Property 8, 100% financed

Rental Property Investor
Reseda, CA

Rental Property Investor
Reseda, CA

Replied Nov 29 2022, 13:11

Quote from @Steve K.:

Quote from @Austin Fowler:

Quote from @Steve K.:

Hmmm... turnkey rental properties purchased at full retail value, with 100% leverage, at the peak of the market cycle, owned remotely, under management, with no value add or upside other than potential natural appreciation, with accelerated depreciation, very little budgeted to fix anything or in case anything goes wrong... expected to somehow spin off enough profit to provide a guranteed percentage return to investors whose money is held in "savings accounts" with no bank charter or FDIC insurance, and only backed (partially) by personal funds... What could possibly go wrong here? This sounds like the same deluded justification that the iBuyers have been using over the past few years: "Too bad we lost $100k on that one property, but don't worry stockholders, we'll make up for it with scale!"

1) Tax assessed value going up from last year has no direct bearing on current market value, especially because the market turned just a few months ago but also in normal times. It's not a data point people use.

2) Cap rate is not used for single family rentals, only multifamily.

3) Depreciation needs to be recaptured when you sell.

4) 3.7% for maintenance and repairs is unrealistic

5) 4% vacancy loss is extremely wishful thinking

6) An average tenant stays 2.5-3 years, not 6 and turnovers can easily cost $5-10k (which would take you many years to recover from with your budget, even if everything else goes perfectly)
7) Always take the operating costs given to you by the seller/ turnkey provider and double them for a more accurate estimate

I’m not seeing enough profit here to have it be a worthwhile use of time or worth the risk for even an individual investor, and definitely not enough to share with outside investors. Hopefully these properties have wonderful appreciation and nothing ever goes wrong with them! Even if your cashflow projections were realistic (aside from whoever sold you these properties, no one believes they are), I still don't see the point. I get the banking side and the investing side, it's not complicated but just doesn't add up due to there being no profit-driver. All this just for accelerated depreciation, very nominal equity gain through principle pay-down, very nominal if any positive cashflow, and maybe enough appreciation to make it all worth the effort in 20 years? By overcomplicating things and over-leveraging yourself in the way that you have, you've opened yourself up to more personal risk than the best-case returns could ever justify. You're doing all the work and taking all the risk while relying on getting really lucky for very little, if any, potential return (maybe appreciation will save you?).

If you want to "be the bank", you'd get better returns with less work and less risk as a private lender. Why not just do that and use your own funds to invest since you already have the capital, and avoid having to deal with the hassle and risk of combining the two? There's got to be a lot of admin, paperwork, financial reporting, legal fees, customer service/sales/ account management/ explaining, software, client portal management/IT, new lead generation/marketing and other overhead involved in this business, and there's real risk of potential lawsuits, audits, criminal charges etc. If your projections turn out to be mere wishful thinking and not actual underwriting (which my experience tells me they are), you could actually even risk being sued or facing federal criminal charges because the rosy predictions you made to investors could end up being deemed as false and misleading statements. Obtaining money from investors by means of false or fraudulent pretenses, representations, or promises is called bank fraud. Your underwriting and financial statements could easily be seen as misleading, because you keep calling them very conservative when anyone with a basic understanding of what a realistic SFR operating budget looks like will agree that's not the case. These cashflow projections are simply unrealistic. Every property has vacancy, needs repairs and maintenance, and requires capital expenditures well beyond what you have budgeted for. You will end up needing to pay investors out from your personal funds to cover operating costs in the near future, unless your plan is to continue raising new capital to cover your losses, Ponzi style. I don't see the point unless this is some sort of fund-raising pump and dump scheme, but I can't see how a savvy accredited investor would participate in this anyway. Why wouldn't they just go directly to the turnkey provider, buy the asset and reap all the benefits themselves? What value do you bring to the deal? I understand how it's a tool for them like a high interest savings account, but why settle for 8% when they could just invest directly in turnkeys themselves?

Literally one garbage disposal going bad, not even a water heater replacement/plumbing leak/fallen tree/ driveway replacement/ sewer line collapse/ anything happening that costs more than your tiny maintenance, repairs and cap ex budget, or a single bad tenant/ eviction/ mishap that creates a few months of vacancy loss causes this model to lose money…. even a minor market correction for that matter considering you have zero equity/ zero margin for error… you’re probably underwater on these properties now with what is happening in the market. It’s unlikely you’d be able to sell them for what you paid never mind factoring in transaction costs and depreciation recapture since you're accelerating depreciation...

Don’t quit your day job as they say. Hold on to your high-paying W2 for dear life now because you will need it to fund this money-losing endeavor. You may hit these extremely optimistic numbers in the very best year, but over time there’s no chance you’ll have positive cashflow. Sorry but I just don’t see it happening. Anyway, this model doesn’t make sense to me. Maybe for an apartment syndication or $100M development, but buying one-off turnkey rentals is an asset class that is notoriously difficult to derive profit from and impossible to scale (scaling will just magnify your losses here anyway). This seems like a lot of work and a lot of risk for not enough benefit and a potential recipe for disaster IMHO. Good luck, I hope you take this feedback as tough love and not a personal attack, and that you do well for yourself and your investors.
Hi Steve,

Thanks for the detailed post, I appreciate it. To start, with a $625k W-2 and just $1.2M in private capital, meaning $96k in interest, I have deep pockets to look after my investors, which is always top priority. I think we'll have to agree to disagree on appreciation of these assets until I have appraisals back. In any case, this is a long term play and that's ok with me.

I have a net worth 2x total investor funds, so I have substantial and growing resources to cover investors. Indeed between vesting stock and cashflow and tax returns my liquid reserves go up an average of $35k a month.

I think you are looking at all of this the wrong way. Let's assume you are a super investor and have much better ideas on how to make money safely grow than professionally managed longterm turnkey SFRs specifically from REI Nation (I've tried another turnkey provider and REI is incomparably better), then I'm telling you you can run a fractional reserve investment business legally (I have a Reg D 506c). This effectively gives you the ability to borrow money at 8% with indefinite capitalization and buy assets with 100% finance and 100% ownership. This is not a fantasy, this is what I'm doing. A great question for you is then what would you do with a loan on such terms? How would *you* invest it? The question is not rhetorical, it's precisely the discussion I'm trying to stimulate.

I do *not* claim that turnkey is better than other things, just what I have found works for me while testing this business model. I'm very interested in hearing what works for you, and how you could take my starting point and make it better.

Best,
Austin.

I appreciate your reply and your ability to accept constructive criticism/"tough love". To address your question above, I would invest in what has worked for me in my market (value-add multifamily), but that will not be the same for everyone in every market. I always recommend that investors leverage their own personal strengths or whatever gives them an unfair advantage over the competition. The ability to do that is what sets real estate above other investment vehicles IMO. I have had success in finding off-market small multifamily buildings that are in distressed condition, buying them at a discount and forcing appreciation quickly by fixing them up and raising rents which works well because multifamily property value is based on cap rate more-so than comps, whereas single family is always based on comps not cap rate so it's harder to force appreciation. If an investor is good at sourcing off-market deals, then that is their advantage which they should leverage. Another may be good at rehabbing efficiently and so flipping becomes their forte. Another may excel at something else and they will do best focusing on that. Almost all successful investors that I know have an unfair advantage. Most also stay local to one area or just a few areas that they have intimate market knowledge of, literally house by house and they have many personal connections in the market (PM's, trades, agents, title companies, lenders, birddogs/wholesalers, etc.). Without that, the risk increases substantially.
For your business model, it seems that you're good at raising capital, deal structuring, and you have a neat banking-style approach to acquiring assets. I think buying larger assets with more cash flow may be a better fit for you than turnkey SFRs. I'd reach out to some commercial brokers in favorable locations (strong fundamentals, recession-proof markets considering where we are in the market cycle and the economic forecast calling for recession) and see about getting into the multifamily space. I have no problem with turnkey for certain investors, but it doesn't seem to fit your model IMO. I'd be concerned primarily about the lack of positive cashflow given your projections. From what I know about REI Nation is that they are very well-regarded and considered the leaders in the space. However the way that they project cashflow has been discussed and debated at length in these forums and what you should know is the 4% number comes from the assumption that owners only hold these assets for a few years and don't do anything major to them (the owner has discussed his justification for the lower-than normal operating cost projections on here, not to put words in his mouth but my understanding from reading his comments is that because they rehab the properties well before sale, and because most of their clients only hold a few years, the assumption is they won't have the normal expenses involved with maintaining properties over time). That's fine and I get it, but what this essentially means is that the projections only work under the assumption that investors will only hold for a limited time, won't ever need to do anything major to the properties, and will basically kick the can down the road for the next owner in regards to repairs, maintenance, and capex. My issue with that is in my experience capex issues don't follow a schedule. They come up for me randomly and often at the most inconvenient times. Also if you plan to hold more than the average REI Nation client, then you need to adjust the operating expenses to a normal estimate. I don't like using percentages personally, because they're derived from a somewhat arbitrary number. I like to total up everything I think the property will need during my hold period and divide that by the number of months in my intended hold period to get a more accurate operating budget, in order to have adequate reserves and predict overall cash flow beyond a single perfect month or year. For example if the roof is 15 years old, has a life expectancy of 20 years, and my intended hold period is 20 years, I can extrapolate from that how to budget for the new roof. I do this with all the major expenses: mechanicals, appliances, roof, finishes, driveway, sewer line, landscaping, etc. This is a much more accurate way to come up with a budget but obviously more time consuming and requires real expertise and construction experience/ knowing what all these things cost. I pad these numbers out for unknown expenses of which there are always, always a few. I would consider this actual conservative underwriting and using a percentage-based approach as more of a "back of the napkin" type starting point to see if it's worth doing a deeper dive, and nothing more. Creating an actual budget for an individual property almost always comes out to a lot more than what one might expect (which is why so many investors in low-rent SFR's fail), so I only invest in properties with high rent and minimum $300 monthly positive cash flow that can cover all the expensive things that properties need over time. So I'd recommend using more accurate budgeting as if you're planning to hold the properties long enough to incur some of the actual expenses related to operating a rental over time. Of course in order for turnkey investments to be attractive for investor clients, running the numbers in a way that shows them cash flowing positively is a must and so we end up with a woefully inadequate repair budget that only works when the investor will not own the property long enough to have any repairs. Also a large portfolio of SFRs is less liquid than a few larger assets. Your worst case scenario is a run on the bank coming at the same time as several big-ticket capital expenses, tenant issues or a market downturn/transition to a buyers market, preventing you from being able to sell quickly if needed and cash out investors as necessary. Owning fewer, larger assets would give you economy of scale which creates more cashflow, less legwork on acquisition and management, more liquidity, etc.

Thanks for sharing your experience in multifamily. I'd love to sit down one-on-one with you and compare the numbers of one of your deals the way you currently finance it, with the numbers you would achieve if you financed it my way.

I don't personally want to stay local in one market, rather I want to buy a large portfolio of cashflowing properties I can essentially buy off the rack and be hands off with across many markets (currently AL, AR, IL, MO, MS, OK, TN, TX) so that they track the average performance of cashflowing property across the entire market. This average performance is good enough to give me the return I need to pay my investors. As mentioned, the net positive cash flow in 2021 was approximately $70k, and I'm on track to double that in 2022. Let's please be clear that is after a lot of maintenance. Big expensive maintenance. I wish to state emphatically that this is a healthy cash flowing portfolio.

What percentage of rent do you consider reasonable to budget for vacancy and maintenance for a long term hold? Let me know, and I'll plug it into my spreadsheet, and I'll be able to tell you right away whether or not the portfolio still cash flows at that level. Better yet, message me so we can set up a time to talk one-on-one.

There are multiple valid investing styles. With single-family I get appreciation without having to increase rents. I get geographic diversity which helps with reducing the risk that any particular city dies whether through economic or environmental adversity. In my mind, smaller eggs in many baskets is lower risk than bigger eggs in fewer baskets. And what I'm doing is good enough. I'm not adverse to learning, but the things I wish to learn at the moment are how to get bigger and help more people. My investing style is adequate to do that.