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Rates Drop Below 5%, Opendoor’s $62M Mistake, and Jamil’s Dead Deal

On The Market Podcast Presented by Fundrise
38 min read
Rates Drop Below 5%, Opendoor’s $62M Mistake, and Jamil’s Dead Deal

Interest rates are dipping below five percent, hedge funds and institutional investors are starting to sell off their homes, and inexperienced syndicators are getting stuck with bad deals. Is this the everyday investor’s version of a miracle? Nope, it’s just another week in the wild 2022 housing market! Joining us is the entire On The Market panel to talk about which up-to-date, hard-hitting stories affect investors the most.

To start, we’ll talk about Invitation Homes, one of the most prominent institutional real estate companies, and how they’re being accused of using unpermitted work to renovate their recent acquisitions. Within the same vein, Opendoor, another institutional investor, was fined a whopping $62M for “deceptive marketing”, but did they really make promises they couldn’t keep? Don’t worry, this isn’t an entirely iBuyer-only episode.

Our last two stories cover commercial real estate and interest rates. More commercial deals are starting to see cracks in their literal and figurative foundation, as inexperienced investors are being slapped with higher fees and rates from banks as their properties become less valuable. But, some good news for investors is that mortgage rates have finally dropped below five percent, getting us closer to the rock-bottom rates we were used to in 2020 and 2021. But can these rates be counted on, or will they skyrocket back up once the Fed has had enough?

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Dave:
Hey, what’s going on, everyone? Welcome to On The Market. I’m your host, Dave Meyer. Today, we are going to be doing a news roundup show. We have all of the regular On The Market co-hosts, Kathy, Henry, Jamil, and James joining us, and each of them has brought a news story that affects the lives of real estate investors to share with the panel and with all of you about the state of the market to help you make informed investing decisions.
Hey, everyone. Welcome to On The Market. Today, we have the full cast joining us. We have Henry Washington, Kathy Fettke, James Dainard, and Jamil Damji, joining us to do a new format of show. We’re calling it a correspondent show. Basically, Kaylin and I gave you all some homework to go research some stories and bring back what you think the most important headline of the last couple of weeks has been and share it with each other and with the audience. Did everyone do their homework or do we have any delinquents? Jamil looks guilty. I think he cheated off, Henry.

Jamil:
I did my homework. I totally did my homework. My dog didn’t eat it either.

Dave:
All right. Good. Well, we’ll see how all these stories come. All right. With that, let’s just jump into this. James, you are up first. I feel like this is high school. You have to come give your report. Step to the front of the class and please give your report to your peers.

James:
I was terrible at spelling bees when I was a kid. Going up and doing that walk to the front of the class and having the… I was always the first one getting called out.

Dave:
Man, you shouldn’t have told us that because now we’re going to do a spelling bee on a future show.

James:
Oh, please don’t do one.

Dave:
We’re going to make [inaudible 00:02:01] a lot. All right. Well, we’ll do something more in your wheelhouse, which is talking about real estate and news and economics. What do you think the most important story of the last couple weeks has been?

James:
Well, there’s been so many headlines going around right now. We have inflation, mortgage rates, and those have been the hot topics. Then, I did see an article I found very, very interesting and it had to do with Invitation Homes and these large head funds that acquire all these rental properties. The premise was at Invitation Homes, unpermitted work leaves plumbing and faulty repairs that renters say. The reason I found this article so interesting is it talks about how many homes that these large hedge funds own, and that has been on the top of all the wholesalers, the flippers and investors, is this… Like Jamil always says, the 800-pound gorilla that’s consuming all the housing, but there’s system breakdowns start to slow these things down. Right? What it talks about is how they’re starting to have a lot more maintenance coming out. They’re remodeling all these homes at scale nationwide, and they’re starting to have a lot of issues and the issues are coming from the same issues that we all have right now, which is labor shortages, quality of workmanship, and paying too much for that quality of workmanship.
But the reason I found it so interesting is what is this going to do for inventory down the road? These hedge funds, they operate, as far as I know, on very slim margins because of the amount of staff they have. It’s not the same as what we run our rental portfolios at. For us to make a good margin, we have to self-manage and we self-manage all 2,000 doors and they’re also self-managing, but they’re self-managing with a tremendous amount of bodies, which is a lot higher expense. Then, when you start stacking a very high maintenance expense because a faulty work being done, it can really affect the bottom line and the numbers for all these hedge funds. The concern for us is, are they going to look at a specific asset class and say, “Hey, we want to get rid of this now?” As inventory starts increasing up, and then all of a sudden the hedge funds, their margins aren’t hitting the same numbers, are they going to start dumping inventory in the market too?
Is that going to cause a spike in inventory with foreclosures and defaults increasing, the market slowing down with sales decreasing, and then are these hedge funds going to start unloading some inventory? I think these same problems too have also caused… Invitation Homes owns 80,000 homes nationwide. They were saying only 12% of those homes in this article had been actually permitted. Unpermitted work is where you’re going to have a lot of different issues coming up because it’s not being inspected. A lot of times, you’re depending on the trade to do it the right way, which a lot of times they’re good trades. They just make mistakes. These things can really start to erode a fund. In addition to think about the liability in that, what happens if something catches fire? What happens if there’s mold in a property because there are slow leaks in the walls and renovating home… I remember back when I was flipping the most, which was in 2015 and I had 130 renovations going at one time for fix and flip.
It was a complete nightmare. I was working 90 hours a week just trying to stay in front of everything, get things renovated. It required so much work. Then, that’s what’s happened is these hedge funds have gone out there. They’ve bought a bunch of properties. They deployed a ton of money. They racked their fees at that point. Then, the hard part starts. The hard part is getting these properties fixed up correctly to where they’re safe. They actually will maintain themselves, managing these contractors at a wide scale with an all time shortage of labor. We’re starting to see it break down a little bit. I found this article extremely interesting because as these hedge funds, it gets harder and harder on the renovation, the labor shortages, are they, A, going to stop buying so they can fix their portfolio? Then, B, is there more inventory coming our way?
It was a very interesting read because at some point, all these big hedge funds or all these big sectors where it’s like these large wholesaling companies that are now starting to have a little bit of litigation in there, is there going to be any sort of litigation coming their way and is that going to affect the whole real estate market that we’ve been seeing for the last five years? Because these guys have been very big players. If that slows down, that’s also going to create a lot of opportunity for investors to re-buy that single family housing again. I just found it very interesting. It seems like once the articles start coming, they start rolling. I’ll be curious to see if it snowballs from here.

Kathy:
Well, James, I’m curious because I know that there will probably be some inventory put back in the market, but from what I understand, it’s still such a low amount. It’s like 0.2% of rental homes with the institutional investors. It’s like under 500,000 and there’s a need for millions of homes. In a way, I see this as really positive news that those homes can go back on the market and whether investors buy them or homeowners are able to buy them, this could help relieve some of the issues that we’re facing.

James:
Kathy, I do think it’s a healthy thing for the market. For me, I like to operate and normalize markets. I like flat and consistent rather than hockey sticking down because you can make educated decisions, but it is something of concern in the short term because from what I understand, a lot of these hedge funds are at least 90% have really stopped buying in the last three months. They’ve of pulled with their chips off their table. They’re waiting to see what happens. They’re looking for the opportunity. As you have large home buyers slowing down and then the investment community, which is also slowed down with the higher interest rates, it’s going to cause this little stall in the market. The only thing that I’m really concerned with is, is there going to be a panic?
If there’s a panic, that’s where you see the over buy, which is A, you could pick up a lot of assets for a good price, but then you also need to be watching out if you are a fix and flip investor or a developer, what is that going to do in the short term? How long do you need a factor to hold these properties? Because we have seen inventory increase in our local market a lot. It was under a week and we’re coming close to two months of inventory on market, which is not a lot, but that’s a very rapid increase. Then, with all these little extra… The hedge funds slowing down, investors stopping buying, homeowners stopping buying. We could see that inventory skyrocket very quickly, which is all of a sudden, going to cause sudden depreciation. These are all things that we have to watch because even though it’s less than 1% of the home sales, it can still cause massive fits especially if you’re looking at buying in the suburbs, because the suburbs is where we saw the highest appreciation, which is not normal. The suburbs doesn’t usually hockey stick like it’s been doing, but that also has to do with the hedge funds buying and all these other factors in there. They start slowing down. We could see a more rapid drop outside urban areas and in the suburbs.

Jamil:
James, oddly enough, we’re actually seeing that in Phoenix right now. There’s a disproportionate ratio of homes owned by institutional investors on the market right now versus just privately owned or just regular resale properties. I think that you’re reading the writing on the wall 100% and in some markets, what you’re describing right now is already happening. We saw that in Phoenix, just in the month of July, our inventory swelled 10,000 listings, and the majority of that swelling came from institutional ownership.

James:
Yeah. The crazy thing is they bought those right too. A lot of these…

Jamil:
They did.

James:
I know Invitation Homeless made great buys in 2013, ’14, ’15, but I think the inefficiencies and the liability are actually causing… Because if you look at a lot of the metrics, their cash flow would be great. There’s no reason for them to be selling off those properties because it’s going to hit all the metrics that they’re trying to get to, but their inefficiencies and construction costs and maintenance expense and liability, I think that’s what’s causing the surgeon inventory because they want to clean… I know for the last nine months, I was really busy moving around my whole portfolio, 1031 exchanging out, putting money on different properties because I saw something coming in the market, so I want to get stable. I feel like that’s what they’re doing. Get rid of any property that’s a headache, but it could cause a massive surgeon. Phoenix, Texas, Florida, all these areas, which I’m guessing days on market have increased rapidly in Phoenix with all that inventory dumping on, at the same time, that waterfall effect.

Jamil:
Absolutely. It dramatically increased, but increased from a ridiculously low number anyways. I want just temper this narrative to say that, “Look. Normally, having 90 days on market is totally acceptable to everybody,” and we’re like, “Hey, that’s a normal transaction.” 30 days on market has been crazy. We’re still under 30 days on market in Phoenix. I think we’re at like 28 days right now on average. It’s gone from like basically you list the house and it’s under contract to you list the house, you wait a bit, it’s under contract.

James:
Yeah. That’s just the trend that people have to stay on. It can be a 90-day market. Who cares? You just got to watch that trend and put it in your performa.

Henry:
I’m glad you said that, Jamil. That’s the color I wanted to put on this because yes, things are changing and yes, more inventory is coming on the market all across the country. We’re getting more inventory here too. But gosh, I listed two houses a week ago and I had one under contract in 18 hours and I had the other one under contract in less than 72 hours with five offers and both went over asking.

James:
Yeah. But are you still offering people to go to dinner with you if they buy the houses because…

Henry:
I haven’t done that yet. Maybe I should throw that in there.

Kathy:
What market, Henry, are you talking about?

Henry:
This is Northwest Arkansas.

Kathy:
See, that’s why I love off the radar markets. There are speculative markets and then there’s these linear markets that don’t attract all those institutional investors because it’s happened time and time again, where you have investors flooding in from all over the world into a handful of markets. If you just took a plane over to China or to Europe and said, “Where would you invest in the US?” It’s going to be Vegas, Phoenix, Dallas, Seattle. So you can make a lot of money on the up and then they can also get affected when things tighten.

Henry:
Yeah. James, I think Kathy is right on too as well. I think this story is good for the traditional home buyer, the person who has been having trouble finding a property, the person who has put in a bunch of offers six months ago and couldn’t get anything. Now, a little more inventories on the market, they’ve got a little more time to react and it’s healthy from the perspective too, that like before, when hedge funds were buying properties, that was it. That property was never going to come back to a person that either another investor, small time investor like us or to a traditional buyer. Those things were going to stay either in that fund or transfer to other funds. We would never see that home again and with a housing shortage, that hurts. But now, you’re right. I think they’re trimming the fat. They’re taking the opportunity to trim the fat on their portfolio, sell the ones that maybe they had some trouble with the… It’s funny. I like the way you put it when you said the hard work started once they bought the property. I think a lot of people forget that when they want to jump into this real estate investing.
Yes. Getting a deal done is the key to building wealth, but closing on that deal is step one, getting that deal to a point where it’s actually making you money where it’s stable. That’s a whole different animal and set of skills that you need to have. If they didn’t have the relationships with the contractors in these individual markets, plus the labor shortages and the supply, the materials, cost increases, boy, man, you’re right. They got to be investors on the buy and then they had to turn into real investors to get that thing stabilized.

Dave:
All right. Well, great insight, James. Thank you for bringing that. Just for anyone listening to remind you, what everyone’s mentioning here is that this could have some localized impact. If you’re interested, you can… A lot of these are publicly traded companies. You can go look at where a lot of their holdings are and you can get information about them. If you want to know more about specifically your market, your area, how that might be impacted. All right. James, hopefully we didn’t bring up too much high school trauma for you, and we can now move on to Jamil. What do you have for us, Jamil.

Jamil:
Interesting article that I read this week that Opendoor was slapped with a 62 million fine by the FTC4, deceptive marketing practices in their business tactics. Between the years of 2017 to 2019, the FTC alleges that Opendoor deceptively told homeowners that they would make more money selling to Opendoor than they would on the retail market. Now, I want to say that I’ve sold houses to Opendoor and they definitely overpaid. I’ve got a problem with this article because I want to know first and foremost, who decided? Who decided that they would’ve been able to get more money on the market if they had gone on the market? Because I have seen Opendoor write some checks for properties that I would’ve never written. I would’ve never bought that same product at that same price. It’s an interesting result.
I necessarily don’t agree. Look, here’s the thing. I think you have to be very careful about what you say. I think if somebody is going to use a convenient solution to sell their house, they need to understand it’s a convenient solution and they need to understand that they’re trading value for that. I think that that’s fair. I think that we should all be okay with disclosing that to people because that’s the purpose of business. Right? Fair, just honest. On the other side of that, I don’t think that it’s necessarily true that some of these people were going to actually get more money having listed their property on the open market. I’m really interested to see who made that determination? How they made that determination? Because Opendoor is wildly, wildly disagreeing with this result. Any thoughts?

James:
Yeah. Jamil, I think this is a great article and you know what? It’s a great way to open up wholesalers and professionals in the real estate industry. I know we sell a ton of homes. It’s a three to 400 homes a year is what we’re usually closing on. What I have noticed over the last 24 months is paperwork and professionalism has gotten pretty sloppy. It’s turned into, “I got to get this contract. I got to get this contract. I got to get it.” People are writing… We’re moving all contingencies. Brokers are having their buyers do that. What it’s come down to is it doesn’t matter who’s interpreting what the damages were. As long as you disclose, disclose, disclose on your contracts, everything will be okay because at the end of the day, we are the big, bad investor and a seller is a seller.
If there’s going to be a dispute on values, we’re always going to be the loser at this point because we’re the guys with the money. We’re the guys that bought the property. If it goes in front of any judge, typically you’re just not going to win unless your contract is ironclad and you go through the right steps and processes. I know when we work with certain types of sellers, whether they’re elder, we send them to an attorney or have them reviewed at the same time. The math is always up for interpretation. As long as your contract is solid, they can only interpret it one way. Don’t let it go down to math and what the comps are and what a third party analysis of maybe what a fair offer is. Just make sure your contract’s tight and everything will be fine.

Jamil:
It’s interesting that they were fined for deceptive marketing versus their contracts because, James, you brought up the concept of contracts and in dealing with Opendoor, they’ve got a very, very interesting way to present an offer to potential seller. They actually put the cash price on line item one, and then all of their credits are taken off after that. What the net price is, is never what the actual purchase price is on line one other contract. The funny thing is, is when the house records, it records at that higher number. All of those credits aren’t taken into consideration on the recorded price. I feel like they do this so that people see it. They’re like, “Oh, wow. Opendoor paid 220k for this house. Now, they’re selling it for 215k. Wait, I don’t understand. How are they making any money? What a benevolent company?” To me, I think that’s where the interesting dichotomy sits because I see that the way that the contracts are being written is being more deceptive than say marketing.

James:
Well, maybe that’s what they’re saying, right? Is like, “Is that marketing?” If they’re presenting to a homeowner that they show you this top line contract that says 220 and then ultimately they get 290, that might be the deceptive part.

Jamil:
It could be. I think it was more the claims that they’re saying, “Make more money selling to Opendoor than you would on the market.” I think that phrase itself was the point of contention for the FTC saying that that’s actually not true.

Henry:
I think the theme between these two articles is real estate investing isn’t as easy as these companies thought it was going to be. Right? It’s not just, “Go get the deal,” and then you have built this wealth forever, and it’s not just, “Get this thing under contract,” and then you’re going to make money. There’s a whole lot of research and due diligence that we’ve all put into mastering our crafts, right? Understanding our contracts and understanding the underwriting and understanding the exit strategy. We have a grasp on what the whole picture is going to look like before we ever make an offer on a property. I think a lot of these hedge funds and these larger companies saw these investors out here making really good money and said, “Well, we’ve got the scale and the dollars to do that at a larger scale and we’ve got the reach for somebody like an Opendoor or Zillow.”
Remember, Zillow got themselves in some trouble doing the same thing. Right? Because they have the scale and the reach to reach lots of sellers, but this business is more than just about being able to reach people. This business is about helping people, right? This business is about doing your due diligence. I think those two things have fallen by the wayside with these larger companies because their goal isn’t to help people. Their goal is to provide a return. Right? I think a lot of the due diligence was missed. When I say due diligence, there’s not just due diligence on the front side like, “Am I buying a good deal due diligence?” There’s due diligence with a deal as a whole with understanding once I get this property, what is it going to take for me to get it from where it is now to the point where it’s a stable asset and then how am I going to exit this property? Right?
I don’t think that full scale due diligence was done. I think people were just scooping up stuff and in a market as hot as it was, it was easy for everybody to be a winner. You could buy anything and it was going to go up in value by 20% over the next couple of months, but that’s not the case anymore. I think you’re starting to see from these larger companies that being an investor is… It’s not as easy as just finding something, putting it under contract and hoping for the best.

Dave:
Do you guys know what the word Schadenfreude means? I’m probably butchering that. It’s a German word. Do you know what it means?

James:
No. Please share.

Dave:
It’s like the feeling of taking pleasure in someone else’s pain. I feel like that’s the theme of the first two articles here is all of the small investors are like, “Yeah. Screw [inaudible 00:23:12]. Keep the Opendoor.” We basically just like it when they have problems like the rest of us.

Kathy:
Yeah. There’s always deception whenever there’s a lot of money to be made. Not everyone, but there can be people, real estate agents, property managers. Anytime there’s a lot of money to be made, some people get greedy and it could be that Opendoor grew so quickly. It was such a wild and crazy time that they couldn’t monitor everything. I don’t know. I’m just guessing on that. But if I were a real estate agent really active in my market, I would be doing everything I could to reach those same people and say, “Wouldn’t you rather have your home on the market where you’ll get lots of bids, not just one offer, especially in such an incredibly hot market that we had?” That’s what I would’ve done.

Jamil:
Kathy, great point. Because I think that we want to make sure that we’re personifying this company in a way that there’s just like this evil person. It’s like, “Oh, I’m going to be mean and deceive.” It’s not like that. They’ve got so many levels of management and so many levels of bureaucracy in that company. Also, there’s probably just a marketing guy over there who was testing different verbiage and different copy and different ways to try to get clicks. At the end of the day, I don’t think anybody at Opendoor was sitting there being like, “Hey, we want to go screw people.” I think that one portion of their company was trying to get better results on their paper click marketing and they used some incorrect words and 62 million… I don’t even know if Opendoor’s made 62 million in profit yet.

Dave:
Oh, no. But it’s funny because it’s like $62 million…

Kathy:
It’s a lot.

Dave:
You think it’s a lot? I just looked up while we were talking as of Q1, they had 3.5 billion in cash on hand. If you had to ask Opendoor, whether or not they would willingly pay 62 million to enjoy the market share and probably even the publicity that this article has gotten them, they’d probably take it all day. I don’t think it’s a good…

Jamil:
That’s another great point.

Dave:
It probably won’t be a huge deterrent, but yeah. No, I don’t think they’ve made that level of profit.

James:
The real question is what else have they done not correctly, and do they have more of these come in their way?

Dave:
Yeah.

James:
That’s a poor piece of marketing, “Hey, we’re going to pay you more than the market.” That doesn’t make any sense. Right? When you put those promises in writing and you start misleading the consumer, you can get yourself a big, hot water. That’s something all wholesalers need to watch out for, don’t over promise and just shoot people straight, but I wonder what other piece of marketing that they have in there? Because again, they might not have done anything wrong. We buy 50% of the homes on market, right? We’re buying market value, discounted property and it got to seller a certain net. They were doing the same thing. It was just a matter of how they were advertising, not really what they were actually doing.

Jamil:
James, I think also the product that Opendoor goes after is a lot different than what you and I and the rest of the panel here go after, because truly I know that they definitely changed their buy box. They were going after houses in the beginning. They were going after houses that required extensive renovation. They were going after the same kinds of turd boxes that we buy. Then, they turned that off. They said, “You know what? We’re not buying that anymore. We don’t want to spend more than 1% of purchase price on the renovation.” I know this because one of my best friends was a contractor for Opendoor. He was there when they made the decision to say, “Hey, we’re going to move away from a 30 or 40 or $50,000 remodel. The most that we’re going to spend on the house is 1% of purchase price.” Think of that. You buy a $300,000 house, you’re going to give them three grand? What are you going to do in three grand? How much work are you actually going to get done in that amount of money?

Dave:
Yeah. It’s a great point. Unfortunately, I do think we have to move on. Cause I do want to hear Kathy and Henry’s stories, but Jamil, that’s a great story. Thank you for bringing this and something I agree. We’ll just have to keep following to see if they continue, if there’s anything else that might be getting them in trouble as well. All right. Kathy, what do you got?

Kathy:
Yes. Well, mine is going to be more on the commercial side of things, because of course, with real estate, there are so many different asset classes and they all are affected differently. I thought this was an interesting article from Bisnow called Rapid Repricing: Higher Interest Rates Slow CRE Deals, But Many Investors Won’t Be Deterred. Of course, CRE is commercial real estate. I’m going to assume that maybe some people don’t know some of these terms, so I’ll explain them as I go. But as we know, there’s been a lot of people teaching others how to syndicate, how to get into multi-family. I’ve been concerned about this for a few years because I was seeing people syndicating who had never really done a deal themselves with their own money and using other people’s money. I think a lot of those people are in the, “Oh, no,” phase of this like, “Wow. It was so fun.”
Kind of like you were saying earlier, it’s so fun to acquire and then you got to manage it. It’s like getting a puppy, so fun. Then, you have a puppy that you have to deal with and train and all of that. There’s a lot of learning that is happening right now in commercial real estate. For those who are new to the process, commercial loans are completely different than anything from the one to four unit is conventional. You can get a 30-year fixed rate. Generally, the banks can’t mess with that. Even if you got a five or a 10 fixed, it’s fixed. You know what you’ve got. With commercial, it changes. With this article, it basically said with interest rates creeping up, fewer deals make sense. Deal volume has slowed down with brokers reporting that the buyer pool has shrunk dramatically.
Some of the big things that are happening from people I know and people who have called me and deals that have come across my desk with people in a panic is that with commercial loans, it’s the DSCR. Right? The debt service ratio coverage. It’s a different deal than the one to four units. This basically means that lenders are going to protect themselves and make sure that there’s enough income being generated from the property to cover the debt. They don’t want to see a 1:1 ratio, meaning that you have just enough income from the rental property. That’s like a 1:1. They don’t want that. They want to see one and a quarter, one and a half to make sure there’s plenty of income generated from that property that if anything changes or there’s vacancies or a recession or anything like that, and rents go down or expenses go up, that still the debt can cover.
Here we are in a dramatically different environment in just a few months where rates have doubled in many cases and people underwrote deals, not anticipating that. Now, they probably should have anticipated that because we all knew as of January of this year, that the fed was going to raise rates and that that was going to slow down the economy. That probably mortgage rates would rise as people were anticipating inflation to continue, so got to pay attention to the fed. They control the environment that we play in. They control the rules. You got to know what they’re doing. What we’re seeing is banks coming back and I looked up this word… New words come to play when things change that people didn’t know about before, and one is the material adverse change. This is in the loan documents, which means that if there’s an adverse change, A, the bank can change the interest rate and that’s starting to happen.
They also expect interest reserves, meaning that, “Oh, if the rate’s going to go up and you’re on an adjustable, we need those reserves now.” I know people who, all of a sudden, got a call from the bank and the bank wants $40,000 a month more. Not something that everybody anticipated. Bottom line is in commercial real estate, really know what you’re doing, make sure you have an attorney reading your loan docs because there’s little things in there that you might not know could affect you in an environment like this where interest rates are going up affecting the debt service coverage ratio.

Jamil:
Why do I feel like everybody’s staring at me because you guys all know what’s happening to me in my deal right now?

Kathy:
I don’t know. I don’t know what’s happening to your deal.

Henry:
When she said that, I looked right at you.

Jamil:
I could feel you. I felt James and everybody. I feel you guys in my… Kathy, I’m walking away from $470,000 in earnest money because of a material adverse change.

Kathy:
Well, you just learned a new vocabulary word, huh?

Jamil:
Yeah.

Kathy:
I don’t know if you remember on YouTube, I put a little comment. Was this on the multifamily?

Jamil:
Yeah.

Kathy:
Yeah. I said, “If it were me and I wasn’t, I think on that show or I didn’t comment, but if it were me, I would have taken the money and invested it in somebody else’s deal that does multifamily,” because anytime we do something, we’re not an expert at, like if I went out and tried to wholesale, I would be fined and go to jail for that because I don’t know what I’m doing. Right? Unless I took your course, then maybe I would. But it’s just tricky. This is why multifamily and commercial loans have always scared me a little bit and if I was going to do it, my LTVs were going to be low, 70% max.
We can’t just assume we know what’s going to happen in the future because things change. I’m in the same boat with construction. Construction doesn’t happen overnight. It takes years to get things entitled and the world can be a different place as we know by the time you’re ready to sell homes. Any long term kind of project, we just can’t know what the future holds. As long as investors know that and people know we can’t control the future and you’ve got all the disclosures and disclaimers and all the things in your documents, then that’s one thing, but it’s going to be interesting. There’s a lot of repricing. There’s multi-family deals where people came in three years ago and spent all this money and time renovating the property with the idea of selling it today.
Now, interest rates are up and they’re not going to get what they thought they would get. There’s repricing of like millions, like 15 million, all your work for nothing over the last three years because of assumptions that didn’t happen. Again, just be careful in any kind of deal where the interest rate can change and you’re not ready for it and not prepare and don’t have the reserves.

James:
This just goes back to even what I mentioned earlier is a lot of rules have gotten broke in over the last 24 months. If you’re a syndicator and I have heard ton, like there’s a lot of people having issues right now raising money, getting their rates locked. It’s because they broke the rules, right? What every syndication property that we’ve always have during our feasibility, we don’t waive feasibility unless we have that check that we will write ourselves at that point. During that feasibility, we are raising capital. We’re locking our financing and everything… By the time we are waiving feasibility and not exposing our earnest money to risk, we have our money locked in on both loans, our take down loan and our permanent financing and all the money’s raised. I think what’s happened is there was so much FOMO going on in the multi-family market that people were riding with no inspections, hard earnest money just to get the deal.
I kept hearing, “Well, I had to get the deal done.” Well, the deal’s not a deal unless you can close it and it makes sense. Just because you’re buying doesn’t mean that you’re winning. You still got to go through your formal steps. That’s where a lot of syndicators have gone a little bit sideways recently is they’re skipping those key steps. Like what Kathy said, a lot of them are pretty new to this business or they maybe took a course and that’s risky because you don’t have that experience of things blowing up. Things blow up in every deal, you have to adapt unless you waive all your feasibility and then you’re just out of a loss.

Kathy:
The biggest issue is this COGP thing that was becoming very popular, which really is a violation of the SEC if your only role is raising money. We’ve seen a lot of people do that and hide the fact that that’s what they’re doing where really they’re just raising money and they don’t even know the deal or understand it. I’ve asked some people and said, “Well, tell me the parameters of the deal and they don’t know.” Now, you have to be licensed, a licensed broker dealer to raise money for somebody else’s project. This is where, again, unfortunately it was a skipped piece for a lot of people and now they’re realizing, “Oh, it’s COGP. I actually am responsible. I am liable.” It could get really ugly out there and everybody learns their lessons. Again, I’ve had hard lessons too as a syndicator in building single family homes when they’re ready to… We got shut down during COVID, then material costs go up and right when we finally could get these things sold, interest rates go up. I get it. It’s hard, but investors understand when things were out of your control. They won’t understand if maybe it was.

Dave:
Before we move on to Henry’s story, Jamil, can you just remind us a little bit about your deal and for everyone listening, basically a couple of… I guess it was like a month or two now ago, we had some of the panelists bring in deals and Jamil was deliberating about whether he should wholesale or hold onto a multifamily property in Phoenix. Sorry to hear you’re losing that money, man.

Jamil:
Yeah.

Dave:
But can you help our audience learn from what happened?

Jamil:
I’m happy to. I’m happy to. Well, first and foremost, guys, everything that was just said here is so incredibly smart when James is talking about fundamentals and not waving feasibility until you have everything locked in. To give you guys just a little bit of a history lesson here for me, I got into a partnership with a multifamily operator that had a lot of experience. I’m not an experienced person in multifamily. I never claimed to be. That’s why for me, it was very testy. The problem was, is I’ve been paying a lot of money in tax, so I needed to buy something that I could use for depreciation. I was hearing all of this talk about being able to write off all of your income by buying a nice big juicy multifamily building. I partner with somebody who has experience 53 units here in an A class neighborhood in Phoenix, Arizona. We put it under contract for 12 and a half million dollars.
Immediately, I have a buyer who wants to take it from me for 15 million and our debate was, do I take a two and a half million dollar assignment fee and do what I normally do, which is wholesale, or do I take this sucker down and use it to depreciate my income and generate cash flow? Lo and behold, the deal is supposed to close in three days and our value has gone from what… We had a buyer at 15, so I’m going to say originally, that’s what I think the property was worth was $15 million because we had a buyer there and now we can’t get lenders to agree that the building is worth seven.

Dave:
Whoa.

Jamil:
Seven. How do you lose $8 million in value in a building because the rates went up? That’s the piece where I’m just shocked. Right? I think Kathy, you’re right. She said stay in your lane, dude. That’s something that you have to understand, what are you proficient at? What have you got knowledge at? What do you have skills at? What could you get into and get out of if you needed to? That’s where I made the biggest error. Guys, learn from that, find a proficiency, get really good at it, learn about it and then go and take educated risks. I think I broke the rules and every single one of these, I didn’t take an educated risk. I got into partnership with somebody I hadn’t vetted right. Then, we waive feasibility before we had our ducks in a row.

James:
Hey Jamil, real quick. Was the guy buying that building at 12 and a half or 15, were they syndicators?

Jamil:
No.

James:
No. Okay. That was my question, because they’ve been throwing crazy numbers around.

Jamil:
It was not a syndicator. It was a professional sports personality who was just parking money because they just have more money than they have opportunities really. Their goal was to just buy it and hold.

Kathy:
I love that you said buy and hold because a lot of what has been happening in the multi-family industry as of the last few, I don’t know, five years is more flipping apartments. It hasn’t been buy and hold. I always found that interesting because I would want to buy an apartment to buy and hold. I want it to be my retirement and I’d probably want it to be newer. Now, I was wrong on a lot of that because I turned down some deals that ended up making people millions, but there was luck involved in that, a little bit of luck over the past years. No one knew that interest rates were… That the fed would lower rates to zero and all the things that would happen over the last two years would happen, but it was more like people are taking these awesome tax benefits, but then they’re going to flip the property and then it’s recaptured, so you didn’t really get the tax benefits and it’s just more speculative. I’m not sure investors knew that either.

Dave:
Well, sorry to hear this again, Jamil.

Jamil:
It’s all good.

Dave:
It’s a rough lesson. Unfortunately, that’s part of investing. There’s always risk involved. Luckily for you, there’s more good than bad.

Jamil:
I intend to milk the $470,000 lost in a YouTube series of how Jamil pooped to bed. Guys, stay tuned for that.

Henry:
In all seriousness, I hope people listening to this really understand the value in what Jamil just shared. We live in this world of social media guru highlight stories where you’re seeing everybody’s wins and everybody says, “Get into real estate. You’ll make millions.” You can absolutely do that, but you can also lose. Right? The idea with investing isn’t to bat a thousand guys. No one bats a thousand. Not a single investor bats a thousand. We all lose at some point. The idea, just like with any other investment vehicle, is that you win more than you lose. Right? You do that by your education, your due diligence, doing things the right way, sticking to what you know, sticking to your guns like Jamil said. When you do what I call relentlessly consistent, you’re going to win more than you lose.
I hope people see the value in Jamil sharing that story in that lesson, because there’s a lot of people who talk on the internet about investing who wouldn’t tell you about that loss or that situation. They’d be too embarrassed, right? They’d be concerned with losing face or reputation. I think that that just shows you how much of a standup guy and how much of a great investor Jamil is, is because he’s sharing that. Not because there’s some benefit to him there. He shared that story to benefit everybody listening so that they don’t do what he did and there’s massive value in that. I commend you for taking that for showing [inaudible 00:43:27].

Jamil:
It’s embarrassing, I’ll be honest. I feel weird talking about it and that’s why I know I need to do it.

Dave:
I do want to get to your story here, Henry. What do you have for us? What have you been watching?

Henry:
All right. For my portion, I’m going to channel my inner Dave Meyer and I’m going to talk about my article in my Dave Meyer voice.

Dave:
Oh, God.

Henry:
Then, curious on your perspectives. The Washington Post just released an article last week that the 30-year fixed rate mortgage interest, which is the most popular loan product has dropped below 5% for the first time in four months. According to the latest data released by Freddie Mac, the 30-year fixed rate average tumble to 4.99%. It was at 5.3% a week ago, but 2.77% a year earlier. Despite the fed raising rates, the data is telling us that the interest rates have actually come down in the last month. The reason they’re saying that it came down is that the fear of a recession and the inflation concerns is creating volatility. When investors are worried about inflation, they stop buying bonds because the return on those investments is less when inflation is high, but when inflation takes away the value of the bond’s future, less demand causes bond prices to drop and yields to rise.
I know that’s a super technical thing, but the moral of the story is that even though the fed is raising rates this month, at least it’s having the opposite effect on what they wanted to happen and I’m curious to hear your thoughts on what you think this means for the market, because a lot of people have been waiting on the sidelines, right? They’ve just been waiting for this perfect time to enter the market. Do you think with them seeing that, yes, even though the fed, they just raised the rate three quarters of a point, but now people are getting rates as low as under 5%. Do you think this means people start leaving the sidelines and buying homes, or do you think it’s still a little too volatile and people are going to wait? Curious to hear your thoughts.

Kathy:
It would be my guess that if anybody was about to buy, they’re stoked. They could lock that in. I don’t know that people suddenly go, “Okay. I’m going to buy a house now.” They may not even be aware. But to me, the bigger concern here is the fed is really mad about this. They did not want to see this. They are realizing they don’t have control over that. The bigger picture is that investors are flocking again to bonds because they’re thinking that inflation has maybe peaked and that we’re heading into recession. There’s a positive and a negative there, but this tells me that the fed is going to continue to raise rates to get what they want because it’s not going the way they want. That could be a deeper, darker recession if they do. It’s concerning to me in that vein.

James:
It’s definitely make it harder to forecast down the road when you’re looking at deals, right? Like, “Oh, they make the three quarter point hike increase announcement,” and then the rates go down. But I think what it comes down to is banks are smarter than us. They know more than us and they have more money than us. I think they got such a huge jump on us when that rates started going that then all of a sudden their demand fell a little bit. They’re like, “Hey, we’re going to get some money working.” Right? The mortgage apps were way, way too low. We definitely saw a surge in the last two weeks in list. My [inaudible 00:47:18] doubled when rates came down across the board, but really the key is you just got to keep watching what they’re doing, watching the trends. I’m anticipating rates to go back up, because like Kathy said, the fed’s not going to be happy about this. Then really, just always remember, they have more money. They’re smarter. As investors, the small guys, we have to be scrappier. Just try to stay in the game, beat it back, but I would anticipate that rates are going to jump up another half point in the next 30 to 45 days.

Jamil:
Personally, I think it’s marketing. I think what’s happening right now is that when the banks take us down to 5% and they make this big like, “Hey, hurrah. Yay, guys. Rates are lower.” They are tricking us into remembering that 5% is a good rate. Right? All this is right now is positioning. They’re planting seeds. They’re planting seeds, because if they got to go back up to six, then they’ll be like, “Hey guys, we’re back on sale at five again.” Then, everybody’s going to start feeling like, “Wow. Five is such a good rate.” They got to hit the reset button on the psychology of the borrower. The psychology of the borrower right now is still mourning 3%. What we need is the borrower to start to understand that 5% is actually the gift, so let’s show them that that’s the gift. Then, we can give them presence every quarter.

Dave:
First of all, Henry, I wish I sounded as cool as you do reading stuff. I aspire to sound that cool.

Henry:
I just figured I should say a bunch of percentages and numbers and then ask somebody a question.

Dave:
That is my literal job description. It’s just go up there and say numbers and then deflect to someone else. I do think it’s really interesting and that people should just be expecting volatility now that everyone saw this linear rise in interest rates from January to June and expected that we were going to continue on a linear path. Then, at some point, it would change and start to go down. But unfortunately, due to the nature of the fed’s job, they are reacting to news constantly so are investors and no one has a clear line of sight on what’s going to happen. As investors, they see… I’m not talking about real estate investors. I’m mostly talking about bond investors here, or stock market investors. They’re seeing GDP data. Then, they react one way and then they see the jobs report.
That’s completely contradictory a few days later. Then, they react the other way. Because the global financial system is so complicated every time one of these things happens, there’s this cascading effect and it winds up with mortgage rates being really unclear. I think people should look at these rates and think that this is probably one of the lowest they’re going to see for the next couple of months. At least, that’s my opinion. I don’t think we’re going to see anything much lower than five. Maybe a little bit, at least for the next six months for a year. Because as everyone else said, fed is probably going to raise rates. I think we should expect a bumpy road. That means that if you’re one of those people waiting on the sidelines and thinking that home prices are going to be a lot cheaper or your mortgage rates are going to be a lot of cheaper, if you wait six months to a year, unclear. That’s very unclear and you should really still just, what we always say on the show, is focus on the numbers today. If the deal works today, go for it because there is absolutely no certainty that things are going to get cheaper.

Kathy:
Yeah. There’s a lot of confusion that what the fed is doing affects mortgage rates and they’re really different. The fed is raising the overnight lending rate and that is intended to make short term rates more expensive, credit cards, car loans, and to curb investor appetite because things cost more, but mortgages are more tied to the 10-year treasury and mortgage back securities. The fed doesn’t have control over that. That’s the global investor world where investors, when they think there’s going to be inflation or when they think the stock market’s going to go up, they’re going to choose that over a boring bond. Bonds are boring and stable. If investors think they’re going to make more money in the stock market or elsewhere, they’re going to do that. But when they… They’re like little chickens. Little chickens scared of every little noise.
If all a sudden, it’s like, “Oh, wait. Inflation is maybe peaked,” and maybe we are going into a recession because the fed rate hikes are trying to create that, they’re trying to create a recession, maybe we have one and then bond investors like, “I got to get back to the safety of mortgage back securities and the 10-year treasury.” In the time that the fed has been raising rates, the 10-year treasury has actually been going down. It makes no sense because if we really were in a long term inflationary environment, you would see people not buying bonds. The general consensus of the world is that maybe this inflationary environment that we are in is going to peter out. Maybe it had to do with the war or maybe the $12 trillion that circulated over the last couple years is eventually going to get spent. Then, we’ve got the fed just hunkering down, raising rates to slow things down, so investors are scared and they’re going to safety of mortgage back securities, which is why rates went down and the treasury.

Henry:
I agree with all of you. I especially agree with Jamil. I do think this is a bit of marketing right. Mortgage applications are down. There’s a lot of fear around rising interest rates. There’s also a lot of, not necessarily misinformation, but lack of education, which is, I think what Kathy was just trying to hit on was to educate truly what the fed can and can’t do or what they said differently, what they truly have control over and what they don’t have control over. What I think is there’s a lot of traditional buyers who hear the feds raising rates and they go, “Well, it’s 7% now,” and they’re doing their mortgage calculator on Google at their new home price at 7% that they want and they’re going, “Well, I can’t afford that payment.”
Then, they see this article and go, “Wait a minute,” just because the feds raised it to this doesn’t mean that’s the actual rate that I might get. Now, they might actually start contacting lenders and looking into buying because 4.99% is not 7% and that makes a substantial difference in your payment. I think a lot of people just didn’t understand that these rising interest rates don’t one to one translate to the rate you’re going to get on your mortgage.

Dave:
All right. Well, thank you all. Excellent job on your homework assignments. I appreciate you all taking the time to do some research. I’m sure you are reading this stuff anyway, but bringing it in and presenting it to our audience. This has been an excellent episode. We were going to take some questions for the forums, but we did get into a lot of these really important topics, so we will defer that to next time. But James, Henry, Jamil, Kathy, thank you all so much for being here. It is always a pleasure having the whole group together. Thank you all for listening and we’ll see you again next week. On The Market is created by me, Dave Meyer and Kaylin Bennett. Produced by Kaylin Bennett, editing by Joel Esparza and Onyx Media, Copywriting by Nate Weintraub and a very special thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions and investment strategies.

 

Watch the Podcast Here

In This Episode We Cover

  • Why hedge funds are hurting and failing to keep up with maintenance on their properties
  • The “deceptive marketing” tactic OpenDoor used to lure in new customers
  • How rapid “repricing” is changing the way commercial real estate deals are done
  • Jamil’s $2.5M mistake and why you should always focus on your own area of expertise
  • Low interest rates and why banks are offering them even as the Fed pushes for increases
  • And So Much More!

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.