Seeing Greene: Cash Flow—The Most Overrated Metric in Real Estate?

David:
This is the BiggerPockets podcast, show 558.

David:
Sometimes taking the safe road is the quickest way to guarantee that you lose. It doesn’t mean you should be risky but it does mean that you should not assume conservative or safe equals success. Sometimes it doesn’t and this is one of those areas. If they stay on the path that they’re on, they’re not going to hit financial freedom, they’re going to be working for a lot longer.

David:
What’s up everybody? This is David Greene, your host of the BiggerPockets Real Estate podcast. Today here with a Seeing Green edition, where you will be submitting your video and forum questions and I will be doing my absolute best to answer them. Now, Brandon isn’t with me today, he’s with us in spirit and we put a little funny Easter egg into this video. Please, if you’re watching it on YouTube, watch all the way through and if you’re not, go check it out on YouTube, it’s going to be probably somewhere near the middle to the end of it that I think Brandon will get a kick out of.

David:
Today’s show is all about teaching you how to build wealth through real estate. We do that by bringing on top performers, expert investors and just everyday regular people and laying out those tactics and mindset that they have developed that will help make you financially free. But here’s the thing, you got to make the simple and consistent decision to take constant action and that’s really what today’s about. We are digging deep into the problems people are having, hurdles that they’re experiencing or just decisions. I’m at a trail and I can go to A or B, how do I know which one to go? I know all of you are thinking it, I’ve thought it many times in my life, I still think in it many ways. I love being able to share what’s in one person’s head with the rest of the BP community.

David:
In today’s show, we get into some awesome, awesome things. Make sure you watch it all the way through. We talk about why rents don’t keep up with the value of homes. Have you ever wondered that? Why is it that when homes appreciate the rents don’t go up to? I’m going to give a very detailed and thorough answer that should shine some light on why that happens. We talk about how to choose which market to invest in. When you live in one but you could invest somewhere else, do you have to pick one? Can you invest in both? What types of things should you get into in each individual market? And then we talk on how to decide between investing in someone else’s fund, like what Brandon’s doing with Open Door Capital versus buying your own deal. What to expect, what the pluses and minuses are of each and a strategy that allows you to do both. That and more is waiting just ahead.

David:
Now, we can’t do this show unless we get questions submitted from you, the awesome audience so I’m going to ask you to please go to biggerpockets.com/david and submit your video question. Now, if you have a question but for whatever reason, you don’t think it’s worthy of the show or you’re just too shy, that’s okay too. Go to the forums and ask it there. You’ve got over two million BiggerPockets members that are all present on that site that can help you with that question.

David:
I’ve asked you all to leave some YouTube comments and I want to share some of what those are and encourage you to keep leaving them because we do read them and we do try to make these shows in accordance with what everybody wants. The first one comes from, looks like Yugen, “Great content. Everything is perfect so far as you manage to incorporate life lessons on each question.” Well, that’s pretty cool. Thank you for that, Yugen.

David:
From Georgie Brennon, “I just wanted to say thank you, David Greene. I spent the better part of a year developing my resume and applying for jobs with no success. After hearing your job search story, I called a buddy and asked if his company was hiring. I got an interview in two days and a job offer the next day. LOL. Thanks again, man.” That feels pretty good. That’s pretty cool.

David:
And then finally from Jay, “Great analogies, just like that two loan offers with a few thousand dollars difference in closing costs on a refi, the higher closing costs ended up better as the lower interest paid back the difference closing costs in 22 months.” That is awesome. That’s exactly what I tell people is oftentimes you want to look at how much higher the closing costs are, what the rate difference is and see where your breakeven point is. You’re probably going to have the property more than 22 months. That’s an amazing application of exactly what we talk about here and I’m glad that I got to help save you some money.

David:
Again, I just want to remind you all, make sure you watch this one all the way to the end. And without further ado, let’s bring in our first guest.

Clyde:
Hey, how’s it going, David? I’m Clyde and that’s little Clyde. Basically my question today is about acquisition. Properties for investors in my area are going for about $200,000. I currently have a HELOC for $100,000 and I’m just wondering which route I should take in order to finance the property. It really doesn’t seem like 20% down will work because I’m sure that a lot of these people want their money immediately. I was just wondering which route I should take or should I use the HELOC to do hard money? I’m not really sure what to do. Thank you for this time and I appreciate everything you are doing at BiggerPockets.

David:
All right, Clyde, little Clyde, thank you very much for asking that question. It gives me an opportunity to answer some stuff that I really like. We can also tell that little Clyde here is going to be very financially savvy when he gets older, if he’s listening to BiggerPockets in the crib. Your question, if I understand it correctly is, should I put 20% down on an investment property when the market’s really hot and people are looking to sell to the strongest buyer? Or should I take out a HELOC of a 100,000 plus a 100,000 of hard money so that I can write the equivalent of a cash offer? And I want to take a minute to sort of explain what sellers care about when they’re taking an offer from a buyer.

David:
The first thing is that whether the cash is coming from your bank account or it’s coming from a HELOC or it’s coming from a hard money lender or it’s coming from a conventional lender, it’s all cash to the seller. They don’t care where that cash is coming from. The reason that they don’t like when a buyer is buying a house with a loan, is that the lender will have conditions that they want the buyer to meet or the property to meet in order to lend on the property.

David:
That could be something like an appraisal. If the house appraises for less than what you put under contract for, the bank or the lender is worried, they’re getting a bad deal so they want you to put more money in the deal to make up the difference in the appraisal. It could be them looking at you, Clyde as the borrower, specifically what’s your debt to income ratio? What your credit score? How long have you had your job? Did you get your hours cut back when you’re in the middle of escrow? Those are all things that can throw deals off when you’re borrowing money to buy the property.

David:
What I’m highlighting here is it’s not the fact you’re getting a loan. It’s the conditions associated with the loan that cause the problem. You could go with the hard money lender and they typically have less conditions associated with the loan. Now again, it doesn’t matter to the seller where that money’s coming from, what they care about is how you wrote your offer. If you’re waiving a loan contingency and you’re waiving an appraisal contingency, in many ways that now is the same to the sellers if you’re paying cash. If you back out of the deal, you would lose your deposit. Same goes with a cash offer. That’s the first thing to understand is loans themselves are not what’s bad, it’s the conditions associated with the loan.

David:
Now regarding the down payment that you asked about, is 20% down not enough for these people because they want their money? I just want to highlight their money comes at the close of escrow. When you put in your 20% and the bank puts in there 80%, it’s all the same to them. It doesn’t matter where it comes from. They just want that money. The reason that sellers will often say, “I want a bigger down payment,” is not because you’re giving them more money. That’s what it feels like to you. You’re putting more money in the deal but it just means the bank is putting in less money. What the seller’s concerned about is if you don’t have a lot of money in the bank, you’re going to get scared and you’re going to back out of the deal.

David:
We sell high price real estate in Northern California. It’s not uncommon. I’d say maybe half my deals are in the million dollar range. And if you’ve got 200,000 to put down and another 400,000 in the bank, when that roof needs to be replaced and it’s a $20,000 roof or something like that, that doesn’t scare you. You don’t back out of the deal when you got $400,000. If someone says, “I can put $600,000 down,” the agent, the listing agent and the seller both feel good that that deal’s going to close because they have enough cash. They’re not going to get scared. When it’s an FHA loan, when it’s a VA loan, when it’s a low down payment loan, it doesn’t mean that the seller’s getting less money, it means the buyer is more likely to get scared and back out of the deal. And that’s why they don’t like these buyers that have low down payments.

David:
Now 20% is very strong. That’s not low. Here’s my advice to you. I don’t think you have to go through the HELOC and the hard money, which is more expensive lending than the conventional lender that you’re already working with. I think 20% is fine. Don’t worry about putting more money down, worry about showing proof of funds that shows I have more money than this 20 grand. If it’s a $100,000 property, you’re putting $20,000 down, show them that I have another $80,000 in the bank and then write your offer in a way that gives them more protection. You may say, “I’ll do a really shortened period for the inspection and I’ll do a shortened period for my loan contingency,” so that they know in seven days or in 10 days you’re committed or you’re not committed. That’s what the seller cares about.

David:
I think personally people get too caught up in the down payment. The sellers don’t care about the down payment. The sellers care about how much money you have, that you can close the deal. The lender or cares about the down payment. You should only be increasing your down payment if you want to or if you’re getting a better deal on the loan, not just because the seller wants that. But thanks very much for asking this question. I really appreciate that and send little Clyde my love.

David:
Let’s go to the forums and the Facebook groups of BiggerPockets and pull out a few questions. The support that you are all giving each other is awesome and I’d love to see you keep that up.

David:
First question from Diana C. in New York says, “I’m trying to wholesale real estate and build some capital to be able to buy rentals. However, I do not have a job with W2 income. When I earn enough money through wholesaling, what can I do to start buying rentals since typically I need two years of income to qualify for a loan? Is there anything else I should be doing right now?”

David:
Very good question, Diana. And unfortunately, in this case, the struggle is real. It is true that if you want to get conventional financing, you’re going to have to show not always two years but a period of time where you’ve been making money. And you may find that that wholesaling income doesn’t count the same as W2 income. You’re an 1199 independent contractor when you’re making money as a wholesaler, you’re not working for someone else. That money is not steady and consistent. It varies from deal to deal. There’s a very good chance that even if you do build up income from two years from wholesaling, that’s going to make it harder to get loans to buy real estate. And this is one of the reasons why I don’t encourage everybody to quit your job and just jump into this thing because financing is highly dependent on consistent income.

David:
Now you got a couple things that you can do if you want to start buying rentals and you’re making money through wholesaling. The first thing is the boring thing. You could just get a job and do that while you wholesale and make sure that you make enough money from that job to get financing. The second thing is you could find a cosigner. You could find a person who does have consistent income, that will help you qualify for the loan and either pay them to be able to help you get the loan and not put them on title or put them on title and give them a share of equity. Either way is an option that you could use somebody else’s income if you don’t want to get it to help you qualify for that loan.

David:
The other thing is you could do direct deals with sellers. You’re already wholesaling. You’re talking to sellers and you’re getting properties put under contract. Maybe a couple of these you could just buy on terms instead of wholesaling them to somebody else. You get a $120,000 property under contract, and you say, “Hey, instead of selling this house and getting your money right away, what if I buy it from you and I make a payment to you like you’re the bank?” The seller of the property might not care that you don’t have a W2 job like a conventional lender would, that’s another way that you can get around it.

David:
And lastly, you could start a partnership with another investor and you could bring money from your wholesaling into the deal and they could get the financing. That’s another way that you could be able to put deals together. And the last one I would say, I just thought of this, is you could buy commercial properties. If you buy commercial properties, you will be able to use the income from the property to qualify for the loan, not the income from you, Diana. My mortgage company has a product where we do this all the time for people. We get them loans based on the money coming in from the property and we make sure it covers how much the property is going to cost. And we can go in qualified irregardless of how much money that they are actually making in their own personal life. You are going to have to be more creative but it’s not impossible.

David:
Next question comes from him. Nate L. in Kansas. He actually has two questions so let’s get to the first one first. “In your experience, if you transfer a property into an LLC, does a lender see the business as the holder of the property or would they still include that on your debt slash income since you’re backing the LLC? Or does this vary by lender?” Now, this is one of those questions that I’m going to answer but I do have to say, I am not a CPA so I can’t give you tax advice but here is how I understand it.

David:
The first part A, yes, it does vary by lender. There’s certain companies and products we have that don’t look at it like the debt is not on your name, it’s in the LLC’s name and so it doesn’t count against you. But conventional lenders, where everybody tends to want to be because they have the best rates and the best terms, they will usually look at the LLC and hold the debt and the income against you. And the reason is, LLCs are pass through corporations. Even though the property is owned by the LLC, you own the LLC and so you are one who is responsible for managing that LLC, which means that the debt the property has is going to be held against you. But the income will be also. If you’re buying income producing properties, this does not hurt you nearly as much and you don’t have to worry about it as much either.

David:
The exception to this would be not an LLC but a C Corp. C corporations are looked at as separate I identities. This is why I’m saying I’m not a CPA because this enters into the question. And instead of the C Corp being passed along to you or the income passing through to you, it stays in the C Corp and you are basically an employee of that C Corp, meaning all of the property that the C corporation owns, you’re not responsible for the same as you as an employee would not be responsible for whatever company that you work for, the real estate that they own. That’s one of the benefits of the C Corp. The downside obviously is it’s harder to get money out of them and there’s more rules with how to structure them.

David:
The second part of Nate’s question is, “When using the BRRRR method, I always hear you say, ‘Get pre-approved before looking for a property.’ Does this apply to both the hard money lenders to purchase initially in rehab and the bank lender you’re going to refinance through?” That is a very good question, Nate. And the answer is, yes, it would apply to both. You know that the last stage of BRRR, well it’s repeat. The one right before that is going to be refinance. You want to make sure that the lender you’re going to refinance through is going to give you the loan. They’re going to probably look at your income, your debt to income ratio, the debt that you’re carrying, your credit score and they’re going to say, “You would be pre-approved to get a loan for this amount, with X amount of equity.” If you’ve got 20% of equity in the property, they’ll give you 80% loan of a certain amount they believe you can repay. You definitely want to do that before you get jumped into this project.

David:
The second piece is that you don’t want to go writing offers on properties if you don’t know if you have a hard money lender, if that’s who you’re going to use, that will even approve you for the deal. You got to talk to the hard money lender if that’s what your goal is and find out what other criteria they have to let you buy that property. Do they care about how much equity’s going to be in it? Do they care about the area that it’s in? Do they care about the price point? Every hard money lender is different. They’re not all selling their loans to the same places like conventional lenders are. They have their own unique criteria because they have their own set of investors that are putting money to buy these properties. Absolutely talk to both of them and get a very clear picture of what they want and then target your search based on those parameters.

David:
When I myself was sort of amplifying my portfolio with the BRRRR strategy, I realized just how important financing was. Once you get more than 10 financed properties, you can no longer get conventional loans, which is what everybody’s used to. These are Fannie Mae, Freddie Mac loans. You as the person who’s buying it don’t always know or care what type of loan it is. You just want to know what the terms are. What’s my interest rate? What are my closing costs? Is it fixed or adjustable? People don’t understand why certain loans are better than other loans but once you get more than four, those conventional loans, which are typically the cheapest, become harder and at 10, you can’t get them anymore, especially for investment property. You’re forced to find alternative sources of lending.

David:
And what I found was, even though I was a very good investor, I bought very good deals, I added a ton of equity to it, I made good money, lenders just didn’t want to lend to any investor that had more than a certain number of properties. And so I found myself getting close to not being able to finance deals because I didn’t know the rules of the lender. I actually found a bank that let me take out a line of credit that would let me borrow 75% of the appraised value after my rehab was completed and I would finance those deals on that line of credit. And then when I used up the whole line of credit, I would refinance into basically am umbrella alone where all those properties were put together in one bunch and analyzes if it was a multifamily property. 10 single family houses would be looked at like a 10 unit apartment complex.

David:
But what I’m getting at is my whole strategy was put together based on what the lender required. I had to build what I did around what they would allow. That’s how important financing was. Don’t be afraid to do the same thing. If you’re hitting a point where getting a loan is hard, find out how you can get the loan and then put your strategy together to comply with that.

Matthew:
Hey David, sorry about the shirtless, but at the local pool soaking up the day. My question is, by the way, love all the content on BiggerPockets. Fantastic. I learn tons. My question is, I own my primary residence mortgage in my name, my fiance, soon to be wife, pays half the mortgage. Is there a way that you know of that I can show a potential lender that she in fact does pay half the mortgage so my debt to income ratio reflects more of what reality is? Again, thanks so much. Love the content. Thank you.

David:
Hey Matthew. First off, don’t apologize for being shirtless. I’m shirtless too. This is some really hot content we’re making and it makes it hard to stay fully clothed. I understand. Now when it comes to your question, you are in a bit of a conundrum here. If I understand you right, you’re saying that you own the property in your name and the loan is in your name but your fiance has been making half of the payment and so you’re not technically on the hook for the full amount and you’re wondering if there’s a way that you can show a lender this is a situation that we’re in, the $800 or whatever it is that she pays I shouldn’t have held against me.

David:
Now here’s the problem. While that may be happening in practical terms, you’re the only one that’s on the hook for that loan. If your fiance broke up with you, decided she didn’t want to make that mortgage payment, got her own house, whatever would happen, you would still be liable for that full payment. And what they’re looking at is what is the debt that you are liable for? What do you have to pay, you’re responsible for? Not what are you actually paying? Now you may find some unconventional lender. We’re talking about hard money lenders, private financing, some of the non-qualified mortgages that our team does. By the way, those are not as expensive as you think. I do on myself and oftentimes it’s rates between four and four and a half percent. They’re not bad at all. That may give you an exception.

David:
But anything conventional that you’re talking about, I’m not aware of anything you could do to get out of it. The only thing you could do is add her to the loan basically and have her responsible for half of that payment. But even then, usually what happens is both of you are responsible for the full payment instead of splinting it in two. Unfortunately on this deal, that’s probably not going to work out for you unless you refinance the property in a different way or you found a lender to do your next loan that wasn’t conventional. If you’re in one of the states that we operate in, send me a message, I’ll get you connected one of our guys and see if we can help you with that. If not, you’re probably going to have to increase your income or lower your debt or buy the next property in your fiance’s name and let her debt to income ratio, which isn’t affected by your property, be what they use to qualify you.

Dustin Byer:
Hey David, thanks for taking my call. My name’s Dustin Byer and my wife and I had kind of a mental roadblock question for you. We have a net worth of around $2 million and we run a bunch of businesses and we have four kids ages four through 12. We’re rather busy. All of our net worth is tied into those businesses and the house that we live in and we were trying to basically diversify and create more passive income. And so we can invest about 10,000 a month. And my question is, would you invest in those small things along the way? Or save and stick it in something like Brandon’s Open Door fund since we’re so busy all the time? Curious your thoughts. Thanks. Bye.

David:
First things first, Dustin, thank you for the video. And this is a pretty awesome problem to have. If I hear you correctly, what you’re telling me is you are pretty successful with running your businesses. You have properties that you previously bought that have a lot of equity that have contributed to this net worth of $2 million, which is awesome. That’s fantastic for you and your wife and your four kids who are probably eating away at that net worth every single chance they get. Macaroni and cheese doesn’t come free. And your question is, what should you invest in? Your fear, your concern is going to be, I don’t want to put all my money into something that’s going to take a lot of time. Something like a short term rental could be really bad for you because you’re running your businesses. And that’s why you’re wondering about investing in someone else’s deals like Brandon’s with Open Door Capital, where you could put the money in, be completely passive.

David:
That is a very good option for you. I would look into that if I was you. However, you’re investing in real estate but you’re not investing in real estate. You’re investing in a fund and this is just the way I look at it. When you invest in someone’s fund, from your perspective, it doesn’t matter that they’re investing in real estate with it. It could be investing in a hedge fund or in stocks that could get you a similar return. From your perspective, you’re giving your money to someone and you’re getting it back with interest. That’s good. You should do it. I do it all the time but I also know that isn’t going to help me achieve the purposes that people tend to look to real estate to help them achieve. Most people are buying real estate because they want to plan for their retirement. They want to grow their net worth. As you’ve seen, it’s worked for you. They want passive income coming in that they can live off of.

David:
Those are not the only things to chase in life. There is definitely an argument to be made for investing in funds like this. Like I said, I do it myself and in the future I’ll be raising money for people looking for the same thing. I just want everyone listening to have clarity that if you’re thinking, I need financial freedom, I want to own a bunch of rental properties, I want to be able to refinance them and buy more. I want to do all the cool stuff, Brandon and David talk about. This isn’t going to get you there. This could be a step in the direction of getting you there. It could help you get more capital coming in. It could also help you earn a return on your capital while you’re in this busy season of life, where you’re running businesses and raising children.

David:
From that perspective, yes, I think that would be really smart. You should be investing into funds of reputable people but you can’t let yourself believe that that temporary solution is going to get you to the permanent goal that you want to hit. You need to look at it like doing this is going to help me accumulate more seeds that I eventually will go plant real estate to get my own trees. I would, if this was me, here’s what I would do. I would set a timeline and I would say, “My youngest kid is going to be whatever age I think I’ll have more time.” Maybe they go into high school, ninth grade, maybe you make it 12th grade, “and my oldest child will be 18 and I won’t have to put as much time into them in 10 years. In 10 years, I’m going to get very serious about buying a lot of real estate. How much money can I make and amplify through investing in other things over the next 10 years so that when I get there, I have X amount of money?”

David:
You’ve said you can save 10K a month, take 10K a month, that’s $120,000 a year. What can you add on that return? If you get a 10% return, that’s another $12,000 in a year. If you get a 20% return, that’s another 24,000. You’re saving 120 plus you’re earning 24,000 if you make 20% in Brandon’s fund or whatever fund you go into, which gives you 144,000 times 10, 1.44 million. That’s what you should have when you’re ready to start investing. Now, you more or less know it’s going to be somewhere in that range, unless you make more from your businesses.

David:
But then I would say, what turnkey properties can I buy while I’m on that journey of investing in these funds? Now, when I say turnkey, I don’t mean from a turnkey company. I just mean, what can I buy in a really good area that doesn’t need a lot of work that won’t be a headache that I can buy it, have a property manager manage it and it will be fine? I don’t have to manage a big rehab. I don’t have to deal with constant tenant turnover. I may not get a ton of cash flow but that’s okay because my target is 10 years out so I don’t need cash flow right now. I need cash flow then. And maybe pick up a property every couple years that fits that criteria, while doing what you’re doing with investing into funds.

David:
And then the last thing that I want encourage you to do is to figure out how to automate your business. Everyone hates it. Nobody trains us how to do this. It’s the hardest part of everything but if you can hire people and get your business automated to where you have more time, you can put more time into buying real estate, which is where your real wealth is going to come from. That’s exactly what I’ve been doing. The last three years. I’ve been getting my butt kicked, trying to hire, trying to train, trying to manage, trying to get good agents on the David Greene team and I finally have them. They’re doing great. I don’t have to do as much of the work.

David:
It’s semi-passive income coming in on the David Greene team. Now I took that energy and I’m focusing it on the mortgage company, building up the loan officers, working with my partner, hiring new people that want to hang their license with our brokerage, finding more agents we can help do loans for their clients, finding people that need to refinance right. Building up that until that becomes passive income. When that happens, I will have all my time back plus these businesses that are bringing in revenue and I can put all of that revenue and that time into buying more real estate, which is where the real big gains come from.

David:
I know I’ve given you a lot of advice and it’s kind of centered around business, which many of our listeners that are W2 workers don’t relate to but you are running a business when you’re buying real estate. And I do want you guys to understand when we interviewed Robert Kiyosaki on episode 500 of the BP podcast, he gave so of really good advice concerning the purpose of business is to buy real estate and take on debt. To take on debt and avoid taxes. That’s the purpose of a business and you do that through real estate. All the business income you’re making is great. It’s only useful to you if you can invest that into real estate and save on taxes, take on more debt using other people’s money to build this empire so that when your kids are gone, you’re not just now starting to build wealth. You actually have had it going. You also can’t jump in with both feet. I understand you’ve got four kids, that sounds like a lot of work.

David:
Put some method of diversification in there where you consistently put money into Brandon’s deals and then you also buy a couple deals for yourself. And then at the 10 year mark, you can stop putting money into Brandon’s deals, you can put it all into real estate until you’re like, dude, I have enough, I don’t want any more of these homes. And then just keep investing into funds like Brandon’s and let them do all the heavy lifting.

David:
We’ve had some very good questions today. I am loving how this podcast is shaping out. Every single time we do it, the questions get better and better, deeper and deeper and they really give us a chance to break down and reverse engineer what it takes to be successful in investing. I love getting to do this because instead of just listening to the story of somebody else who built real estate, you get to get deep into the specific questions or struggles or obstacles or opportunities that other people are having.

David:
In fact, if you notice the pattern of what I’m getting into, most people believe they’re at a situation or an obstacle that they can’t overcome but I’m looking at it and I’m seeing that there are several ways that you could overcome this. I really hope you guys benefit from seeing just the way that my weird brain works as I look at of how I can get A plus B, how I can take advantages of strengths in different markets while also limiting my downside. Real estate is one of the few things that has so much creativity that can be applied, that you can make almost any situation work.

David:
Thank you guys very much for submitting these questions. Please go to biggerpockets.com/david, submit questions there. And maybe when you come across somebody that’s asking you something that you don’t want to answer or you don’t think that they should be asking you or you just don’t have the answer for, tell them to go ask their question there. It’s kind of cool to be able to be aired on the BiggerPockets podcast and you can share it with your family and friends and let them know that you were on the biggest real estate podcast in the world. If you guys could take a quick minute to please hit the like button on YouTube and share this with anybody that you think would benefit from it, I would really appreciate you as well as leave me a comment of what you think about the show so far.

David:
Our next question comes from Solly M. in Hayward, California. Hayward is very close to me. I represent lot of clients in that area, helping them get houses and I was just looking at houses for myself a month ago or so in Hayward. Any of you in Northern California or if you’re in Hayward specifically, please let me know. I’d love to get to know you guys better. Maybe go to the Red Chili in Hayward, best Vietnamese Thai fusion that I’ve ever had. It’s probably my favorite at restaurant and we need to get connected and have you at some of the meetups I put on.

David:
Solly asked, “My husband and I are buy and hold long distance passive investors. Our goal is to grow passive income, enough to retire in the next five to seven years. Basically we want to build a nice nest egg. We are following a rather conservative, slow paced strategy. We used our own savings for down payments and repairs and used conventional mortgages on five single family homes, four conventional and one BRRRR in suburbs of Detroit, which are A and B plus areas. Our average cash flow is about $300 per door. The ROI is about 5%. After two years of experimenting and learning, I now realize that we can’t achieve goals with this strategy. My question is, what should we do differently to increase ROI but still remain conservative enough? Generally, I believe in quality over quantity. Rather than owning four properties with $100 of cash flow per door, I prefer one door with 400 cash flow. Thank you.”

David:
What a good question that we have here. A few things that I’m going to assume based on Solly’s situation. The first is when she says that they’re buy and hold long distance and passive. And I know they live in Hayward. They probably have pretty good jobs that pay pretty well but require a lot of their time. Maybe this is software engineers. Maybe they work in some of the tech companies that are not far from Hayward. That would be the Silicon Valley area, if you’ve heard of it, where wages are really good and you have great opportunity, but it is a lot of your time. You spend a lot of time commuting because traffic can be hard. And then you spend a lot of time committed to accomplishing the goals that your project manager’s giving you at those companies. I don’t know if I’m right but Solly might be sitting there nodding her head saying, “Yep, he totally gets it.”

David:
Now what Solly said that so profound that you all need to hear is that taking the conservative approach at every single step is actually shooting them in the foot at hitting their goal. They want to be able to retire with cash flow in five to seven years. But looking for properties that are not cash flowing quite enough or not appreciating quite enough, being extra conservative so to speak, has stopped them from hitting that goal. And this is a perfect example of what I was saying earlier. Sometimes taking the safe road is the quickest way to guarantee that you lose. It doesn’t mean you should be risky but it does mean that you should not assume conservative or safe equals success. Sometimes it doesn’t and this is one of those areas. If they stay on the path that they’re on, they’re not going to hit financial freedom. They’re going to be working for a lot longer.

David:
Now, a few things that I can look at with your strategy right now, Solly, that I think would probably need to change. I agree that I’d rather have one door with $400 cash flow than four doors with 100. I don’t know that I would say that that’s risky. Sorry, I don’t know I would say that’s conservative that having less properties with more money is harder to do. I think that you wanting to buy in the Detroit area feels safe to you because you probably really like the price of the homes. That’s what I’m guessing drew you there. They are priced low and they’re in A to B neighborhoods so the gain that you’re getting is easy to get in and not a lot of headache because the tenants are great. The downside is they’re not appreciating very much and they’re not making you a lot of money. That’s what you need to question yourself on.

David:
My philosophy is that cash flow is incredibly difficult to build. And what I mean by that is if I want to cash flow $10,000 and I’m going to get a $100 per door, that’s a lot of doors that I have to get to get it to 10,000. In fact, I probably wouldn’t even want it once I had it because that’s a lot of work. Even if you get to $500 per door, to get to $10,000, what would that be? Two houses is a 1,000 so that’d be 20 homes that you’d have to own to get to 10,000 in cash flow. And $500 a door is very hard to hit. You’re probably more looking at 40 to 50 homes. A better strategy, the ones that I employ involve delayed gratification, specifically when it comes to cash flow.

David:
Rather than trying to get 10,000 a month in cash flow and then saving $10,000 to go invest into real estate, I take the opposite approach. I try to build equity because I can control equity much more than I can control cash flow. Cash flow depends on what the market gives me. Equity is something I have a lot more creativity in. I can buy fixer upper homes. I can add value to homes. I can look for the worst house in the best neighborhood. Typically as home values appreciate, rents do too but rents don’t keep up. Because at a certain point, if rents kept up with home values, people would say, “My rent’s too high, I’m just going to go buy my own house.” Inflation helps the home value even more than it helps rent, although it helps both.

David:
What I do is I buy properties in areas that I think are going to appreciate over time. I build equity in those and then I 1031 all that equity into the cash flow thing that I want, like an apartment complex. It is much easier to build a million dollars in equity through elbow grease and smart decisions and time and then transfer that million dollars into a cash flowing property where an 8% return would say make me the 10,000 a month that we’re talking about, than it is to try to wait for my cash flow to equal a million dollars And then do something with that. What I would say is stop investing in areas that are this conservative. You guys need to get into something that has a higher ability to appreciate over time, where there’s going to be less building, less supply. It’s going to be harder to get into initially so you’re going to have to put more time into getting it under contract. You may have to pay over asking price, where you may not be doing that in the Detroit suburbs that you’re in right now.

David:
You’re going to give it up on the front end. It’s going to be harder work to get that property. But once you have it, it’s going to go up a lot. What if we helped you, because I work in your area, find a house in the San Jose area? You’re going to put a lot more money down. It’s going to be more work to get it. But once you’ve got it, the rents are going to go up so much more and the values are going to go up so much more. If you bought a handful of houses in somewhere in the San Jose market and you let each of them appreciate by 300,000 and you had four of them, you got 1.2 million that you can then go invest and you’ve met your cash flow goals once you convert it.

David:
What I’m getting at is while cash flow is the goal, it doesn’t need to be the first step. Make it the end goal. And that’s what I’m doing. I look to build appreciation first and I transfer that into cash flow later versus just chasing cash flow right off the bat because that’s where you run into the situation you’re in now where you’re realizing it just takes too long. I don’t have 900 years to live before I’m going to get there. Thank you very much for asking this question. I hope I answered it well so everybody understands that I’m not saying cash flow doesn’t matter. I’m just saying I can get to cash flow quicker if I pursue it through appreciation and that doesn’t mean taking risks. That means buying fixer upper properties, buying in the best neighborhoods, getting really good deals and then waiting. Lastly, we live close to each other so reach out to me and I would love to be able to help you do something out here.

David:
Next question is from Palmer in South Carolina. “As is probably pretty common in this current market, my rental units have gone in value substantially over the last few years. As they’ve gone up in value, the rental income has not kept pace with the spike.” Side note, this is me not Palmer. That is exactly what I just described when we were talking about Solly’s question is that they don’t. They both go up, but they don’t go up proportionally.

David:
“I am looking to start selling and was wondering what factors I should take into account or if I should sell it all. I’ve been trying to think of selling in much the same terms as I consider when buying. As an example, if there is a house on the market for 80K that would bring in a $1,000 a month, then given all the other expenses that are reasonable, this makes good sense to purchase. If the same house was on the market for 120K and brought in the same $1,000 a month, then this deal I would pass on. That’s because the money’s opportunity value is worth more to me than the house. But why doesn’t the same apply when the house I purchase for 80K appreciates to 120 K and the rent lags the appreciation? Some of my houses have almost tripled in value and tripling rent would put me well above market rates. I understand there are tax burdens and other factors, including appreciation, income stream, et cetera, that need to be considered and was wanting to hear your thoughts on when to sell a rental unit.”

David:
If we had some kind of alarm, I would totally hit the button because this is going to be my favorite question of the entire day. This is big boy and girl stuff, folks, and you won’t hear answers like this almost anywhere else. Not because I’m tooting my own horn but because I don’t think other people think about these questions. But because I work with people who own real estate or want to buy it every single day, I’ve had to figure out why Palmer is in the situation he’s in because he’s exactly right. What Palmer has realized is that as the price of the house goes up, the rent doesn’t go up with it. That’s the first thing I’m going to address.

David:
The next thing I want to make sure that I cover is that he says, “If I could buy a house for 80,000 that brought in a $1,000 a month, I would buy it but I to buy a house for a 120,000 that brought in a $1,000 a month.” In fact, I’m going to start there because I want to highlight a few things. Palmer’s logic is sound. He wouldn’t spend a 120 to get a cash flow stream of a 1,000 in rent or revenue, not cash flow. And he would do it if he only had to spend 80,000 to get a $1,000 in revenue for rent. Where I think Palmer has it wrong and a lot of other people are in the same boat, especially if you’re somewhat like a newer investor. You don’t own a ton of properties, is his logic is built on the foundation that cash flow is why you buy real estate. And this is coming up a lot.

David:
Cash flow is not why I buy real estate. It is a wonderful perk. It is icing on the cake. I really like it. But cash flow alone pales in comparison to the wealth that I build from buying a $500,000 property, putting 50 grand into it and making it a $700,000 property. That’s $150,000. Cash flow takes a long time to build up that wealth. The first thing Palmer that I want to challenge you on is look at real estate from a more broad lens. Don’t zoom in and say, “Cash flow is the only reason why I buy real estate.” Say, “Cash flow is a reason why I buy real estate.” And at some form of your life, usually near the end of our lives, cash flow is much more are important than when we’re 24 years old.

David:
In fact, I’m going to go out here and say a controversial thing. If you’re 24 and you’re trying to retire in two years and you want all this cash flow so you can do it, that may be good. If you feel that’s the calling on your life, that’s cool. It may be one of the worst things that ever happened to you. You gain a lot in life through working and learning and developing skills and letting that mature you and screwing up and having mentors tell you, “Hey, you screwed up. Do it better.”

David:
There’s a lot to be said from going through life, working for people or working with people or doing some form of, I don’t just sit on the couch and watch Dancing With the Stars. It’s good for your character. It’s good for your relationships. It’s good for friendships. You build a richer life by doing something difficult, which most jobs have some bearing degree of difficulty. I’m not a huge fan of I’m 20 years old and I want to be retired in three years and never work again. You might be robbing yourself of a lot of what life offers you.

David:
And that’s one of the problems with this cash flow, cash flow, cash flow. I need cash flow. Is it sort of sets you up to make some worse decisions in life. Doesn’t mean cash flow is bad. Cash flow is incredibly important, especially if you don’t have a ton of money. That’s the first thing I want to say is look, if that or $120,000 house that you don’t want to buy because you would only buy it if it was for 80. If that one goes from 120 to 240 in six years and the 80,000 house goes from 80 to 90 in that same six years, you made way more money on the 120 house even though the cash flow of a 100 bucks or whatever the difference is, very nominal, wasn’t that much. The rent probably went up faster on the 120 house than the 80 house too. Guys and gals, as you’re considering these things, ask yourself if you are obsessed on cash flow and if that obsession is getting in the way of you making better decisions.

David:
Now, why does rent not keep up with the price of homes? Man, I love answering this. I talk to my team about this all the time. Here’s what you got to think about. The people who rent homes sometimes rent them because they want to, they don’t want the commitment of owning a home. They don’t want the maintenance and the upkeep. There is a percentage of people who rent that come from that point. I would say the bigger majority of people who rent would want to own but they can’t. They can’t get a loan or more importantly, they can’t afford the house. They can’t save up the money to buy it or houses are too expensive for them to be able to buy. And so what happens is they become a renter by default. They don’t want to be renting. Most renters if you said, “Do you want to own your house?” They would say, “Yes.” Oftentimes in it’s the price that stops them from doing it.

David:
Now, if you’re a person who can, let’s say that you bought this house for 120 and the rent was a $1,000 and Palmer here is saying, “Well, if it goes up to 240, shouldn’t the rent also double? It should go to $2,000.” The problem is at a certain point when let’s say the rent hits 1,800 or so, maybe 1,500, let’s go with that, the tenant if they could afford that rent would be better off buying. They could get qualified to buy the house themselves. You start off with tenants are always typically in the lower priced homes. Doesn’t mean that they’re bad homes. They’re just in the lower part. They’re not buying luxury homes. Not as many people rent that.

David:
Prices of homes go up, rents go up, you start to see this happen and then the rent hits a ceiling where the tenant either can’t afford it so they’re going to stop this house and go get a cheaper one. Or if they could afford it, they’re like, “Why am I going to pay $2,000 a month for rent when I could own the house with a $1,600 mortgage payment?” And that’s why they don’t keep up. What you find, if you really think about it in most areas where investors are investing, if they’re cash flow, they’re not the nicest areas. They’re not the most expensive homes. You typically take the city and the lower rung of it is where you’re going to find that you can actually make your money as an investor. There’s not a ton of investors that own a lot of Beverly Hills real estate is what I’m getting at.

David:
You’re in the situation, Palmer, where your house has naturally outgrown being used as a rental. I want you to think about a child that just has a sweatshirt and they got bigger. Maybe this sweatshirt stretched a little bit but at a certain point that it couldn’t keep up with the child growing. You need a new sweatshirt. It is natural in the real estate investing cycle to take a house that doesn’t cash flow as much as it could, meaning if you look at the equity on your property and you divide it by what it brings in every year, your return on equity, that number is lower than the return on investment you would get if you bought another property. And when that happens, if what you want is cash flow, you sell it, you take your gain and you go buy two to three more properties and you start the process over.

David:
If you wait and get frustrated that rents aren’t keeping up, you’re never going to get anywhere. What you have to recognize is I did so well that I out kicked my coverage. This doesn’t work as a rental anymore. I will sell it and turn it into three rentals and start that process over with them, letting them grow. You can buy and hold forever. There’s nothing wrong with that. But if your goal is cash flow, buy and hold forever actually works against you in many cases.

David:
Our next question is from Daven like raven. “Structuring an owner financing deal in Atlanta and there is a bit of land in the back that I would want to build on. Is that something I could get financing for? Or would I need to pay for that in cash? Assuming I got permission from the owners, P.S. It would be a cash flowing property, short term rental or long term rental.”

David:
Daven, so your question, if I understand it correctly, and by the way, Daven and David are very similar there. Is you’re buying this property, it’s got land in the back. You want to build on the land and you’re trying to figure out how to finance that. There’s a few things that we need to look into here. First off, the quick answer, if you’re expecting can I put 5% down or 10% down and the bank will give me the rest of the money to build on it? No, they will give you those really good loans when it’s the property is already improved or the land is already improved with what’s typically a property. That’s not the case here. You’re not going to be able to borrow money the same way you would when you’re buying the house in most cases.

David:
You should look into if the city or the county will allow you to reparcel that land. In which case you may be able to basically splice it off from the main parcel that you’re buying, create a second parcel with its own APN or assessor parcel number, I believe it is. You get a new number for property taxes and it’s like owning two properties now. You could sell that land or you could build on it. Either way, when it comes to the building, you’re going to have to get some form of a construction loan. You may find a hard money lender or a primary or a private lender that will let you do it but it’s going to be more tricky. How these loans usually work is they don’t give you all the money at once because they think if I give you 300 grand to build a house, you might just take off and go to Switzerland, I never see you again. They also think what if I give him 300 grand and all he does is get the foundation built, the contractor rips you off, or you don’t know what you’re doing?

David:
They’re very concerned that that’s going to go poorly. Versus when they give you a loan on a house that’s already built. How many ways can that go wrong for them assuming the house is built well? They’re going to say, “Here’s your first draw. Here’s a chunk of money. This is the interest you’re going to pay on that money.” And then you’re going to build the first phase of it, say the foundation and all the concrete and get your plans drawn up. Sometimes you have to pay them interest on the money that you’re not using because they can’t lend it to anybody else. I’ve heard that referred to as Dutch interest. I don’t know where that comes from but if they’re like, “Hey, you need 300 grand. We’re going to give you 80 grand right now but that other 220, we can’t give it to anybody else. You got to pay us, usually a smaller rate on the money, you’re not using in a bigger rate on the money that you are.”

David:
After they send someone out to verify that the construction was done well and it’s completed, they give you your next draw of say 80 grand and now you’re going to put up the framing and you’re going to do some of the other stuff and it’d be you’re rough in or whatever. And they go through phases like that with lending you the money. Now, the rates will be much higher than you’re used to because this is much more risky for them. A lot of things go wrong when you’re building a house. And I remember when I was a brand new person, it was 2005 and I was so frustrated with what house prices we’re doing and I said, “I’m just going to build my own house.” I just had no idea what it was like to build a house. And I thought the same thought I think a lot of other people think. Housing prices are getting so high. I’ll build my own. You’re probably not going to.

David:
Even the guys I know that have construction licenses don’t build their own homes. They still look for houses already built and then try to fix it up. I don’t want to discourage you from trying to build a house on the property. I do want to let you know, it has many more moving pieces. You might lose money doing this that you could have made in other areas. And this is one of the reasons that even though Californians are allowed to add ADUs to their houses, it’s not always a good financial decision because sometimes the ADU might cost $200,000 to build and you could have bought a whole house for $200,000 down and had two really big houses and nice ones versus one house with a tumor, the ADU type of a thing. I’ve said it before, financing makes deals. And I don’t want anybody here to get caught up in, oh, I would have a short term rental, longterm rental with cash flow whatever. If it takes all your capital to do that, you’d have been better off putting that capital into other opportunities where you can get a better return.

David:
And our final video question of the day comes from Mark in Northern Colorado.

Mark:
Hey David, it’s Mark Amatee from Wellington, Colorado. I’m about an hour north of Denver and maybe 10, 15 minutes north of Fort Collins. My primary question is, should I do a HELOC on my primary residence to pull out about $54,000 in equity to then buy income producing property in Ohio? Or should I wait until the house has say a $100,000 in equity? Right now it’s a three, two, it’s a new build and I’m going to be turning the downstairs into an extra two beds, a bath and a kitchenette. It’ll be a five bed, three bath after that.

Mark:
And the second part of the question is, which market should I try to focus on, the Colorado market or the Ohio market where I lived all my of life, know people and they know me? And what I’m doing out here in Colorado is I did get my real estate license but that could take forever to find clients or get to know people out here. But once I do get the downstairs finished, I’m going to be getting roommates. I’ll do a little bit of house hacking and that could provide maybe a 1,000, 1,500 a month just depending on what rent would be and who I can get.

Mark:
That’s basically all I have. And basically I’m just trying to make it as a real estate investor. And in real estate sales, I did a flip in Ohio, bought for 9,000, did some updates to it, basically at the end of the day, I made about 35,000 on it and then took that money kind of moved back here to kind of start a new life out here. Appreciate it. Thank you for your service as a cop. I was a cop as well and thanks, have a good one. Bye.

David:
Thank you, Mark. Hope you’re enjoying your time out there in Colorado. That’s actually the mecca for BiggerPockets. They are located in Denver. I love every time I get to go visit them, they got awesome staff and friendly folks. What you’re your question is, is basically coming down to, where should I buy? Should I keep buying in Ohio where I know the market and I’m comfortable? Or should I buy more in Denver where I live right now? Before we answer that and I do have some good practical tips for you, let’s talk about the pros and the cons of each so that the listeners can understand my thought process.

David:
The first thing that I like to say is, is whenever I’m given a A or B question, I want to figure how to turn that into a, A and B answer. Now I think that one of those books like Millionaire Next Door might have talked about that’s something that millionaires do is they often try to say, “Well, how can I have both?” And I do naturally think that way. And I think you can pull that off with this situation that you’re in. Let’s talk about the merits of Ohio. The price point is smaller. The deals are probably easier to come by and when I say deals, I just mean the ability to get something under contract, because Denver can be very hot and your cash flow will likely right out the gate be stronger than in Colorado.

David:
In Colorado, the upside would be you’re likely to see much more appreciation. Rents are going to go up more. The value of the property is going to go up more. You’re going to have less headache from the majority of the tenants because you know people there so you can kind of pick the people that you’re going to rent to. Overall, my opinion would be Colorado is going to build you more wealth than Ohio but Ohio would be easier to get started. Colorado has the higher upside, Ohio has the smaller downside.

David:
What I would say is how can we do both? Now, what’s going to limit you is you’ve got 54,000 that you believe you can pull out of that HELOC which is not a ton of capital to make a lot of things going but it is enough. You also mentioned that you may be fixing the property up. Here’s what I would say. Take out the HELOC with what you have now, get that $50,000 out. Do your rehab and then get another appraisal on your home, see that you’ve added value and get that line of credit to go higher. If your house is worth $500,000 now, after you fixed it up maybe it’s worth 600,000. They let you borrow 75% of that extra 100 grand. That’s now 75,000 that you’d be able to theoretically borrow on top of the 50. You’re going to have more room to play if that’s the case.

David:
But let’s start with the initial 54,000. I like that you said you flipped a house in Ohio that you bought for nine grand and made 35. That’s 60, 70% of the total capital you have right now of the 50,000 that you can take out. Can you do that again? Can you flip a couple houses in Ohio and build that nest egg to get it bigger? That’s the first thing is I don’t want you dumping your money in Ohio because it won’t earn you as big of a return over time but that doesn’t mean it’s useless, you can’t do with it. Use that money to kind of make more money short term. Flip a couple of those houses. If you get a good contractor and you can do two or three of them and you know how to find those deals, turn that 50 into a 150 doing maybe three, four or five flips. That changes everything.

David:
While you are doing that, house hack a new place in Colorado every single year. Now here’s why I’m telling you that. Everyone assumes cheaper properties equal lower down payment, equals I can buy more. And they forget that when you’re buying investment property, you got to put 20% down. If you put 20% down on an investment property in Ohio or 5% down on a house hack in Colorado, you could buy a house that’s four times as much money in Colorado and it’s the same capital out of pocket. That’s what I think you should focus on. Every year, find a new house hack that you buy with a primary residence loan, three and a half percent to 5% down depending on what you can get. It’s not going to take up all your capital. And then with the rest of your capital, use it to flip houses in Ohio. If you’re not going to flip, then only BRRR. You need to buy something in Ohio that you can get your capital back out. You don’t want to sink it in there because it won’t grow as fast but you do want to play in that space.

David:
The BRRRR method will work great in a market like that if you can find more fixer upper properties because the price to rent ratio will support it. BRRR is much harder in Colorado so don’t BRRRR in Colorado. You don’t need to BRRRR in Colorado. You’re only putting three and a half to 5% down. That’s basically the same thing as a BRRRR without all the work. What I’m getting at here is both properties have strengths to them. You got to plan on both of it. Ohio will work very good for BRRRR and for flipping because you know people, you can find deals, you can build the capital you have. Colorado will work better for the longterm place. Ohio is short term, Colorado is longterm where you’re going to continue to put low down payments down and build up your portfolio there. And if you do this right, you shouldn’t be putting all of the money that you make in Ohio into Colorado.

David:
Then nest egg should continue to grow in the middle and you pull some of it out to go into Colorado and you put some of it back into flipping more houses in Ohio and you have two sustainable wheels that are turning at the same time that are growing your wealth and you just let real estate build it up for you the way it does, boring and slow over time.

David:
All right, folks, that wraps up another episode of the Seeing Green BiggerPockets Real Estate podcast. I have a blast doing these. I really appreciate those of you that are sending in your questions and I’d like to see more. If you like this, if you heard this and thought, that was incredible, that was amazing. Or even, eh, it was mediocre. He was okay but he could have been better. Put that in the comments. I want to hear on YouTube what you guys like and what you don’t like.

David:
Also, you can comment on the show notes and get a conversation going with other people who listen to this, if you go to biggerpockets.com. Look it up. See what other people are saying, throw your opinion in the hat and get a conversation going with other people who are learning things just the same way that you are as well. All right, please be sure to follow BiggerPockets on Instagram @biggerpockets, my best friend Brandon @beardybrandon and myself @davidgreene24 and get more content and more insight into what’s going on in our worlds. For today’s show, this is David, no shirts, no shoes, no problem, Greene signing off.