All Forum Posts by: Bill Renner

I have now been through the 2000 and 2008 crashes. What we know for sure is that real estate always goes up AND down. 

Diversify your portfolio. Build three buckets including Wealth Preservation, Cash Flow and Accelerated Wealth.

1) Wealth Preservation. Buy super safe investments that historically don't lose during crashes. One option is first deed of trust notes at 8% at 50% LTV in an collateral that cash flows. Another higher return but safer option is tax lien certificates at 12% to 18% IRR.

When you understand blended cost of capital, then you understand how to make money in real estate. If you can raise money from private money at 8% through securitization can use the capital at a 2-to-1 ratio to get tranche money at 3.5%, then your blended cost of capital is 5%. At 5%, you can arbitrage things like tax lien certificates. And in the worse case scenario where the tranche market freezes, you can still arbitrage the private money at 8%.

Hard money lenders in 2008 went under because they were getting 5-to-1 tranche to cash/equity leverage, investors turning keys in or getting foreclosed, drop in collateral values, and their underlying investors getting nervous and wanted to get out. 

By nature, I am the type of person who does everything 10x. Investors like me to acquire too many properties and grow too fast. You can be your own worst enemy. When you acquire 80-100 properties a year, it's hard to get enough construction crews at least in my area. You add issues with labor regulators. And you expose yourself to market crashes. So here is how I strategical decided to prepare for what I believe is a market crash in the near future... Decided to slow down.

I simplified my acquisition strategy to what I call for myself the 10-10-10 rule. My simple annual goal now is to acquire 10 tax lien certificates or other Wealth Preservation strategy, acquire 10 BRRRR properties in Tacoma or other Cash Flow strategy, and build 10 townhouses or other Accelerated Wealth Strategy. I ended flipping as I think it is getting to risky and will explain below.

2) Cash Flow. Contrary to what some are saying here, I don't think cash flow properties are as safe as people think especially in the turnkey areas.

George Soros has a theory called reflexity that says that the crowd puts together a consensus that becomes the "established norms" until a catalyst changes the paradigm and then changes the consensus on the "established norms." In turnkey areas, appraisers are challenged by the comps that are not rehabbed and the comps that are rehabbed. The turnkey providers set the market for comps based on their rehabs and create a false sense of security on the values. When the market crashes, the consensus for these values change dramatically. These rehabbed comps get foreclosed, out of state investors sell out in fear and the rehab comps drop closer to the non-rehab comps. Is your cash flow properties really that safe?

You have to also buy in the right locations. It maybe deceptive to buy into the 2% rule because of lot of properties that fit the 2% rule are in C- and D areas. It is getting harder to buy turnkey properties in A and B areas that fit the 2% rule. So a blind reliance on the 2% rule may blind you and this is the challenge buying out-of-state properties from turnkey providers.

Cash flow properties to me is not a long term strategy. I like to buy cash flow properties when my acquisition price exceeds the replacement cost. When this happens, it is wise to buy as many as you can but you will get very high returns with a lot of safety. With cash flow properties, you mostly buy at the bottom and selectively add each year. Then you sell high and often times way before the market top (as you cannot predict the market top).

I look for 20%+ return in my cash flow part of my portfolio and it is important not to cross collaterize all of your cash flow properties and to get 30-year rates. I use BRRRR and my average deal has 30% equity when I purchase. I don't touch the cash flow income generated on my 80 cash flow properties but instead use the income to pay down the debt. Since I do only "gut out" rehabs on these BRRRR, my capex is minimal for the first 5 to 8 years. I also don't use banks and use 100% private money, which I realize is not something most investors have access to. Having over leverage and relying on banks is a way to lose everything when the market crashes.

3) Accelerated Wealth. I got of flips because everyone in my area is trying to flip now. But if I were flipping, here are some observations. In my left leaning state of Washington, I found that construction doesn't scale. In most businesses when you expand your operations, economies of scale make it cheaper and more efficient and you decrease your expenses. My experience at least in my area was that I hired more workers and ran more crews that it was getting more expensive as I grew it. What most rehabbers don't think about is risk management. Flips are difficult because investors do not know how to estimate costs related to risk management. As an analogy, most flippers are driving around without car insurance. They will probably be okay without car insurance until they are not okay.

Long story short, I found that I cannot beat the market when it comes to construction. Every time I think I am beating the market I always not budgeting the right amount of risk management. I found that every area has a going rate per sq ft for construction. In my area, a gut out rehab costs $75 per sq ft right now. A BRRRR rehab costs $50 per sq ft. A cosmetic rehab costs $35 per sq ft. These prices are kind of ridiculous because I remember paying half of this just 4 years ago. In my opinion, you cannot beat the market rates on rehabs at least in my area. You maybe beating the market driving around without car insurance, but the one accident you get into without insurance will average you back to the market rates.

I see flippers every day trying to pay $40 per sq ft on a $75 per sq ft rehab. They blame the contractor for their woes. If you try to do the rehab below the market rates, you will be hit with inferior quality and it will take forever. Most investors get lucky with a contractor on their first two dealings with the contractor. They don't realize that the contractor lost a ton of money. On the third project he does for you, he will want to recover his losses. That's why the "good contractors" are only on your first two projects.

So if you can't win on the construction side, then how do you win on flips? You have to win on the blended cost of capital side and on the deal acquisition system side. 

Interestingly, I have access to $30 million at 5% blended cost of capital and I still think flips are risky right now at least in my area. I even have deal acquisition systems that get better deals than almost everyone in my area and have two construction companies. Many rehabbers are paying 17% blended cost of capital through their hard money AND not acquiring at 70% per sq ft minus the market rate construction cost per sq ft.

On a typical cosmetic flip in my market, the acquisition price is $425,000 and needing $75,000 in rehab. When you take out the hard money loan at $500,000 at 12% and 3 pts, you're paying about $20,000 up front. If the average timeline to finish the rehab and get the property listed and sold is 8 months. You paid $5000 a month in interest times 8-months or $40,000 in interest. You probably also had to pay an extension fee of 2 pts when passing the six-month mark for another $10,000. That is $70,000 if you close in the average time.

Now let's say the electrical subcontractor flaked out and caused you a 3-month delay. Same $20,000 upfront cost, $60,000 in interest and $20,000 in extension fees. Total is now $100,000. If the ARV is $750,000, the hard money in this example accounts for almost 14% of ARV with just one delay.

Now let's say the market goes through a 2008 crash and the average sales time is 18-months. $20,000 up front. $120,000 in interest, $100,000 in extension fees and hard money refinancing. The ARV also dropped to $650,000. The $240,000 cost is going to lose you $160,000. So the best hope is to finance into a bank loan but oh that's right the banks shut down lending. You can see why flips are pretty risky if you use Hard Money and can't get out before the market crashes.

I do believe the market correction or market crash is coming, but that doesn't mean to stop Accerelated Wealth strategies. Just having to lower the cost of capital and getting very very good deals. I look for deals that will get a 100% IRR and only find that in urban townhome development. But you always need to assume the worst and have multiple exit strategies. But I diversify and have 70% of my capital in Wealth Preservation and Cash Flow.

So going back to doing things 10x. I just have too much energy and can't sit still. So I am diverting all of this energy into setting up self-directed solo 401(k) groups nationwide. I learned in the last crash that the only capital available during the 2008 crash was the $18 trillion in qualified retirement money. 

The best hedges to a market crash are having your own cash (or cash equivalents such as the cash value in a life insurance policy) and having access to private money at a lower cost of capital.