All Forum Posts by: Eric Fernwood

Hello @Michael Baum,

If I gave you the impression that I would purchase a low-quality property with the hope of future appreciation and rent increases, that was not my intent. You should never buy a bad property. I agree that low-cost locations can provide good initial cash flow. So, if your only criteria is initial cash flow, then low-cost locations are the way to go.

Financial security is the goal of most real estate investors. Financial security means that the income must continue for as long as they and their spouses live, which could be 30 to 50 years. Additionally, the generated income must keep pace with inflation because we live on buying power, not a fixed number of dollars. An example will illustrate this point.

Suppose that every time you go to the grocery store, you buy the same basket of goods and today they cost $100. The table below shows the decline in buying power over time, based on the difference in rent growth versus inflation. For example, if inflation is 6% and rent growth is 1%, the rate of buying power loss is 5 %/year.

If the difference between the rate of rent growth and inflation is 4%, in ten years, $100 will only be able to buy 66% of the groceries it can buy today. In 20 years, $100 will only buy 44% of the groceries it can buy today. Therefore, buying properties based solely on their initial return is unlikely to provide the long-term financial security people are looking for, because rents will not keep pace with inflation. So, I recommend a long-term view instead of only the initial cash flow.

I looked up the stats on Coffeeville, KS. The population has declined since 1960. So, as long as the refinery jobs exist, your friend will do well. However, if the refinery jobs go away, there are few alternative employers. Again, it is the difference between a short-term view vs. a long-term view. I know that I would not want to bet my financial future over the next 20 to 40 years on a small town with a declining population and only a few employers.

Source

Hello @Greg Parker,

There are many low-cost locations where people can invest (Mobile is a beautiful city.) Where people should invest depends on their goals. If their only goal is immediate cash flow, then there are many options. If their goal is financial security, location choices are limited.

Financial security means that the income must continue for as long as you and your spouse live, which could be 30 to 50 years. Additionally, the generated income must keep pace with inflation because we live on buying power, not a fixed number of dollars. An example will illustrate this point.

Suppose that every time you go to the grocery store, you buy the same basket of goods and today they cost $100. The table below shows the decline in buying power over time, based on the difference in rent growth versus inflation. For example, if inflation is 6% and rent growth is 1%, the rate of buying power loss is 5 %/year.

Assuming a 4% difference between the rate of rent growth and inflation, $100 will only purchase 66% of today's groceries in ten years and 44% in twenty years. This demonstrates that buying properties based solely on their initial return is unlikely to provide the long-term financial security people seek, as rents will not keep pace with inflation. Therefore, I recommend taking a long-term view rather than focusing solely on initial cash flow.

Below are some considerations when choosing an investment location.

• Increasing state and metro population - Property prices and rents are likely to remain the same or decrease if the population is static or declining. It is population growth that causes prices and rents to increase. Therefore, never invest in any city if either the state or city population is static or declining.

• Minimum population size - My cutoff is 1 million people. Smaller cities tend to be too dependent on a single industry or market segment.

• Low crime - The economic growth of a city is dependent on the creation of new jobs. Companies seeking to establish operations avoid high-crime locations. Do not invest in any city that appears on Neighborhood Scout's list of the 100 most dangerous US cities.

• Operating cost - Every dollar lost to overhead reduces the amount available for living expenses. The table below shows the average overhead costs and rates for Florida, Nevada, Texas, and Alabama.

Next, I compared the operating costs for a $400,000 investment property with a $15,000 annual taxable cash flow in the four states.

As you can see, operating costs make a huge difference in net cash flow.

Operating costs have a significant impact on the amount of money available for living expenses. In order to achieve the same net cash flow, a property in Texas would need to generate $6,192 ($9,736 - $3,544) more in cash flow compared to the same property in Nevada.

If your goal is financial freedom, choosing the right city to invest in is the most important investment decision you will make.

Hello @Amy Healy,

This is a question I get asked fairly often by our clients. There is no good answer but below are some considerations:

Cash-Out Refinance

Over the years, many of our clients have used a cash-out refinance to leverage the equity in their properties. However, with current interest rates at 7% to 8%, it can be challenging to see favorable returns. (I will discuss interest rate buy-down options later.)

How much would refinancing cost you in increased debt service? So I have some numbers to work with, I will assume you purchased the property for $400,000 with 25% down and a 2.7% interest rate. If so, your monthly debt service is approximately $1,200/Mo. If you refinance the same amount but with a 7.75% loan, the debt service will be approximately $2,150/Mo. Will the property still be profitable if the debt service increases by almost $1,000/Mo? Will you be able to buy another property with the proceeds at the current high-interest rates and will it be profitable?

Investment HELOC

You can get a HELOC on an investment property. However, few lenders offer such loans. I searched and found one HELOC lender that handles investment properties and below are some of the requirements.

• Typically a credit score of 720 or greater.
• A maximum loan-to-value ratio of 80%.
• Cash reserves covering six months or more and for rental properties, proof of long-term tenants.
• A debt-to-income ratio between 40% and 50%.
• There are higher interest rates on an investment HELOC than on a residence.

1031 Exchange

Another consideration is whether you want to keep the property. So far we have completed over eighty 1031 exchanges, and a significant number were from Portland.

As you know, Portland's population is declining. There are rental restrictions and rising crime. Plus, taxes are high. So, is Portland a good location for a long-term investment? I do not know Portland so I can not answer that question.

What We Are Doing to Mitigate High-Interest Rates

Currently, clients are obtaining pre-approvals for 25% down investor loans at interest rates ranging between 7.5% and 8%. To address this, we implemented a process whereby, once we secure a property under contract, we reach out to multiple lenders to obtain their interest buy-down rates. We then choose the lender with the best option and move the loan to them.

Note: Interest-rate buy-downs are also available for HELOCs and cash-out refinance.

How Long Will High-Interest Rates Last?

To determine the best finance option, it would be helpful to know when interest rates will drop to 4% or 5%. After polling many clients, the consensus is that interest rates will decline before the presidential elections. I am not that optimistic. My best guess is that we'll see 5% interest rates again in about three years, but I have no basis for this statement. Your guess is as good as mine.

When considering buying down the interest rate, take into account the length of the payback period. Some interest rate buy-downs pay for themselves in three years, while others may take 15 years. Therefore, it is important to think beyond the present and evaluate the best option based on foreseeable future events.

Hello @Ann Seffens,

What I would do depends on how the property has performed in the past and is likely to perform in the future. So far, we have completed over eighty 1031 exchanges, mostly from California. Below are some of the more common reasons clients have given for moving their investments out of California.

• Rent control and the difficulty of removing non-performing tenants.
• The populations of the Bay Area and California are decreasing.
• High operating costs: income taxes, property taxes, insurance, etc.
• Rising crime

When considering an alternate location, take into account all of the major recurring costs. Below is a table comparing California to three other states.

Sources:

• Average property tax rate
• Average Insurance Cost
• State income tax rate

So you have some perspective, what are the basic operating costs for a $400,000 property in the four states?

This does not take into account indirect costs like rent control, etc.

You asked about DSTs. I do not know enough to comment. I found this article to be informative on DSTs. However, if you do a 1031 out of California, there may be no advantage to a DST.

Hope this helps.

…Eric

Hello @Pamela V.,

Focus on your goal of financial independence rather than buying a specific property type. Whether it is an STR, MTR or LTR does not matter, as long as it gets you where you want to be.

Cash flow is not where you make the most money or scale your investments. The most profitable aspect lies in appreciation.

I have created the following example to demonstrate the benefits of cash flow and appreciation over a five-year period. Property A has an annual appreciation rate of 7%, but no cash flow. Property B has a 7% cash flow, but no appreciation. Note that between January and today, the properties we are targeting in Las Vegas have appreciated by over 10%. Therefore, a 7% annual appreciation rate is not unreasonable.

Given the current 7% to 8% interest rates, a cash-out refinance may not make sense. However, I believe that high-interest rates are not permanent.

Another factor to consider is the effort involved in operating a short-term rental. Furthermore, Airbnb caters primarily to tourists, and during bad economic times, fewer people go on vacation. A better alternative might be mid-term rentals, which primarily accommodate traveling nurses.

Additionally, you may want to consider choosing a location with lower costs. Properties that appeal to our target segment typically range from $320,000 to $475,000. Also, buy a property that is an excellent long-term rental (LTR) and use it as a medium-term rental (MTR) or short-term rental (STR). This way, if the market changes, you have a fallback position.

One last recommendation. Wherever you buy, your financial future is tied to the long-term economic growth of the city where you invest. Below are a few location considerations:

• Only invest in cities with a metropolitan population greater than 1 million. Small cities can be overly dependent on a single market sector or major employer.
• Never invest in a city unless the state and city populations are both increasing.
• Do not invest in any city on the Neighborhood Scout’s list of the 200 most dangerous US cities.
• Prices and rents are driven by demand. Where prices are low, there is little demand for housing and rents will not rise fast enough to keep pace with inflation. In such locations, it does not matter how many properties you own, you will soon be back on the daily worker treadmill because your buying power is declining every day..

Hello @Rahil Jain,

We have completed over 80 1031 exchanges, with the majority of them coming from California. I cannot provide assistance with the disaster extension and how the IRS may view it, but I do have some considerations.

• We’ve delivered over 480 investment properties to over 180 clients. All (100%) that consulted their financial planner were told never to invest in real estate. Of the CPAs our clients consulted, many also recommended against real estate. One of our clients is currently receiving over $130,000/Yr net from their rental properties and their CPA is still advising them to sell the properties. So, conservative CPAs are not uncommon.
• Simply identifying three replacement properties within the 45-day identification period is not sufficient. In most of the 1031 exchanges we've handled, we closed on the replacement property within the 45-day identification period. The reason that identifying the properties is not enough is that if you are unable to close on the identified properties, you will lose your tax deferment. By using our approach, we have time to look for a replacement property if needed.
• You cannot use the proceeds from the relinquished property for renovations. Some of our clients have paid capital gains taxes on a portion of the proceeds and used that money to cover the cost of renovations.
• Simply buying a property does not solve the problem. If your goal is financial independence, you need a passive income that meets the following three requirements. Meeting these requirements largely depends on the city where you invest.
  • Inflation compensating: Rental income increases faster than inflation, compensating for rising prices.
  • Persistent income: Your income will last, ensuring that you and your spouse won't outlive it.
  • Reliable income: Your income continues even in difficult economic times.
• When investing remotely, having a reliable local investment team is crucial. While podcasts, books, seminars, and websites can provide useful general information, what you really need is hyperlocal information that can only be obtained from a local investment team.

Rahil, I hope this helps.

Hello Allen,

Last year, we conducted a study with a few clients and produced a white paper. If you would like a free copy of this white paper, please DM me.

Below are some of the results of our study:

• Short-term rentals and mid-term rentals are fundamentally different. Short-term rentals mainly cater to vacationers. During difficult economic times, fewer people tend to take vacations. This is why many short-term rentals in Las Vegas were sold during the COVID-19 pandemic. In contrast, mid-term rentals are primarily driven by business necessity. For instance, there is currently a nursing shortage across the US, and traveling nurses help to alleviate it. Our research shows that traveling nurses usually start with a 13-week contract that may be extended. They require a place to live, which is why mid-term rentals are driven by necessity.

• The primary consumers are traveling nurses. Hospitals with trauma care levels one and two and neonatal intensive care typically have the most traveling nurses. Properties should be within about 5 miles of such hospitals. However, the property must be in a safe location, which is sometimes further than 5 miles from the hospital. See the map below for trauma and neonatal intensive care hospitals.

• There are two primary places to market furnished rentals, the MLS and sites like Furnished Finder. Our research showed that furnished properties rented through the MLS have a $.60/SF to $.70/SF incremental rent above non-furnished long-term rentals. On Furnished Finder, the incremental rent appears to be about $1.20/SF.

• Having a property manager to handle mid-term rentals is crucial. The property manager we work with offers reasonable rates for this service and will take care of inventory management, leasing, maintenance, and overall property management.

• Always buy a property that would also be a good long-term rental. You need the backup option in case the mid-term rental market changes.

• Minimizing turn costs and downtime is critical. This requires the right renovation components and speedy make-ready after a tenant departs. A renovation company that has already completed over 350 renovations for us will quickly do whatever touchups/repairs are necessary so we can get the property back on the market.

• Use electronics to control access and reduce turnover time. For example, the garage door must be remotely controlled so:

  • The property manager can remotely open it to allow delivery and service people access.
  • Access to the garage will be through an app on the tenant’s phone, no clickers or digital keypads to reprogram. Also, immediately after the tenant leaves, the access can be changed.

• Minimizing vacancy is critical. We believe the best way to do this is:

  • To ensure sustained occupancy, positive tenant reviews are crucial. Providing a simple and easy move-in process can help create the best experience for new tenants. The gateway to tenant resources will be accessible through their phones via a QR code, which will give them access to a property-specific website. This website will include links to download the necessary apps to control the house, QR codes for food delivery and other services, maps to locations of interest, requests for repairs, and more.
  • Attractive furnishings. There are multiple companies that, given the dimensions and such, will provide a list of everything you need, down to spoons and salt shakers.
  • High-quality photos. The photos must show a bright, attractive, friendly property. For several years we've worked with a commercial photographer so we can get quality photos at a reasonable price.
  • Currently, properties are marketed solely with photos. We will create a unique website for each property which will increase its desirability. This website would include a walk-through video, more photos, information on what to do in the area, shopping recommendations, places to go, and things to see. By providing an overall guide to the area, potential tenants will realize that there are many things to do and places to go, increasing the desirability of the property.

  This is a summary of the study. If anyone is interested, DM me for the complete study.

• ...Eric

Hello Sophia,

Happy to share.

As an example, I will estimate the overhead for the Triangle. Below are the steps.

• I went to this page: State income tax rate, and got the minimum income tax rate for North Carolina: 4.75%
• I went to this page: State average insurance rate, and got the state average insurance cost for North Carolina: $1,800
• I went to this page: State property tax rate, and for the state average property tax rate: 0.84%

Now that I have the basic data, I assumed the investment property would cost $400,000 and the cash flow would be $15,000/Yr. (Change the numbers to match your specific situation.)

I then estimated the overhead as follows:

• Income Tax: $15,000 x 4.75% = $712
• Insurance: $1,800
• Property Tax: $400,000 x 0.84% = $3,360
• Total: $712 + $1,800 + $3,360 = $5,872

This is only an estimate but is close enough for comparing state overhead.

...Eric

Hello @Chris Rodriguez,

The decision on whether to Flip or BRRRR is straightforward, which I will explain. Your statement that you do not want to manage tenants is understandable. I will address this first.

Property Managers

We have delivered over 480 investment properties to more than 180 clients worldwide. However, only one client manages their own properties. Why? Because even though you may think you can save money, one bad tenant can cost you far more in the long run. Additionally, managing properties requires a significant amount of time and expenses if you do not have access to the right service people.

As an owner of 6 investment properties in Las Vegas, I have found that using a skilled property manager is essential for making money, lowering maintenance costs, and avoiding tenant issues. If you would like my free guide on selecting a good property manager, please DM me. (Spoiler alert: Do not base your decision on selecting a property manager based on Yelp reviews.)

Flip or BRRRR?

Ask yourself the following questions:

1. Is the property currently profitable (after all recurring expenses) and are rents and prices increasing fast enough to keep pace with inflation?

• Yes - Keep the property and consider BRRRR.
• No - Flip or 1031 the property.

1. Does BRRRR make sense?

• Do you have enough equity in the property to do a BRRRR (ARV)?
  • No: Flip or keep the property and continue renting.
  • Yes: consider BRRRR.

1. Does Flipping make sense? Do you possess the experience and resources necessary to successfully flip the property and generate a profit?

• No: Unless you have the experience and skills, chances are you will lose money flipping. If anyone wants my free guide on profitably flipping properties, DM me.
• Yes: Determine how much money you will net and decide based on this.

Other Considerations

• Many of our clients used BRRRR to expand their portfolios. However, when interest rates are as high as they are, it requires further consideration. For example, suppose your property is profitable with the existing loan at 3.5%. If you refinance the property, will it still be profitable at 7% or 8% and with a higher principal?
• Making money flipping is not easy - I often read about people advocating for flipping properties as an easy way to make money. However, flipping is far from easy. We encounter properties three or four times a month where someone is selling a flipped property but failed to sell it for enough to even cover their expenses. Zillow's attempt at flipping is a good example of a large-scale failure, which they eventually stopped. Another example is Open Doo. We occasionally see their properties on the market and it seems they are losing money on many of them.
• What we are doing to mitigate high-interest rates - We implemented a process whereby, once we secure a property under contract, we reach out to multiple lenders to obtain their interest buy-down rates. We then choose the lender with the best option and move the loan to them.

Summary

Deciding whether to flip or use the BRRRR method is largely a spreadsheet decision, especially during times of high-interest rates.

Hello @Khaled El Dorry

We’ve completed over eighty 1031 exchanges and I can make a few suggestions.

• Although it is possible to coordinate the sale of multiple properties simultaneously, it is not an easy task. One option is to offer the properties for sale with a “closing date to be determined.” This may limit your pool of buyers and could result in a slightly lower sale price. However, it is the most effective way I know to have all properties close nearly simultaneously.
• The odds of everything going right with multiple properties are small. Therefore, I would suggest planning on purchasing two or more properties. This will make coordinating the sale of the relinquished properties easier.
• You are not allowed to use the proceeds from the relinquished property to pay for renovations. Some of our clients have opted to pay capital gains tax on a portion of the proceeds and use that money for the renovation.
• Not all purchase contracts include 1031 exchange verbiage. Obtain the correct verbiage from your exchange agent and include it in the agent-to-agent remarks, specifying that the 1031 text must be included in offers..
• If you need the name of a 1031 exchange agent, I can recommend three who are very good. If you would like their contact information, please DM me.
• If you do all the properties with one agent, ask for a discount.
• Be aware of the 45-day identification period. Although you only need to provide details for three potential properties, there is no guarantee that you will be able to secure those specific properties. We coordinate the purchase of the replacement property with the sale of the relinquished property. For instance, we recently had a client who was selling a property and buying five replacements. Once the seller had the relinquished property under contract, we made offers on the replacement properties. As long as the replacement properties do not close before the exchange property, this approach will work. It has allowed us to close on the replacement properties within about two weeks of the start of the identification period. By using this approach, if something does not work out with one of the replacement properties, we still have enough time to contract another one and stay within the 45-day identification period.

Hope this helps.

…Eric