio that just doubled in size. Okay? That’d be a smart thing to do. Stay living beneath your means, keep saving more money every month in what you spend so that if you do hit a period of time where things go bad, you’re okay, because you’re not living at the very edge of what you can afford. All right?

David:
Then don’t buy foolish homes. Don’t go buy brand new home construction just because that loses you money. Make sure you find the best deal you can and the best air you can with the best terms that you can with that money that you got. Now, sometimes refi money can seem cheap and easy because it just came right away, and it’s not the same as if you had to save up the $160,000. But you got to understand, saving 160,000 and pulling that much money out of a property are exactly the same thing. You got to value that money in exactly the same way. It’s not worth less just because it came easy, but your brain might tell you that it will.

David:
Be disciplined, set some money aside in reserves, continue to live beneath your means, buy good deals, and then wait. You do that, you’re going to be doing great. Thank you very much for bringing that up. I’m hoping that that question I was able to cover really just the basic story of how real estate builds wealth for the people that own it. All right, that was Luis A. from Ennis, Texas. Next up, we have Bethany Clark from Milwaukee. Bethany, what do you got?

Bethany Clark:
Hello, David Green. I listen to the podcast a lot, and came across on Facebook that you are looking for questions from us on what we could use some help on. One topic I’m more interested in right now is on wholesaling. I am a real estate agent, so I work on the traditional end, but I am unclear on few details as far as being a wholesaler, as far as signing contracts and what we do with earnest money, if that is something in wholesale.

Bethany Clark:
If you do earnest money, when you find a buyer, how does that actually work to put the buyer on contract, and what happens or how do you arrange, what language do you use to collect your fee as the wholesale person? That’s what I’m curious about, and that’s what’s holding me back from pursuing some deals because I haven’t connected the dots on all of that yet. I appreciate your help and your advice, and hopefully, I find out more from you soon. Thank you.

David:
Okay. This question has to do with wholesaling, and Bethany is actually also a licensed realtor. Bethany, here’s the first thing that I want to say. You need to go talk to your broker and make sure they’re okay with you working as a wholesaler while working under their license. A lot of people don’t realize this, but agents don’t actually have the authority to sell houses. Brokers do. Agents work under brokers. When an agent takes a listing, their agent actually isn’t taking the listing. The broker is taking the listing and the agent is authorized from the broker to act in their capacity.

David:
Many people don’t understand that, and what that means is that agents don’t have as much authority as people tend to think. You got to talk to your broker first. Many brokerages just don’t let their agents engage in wholesaling activities because, to be frank, in many ways this is a gray area of the law. I’m not saying wholesaling is illegal, but it could become illegal very easily if it’s not done the right way, and every state has different rules. That’s one of the reasons that I’m a little hesitant to try to answer the question, is because I don’t know the rules in your state for wholesaling and I don’t know how that affects you being an agent.

David:
The last thing I would want is for you to jump into this and jeopardize your license because you’re acting in a dual capacity. Here’s the problem that agents or fiduciaries get into trouble with when they are wholesaling. As an agent, you’re a fiduciary, meaning you have to do what’s in the best interest of your client. Now, if you’re wholesaling, you’re not acting in the capacity of an agent. What you’re doing is you’re putting this person’s home under contract in your name, with the right to assign it to someone else. When you get a deal from a wholesaler, what you’re really getting is the right to buy the contract that they’ve already negotiated.

David:
You’re not hiring an agent to walk you through the process. Where this becomes sticky is if the seller or the seller’s family, or someone who knows the seller goes to you and says, “Grandma only assigned that deal to you because she thought that’s what it was worth because you’re an agent and she trusts you and your reputation in the community is all over the place. You’re on billboard, so she thought that’s all her house was worth. But we know it’s worth several $100,000 more than that. You take advantage of grandma and we’re going after you because you’re a fiduciary.”

David:
Now you’re in court trying to explain how, in that circumstance, you weren’t acting in the capacity of an agent, you were acting in the capacity of a wholesaler, and we don’t know how the judge is going to rule. That’s one of the reasons that brokerages don’t like agents doing wholesaling, and it’s one of the gray areas that frankly I just recommend, if you’re an agent, don’t get into wholesaling, and if you’re a wholesaler, don’t try to be an agent. I can’t give you specifics on how to do it, but I can give you a general understanding of what you want to do.

David:
When you’re wholesaling, you are essentially telling the person who owns the property, “I will buy this or somebody else will, but it will be bought.” What a lot of wholesalers do is they say that, but they include contingencies in the contract that let them get out of it. They just don’t tell the seller that that’s what’s going on. That becomes unethical, this is why wholesalers and realtors can get a bad name. Because if I say, “Hey, I’ll sell you my house for cash,” and you say, “Great, I might sell it to someone else,” I’m like, “I don’t care. I just want the cash.”

David:
Then if your buyer backs out but you don’t buy the house, I’m going to be pretty upset with you, and that’s when I’m going to be considering a lawsuit. A lot of people don’t realize this, but most lawsuits don’t come from the people who practice the worst. They come from the people that are disliked the most. I remember reading a study about doctors that were sued, and they weren’t the sloppiest doctors, they were the doctors with the worst personalities. Those were the ones that everybody wanted to sue. Basically when you make someone unhappy with you is when they’re likely to pursue a lawsuit, and that’s the danger that you have.

David:
If you’re going to put a contingency in that contract that you will buy their property under the terms and with the price specified in that contract, it needs to be made clear to the seller that there is a contingency in there that you can back out if you don’t find an end buyer, or if you decide you don’t want to buy it, just like it’s a regular purchase contract. If they understand that and they agree to it, you’ll be fine. Because if your end buyer backs out or you can assign the contract, no one’s going to be upset because they knew that was a risk they were taking when they sold their house with you.

David:
Now, as far as your question of how do you get paid, that’s something that the title and escrow company needs to understand. That’s different from every state. Again, I can’t give you specifics because I don’t live in your state. But when you take that deal to an escrow company, they’re going to be told, “Hey, I’m selling the property to this end buyer for this much money. This is the lien on the property itself, that has to be paid off. These are all the closing costs that have to be covered with the money coming from the buyer, and everything leftover is going to go to me. This chunk here that’s left after all these expenses are paid is going to go to me.”

David:
The seller is going to see that and when it’s disclosed to them from the notary, when they go there to sign off on the closing documents, they’re going to see that you’re getting what’s usually called an assignment fee in that deal, and when they sign the documents that the title or an escrow company issues, and the escrow company has specified how much money you’re going to get paid, and the buyer signs off on their side too when they can see it, that’s when the escrow company is going to cut you the check. I hope that answers your question about how the wholesaler is typically going to get paid.

David:
Now, disclaimer, for wholesalers listening, they may be saying, “That’s not the way I do it. There’s different ways to do this.” There’s the double sale, there’s a way where it closes and then immediately you sell it again right after that. I’m sure there’s different ways to do this in different places. But that’s more or less the way that this works. Again, just remember you’re a realtor. If you make money doing that, if your brokerage makes money doing that, don’t risk your relationship with them trying to go get the wholesale fee. Disclose to them what you’re doing, make sure that they’re okay with that, and they may be able to give you some guidance too on how this works.

David:
All right. Well, we’ve had some great questions so far. I’ve really enjoyed being able to answer some of these because these are not the typical stuff that gets brought up all the time. Some of these are just frankly shots in the dark that I haven’t even had to consider very often. This has been pretty cool that people are getting a chance to hear stuff that doesn’t get asked very often. Are you enjoying this? What I would like to know is do you guys like this type of stuff? If so, leave me a comment below. Tell me what questions you have about real estate, tell me what you wish we would have addressed, or tell me what you’d like to see more of.

David:
We want to get a feel for what everybody is thinking as they’re listening to this. Leave me a comment, tell me what you’re thinking. Then don’t forget, you can ask your question at biggerpockets.com/david. That’s biggerpockets.com/D-A-V-I-D. Okay, looks like we have some more Facebook questions coming in now. Let’s see what we’ve got. Now, some of you may have heard murmurs about the 1031 coming. Let’s answer another question about that. Can you 1031 exchange flips to buy in holds and still not pay capital gains? I’m thinking maybe I should do cheap flips to build up cash faster until I can afford to outright buy a decent property that I would rent out, then just keep it forever.

David:
Okay. The question here is if I do a flip, can I do a 1031 into a rental property and not have to pay the gains on that flip? This would be a really good question for a CPA. We’re going to try to answer it here, but I need you guys to remember that I am not a CPA and I’m not a licensed tax professional. Here’s why I give that disclaimer. I’ve heard both sides of this. I had one CPA that said, “No, you cannot do a 1031 from a flip into a rental property.” Then I had a completely different CPA that said, “Yes, and you should have called me before you did it because I know a way to do it.”

David:
As with most things in the tax code, the answer is usually, it depends. Now straight up, there’s probably some prevention law against taking a short term capital gain and 1031 into a long term capital gain. Maybe there’s an argument that would be made that there’s not a light kind exchange going on. I don’t know the case law on that, but that’s what my gut would tell me. But if you’re doing it in the same business that might be differently, you might be able to flip a house in the name of a business and then go buy an entity in the name of that same business, and that’s how you could get around the 1031 exchange. Like most things in life, don’t just ask, “Can I?” Ask, “How can I?”

David:
This is why you want to have a good CPA. If you guys would like, send me an email. I’m happy to connect you with a CPA that I’m using right now. They know a lot about tax strategies. There’s also plenty of CPAs on BiggerPockets. I believe that there’s actually a book that BiggerPockets wrote. I believe there’s actually a book that BiggerPockets published with tax strategies for real estate investors that I would recommend you buying and checking out. Or talk to one of the CPAs that’s on the site and ask a question like this specifically. But what I want to leave you here is don’t just say, “Can I do it?” Say, “How can I do it?”

David:
All right. Jack A. writes, “No dumb questions, right? If I get a property through seller financing and sell [inaudible 00:50:03] property, do I pay the original seller in full or continue to make payments to them? All right, let’s think about what we’re asking here. Jack is saying, “If I buy a property and I take a note from the seller that I am going to be making payments to them, when I sell that property, do I have to keep making payments to the seller?” Now, I love the Jack said no dumb question, because believe it or not, this has come up before and I don’t want you guys to feel bad asking me questions.

David:
I literally had one person in my Instagram one time that said, “When I do a BRRRR, why do I have to pay back a loan to the bank? Why do I have to make a mortgage? In their head, they just thought I added all this equity, I should just get the money from somewhere. They weren’t realizing that the money comes in the form of a loan.” I didn’t want that person to feel bad because then they’re not going to keep asking questions. We’ve all been there where we just had that, “Oh, I didn’t think about that, but that’s obvious now.” This is not a bad question at all. The answer would be when you buy a property with seller financing, what’s really happening is the seller is being included on the property as a lien holder.

David:
Just like if you bought that property with money from a bank, the bank is being included as a lien holder on the property. When the bank is a lien holder, if there’s any lien holder, if you stop making payments to the person, they have the right to foreclose. This is why banks foreclose because they gave a loan to a borrower, and if the borrower stops paying, the bank or the lien holder has the right to take the asset to recover the capital that they lent out. Now, when you’re doing seller financing, the previous owner that you bought the title from is the lien holder. They would be able to foreclose if you stop making the payment.

David:
When you sell the house to the next person, the lien holder gets contacted by the title company and has to give permission for that lien to transfer to the next buyer. In essence, when the title and escrow company says, “All right, this house is going to sell for $200,000, there is a loan for $150,000 to Mark.” Mark Smith over here. He was the person that Jack A. bought this property from. They have to contact Mark and get Mark’s permission before they can sell that house. Because they say, “Hey, Mark. This house is being sold, we got $150,000 coming your way out of the proceeds. How do you want that money? Should we send you a check? Should we deposit it in your account?”

David:
Mark can’t stop the sale of the property unless that’s written into the contract in some way. But if Mark says … I guess if you’re asking is do I have to pay back the seller or can I just keep making payments to them, the problem would be there’s no more lien that the payments are coming from. Okay? Mark sold you the house, there’s a lien on that house, now that house belongs to someone that’s not you. If you’re still trying to make payments to Mark so that they didn’t get paid off, how do they take the house from the new person? The new person’s buying the house with clean title, meaning Mark got paid off. Okay?

David:
If your intention here is to say, “Well, I owe Mark 150 grand on this house, I want to sell it to this other person, but I want to do seller financing with them. Or I want the full $200,000 myself, and I’ll keep making payments over here to Mark who used to own the house,” Mark’s exposed because if you stop making that payment, they have no way of getting their capital back. What we’re getting at here is before a property can transfer title from one person to the next, any liens that are on it have to be paid off, or the lien holder has to agree to transfer that lien to the next person.

David:
If Mark, who you bought the house from, agrees to let the seller financing go to the next person, so instead of you owe me the 150,000, they owe me the 150,000, and they’re making the payments to me, in those circumstances you can get around it. But if what you were thinking is you could keep the full value of the house and just keep making payments to this person, the answer’s no because the title and escrow company won’t let title transfer from one person to the next without paying off the lien. I’m not used to answering questions like that, so I hope that I said it the right way. I hope you guys all have a pretty good understanding of why that wouldn’t work, but that’s correct.

David:
Otherwise, people would go buy a million dollar house, borrow money from the bank, borrow $900,000 from the bank, sell the house to someone else for a million, keep the whole million and then just stop making payments to the bank. What would the bank do? They can’t take the house back because somebody else owns it. All right. Next question from Roy P.. He is asking, “When you analyze a duplex, would you double the capital expenditures maintenance and vacancy when running your calculations?” Well, this is actually a pretty good question, and it’s more of an accounting question than anything.

David:
The logic here would be if there’s two units, does that mean that I have double the capital expenditures and double the vacancy? Right? It depends, because typically when we analyze a property, we’re taking a portion of the total rent and we’re attributing it to vacancy. Because we never know what vacancy is accurately going to be, we typically say take 5% of the gross rent or 10% of the gross rent and subtract that, and that’s going to cover your vacancy. If each unit of this duplex is going to rent for 1,000 bucks, that’s 2,000 total gross revenue that you’re going to be bringing in, and you’re going to use 10% of vacancy, that’s 200 bucks.

David:
Now, you can either do 10% of 2,000 or 10% of 1,000 twice. But it really ends up being the same thing. It just depends on how you’re looking at it. Now, you are going to have two air conditioners that have to be eventually replaced, twice as many sinks and showers and plumbing. Okay. You’re going to have more things that can break in a duplex than in a single family house in most cases. However, it’s not always the case. What if each duplex has one bathroom and two bedrooms? How is that different than buying a four bedroom house that has two bathrooms? Would it make sense to double it just because they’re two different units? All right?

David:
What I’m getting at here is that when we set money aside for repairs, for maintenance, for vacancy, the things that you said, there’s no way that most investors can accurately tell what vacancy is really going to be, what things are going to break, when they’re going to break. We don’t know. What we recommend is that you take a percentage of the rent, say 5%, and you set that aside so that when something breaks, you’re covered. Now, what that would mean is you wouldn’t double everything because the rent’s already been doubled. When you take away 5% for each thing, or 10% for each thing, however you do it, you’re covering yourself because the rent’s been doubled, so you’re taking double the amount out.

David:
They should cover double the stuff that could go wrong. To answer your question more succinctly, no, you shouldn’t double the stuff that goes into a duplex because it’s not different than if you bought a bigger house that had the same amount of stuff. There you go, Roy P.. I’ll give you guys this advice too. I own a fourplex, and it’s a great property. But it does have four air conditioners, the roof is the same for the whole thing, so it doesn’t make any sense to quadruple what my capital expenditures would be for that.

David:
But because, in essence, you got four units and two people live in each one, you got eight tenants in your property, they are going to wear through things faster than if you have two people living in one unit somewhere else. What I did was I got a home warranty on that property. It’s the only property I have that I got a home warranty on, and it covers an air conditioner breaking, plumbing leaks, big ticket items, like water heaters and stuff like that, because I just assume that those properties that have more turnover and more people living in them are going to have more things go wrong.

David:
That’s one little quick tip that I can give you. If you have a multi unit property, consider getting a home warranty on it to cover the big stuff for you, even if you don’t normally do that with single family homes. All right. Next up is Jake Lancaster from Boise, Idaho.

Jake Lancaster:
Hey, guys. Thinking about starting a property management business alongside building my portfolio, and we’re wondering if you guys thought it was a good idea and what the pros and cons of that would be. Awesome. Thanks for your time, guys.

David:
Okay, thank you very much for that, Jake. This is a good question. I like this because it’s kind of the thing that I do, right? I became a real estate agent, then I became a broker, then I started a team, then I started a mortgage company, I’m going to be buying an escrow company. I do like to buy and build the ancillary companies that affect the business that I’m in. But here’s why. I mostly do it because I want control. I got tired of having clients that were buying a house from my real estate team that had questions about how their loan work. They came to me and us to ask that question because the loan officer didn’t do it.

David:
I got tired of loan officers that didn’t answer their phone, or they didn’t give good customer service, or didn’t explain things well, and I had to do their job. I said, “You know what? I’m going to start my own company, and I’m going to train them myself so that that doesn’t happen.” That’s a big reason why you do something because you don’t want to rely on somebody else to do it instead. Now, Jake, I have to assume that’s the same reason you’re asking this question. You are thinking I’m doing most of the work or managing the property, so I might as well start a property management company.

David:
Let’s unpack this and help people understand if that’s the route that they should take. First off is why are you doing it? Are you doing it because you want control, or are you doing it because you want to generate revenue? I don’t think property management companies generate a ton of revenue. In fact, I often call them the lymph node of the real estate investing process because they have what I think is the absolute worst job. They got to deal with people’s emotions, they get a very small percentage of the overall rent that’s coming in, and they still have to pay for employees and compliance regulations and they have to store information and they …

David:
I just would never want to do that job. I don’t think the revenue is great on a property management company. Here’s what I think is great. I think they get access to deals before everybody else does. I think if you’re a landlord, you’re going to go to your property manager before you call your agent and say, “Hey, do you know anyone that wants to buy this house?” I think if you’re a smart property manager, you’re going to go to your landlords that have their houses under contract with you, and you’re going to say, “If you ever want to sell it, I’ll buy it,” or, “I’m an agent, I’ll sell it for you.”

David:
Something like that to generate additional revenue. Jake, if your plan is to expand and you want to use the property management company as a funnel to get deals to review, that would be a good idea. If your goal is to just build revenue, I would think that’s probably a terrible idea because that’s not really a revenue generating business. The other thing I would say is it depends on how many rentals you have. Let’s say that you’ve got 200 units that you’re managing. Starting your own property management company could actually save you a decent chunk of change, and would it really have a huge effect on your businesses in a negative way? You could have a positive effect because now you have more control over the work that gets done.

David:
But make no mistake about it, this is work. You’re now responsible for hiring and training and managing and giving time off and dealing with sick employees and all the stuff that comes from running a business that previously the property management was dealing with. That’s why I don’t want to own a property management company. I’m not bagging on property management. But if you’re a property manager, you’re sitting here shaking your head saying, “Yeah, these guys have no idea.” The property managers that I use are constantly going through new employees. It’s a different person every single time I email them. Does anybody relate to that?

David:
That’s because there’s a lot of turnover in that industry. They can’t afford to pay people super well because they’re not making a ton of money themselves. It’s a hard industry to make it in, so that’s one of the last places I would go to if I was trying to generate revenue. It’s one of the first places I would go to if I was trying to find off market opportunities. That would be my advice there. I like to use property managers and then hire a person to manage the managers. That’s the style that I use because I don’t use it as the beginning of my funnel. But if that’s what you’re looking for, that might actually be a really smart option for you. Final video question is from Micah Shelton in Happy Valley, Oregon.

Micah Shelton:
Micah Shelton from Clackamas, Oregon, just outside of Portland. Got a question in regards to your recent Q&A podcast you did. You mentioned using notes versus going the syndication route on commercial properties. I’m wondering what the terms you’re using for those notes, while you renovate the property, while you get it turned around, is there a dollar figure you go after? What’s the interest rate you’re offering those investors, and for how long? Lastly, I’m wondering if you’re putting them on title in any regards for their peace of mind, or if it’s strictly just a personal investment note? Thanks. Look forward to hearing from you for the answer.

David:
All right. Thank you, Micah. First off, love your hair. Looks amazing. Probably don’t think you can improve on that even if you tried. Now, Micah’s question here is about my personal investment portfolio, I guess you could say, where he heard me mentioned that I own notes. Now, let me bring a little bit of clarity into this. The most of the notes that I own are notes that I bought. I literally bought from Dave Van Horn’s company, PPR Note company, the right to collect a mortgage from somebody else, okay? That’s different than the question that he actually asked, but I wanted to clarify it.

David:
Micah’s question was about money that I lend myself. Now, there’s several ways to do this. Why don’t we use this question, rather than just talking about me, but I will answer my own thing, to highlight how lending works in general? There’s several ways that people can earn a return on their money through someone else. The most common is syndication. Now, when you’re syndicating, what you’re doing is you’re putting money in a pool with a bunch of other investors and you become a limited partner in that deal.

David:
The money is used by the general partners in that deal, the decision makers, to go by what’s usually a large property and then they manage it and they get some money off the top to find the deal acquisition fees, and then they get paid to manage the property. There’s a predetermined period of time where they give you a percentage of the rent and then after, say, five years or eight years or 10 years or whatever, they sell that property and everybody gets back the money they invested plus whatever their proportion of the return is. Now syndications are very, very popular right now.

David:
There’s a lot of people doing them, and the big reason is that money is cheap, and it needs a place to go and real estate’s one of the best places to put I. As well as the fact that prices and rents have continued to rise, which makes making money in syndications relatively easy compared to most markets that you might find people in. I do invest in other people’s syndications. In fact, that’s the only kind of partnership I ever do, is when I’m a limited partner in somebody else’s syndication. I have never been the general partner where I gathered money from other people and I invested in a syndication or I ran a syndication that way.

David:
When you syndicate money, you are giving away equity in properties, and that means that the SEC is now governing how you do business and they have a lot of laws about who you can talk to, how you can’t talk to. I get nervous with my position in the podcast where I don’t really want to cross into that barrier of getting into syndications at all as far as being a general partner. I don’t do that. There’s other forms of borrowing where you might be a private lender, meaning I would go to you and say, “Hey, I’m going to buy this house and I’m going to rehab it. I’m going to get your money, and I’m going to give you a lien on the property,” like with the question that we answered earlier, so that if I don’t repay it, you can take the property from me.

David:
You can foreclose on me in essence, and then go sell the property. There are people that do that, and that’s what Micah asked when he said, “Hey, for your investor’s peace of mind, are you putting a lien on the property?” That’s not really my style either, and here’s why. When you put a lien on a property, when you let somebody borrow your money, in many ways it’s a purely business transaction, okay? If the person’s borrowing money to flip a house, and they’re borrowing it from you and they screw up on the flip, they’re going to say, “Hey, that’s what you get. You made a business decision, you can just take the house.”

David:
Now, you the person that borrowed the money, you have to take the house and figure out how to finish the rehab that the professional that was trying to do it did wrong or couldn’t do it, or sell the house in its condition and try to get whatever you can and you’re probably going to lose your money. But in essence, what happens is when they screw up, it becomes your problem because you were funding the deal. That lien on the house does protect you in some way, but you’re getting back an asset that you don’t want. Now, let’s say the house is not in habitable condition.

David:
It doesn’t have flooring or there’s holes in the roof still, or it doesn’t even have a kitchen in it, it’s just a bunch of framing. They tore it down to the studs, and then they ran out of money. You can’t sell that house to a regular buyer using a regular loan. Fannie Mae and Freddie Mac are not going to underwrite that. Savings and loan institutions and credit unions, they’re not going to underwrite that. They’re not going to let you buy a house that nobody can even live in.

David:
Now you have to take this property back, and you have to finish the job that they started before you can even sell the house, unless you find another flipper, and they’re going to want to deal which means you’re not going to get your money back. You see how messy this gets? That’s the reason I don’t do it. Personally, I don’t operate like that. I don’t want to borrow money from somebody and then say, “Hey, if this business decision doesn’t work out, you figure it out.” That just isn’t my personality. There’s nothing wrong with doing that, okay? If you hear people doing this, don’t think bad of them.

David:
There’s nothing wrong with being a hard money lender or a private lender that gives money to somebody who’s going to go use it to develop real estate. If they do a great job, you should do well too. You can make a lot of money lending that way. It just doesn’t work for me. I lend on a relationship basis. When I borrow money from somebody, I’m going to pay them back regardless of how the property performs. If I screw up, they’re still getting paid back. But I’m not going to put a lien on the property. I’m just going to pay them back on a promissory note because I couldn’t live with myself if you let me borrow money and I screwed it up and said, “Oh, well, now it’s your problem to deal with.”

David:
Just the way that I do business. Josh Dorkin started BiggerPockets. He and I are good friends. It’s something where we both look at it the same way. Neither one of us are people that are out to get other people, which isn’t really the personality that I have. If somebody trusts me with their money, they’re usually trusting David, they’re not trusting the deal, if that makes sense. If you’re trusting in the deal, get a lien on the property, go after the person if it doesn’t work out. If you’re trusting in me, the person, you’re giving a loan to me that I’m going to pay back, and whatever I do with that money or if I screw it up, or God forbid something terrible happens, you’re still going to get paid back and I make sure I have enough money in reserves to be able to do that.

David:
Hopefully that clears things up for you, Micah. In addition to you guys learning about how I do lending, I hope that you learned a little bit about the different options you have when it comes to lending your money into real estate. All right, everybody, the fun is done. It is time to wrap this solo show up. Again, I want to know what you guys think. Please leave me a comment below. Tell me what you think about this show. As you’re listening, you may have had questions. I hope you did. Go to biggerpockets.com/david, and ask those questions so that we can talk to you. Also, keep an eye out for future Instagram and Facebook Live requests.

David:
We are going to have situations where we have you get on Instagram Live or Facebook Live or Riverside, and you can ask your question live and I’ll be able to answer it with some back and forth from you guys. Those are even more fun than this. But hopefully you guys enjoyed today’s show. The beard is away, David got to play. This was seeing green with David Green of the BiggerPockets Podcast. All right, I really hope I was able to help some of you brave souls that ventured forward and asked your questions. You guys embody the spirit of what BiggerPockets is all about.

David:
I really appreciate you bringing us the content that we could provide. Just to wrap things up, we talked about the way that CapEx budgeting tends to work in single family real estate, and we cleared up some misconceptions there. We talked a little bit about wholesaling and being a realtor at the same time and some pitfalls to avoid. We talked about contingencies in land contracts, how to make sure that you give yourself time to do due diligence and don’t get wrapped up into something you don’t want to be a part of. We talked about how I do private lending, and my favorite question had to do with the mindset of when to leave your W-2 and when to venture into being a full time real estate investor.

David:
Now, please everybody, remember this is just my opinion. There’s many ways that you can skin a cat. These are the ways that I like to go about things. But what I really, really hope that everybody took away from this is confidence that comes from knowledge. You can make money in real estate, you can invest in real estate. Many people that are less smart than you, like me, are able to do it. Thank you guys for joining me. I hope we make this a regular occurrence. Please submit more questions and I’ll see you on the next one.

Outro:
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