Time to talk about leverage!

In part one of this two part series, the BxB team discusses the essentials of real estate lending, including industry terminology: LTV, DCR, DTI, NOI, and more!

We also talk pricing, terms, and additional variables to ensure that you match the right loan with the right project.

 

(Transcript below.)

 

Ben Shelley: [00:00:00] Welcome back to the Brick x Brick Podcast. Today's episode is part one of a two part topic on debt financing. Part one is focused on terminology surrounding the financing process. Enjoy.

 

Ben Shelley: [00:00:21] Welcome back to the Brick x Brick Podcast. I'm Ben and I'm here with John and Ryan. And for today's episode we're going to talk about debt financing. Now if you've been a avid listener of the show which I'm sure many of if not all of you are you know that we've already done a sort of overview episode about real estate financing more broadly today. We want to hone in a little bit more specifically on the debt side. And why we want to do that is so that you both the everyday intermediate and expert investor have a sense of the landscape and know where to go and what to look for when you're negotiating and talking with lenders. And so some of the types of financing in lenders you may be dealing with are conventional lenders portfolio lenders FHA lenders hard money privateetc. So our experts are going to take you through it. Nobody knows it better than John and Ryan and so I'm going to start by throwing it over toMr. Wells Fargo himself. Ryan Goldfarb where do we want to start this?

 

John Errico: [00:01:13] Ryan quote Wells Fargo quote Goldfarb.

 

Ryan Goldfarb: [00:01:17] Together Wells Goldfarb so far has really come. It's one of my friend's jokes. I want to try to get him right here. I think it's Neal. Okay.

 

John Errico: [00:01:26] And about 50 years when you acquire Wells Fargo you can.

 

Ben Shelley: [00:01:30] You don't want that kind of publicity.

 

John Errico: [00:01:32] So just over set big goals and then try to achieve. And that's you know that's just put it out to the world see what's gonna happen.

 

Ryan Goldfarb: [00:01:38] Interesting too. It's interesting to think about where these banks will be in 50 years from now.

 

Ryan Goldfarb: [00:01:42] Any who because.

 

John Errico: [00:01:44] They keep loaning money to us. I mean they might say.

 

Ryan Goldfarb: [00:01:48] Well we in Ben's eyes are the experts on this.

 

Ben Shelley: [00:01:51] Now of course my only goal is really to convey every episode that you guys are experts at fill in the blank topic of that episode should I cut that.

 

Ben Shelley: [00:02:00] I don't know.

 

John Errico: [00:02:00] Well we're always there's like the point 0 0 0 1 percent of the Earth's population that we listen is like these guys go to the bank for 40 years. Well they set it on the by podcast. It must be true.

 

Ryan Goldfarb: [00:02:12] Well sir I worked at one for three years.

 

John Errico: [00:02:14] I want to make sure that we accommodate that person. What incentive do that person who's like five people enter.

 

Ben Shelley: [00:02:20] We are way off the rails.

 

Ben Shelley: [00:02:21] We didn't even get started yet more sidetracked.

 

Ryan Goldfarb: [00:02:24] Anyway. Taking us back to square one.

 

Ryan Goldfarb: [00:02:26] The way that I've been thinking about this is in the context of buying let's say a car. There's so many different places where you can start and there are so many things to think about. You'll walk into a dealership and they'll start throwing all these terms out at you both pertaining to the car itself and to the different ways that you can obtain the car. You can buy it outright. You can lease it and you can finance it. And in a lot of ways I think there are parallels to buying property. You can buy it outright. You can buy it with financing.

 

Ryan Goldfarb: [00:03:00] You can lease iti.e. rent it as as many of us do for our own purposes.

 

John Errico: [00:03:05] Steal it buy adverse possessing defective squatters.

 

Ryan Goldfarb: [00:03:10] That be an interesting episode that is going to anyway.

 

Ryan Goldfarb: [00:03:14] So that's kind of how I think about this high level. There are I guess to start any number of ways that you can buy it. As I alluded to before it can be through all equity or in the case of you know just buying a property for 100 percent cash or the more common way to do it would be to put down some money in the form of a downpayment and then obtain a loan for the remainder.

 

Ryan Goldfarb: [00:03:44] That loan is what is classified as debt.

 

John Errico: [00:03:47] And usually just to clarify that the loan is secured by a lean on the property. So that's what classifies this type of financing from me. You could also get other types of debt I suppose that aren't secured by leans like you can get a personal line of credit or something like that that's secured by your personal credit. But these are all secured by the actual asset. So that distinguishes there's a category of thing. Right.

 

Ryan Goldfarb: [00:04:12] So under that umbrella of debt some of the options are conventional financing which is what most people think of when they're going to buy a home. It's you go to the bank and your banker says we can get you into this new house for 20 percent down while we're on your credit. It's oftentimes the loans are guaranteed by Fannie Mae or Freddie Mac and they fall into this bucket that allows them to be offered to you at pretty attractive rates. And so that's that's generally more applicable to the owner occupant class of purchasing which is what you would use to buy a primary residence on the investment side. There are also a litany of other options including commercial portfolio lenders hard money loans private lenders each of which have many similarities but also some key differences that are important to be aware of before you dive in and pursue any one of these paths. John, am I missing anything here.

 

John Errico: [00:05:12] Well I think we'll get into it. But part of the the skill of being a real estate investor is knowing when and how to use these different financing options. So oftentimes with the home you'll you might buy a home with a certain type of financing or no financing and then obtain financing for that home at a later time or you might start with one type of financing change or a different type of finance in Exeter et cetera it be known as a refined refinance right. And depending on your goals of the property and the type of the property that may be very advantageous or not so we can run through some examples. I mean just very high level of you if you're familiar with reading say BiggerPockets or that community of thing you've probably heard of the Byrd strategy which is buying renovating renting refinancing and then repeating and refinancing is sort of the key word or what we're talking about which is normally in a BR technique you might start with could be conventional finance and could be FHA financing whatever and then you got to refinance that into a conventional loan and take money out of it. So even like very beginner like house hacking type strategies you're going to have to know knowledge about financing and how it works.

 

Ryan Goldfarb: [00:06:23] Then I guess before we get too deep into the weeds here it's probably good to start with some definitions or with understanding some of the key components of what these different loans will offer. The first one is leverage. That's often referred to as the loan to value or in some cases loan to cost. So if you're buying something for two hundred thousand dollars and your lender is offering a loan product with an 80 percent loan to value that means that the lender so long as they support that two hundred thousand dollar value via an appraisal or some other type of internal valuation they're willing to loan up to one hundred sixty thousand dollars on that property for that purchase. Which means that you as the owner investor whatever you want to call yourself. Need to bring the remaining forty thousand dollars to the table plus allocations for all the closing costs that you that you will incur. Plus any holding costs that you will have for any period of time thereafter up until you are fully stabilized with your rental property and have tenants in place who are going to cover those holding costs. So.

 

Ryan Goldfarb: [00:07:38] Leverage. Most commonly I think the most common benchmark that you'll see is generally 75 to 80 percent loan to value for investment property. The more risky an investment can be generally the lower loan to value that a lender will offer out because it's true.

 

John Errico: [00:07:58] That's that's a victory for the world of residential loans properties for commercial loans.

 

John Errico: [00:08:03] You can get a lot lower or higher whatever you want to call it requirements so you might be a little like 70 percent loan to value 65 so a lot of other things that graduate.

 

Ryan Goldfarb: [00:08:11] As you get into as you get into say commercial property like a strip mall or a standalone office building or something akin to that you may find lenders that are a little bit more averse to lending and high leverage because the secondary market for that kind of mortgage is a little bit different. There aren't as many means to securitize and sell off that paper which means that the lender themselves often has to hold on to the loan for the lifetime of that loan whereas when you're buying a residential mortgage through Wells Fargo or through ABC lendingCorp. in your town that is a well known mortgage broker. They're originating alone but within a few months that loan will get bought by an investor generally as part of a pool and that investor will be the one who's essentially clipping the coupons and earning the interest on that.

 

John Errico: [00:09:06] Yeah. So the banks are like recycling cash. That's how these big originators are able to do so much volume because they're not at any given time loaning out like a hundred million dollars of cash they're loaning out X amount they're selling it to an investor or securitizing it or whatever and then they're recycling that money that they got back to re lend it out to more people. So right. So it may be worth noting sorry to cut you off right but that for primary resident if you're living in the home that's generally the most leverage that you can obtain. Actually no. I mean I could fathom exactly why.

 

Ryan Goldfarb: [00:09:41] Well I think I'll do that but I don't think it's necessarily a business play. I think the reason for it is because the so if you if you think about the existence of Fannie Mae Freddie Mac FHA FHA I think about it. FHA is is a government agency Fannie and Freddie are quasi government institutions so they are effectively the Federal Housing Administration right authority administration authority for monetary Administration FHA and Fannie and Freddie meanwhile are technically private entities but they are kind of under the oversight. Yeah they're under the oversight of the of the federal government. And the reason that those institutions are in place are for a few different purposes. One of which is to make homeownership more accessible to the everyday American. We've actually discussed this in the past. The idea of through and through government trying to catalyze good behavior or sound behavior in this case buying a home is probably better than spending that same money on a car or a or an asset that is under any circumstances going to depreciate. Home at least has a high chance of retaining its value and potential even increasing value.

 

John Errico: [00:10:59] So if you're living in the home as your primary residence you can get loan products that are as low as even zero percent down or maybe even pay you closing costs. But for most people it's more like three and a half percent down 5 percent down or conceivably possible depending on your credit in the home at Exeter cetera.

 

Ryan Goldfarb: [00:11:14] But then the other reason why these institutions exist is to promote liquidity in the marketplace. And that's mostly for the health and longevity of of the real estate markets. Anyway getting back to leverage. So as John alluded to they're actually somewhat products out there. I believe the conventional ninety seven still exists store something in that realm and then there's an FHA loan product as well that can provide access to or access to a mortgage with as little as three or three and a half percent down.

 

John Errico: [00:11:49] Is there evidence of a loan at zero percent interest rates on other things.

 

Ryan Goldfarb: [00:11:53] And then there are also some sometimes in addition to these attractive loan products there may be some down payment assistance programs and through different grant programs or other subsidies.

 

John Errico: [00:12:04] So you get anywhere between over 100 percent loan to value ratio to 60 percent 50 percent depending on the type of building asset that you're buying your personal creditetc. so that we'll get into that. Right.

 

Ryan Goldfarb: [00:12:15] And then another offshoot of the leverage question is that is the fact that some loans allow for the ability to borrow renovation proceeds. So there is still some calculus in there pertaining to to leverage limits. They generally won't let you borrow something in excess of what the property is going to be worth. At the conclusion of renovations I think two or three K may actually have an exception for that but generally any kind of investor focused loan will not. So if you're buying something for a hundred thousand dollars and plan to put twenty five thousand dollars into it you may be able to finance both a portion of the purchase and a portion of the renovation so long as your value upon renovation or upon completion is in excess of the value might be a minimum of one hundred fifty thousand and might be a minimum of 175 or 200 but depending on the loan program that will be that would generally be considered loan to appraised value or as stabilized LTV.

 

John Errico: [00:13:17] It can be enumerated so that you can wrap multiple loan products into one loan depending on the banks. You can get like a construction loan construction to purchase Russian to permanent something all sorts of things.

 

Ben Shelley: [00:13:28] To what extent do you have influence when you're talking with I know we'll get more into the process of of what is the give and take between you and a lender when you're offered terms. Can you play a part in the process of determining that after renovation value for example. Is that purely on the banks assessment or are you able to have some say in what you think that is and where you think the fairest terms are. Well.

 

Ryan Goldfarb: [00:13:52] If you're talking about just with respect to what the appraised value is on the back end that's generally gonna be driven by some kind of internal valuation by the bank or more than likely driven by an appraisal which is supposed to be done by an independent third party. So you may be able to make the case that based on something you know or some kind of substantive experience that you have that you know this property is gonna be worth six hundred thousand dollars when it's done because you just renovated and sold the one next door which is identical and you got six hundred thousand dollars for it. Generally on the residential side it's gonna be driven by mostly by comps sales comps that is on the commercial side. On the investment side it's generally gonna be driven by the what's called the income cap approach which is it's a valuation methodology driven by capitalizing the NOI on a property. So you go through an income and expense pro forma something out arrive at an NOI and then apply a cap rate to that NY to arrive at a value. That's something that we've gone into and a little bit more detail in in prior episodes but high level that's that's how it is.

 

John Errico: [00:15:02] Cap rate is usually from the market with market cap rate red is for that area.

 

Ryan Goldfarb: [00:15:08] Right. For that area for that asset class.

 

John Errico: [00:15:10] Appraisers I mean it's a whole nother different episode.

 

Ryan Goldfarb: [00:15:15] We can I guess move next to the loan term. So that's always going to be a big factor in weighing different investment options or loan options. The standard again in the in the residential space nowadays at least is the 30 year fixed rate loan. 30 years is advantageous to the borrower because it spreads out the principal payments over a longer period of time which means that your monthly payment is able to be kept within reason and it ultimately gives you more buying power.

 

John Errico: [00:15:51] So 30 years amortized and fully and so that the passive barely fully advertising loan correct advertising would mean in this case that you're not paying only the interest on the money that you lend you're paying back the principal interest for all time.

 

Ryan Goldfarb: [00:16:03] And that's and that's governed by an amateur nation's schedule which if you look into is is quite unfavorable to borrowers.

 

John Errico: [00:16:10] So you're paying mostly interest at the beginning of your loan. You're paying mostly principal at the very end of your loan.

 

Ryan Goldfarb: [00:16:15] Even though your payment might be the same. Twenty five hundred dollars a month for the duration of the loan. So the loan term again 30 years is common in the residential space but when you get into the commercial space it's more common to see maybe a five seven or 10 year loan. Oftentimes there's variable pricing within that. So you might have a certain period of a fixed rate loan and then it adjusts after the fifth year every year until the end of the term so you might have five years of the fixed rate loan and then after starting year 6 you will have a new rate that maybe cannot increase more than a certain amount but that will generally be pegged to the prime rate or live or perhaps the Treasury although that's a little bit more common on fixed rate loans. The loan term is is important to keep in mind as an investor for a variety of reasons but probably the most important of which is you don't want to be caught. If you're looking at. If you're looking at a five year loan and a 20 year loan and you decide to go with the five year loan because the interest rate is significantly lower it's important to bear in mind that there's risk associated with that if you're buying. If you bought in two thousand four and you put five year financing on your property and your price and your loan came due at the end of your five you were. Your loan is coming due at a time when property values were at maybe not an all time low but we're at a low for a significant period of time preceding that.

 

Ryan Goldfarb: [00:17:47] So you are going to be the reason we saw so many foreclosures during that time in part was because people who were in that situation and we're seeing their loans reset or we're seeing a pending maturity they couldn't purchase or they couldn't sell at a number that would allow them to pay off their loan and they couldn't refinance based on current values at a number that would make it. That would make it feasible for them to hold onto the property.

 

Ryan Goldfarb: [00:18:14] So that kind of fed this vicious cycle of increasing supply which further suppressed property values and just kept the spiral moving downward.

 

John Errico: [00:18:25] If in the short term if you're flipping for example and you have a non amortizing loan like an interest only loan you might have the term the length of time of that loan is gonna be very important because that sort of determines the amount of time that you have to sell or refinance out the property to give a six month hard money loan that gives you essentially six months is other property which is not a very long time versus a year versus 18 months. And those are usually interest only as we were talking about before they're not fully amortizing so you're only paying the interest you haven't paid the principal and at the end of the loan terms you need to pay back the entire loan in one go.

 

Ryan Goldfarb: [00:18:59] On the flip side of this there are also investors who use this on the more conservative side of things but they will really take a long term view view towards this and they'll say look my retirement goal is in 15 years and all I'm really looking for this property to do is to serve as a source of income for me during retirement. So they might buy a property knowing that they're going to be putting 15 year financing on the property and they might amortize that loan only over 15 years. So they're paying back a lot more principal during those 15 years than if they had spread that out over 30 years so their monthly payments are going to be higher and their cash flow is going to be lower because of that. But their goal is to have this source of income for retirement so they'll have in theory a fully paid off property at the end of year 15 no mortgage which will mean more more cash flow down the road at the expense of cashflow in those first 15 years.

 

Ben Shelley: [00:19:56] Good point.

 

Ryan Goldfarb: [00:19:57] John alluded this before but the flipside of this is when you're talking about. No pun intended flips. When you're looking at a much shorter time horizon and this is another area where investors can get a little ahead of themselves and they'll think that they can complete a flip in six months. No problem but they underestimate the scope of the work. They underestimate the obstacles with zoning or the building department. They get screwed over by a contractor and they get left with a project that's going to take them a much longer to finish than just 12 months. But I think in the hard money space it's very common to see twelve months as a typical loan term and what that loan term means is that at the end of it you were loan is due and if you can't pay off that loan then you are in default and that's that's not a road you want to go down.

 

Ben Shelley: [00:20:46] That's bad that's bad in the words of bench expert opinion.

 

Ben Shelley: [00:20:50] But I think it's probably fair to point out from a hard money perspective too that it's it can be a good option for people who may not either qualify for two reasons either.

 

Ben Shelley: [00:21:00] If you're looking to flip in a short term period or for investors who might not initially qualify for conventional loans for whatever reason as almost like a bridge to that conventional loan via refi we'll get into those strategies right.

 

John Errico: [00:21:12] Yeah well I guess I should go. Just leave particulars.

 

Ryan Goldfarb: [00:21:18] What other one other subset of the of the term is that you can have a different amortization period than what your loan term is going to sound very confusing. And it took me quite a while to grasp fully but you may have a 10 year loan that is due at the conclusion of 10 years and you may have an amortizing loan but it may not fully amortize over that 10 years. So you may pay off that loan as if it's a 30 year loan in which case you after 10 years you've maybe paid off 20 or 20 or so percent of the principal. But at the end of that 10 years your loan term and maybe up so your you may either have to sell or refinance or pay it off in cash if you are so inclined. The reason that this is done is because it gives lenders a little bit of cushion. And frankly borrowers as well but it gives lenders a little bit of cushion and lessens the risk on their side of things. Because if you're doing a 10 year loan as a lender if you offer it as interest only that's super risky because your borrower is not paying anything down and if they're buying it at the height of the market when they go to refinance there's a high likelihood that the valuation that they arrived at on day one will not be the same at the end of year 10 in which case they may be it's it's more likely that they will be unable to refinance the property. That's that's what we would call refinance risk. So to allay that concern to an extent they will build in some amortization into the loan schedule so that 10 year loan might amortize over 30 years which means that the principal payments are going to be embedded in every monthly payment. So it's a little bit more expensive for the borrower on a monthly basis but it's far less expensive than it would have been had that 10 year loan be fully been fully amortizing and if you if you just kind of play around with a mortgage calculator. I mean I do this all the time. If you go into Google this is what I do in my free time ladies and gentlemen if you go into Google and just type in mortgage calculator Google has a built in mortgage calculator right there and you can kind of play around with some of these things so you can see a million dollar loan at 5 percent on a 10 year term versus a 30 year term. That assumes that these loans are loans are fully amortizing so you can kind of get a sense of how that impacts the monthly payments.

 

Ben Shelley: [00:23:47] I mean I think it's a lot of fun when we do a lot of something that we talked about at the beginning which is interest only hard money cash purchases and refinance now we're going to talk about it later on and refinance to conventional mortgages but to to to Ryan's point I think one of the most the things that gets my blood going is playing around with the numbers in such a way to see just how much we're reducing our interest. You like playing around with those numbers. I love playing around with those numbers. Talk dirty to me. When we refinance right the whole purpose is to make your debt less expensive in essence. And sometimes that means along getting your amortization periodetc.

 

Ryan Goldfarb: [00:24:24] That's great.

 

Ben Shelley: [00:24:26] Like I didn't really I don't care at all. I'm sure you know I'm just trying to do my part. I'm sorry that I'm sorry. And we value you here. That's very clear. And the interest in the interest

 

Ryan Goldfarb: [00:24:43] of time. I just want to highlight some quick definitions so that we can get a little bit more into the strategy of things. But it will be useful for the details of the later conversation. So amortization we discussed on DSC RR is the debt service coverage ratio. You may also see it abbreviated as DCR and the formula for that is NOI divided by annual debt service payments. The sum of those effectively what it is showing you is the cushion between your net operating income and your debt service obligations.

 

Ryan Goldfarb: [00:25:18] So it's the lender's way of saying okay they're paying us ten thousand dollars a month on their mortgage. That's one hundred twenty thousand dollars a year they're projected NOI is one hundred fifty thousand dollars. So the form the math is one fifty over hundred twenty thousand which I believe is a one twenty five DCR one point to five which is oftentimes is an arbitrary threshold.

 

Ben Shelley: [00:25:42] I know at least federally backed financing I got rent high.

 

John Errico: [00:25:45] I don't know. Yeah.

 

Ryan Goldfarb: [00:25:48] So there's been a little duel that we'll discuss that a little later but one twenty five is a pretty common benchmark in this maze. All right. So beyond the DSCR we have the mortgage constant or debt yield. I think this is actually more of an internal metric that banks use. But the formula for this is pretty simple. It is the NOI divided by the loan amount. So for if a bank's a 10 million dollar loan on a property with eight hundred thousand dollars I know I.

 

Ryan Goldfarb: [00:26:15] That's a debt yield of an 8 which is another way of saying it's another way of gauging the bank's return. If they had to take over this property next we have interest rate. That's pretty straightforward though it can get a little bit more complex when you get into some some more unique deal structures.

 

John Errico: [00:26:36] You talk about interest rate versus EPR.

 

Ryan Goldfarb: [00:26:39] Yes. Would you like to do that?

 

Ryan Goldfarb: [00:26:42] Well no I would not like to talk about interest rate versus you. I don't I don't either. I don't know all the technical.

 

John Errico: [00:26:49] I mean APR is just like your interest rate. So an APR is inclusive of like additional fees or other things that might be wrapped into the loan. So you might have an interest rate of you might be quoted an interest rate of say 5 percent but then you're effectively paying five point to 5 percent because of various fees and other things that are that are wrapped into it so like it doesn't like a credit card. So you see like a credit card APR it's sort of like the effective rate that you're paying even though the your set interest rate might be below that.

 

Ryan Goldfarb: [00:27:20] Thank you John.

 

Ben Shelley: [00:27:22] Notice Ryan's different reaction when John speaks. Then when I speak out how should we feel sorry for Ben. Is trending on Twitter right now.

 

John Errico: [00:27:31] Anything we hear like the voice of God kind of man. You know a deep sonorous mass where he wears a voice whereas George I need Joe. Thirty two years of life pulsing over my veins.

 

Ryan Goldfarb: [00:27:42] All I want is for this episode to consist

 

Ryan Goldfarb: [00:27:45] of more than just a few definitions. All right so under the umbrella of interest rates we have a few different benchmarks that are used to determine when interest rates are some different ones that you'll hear our library which is the London Interbank Offering Rate. I believe the Treasury rate which is based off of the Federal Reserve or the Treasury Department's current yield on bonds and that's over different timeframes you have a you might have you'll have a five year treasury a seven year treasury and a 10 year Treasury and there's a yield curve that's a pricing curve that is generally accepted in that space and so you'll see a little bit of a difference between the 5 7 and 10 year pricing as a result of that. And then there's the prime rate which is I think it's actually pretty murky or unclear as to what the actual science is behind the prime rate. I don't know if John has any more.

 

John Errico: [00:28:36] I don't know if you're into that but it's a good question. I do know that the primates are only 1 2 3 5 7 13.

 

Ryan Goldfarb: [00:28:44] Yes prime no jokes ladies undergraduate Rob it's like a dad Joe our graduate. Thank you.

 

Ryan Goldfarb: [00:28:53] Well that's like a very specific type of bad joke that's a dad joke for a dad who's a math teacher I know.

 

John Errico: [00:28:58] I'm neither of those. It's unbelievable. Thank you so much. You're welcome.

 

Ryan Goldfarb: [00:29:02] But prime rates I believe are published publicly but I believe they're determined based on like a survey of banks and their current.

 

John Errico: [00:29:13] Yeah I think that's great thing it's maybe a survey of the Fed Reserve Bank. Something like something like it's a it's a it's like small sample size of banks and it's a it's it's a said obtainable number but I don't know how it's obtained.

 

Ryan Goldfarb: [00:29:27] But the primary it's actually important because a lot of a lot of loans are priced off of primes. You're your pricing might be prime plus 1 which would mean 1 percentage point over what the prime prime rate is of primes 5 your price that your interest rate is going to be 6. That's also adjustable rate mortgages are commonly priced as a in relation to prime.

 

Ryan Goldfarb: [00:29:49] Other things that you will see when shopping around are prepayment penalties which can take the form of defeasance or yield maintenance.

 

Ryan Goldfarb: [00:30:00] Sometimes they're in a step down pattern after a certain period of time but essentially it's just the the banks way of protecting their downside because they don't want to spend three months underwriting a loan for five million dollars and have you come back day two and just pay it back with any. Yes Ben we have a question.

 

Ben Shelley: [00:30:21] Yes I do. Thank you.

 

Ben Shelley: [00:30:22] Just curious actually so I know obviously for for hard money generally there is either no or very minimal prepayment penalties given the term but is it a direct one for one. Generally speaking that the quote unquote shorter your term the shorter the prepayment penalty will be or what is your experience.

 

Ryan Goldfarb: [00:30:40] I'm just curious. I don't necessarily think that's the case. I believe unconventional financing conventional loans for a home. I don't know if there's any prepayment penalty built in

 

Ryan Goldfarb: [00:30:50] whatsoever. I've never seen it before. I think I do. I think lending you might burn some goodwill with your lender. But I don't think there's any monetary. But again the lender is probably selling your letter. They really don't care. I think there is a minimum amount of time that they have to hold. I could be wrong but made so in order for them to articulate your views.

 

Ryan Goldfarb: [00:31:04] I mean maybe the 30 60 days like that but so the answer I would say is no on.

 

John Errico: [00:31:12] And your question is this is this episode to turn into the roast of Ben Shelley.

 

Ryan Goldfarb: [00:31:19] That's like the like you really really like the chocolate factory. Like you get nothing. You are awarded no points and then God have mercy on your Exactly.

 

John Errico: [00:31:28] Yeah.

 

Ryan Goldfarb: [00:31:29] So sometimes I'm like a hard money loan you may see that the lender wants like a guarantee of three months worth of interest payments. Other times you might see a loan prepayment penalty of like 1 percent of the loan amount. So it varies loan term amortization. We talked about that. Interest only has been alluded to before. It's pretty simple it's a loan on which there is no amortization and you're paying only interest. So it's a lot easier to calculate the rate on that if you have a hundred thousand other loan and your interest rate is 12 percent. That's twelve thousand dollars a year or 1000 dollars a month. That's your interest. That's your mortgage payment. That's all you pay on a monthly basis outside of your holding costs interest only loans are only really comment on investment property I've never really seen them offered on at least conventionally on owner occupied either.

 

John Errico: [00:32:21] It's either for hard money flips or for like commercial or he locks are like what he likes are often interest only but that can be advantageous because they may obviously allow you to have a lower monthly payment than men if you are paying decades as well shall we say.

 

John Errico: [00:32:38] Juice somebody returns you you have to buy and hold property if you really wanted to cash flow and you have an interest only loan.

 

Ryan Goldfarb: [00:32:45] If you're and if you're working with a more sophisticated lender or a lender who is willing to get a little bit creative oftentimes one way that you'll see these structured is that you'll have an interest only period so you might have six months 12 months two years of interest only payments and then it goes to an amortizing schedule and that's all.

 

Ben Shelley: [00:33:05] Now that's fun to underwrite.

 

Ryan Goldfarb: [00:33:06] Yeah that's generally done for the purposes of giving the owner time to get their operations up to par. So if you have a big repositioning or if you have a development occurring it's a way to say like OK we understand that your cash flow is gonna be tight for the first six months or twelve months or two years but we understand that there's upside in that and we'll work with you to to create something that's gonna work for you. The one last thing that we can touch on are that we should just highlight now as the DTI or debt to income that's a common metric for conventional financing because that's underwritten on an individual level versus against the property. So your debt to income is it's the ratio of your debt to income.

 

John Errico: [00:33:50] It's important to consider that the debt to income ratio and that's thrown around a lot particularly in the residential world too could be inclusive or exclusive of the debt that you're about to assume. So oftentimes the minimums are inclusive of the debt. So if you're buying a home your debt to income ratio has to be a certain number including the debt you're about to assume which is often quite substantial. So just as a very high level overview and we should talk also about what underwriting is. I know that that might be very obvious but we've just used the word underwriting many times. Underwriting is essentially like the call analyzing like you're just like running the numbers and seeing like do the numbers make sense. So a lot of people in the finance world say I'm going to underwrite a deal it sounds very fancy but just means that I'm going to take like three numbers together and see what they are.

 

Ryan Goldfarb: [00:34:35] So my first title was underwriting analyst and it took me a while to understand what that even like what that even meant analyzing I think is redundant.

 

Ben Shelley: [00:34:45] I think it is fair to say that in previous episodes we've alluded to a very basic form of underwriting this idea of underwriting or analyzing for the common investor or rental properties. I was an underwriting analyst for a mortgage debt lender.

 

Ben Shelley: [00:35:00] You were an underwriting analyst for a mortgage debt lender.

 

John Errico: [00:35:03] Do you ever underwrite the La Brea Tar Pits which is the tar tar pits.

 

Ben Shelley: [00:35:08] This is so over my head at this point I just don't even know that's not involved in it.

 

John Errico: [00:35:12] It doesn't matter because you can't. I just made a very common joke. I didn't I mean it's like no complexity.

 

Ryan Goldfarb: [00:35:18] No. I made a unique joke.

 

Ryan Goldfarb: [00:35:19] It just wasn't that funny.

 

John Errico: [00:35:21] Laughing very hard it was. Cut it out actually. We're moving further and further away.

 

Ryan Goldfarb: [00:35:26] Nobody laughed harder at Ryan's joke that Ryan himself.

 

Ben Shelley: [00:35:30] Point being that if you listen to some of our previous episodes you hear some of also the assumptions that we draw from our quote unquote analysis and underwriting cash on cash, IRR, etc. That's all part of this and I definitely recommend listening to previous episodes to make sure you have a firm sense of the concepts. For the folks listening at home make sure you subscribe to us wherever you get your podcasts. You can find us on the brick by brick. That's Brick X Brick. Facebook and Instagram. Thanks so much for listening.

 

The BxB team discuss various pieces of technology that they use in their real estate and construction businesses to help with everything from communication to document storage to project management and invoicing.

 

(Transcript below.)

 

Ep 14 - Leveraging Technology as a Real Estate Entrepreneur.mp3

 

Ben Shelley: [00:00:07] Welcome back to the Brick x Brick Podcast.

 

Ben Shelley: [00:00:09] I'm Ben and I'm here with John and Ryan for today's episode we're going to talk about technology something we're all familiar with but specifically related to how you can utilize modern technology to efficiently run your business or operation. I think there's a lot of tools and apps that people may or may not have heard of who think why would that be helpful for me. Or maybe they recognize that they could utilize these tools in certain ways but simply haven't tried them yet. So we thought it might be helpful to talk about some of this technology more broadly and then specifically some of the things that we utilize which we think really helped push our business forward. So where do we want to start guys I mean we can really talk about any of the I mean I'm a slacker. To be honest I am a big slacker which really sounds bad but is actually very good.

 

Ryan Goldfarb: [00:00:56] Well for starters I think it's relevant to say that our utilization of technology is ever changing since we've started working together over the about eight nine months ago. I think we've at this point probably employed like five six seven eight different platforms some of which have stuck. They've withstood the test of time and they are still a relevant part of our practice today. Others we experimented with and found that they either didn't work for their intended use or we found a better solution for that same problem. I think as a general theme one one thing that I like to consider here is that the best system that you never use is not as valuable as the OK system that you already are in the habit of working with. And this is particularly true for things that are repetitive in nature things that require constant updating. And so I guess for our purposes and for our context this is particularly relevant in the communication space in the document management space in the project or task management space. John you wanna maybe give a little high level overview of of what we use and why we use it.

 

John Errico: [00:02:17] Yeah I think this is another general framing point. Like all technology is some of the technology that we use I would describe as being very important or maybe even essential. But at the same time it's all for us it's more of a it's a productivity saver. It's also I think a way to save processes and make things repeatable which is important to the business. But like nuts and bolts I would say we we use the Google suite of products to do a lot of stuff. We have all of our central documents for. So what we do is we have a construction company. We have a management component. I do legal work in relation to real estate stuff and then we have the private equity fund which is a lot of legal work and documents and we also have our own private real estate holdings and acquisitions which we do sort of all the time. We have a lot of different components to that. We use a Google Drive calendar emailG.M. for everything like step one. And I think a lot of organizations do similar things with that. We use we've started to use it has become I think an essential component of our workflow Tello Tello is a task management system I guess you could call it. We use it. I think you can do a lot more powerful advanced things for it but we basically use it as a repository for things to do. So. We employ in conjunction with our use of technology very high level project product management type systems that I used to employ when I was in my technology startup days. So again very high level what we try to do is have a weekly meeting which actually is today for us where we talk about all the tasks that we're doing this coming week. All the tasks that we did in the prior we talked about how much time or complexity going to take et cetera et cetera but we use truckload to keep track of all that. So if there's something that comes up like a task that has to be done but as an emergency we can just put it in trailer and say like here's where it'll live. And when we have the meeting we can go back and refer to it real quick.

 

Ben Shelley: [00:04:25] I think it's worth highlighting that the a lot of these workflows are relevant for the team context. So if when I was operating as an individual proprietor mostly working solo a lot of these things probably would have been overkill and might have been nice to have them written down somewhere. But it's I think it pales in comparison to having three or four people working together in conjunction with one another on a recurring basis. I think it's arguably a necessity in that context. So I think a lot of these tools are kind of geared towards that context. So keep that in mind for all residents.

 

John Errico: [00:05:08] And like we reference this in a previous episode as well but a lot of what we're doing is we are ourselves trying to impose processes on all the tasks that we're doing and we're using technology to help those processes. So like for example we use Google Calendar for all of our calendars calendar ring needs but or on the counter we'll put things like Hey we're gonna be done with whatever rough inspection for this property by this date or we're closing on this probably by that date and that's part of our process system of like you know what. One issue which may not be obvious but is a big problem for us is that we have a lot of properties that we ourselves own. We're also doing the construction work on them and so we don't have a client that's sort of breathing down our back to say like hey are you gonna get this done. But at the same time we have to push them through because their dollars and cents consequences for it. So we're trying to impose the same processes that we would do for a third party project on our own projects just to do it.

 

Ben Shelley: [00:06:00] I think from a productivity standpoint when you talk about practical use right so for example John talks about I like the phrase calendar in so when we calendar in our daily weeks and schedules what have you. It stops us from having to waste any time saying I know I don't have to call John if he say Hey I'll meet you later at this property to meet with a potential construction client. I don't have to call him out of the blue to find where the address is right. I already know it's in the calendar and from trellis standpoint and maybe we could talk a little bit more about our points system but is the system we use I happen to really like because I love putting in travel and not just from a standpoint of knowing what everyone else is doing in the context of what my goals are but setting weekly goals is remarkably motivating. I know for myself just to have everything organ. Okay yes I need to do this I need to do that and you do this as priorities. And then if I have time I can do X Y and Z. So from a practical standpoint I think it's been great.

 

John Errico: [00:06:50] Yeah yeah. Both times I agree. Yeah. Another tool that we use that we've been using quite frequently that Ben mentioned at the beginning of the episode is slack so slack for us as a communication tool that has replaced a lot of ways email and text messaging. So they deal with slack is that there are no important pieces of communication that we need to share among each other but we don't necessarily need to want to interrupt someone in the middle of whatever they're doing with that information. So for like not absolute emergency pieces of information we put it in slack. We can look back at previous things like decisions that we've made which has become very very helpful because we have a lot of different projects in the frying pan if you will. So we've been using that. We have channels for individual projects individual homes individual business ventures whatever it might be. And that is something that we've adapted adopted I would say over the past month but it's been very immediately an essential tool for us to be more productive and to keep track of things.

 

Ben Shelley: [00:07:48] I think my favorite thing about slack beyond its practical helpfulness is for people. Why would people know this our office setup is the three of us all facing back to each other and I think my favorite moments are when we're actually having a conversation on slack while we're all sitting within two feet from each other because that's how productive that's how committed to the work we have at hand is.

 

Ryan Goldfarb: [00:08:08] But it's also worth bearing in mind that the reason for that is because if Jon is working on something that requires immense focus it doesn't distract him in the moment because Ben and I are having a conversation about something that could be could be discussed in the background over the course of the day and then isn't immediately urgent.

 

John Errico: [00:08:29] Right.

 

Ryan Goldfarb: [00:08:30] The other thing I want to highlight with slack is this speaks to the point earlier about the the perfect system that you never use is not as valuable as the system that that you use regularly. One concern we had in Slack was that we were implementing a new system and the adoption of that new system was really going to be the key to success. One thing that was nice about working within a team context was once one or two of us made a concerted effort to use that system by virtue of necessity. The other two had to do the same in order to stay on board. So adoption really wasn't as much of a concern for us as I thought it might be. And that made things a lot easier. I think if we already had another system in place where maybe we had a group me or WhatsApp group or a Facebook group or something like that where we had been previously communicating I think it would have been a little bit tougher of a transition but up until this point we were mostly just communicating between some combination of text messaging email and a little bit of back and forth on Trello itself.

 

Ben Shelley: [00:09:37] And I think a good thing about it too is it's helped to delineate the quote unquote most important or like high line items for us to discuss.

 

Ben Shelley: [00:09:45] You know I think Ryan was the one who described this when we started this but we've all adopted this which is that you know slack tends to be this is just our choice obviously but slack tends to be things that we you know maybe don't need to address right right away but are things that we can look back on and respond we have time versus making email like OK if we need a contract signed for closing or to talk about some major issue at a property and that's what email really is for and so also delineating those in terms of importance. So you know in your mind if there's a slack I'll get to it versus an email. I need to address it right away. I think that's how productivity as well and can help your team.

 

John Errico: [00:10:21] Yeah. I mean what a feature that I like about psych too is that it's a it's a nice repository of information that is easily searchable so oftentimes I have the problem where like I need to find something that's buried in an email or a text message so hard to find that even there's just this morning we had a subcontractor going to one of our properties and needed the lockbox code and we just had this exact problem but we communicated over slack about how to solve it. And so I was able to send him a picture of that that someone had said on slack about how to solve this problem. And if I'd try to find that I'd like a text message or an email would have taken a long time to revive Zach in a lockbox channel I hadn't even thought about that would be brilliant because I just clicked on story just getting the last I could do.

 

Ben Shelley: [00:11:03] Yes that's right at this.

 

John Errico: [00:11:06] Yeah. So yeah we use Slack for for accounting we use quick books and I think that's been OK. We switched over from an accounting service that we used in 2018 that we weren't really satisfied with but garbage would be the right term to use.

 

Ben Shelley: [00:11:25] Yeah.

 

John Errico: [00:11:25] I mean we had some problems but so quick books has been it's you know I I we have another way of doing some of our accounting that I'll touch on a little bit but quick books is a great way you know the sort of ultimate source of truth for accounting or are our transaction logs from our checking account and or other accounts credit card accounts.

 

John Errico: [00:11:48] So there's there's no like there's no lying or confusion when you look at the actual brass tacks the amount of money that you spend or you took in. So we use quick bucks to keep track of that. We used to call rail as a a phone system. So we have phone numbers that we're forward to each of our phones for various reasons like we have a construction phone number that photo sales phone number that fraudster phones with a construction work number that forwards to our phones I think for four acquisitions we have in the past set up you know numbers that flow to our phones.

 

Ryan Goldfarb: [00:12:23] Yeah a lot of that a lot of CallRail's intent is to help with tracking. So if you're running multiple campaigns let's say for acquisitions you're running an online campaign you're doing direct mail you're doing Facebook and you are bandit signs setup. If you have a different phone number allocated to each one it better allows you to track the efficacy of each different path as opposed to just saying I had 10 leads come through this month but I don't know where they came from. Going back to the Google suite. One of the most I think in a lot of instances one of the most effective solutions is often the simplest.

 

Ryan Goldfarb: [00:13:04] And I would say that just taking photos using the stock app in your phone taking photos is quite possibly the biggest time saver that you can have as either a construction individual a construction person or as an investor. And one thing that I think we should do a little bit more often but that we've been getting better at recently is chronicling each project through pictures and through video and then depositing those photos or those videos into a folder for that specific project. It helps for a variety of reasons it's obviously nice to have some kind of before and after photos but it's also helpful to have to have a point of reference if you're thinking about you know how many outlets you have in a room and you're going to buy you're going to buy the electrical boxes or you're looking at purchasing light fixtures and you want to know exactly how many you have rushed into rushed into a room or if you're getting into a dispute with a subcontractor who's saying you know this wasn't there before I started it and you can say Yeah I know it was there I can show you the pictures it's super helpful and there are a lot of instances where it can save you a trip to the property and when you have multiple properties and multiple projects going on or at any point in time that can be a huge time time saver.

 

Ben Shelley: [00:14:22] I also think coming back to the G suite at a high level look I think it's fair to also caution the convenience of it sometimes I think I know I create a lot of Google Docs and Google Sheets and we'll drop a ton of stuff in the drive and so I think oftentimes it's something that we found too is because everything the G suite incorporates so many things where you can drop the information that both Ryan and John have talked about it can become almost a black hole. So it's really one of the things I've really enjoyed about some of these other resources. It's helped to aggregate a lot of information. I used to just drop in G suite in a drive and so unless you're being really active and again another thing we've talked about about organizing your drive you just want to be really careful because you can just get in a habit of saying now it's in my it's somewhere in my g suite so. I'll always be able to find it but that becomes a very slippery slope when you actually need information on hand right away.

 

Ryan Goldfarb: [00:15:13] One other one other tool that we've used not to totally Segway off of that point now is Segway away. One other tool that we've used is joist. We use that for our invoicing and estimating for the construction business. It's a pretty simple tool but it allows us to kind of operate in a professional manner. It helps in some capacity it helps with tracking invoices and outstanding invoices. What the balances for any given project but I think one of the things that I've liked about it is when we're managing our own projects we can employ some of the same practices that we use on third party work which is I think just generally a good practice to have a good habit to get into. It's very easy to just kind of like lose sight of of the bigger picture when we're working on our own projects. We don't have another investor or we don't have a client to be accountable to you. But this is also something that I've taken from working with certain hard money lenders. Having them in the picture obligates you to keep a scope of work. Keep track of where you are in the projects to kind of tabulate your costs on a consistent basis for each division within the project overall. And it just kind of creates a sense of order in what can otherwise be a pretty chaotic process.

 

Ben Shelley: [00:16:34] Ryan I was also going to say do you want to talk about Carrot as a tool.

 

Ryan Goldfarb: [00:16:38] Sure. So one of the platform we use as real estate investors as investor carrot which is I think we've mentioned them in the past but they are a firm that has templates Web sites and a suite of online marketing services that are geared specifically towards real estate investors. So that's how that's one channel through which we do some of our online marketing for mostly for motivated sour weeds. So this is mostly an acquisition tool for us. There are a few others out there and a lot of these platforms are great but they there's a pretty critical element of consistent practice and oversight and management on behalf of the business like on behalf of us as investors. You can have the greatest site in the world but if you ever market it it's not going to drive any traffic.

 

John Errico: [00:17:30] When we use have used in the past and would again cozy for certain property manager related tasks. Cozy is a Web site where you can put a listing for a property and it will syndicate. You're listening to a couple of other Web sites but primarily I use it for the application and sort of credit score component of it. So once you set up a listing you can set up a an application for it accept applications through the Web site and then if you want to you can also collect rent through the Web site. I generally don't do that just because it's easier for me to collect rent and tenants will pay in various ways. But it's intended to be like an end to end full service property management tool and it's essentially free to you as a landlord. They charge tenants for various things like credit checks and background checks.

 

Ryan Goldfarb: [00:18:16] We actually used cozy for one of our tenants to collect rent and it's nice that it's nice that it all integrates together my one gripe about it is it's a little slow when it comes to processing a payment but it's not. It has improved and as we know pretty well catching a track through a bank standard process or is is not the quickest to begin with.

 

John Errico: [00:18:38] We've had the same problem with Joyce. Actually because Joyce can also do payment payment processing but it's something else that we've or that I've used and I think we all use probably pretty frequently is Zillow Trulia Redfin all those websites are pretty good reference point mostly because they provide a good user interface for looking at property and with the map views it's pretty intuitive as opposed to some of the.

 

Ryan Goldfarb: [00:19:06] A lot of like realtor websites that integrate with the MLS. Maybe you don't have the best interface or don't have the the best ability to filter in in a specific way. I also use Google Maps a ton both for obviously for navigating purposes but also the street view tool is indispensable. It's also it's also it's also a really cool tool tool to use. You can go back and scroll through the history of a given location so you can look at you can gather the street view history from 2011 or 2012 2013 whenever they first started gathering that data up through today and then a lot of areas they've gone back they've gone back and forth to and covered the same locations multiple times. So you can kind of get a sense of how things have changed that can be helpful if you're looking for a looking at a specific building and you're trying to cross-reference different different old listings or different stories that you're hearing together whether whether things were renovated.

 

Ben Shelley: [00:20:06] Just as a specific example of that in particular we were just looking at a property in New Haven that is packaging together a second plot of land as part of a sale.

 

Ben Shelley: [00:20:16] And we still don't know if legally you'd be able to build on that but by actually going back into Google Maps years in the past I was able to see that at some point or another there was a home built on

 

Ben Shelley: [00:20:26] that area. So it's just just a practical use of it and then of course just sort of going back and getting a sense of the wider.

 

John Errico: [00:20:31] And like the satellite or Google Earth satellite version too because you can see that you can try to see the bounds of the property like if there is a parking area or garage or whatever it might

 

Ryan Goldfarb: [00:20:41] be. I have also seen a tool I forget the name of it but there's one that can estimate the footprint of a

 

John Errico: [00:20:46] building. I've used that based on based on the aerial view kind of dimensions that you can draw on it and say like here's the approximate square footage if.

 

Ben Shelley: [00:20:54] There's a whole mess of apps to that that I should update in the next episode that I don't know offhand that that you can look up for going in property getting measurements and getting a sort of a specific layout when you're physically in a property not just sitting by another.

 

Ryan Goldfarb: [00:21:09] Another tool that I love and this is an online tool. It's a physical tool but the laser measure laser measuring tool (Ryan goes nowhere without it). I love those things. It's just it's really nice for approximating square footage even even if you just use it to get one one clear shot from end to end of the building just to get a general sense of the footprint.

 

John Errico: [00:21:30] And then multiplying that by the number of stories that are out there to return to your earlier point right about you know looking at property data through Zillow there there there are wrappers as well that we use a lot that will take city or county or state data and then repackage them in a digestible form. A lot of increasingly cities and counties and states will have online data but oftentimes it's really inconvenient to search through it or whatever. New Jersey is and is a good example of that. So something that I use I don't know if you guys will use it as NJ parcels dot com I really like that it's a wrapper around the tax records essentially.

 

Ryan Goldfarb: [00:22:04] For whatever reason I is the tax records which is also good.

 

Ben Shelley: [00:22:07] I also want to plug state info services which is Jersey specific it's like another form of NJ passes that I absolutely love is property shark which is a paid service but has similar information.

 

Ryan Goldfarb: [00:22:17] A lot of these systems or most of these systems are only as good as the data that they collect. So to the extent that they differ in terms of data services you'll see some variation and.

 

Ben Shelley: [00:22:26] I would always suggest to cross-reference.

 

Ben Shelley: [00:22:29] So never just rely on one source. So I know that when I'm looking at comms I take the MLS out of it first second I'll probably go through some combination of Zillow and Trulia and then also cross-reference facts on state info services and NJ parcels and aggregate that all in a summary I'm doing of a given property just because the more info you can gather on it the better. It's a great way to verify some of the things that you're seeing.

 

Ryan Goldfarb: [00:22:50] It's also we've mentioned a few times already but the MLS itself despite its its deficiencies it is super helpful in terms of being in terms of being a repository for a lot of data specifically historical data. So it's nice to be able to if you have a specific property that you're looking at and you have a realtor there that you work closely with at the nice to be able to pull all relevant MLS history for that property. It's also nice to be able to search if you're in an area where a lot of the housing stock is similar. It's nice to be able to search for example as granular as like a specific block and look inside and get a sense of what each and every house on that block is like. Because obviously one of the big challenges that we all face is finding relevant Thompson.

 

Ryan Goldfarb: [00:23:33] Oftentimes that's the closest you're going to get.

 

John Errico: [00:23:35] One piece of technology that or suite of technologies that we do use which is unique to us is that we've actually built some of our own technology to manage the construction process so as we as we mentioned probably a few episodes ago when one major issue that we have as a construction company is we have a lot of projects that are going on simultaneously. And you know we're paying out expenses for these projects and to the greatest extent possible we try to use built in things with things like credit cards to divide out what expenses are per projects. But at the end of the day it can be very very challenging to keep track of where our guys worked. On any given day what we bought for a project in any given day. Well we made in a project any given day like. I mean there are definitely construction companies out there that have no idea what they're making on a project like how much margin they made or whatever else which is a whole nother episode about how these construction companies price projects but. So we I built something for us essentially to input a summary of what we did every day which allows us to keep track of our workers allows us to get progress updates on the particular project we can keep pictures in there we can put expenses like receipts in there in the future we should be able to track income and what our subcontractors are doing at every project. So with even without doing the sort of quick books based accounting we can go in and very quickly see Hey how much do I spend for framing for this particular project. How many days to take me and do in every given day or the same is true for sheet rock or plumbing or whatever else might be. So that's I would say it's been very helpful for us to keep track of our our money and our labor when we're not necessarily there at every single project every single day.

 

Ben Shelley: [00:25:21] And I would just say first and foremost if you're interested in learning more about managing the construction process I'd refer you to managing the construction process part 1 and Part 2 earlier episodes in our repertoire.

 

Ben Shelley: [00:25:31] But to John's point that's exactly right I mean one of the things if you have the capabilities we're lucky to have John who is able to build these systems for us. You know obviously you're going to have we're talking about are the uses of some of these programs and technology in the context of what we do. If you can fit that into what you do that's phenomenal. But if you're also able to build certain things that are tailored to what your specific needs are and you'll find what those are as you go on through through your operations then that's phenomenal. And just as another example John built out something to help us track our accounting he's also helping all of us build out a an acquisitions platform so that we can better keep track for example of what we're looking at. Our thoughts and opinions on on projects both that we we put offers on and didn't and that again is something that's specifically tailored to us from a technology standpoint so if you have that capability obviously that that is quite ideal.

 

Ryan Goldfarb: [00:26:21] A few other things I'd like to plug while we're at it. I have an app on my phone called Jotnot, J-O-T-N-O-T. I think there are various competitors to it but all of them kind of serve as like a mobile scanner. So it allows you to take a Ben Shelley scan a PDA off of a document onto your phone which I've found super helpful when I don't have a true document scanner on hand. I also do have a document scanner. It's a little bit of an older piece of technology but in terms of scanning text based documents both in terms of accuracy and speed it's it's been super helpful for contracts and invoices and things like that.

 

Ben Shelley: [00:27:01] It's a good idea by the way to just look at the five and even think about that just going on my phone a lot of the apps I use going through air Dropbox can always be helpful in whatever business that you do I realize that's not really where we've been.

 

John Errico: [00:27:11] We've had a debate about Google Drive there's a repository for documents versus Dropbox.

 

Ben Shelley: [00:27:17] I prefer Dropbox team Dropbox only using Google Drive which is crazy. That's a majority. I think that's all my fault.

 

Ryan Goldfarb: [00:27:23] I also use healthy use a cloud files though it may not be the best at integrate I'm a Mac guy and everything is OS X iCloud. I use it for some document stuff.

 

Ben Shelley: [00:27:36] And it's worth download where we use Canva a little bit to work on our social media I mean obviously we didn't talk about this clearly because everyone is we're on Instagram and Facebook even Twitter which we use less if at all. So having anything any kind of app or technology that can help you individually or aggregate some of your other tools can be of service.

 

John Errico: [00:27:56] Yeah I use Hello sign for signing document just gonna say W H genius scanner for. For the scans. That's just another. Just another scanner test which integrates with Nest.

 

Ben Shelley: [00:28:10] It's good to have the apps of anything so if you go to Home Depot a lot. Download the Home Depot app library. Same thing. Got to go to Lowe's I don't got to go to Lowe's actually.

 

Ryan Goldfarb: [00:28:18] That's actually lose it but that's Mo's. I think it's low is low. Got to go to Mo's, Modell's!

 

Ryan Goldfarb: [00:28:31] There's also there's also actually an I think the newer iPhone OS there's a measure app which is like kind of an augmented reality measuring tool. I don't know exactly how precise it is but in theory it's cool.

 

Ben Shelley: [00:28:46] I also have you have you have to have the pioneer app obviously because you can't live in business without going up and.

 

John Errico: [00:28:51] I also like the phone feature of the phone you can make a phone call.

 

Ben Shelley: [00:28:55] This is crazy thing called text messaging. Wow. Coverage. Was really really diverted. Any other things that you think can help people in business moving forward.

 

John Errico: [00:29:05] Operationally we could touch a little bit on I don't know if we have a lot of time but the process that we use to do product management or project management which is in conjunction with cello but. Sure. So it's I mean I guess you could call it like a pond bond or lean or whatever mini terminology is to describe it but we operate on the premise that obviously all of us have discrete amounts of time and effort that we can put into work in a given week. And one big detraction from the amount of time we can spend is figuring out what to do and also having meetings about deciding what to do. So the takeaway or the observation is that what if we just had essentially one meeting once every time period we've decided a week. But you could do it every two weeks or month whatever you'd like to determine what it is that we're going to be doing in that given time period. And so that there are recurring tasks that we all do those would not be appropriate for this type of meeting because ostensibly the things that you do every day. So like if every day you do the accounting or you update the counting and that's not a task for this type of system it's just something you do every day. But the idea being that every person has a set number of points. What I'm going to call it meetup meetup units. They can do per time period SEO per week. So you might have ten points and you can call them story points you can call them complexity points. You can call them whatever. But the important thing is that these are not time. So you might say every week I have 40 hours a week to work. But the problem is that human beings are the premise that human beings are not very good at determining how long tasks will take. But it's a lot easier to determine how difficult or complex a task might be. So even a task that might take a very long time could be very simple just because it's very repetitive like and I don't know how to treat that system but a task that might be not take a lot of time like maybe filling out an application might require a lot of thought and effort because I need to pull documents from somewhere I need to think about how to answer certain questions you know whatever else it is that willpower is a renewable resource. But it's also an expendable resource. So if you expend all your willpower doing one very complex task and one day that might really ruin your productivity for the day even if it only took you an hour or two hours to do that. So the point being is that you ascribe points to yourself or to other team members and then ascribe tasks with a value of points. So if I have 15 points to do in a week and one task takes me five points to do it then that detracts from my fifteen point total I only have ten points left for the week. So that's the system that we use to delegate work to each other. And it's used in conjunction with with check ins. So every day although we haven't been good about this recently to be frank because we see each other so often but every day we'll do a meeting that's supposed to be no longer than five minutes where we all very quickly say well we did the previous day and if we need help on doing anything the next day. So that's a way for us to keep accountable to each other and also to check in and say you know hey this task I'm waiting on you know Ben to finish something. And unless you finish it I won't be able to do it so can you talk about how to finish it or how to get it going. It's not a perfect system and we're we're evolving and working on it. And I think it's most appropriate for four companies that have our very project and task oriented which can be us sometimes but other times it's not. But in any event it's been effective for us just as just as a management tool and as a way for us to scale in the future. Know Right now we only have essentially four people that work for us that some contraction guys. But at some point when we have 10 15 40 people that work for us some system like this is going to be very important both to minimize the Times of meetings and context switching and figuring out what I'm going to do. And also just as a high level management technique where say I'm overseeing people I can understand what everybody is doing without having to go into the details and minutia that every individual task.

 

Ryan Goldfarb: [00:32:59] This all comes back to the the theory that that which gets measured gets managed. I think for a while we weren't really managing these things or measuring these things in any.

 

Ryan Goldfarb: [00:33:08] In any real way. And and now that we are. While it may not be perfect I think we're constantly iterating on it and we're constantly trying to improve it and the fact that we have a processi.e. these weekly meetings is super helpful during those meetings we also generally review whether we felt we adequately allocated points to each of us and how we could have done that a little bit better.

 

Ryan Goldfarb: [00:33:31] And then generally the challenge that we seem to have with this is is by the nature of what we do and we're oftentimes putting out some type of fire and it becomes difficult for us to just focus exclusively on the six tasks that we were assigned for the week. So while none of those tasks may be insurmountable or unachievable when they're taken in the context of everything else that we have going on sometimes they fall by the wayside a little bit more than they should. But it's been I think a vast improvement over the essentially nonexistent system that we had in place before here.

 

John Errico: [00:34:09] Is it true. For me it's the difference between working for myself and working for a company that I own is in some way creating these processes because that in a large part is like the secret sauce of a lot of these companies is having repeatable processes that say I say I am working for myself well I might do everything and everything might run through me but say I'm working in a company that has a process I might be an integral part of that process but I also might be hopefully at some point in interchangeable part of that process. So if I can't do something in it I can hire someone else to do that thing and then scale in that capacity. So you know we are already in our sort of early history of the company. There are already too many tasks where it was just me and you Ryan for example we couldn't possibly do all of the things but now that we have other people working for us we can do more thing however in order to keep scaling and keep expanding we have to put in processes in place where we're able to do that effectively and without a lot of setup and thought costs to do it. So like if we can expand to a new market we're just talking about this in fact what is the process they're going to have to say go into a market that we've never been before. And once we develop that for a market a then we can apply the exact same process with market B and C and D just plugging in different people who might be local to that market and be able to do the same processes that we've already developed and consistent with that theme.

 

Ryan Goldfarb: [00:35:37] Another tool that we've implemented over the last three weeks maybe is we've put a little forum together and the idea was to kind of tease out some of the repetitive tasks that we each face and to first and foremost bring them into our consciousness so that we're aware of them. And then secondly to think about ways that we can either automate the process or streamline it or outsource it to somebody else. And I think you know for John just one example of this is so taking us that back the way that it works as every day in the evening it sends us each a text message with a link to a form click the link and the form asks you a few simple questions.

 

Ryan Goldfarb: [00:36:20] What did you do today. What of the tasks that you did today is repetitive in nature and then how can you streamline any of these repetitive tasks and I know one thing for John a consistent theme in his responses is Airbnb messaging Airbnb responses and so naturally you know it's not something that you can necessarily automate but it is something that could potentially be outsourced and I think the the idea is to get things like that into our consciousness so that you know it sparks a debate or it sparks a conversation at some point about when the time is right to bring someone onboard to handle that task.

 

Ben Shelley: [00:36:57] And I think just as a final note it's just worth remembering trial and error is your friend right. Trial these things I think it's worth you.

 

Ben Shelley: [00:37:04] I knew of a lot of these apps Slack was something I'd done before but I had never used Trello. I had never heard of Joist I've only just learned about cozy maybe for future rentals I do try as much as you can and don't be afraid or worried if you know you stop using it or if you're not enthusiastic about it do what works for you I think that's sort of the most important theme here I think we have come to this point both from a technology of our own creation and things that already exist a nice balance for how we operate but again for for the listener out there do what what's best for you and try as many possible resources as you can as you try to streamline and make your business as efficient as possible.

 

John Errico: [00:37:43] And I would also briefly say and realize that there are other too. If you have a problem a business problem you are not the first person to have this problem and it's more than likely that someone else is out developed a tool to fix your problem. So sometimes businesses will go and they'll like describe their problems in such unique ways that it sounds as though like the only way to solve it would be to just build your own you know roll your own product but nine times out of ten there's gonna be something else out there it's just a matter of you know I think if you're listening to this episode then that's a great start because you can learn from our experience but also just go out there and say like hey I have this problem. I guarantee someone has thought of it thought of a solution you know whatever else so much much easier to implement somebody else's solution than roller will rule your own.

 

Ben Shelley: [00:38:26] Gentlemen thank you for your time and expertise as always. For the folks listening at home make sure you subscribe to us wherever you get your podcast reach out to us on the Brick x Brick. That's Brick x Brick Facebook and make sure to listen to us and iTunes and Spotify. Thanks for listening.

 

Broken toilets, leaky boilers, non-paying tenants, and mice infestations...

Today, the BxB team discusses the glorious world of property management!

The team touches on the good, the bad, and the ugly in order to prepare you for what's in store as a property manager -- whether you're self-managing or hiring it out to a property manager.

Property Management is a make-or-break for any real estate investor who holds rental property, but it's not for the faint of heart.

 

(Transcript below.)

Ben Shelley: [00:00:00] Welcome back to the Brick x Brick Podcast. I'm Ben. I'm here with John and Ryan. And today we're going to talk about property management now whether or not you were less or less see if you're involved in real estate or interested in investing in real estate. Understanding how property management works especially for rentals is a vital part of understanding the real estate business overall. So we're going to jump right into it and we're lucky for us. We have a property management expert in our midst. John Errico one of the top property managers in all of northern New Jersey.

 

Ben Shelley: [00:00:33] John I'd love to know. I'd be interested to know from an origin perspective. First and foremost how you got started as a property manager and I think that would be a nice way for us to get into what property management really is.

 

John Errico: [00:00:45] Yeah I mean I killed the previous property manager.

 

Ben Shelley: [00:00:48] So no I mean this is on video you know.

 

John Errico: [00:00:52] Yeah no. The central premise of property management when you own an investment property is that you will have to manage the property that you own in some capacity. And I think that that we talked about this in previous episodes but I think that that for a lot of investors newer investors is not necessarily obvious to them. They think that they will either you know manage it themselves or whatever but but don't we think about what goes into that. So when I bought my first investment property which was in Union City here in New Jersey I was a 2-family home very immediately. I read it out part of the house to tenants and very immediately we had you know what I would call property management concerns for me. They were also the homeowner concerns because I was living in the home as well as renting it out. But just as a basic premise whenever you buy a piece of buy and hold real estate you will have to manage it in some capacity and as you scale larger and larger that can become a bigger and bigger burden on your time or your capabilities. Before I started the construction company and did all the things that I do with Ryan that we began last year I would say that my primary job was a property manager. I manage my portfolio in Hudson County to some extent properties in South Jersey and then a little bit properties in Connecticut. And that can be a full time job. I mean you think well how often can you know X problem happen. Well I might be not very often but if you multiply that by say 15 properties then it's going to happen pretty often. So like I've as I said before in previous podcasts like the number of times I've had to fix something leaking like water is the enemy of homes and water from the outside water from your plumbing whatever it is the number of times I've had to deal with a water related issue is so many and it happens all the time and every season has its own particular annoyance like winter is heating summer is cooling and rain fall and spring or like the transition period of time so it might be too hot and might be too cold and maybe this might be that. Lots of issues.

 

Ryan Goldfarb: [00:02:51] Did you set out and make a conscious decision that you and some combination of you and Shannon were going to manage your properties when you guys started acquiring or did it just kind of naturally morph into that over time as you scaled up the portfolio.

 

John Errico: [00:03:04] No I think it morphed into that. And the reason why I like to bring up the point about new property investors not realizing the management challenges is because we were very much in that position where we bought the property and we were living in it. We're like oh it's no problem to rent it out to other people and it wasn't. But along with that came the challenges of actually operating it in the the more the farther a move that you get from properties. I think in some ways the more difficult thing can become like when you're living at the property you obviously know what the problems are and if you're observant and proactive you can solve a lot of them before they happen. But if you're not at the property you know actually during the filming the recording of one of these episodes they had a very large problem which was that one of our basements in one of our properties totally flooded like over a foot of water and destroyed the boiler and the hot water heater which was very very expensive and challenging replace in the middle of winter so people didn't have heat.

 

Ryan Goldfarb: [00:03:56] And being the consummate professional that you are you were unflappable on air you really.

 

Ben Shelley: [00:04:01] Was impressive given the context of what we were dealing with.

 

John Errico: [00:04:03] Oh thank you. And that means a lot. But as an example you know I think if I had been living at that house I probably would have thought ha like I wonder what that dripping sound is or I wonder why my water pressure is low or whatever. And I probably would have stopped the problem before it got to the extent where it destroyed these this equipment in the basement but because I wasn't there and because I have tenants not to denigrate them in particular but obviously they're not either gonna be as observant or know what's going on you know what happened happened. So if you have tenants or you truly don't know them at all or you inherit a property with tenants that are in place you know Ryan and I have had this issue recently that has been some of those have been some of my my least favorite or most difficult property management experiences because the tenants you didn't you never talk to them when they went to see the property you have no idea who they are there they could have any manner of problems or issues that were inherited from the previous property owner and that the property owner didn't tell you because he wanted to buy the property no wherever it might be it's now there's.

 

Ryan Goldfarb: [00:05:02] No ending their merit in qualifications as talent.

 

Ryan Goldfarb: [00:05:04] They may not have been. They may not have been up to par for you if you were managing it but that the previous owner had no issues about exactly.

 

John Errico: [00:05:12] Yeah. So there's there's a reason why there are. There is a class of property managers because it is a job and frankly it's oftentimes not a very well compensated job given the amount of work that sometimes goes into it. But it is a job and it's one that I fulfilled For my own properties.

 

Ryan Goldfarb: [00:05:29] At any point did you consider. Did you consider outsourcing it and going with a third party property manager or was it always. Once you started it was something you were going to keep it.

 

John Errico: [00:05:38] No I didn't really consider outsourcing it because the class of properties that I owned and that we buy are primarily single family and small multi-family properties and finding a property manager to manage those properties can be uniquely challenging mostly because the way that property managers make money is by scale. If you manage a single property and your say taking a percent 10 percent of gross rent per month that's not going to be a lot of money. I mean you're talking about two three two dollars at most in this area. So to to employ yourself full time you'd have to have a portfolio of maybe 20 or 30 different properties. And if you can do that all under one roof if you can manage a 20 unit building that's great because you have one location you have maybe one boiler, one roof, maybe a few hot water heaters things like that. So to manage a lot of small one in 2-family properties you're not going to find a great property manager. And I know from being in the business that there is so many bad operators in this business. Finding a good operator was gonna be very challenging and if I had the time and inclination to do it then I might as well do it and start a business you know doing it professionally which is what I have done.

 

Ben Shelley: [00:06:55] I have a ton of questions that kind of come from what you what you were just describing but I think my my first one would be so if I'm trying to let's say House hack in an area and I want to take on property management for my individual unit whether because I think it's cost effective because I think I have the time or because I can't find to your point a property manager that's worth you know anything that's willing to take just my one unit. What were the what maybe are the first things that I should be prepared for or maybe even better. What were the first things that you realized gosh I really need to have X Y and Z in place to properly manage this property.

 

John Errico: [00:07:31] Yeah it's a good question. You can sort of think of it as the lifecycle of a tenant if you're sacking a property you probably have a unit that's vacant. So step one would be preparing the unit for a tenant to actually live in and in that dovetails a little bit with construction as well but you know basic things like do all of the utilities function in the unit. Are there things in the unit that would disqualify it from being rented to a tenant or would maybe reduce the the market price of a unit. So that would all be things like and you can even classify this in the category of preventative maintenance. So if I have a really old say stove in the unit I might think well the stove is functional or operational but you know at any time it might break. Or am I going to get the sort of tenant that if the stove breaks is going to be a big deal or we have to go and replace the stove maybe it was easier for me before I rent the unit to replace the stove that I can marketed as equipment in the kitchen is new. So there's a whole category of things that you might consider you might consider painting it. For example if the walls are scuffed up or have holes in them which is not uncommon from previous tenants just little issues that that if you yourself are living there you might want to fix.

 

John Errico: [00:08:36] You should probably take care of them for the tenant and then the second step is actually finding a tenant. So that is is its own challenge and there's obviously a class of real estate agents and brokers that can do that for you either for four cost or for no cost to you as the landlord depending on where you might live. But tenant selection is its own art and skill and there are a lot of legal issues as well involved with that involving anti-discrimination and whatever else. So I mean we could delve into any of these topics more specificity but I would think of preparing the unit finding the tenant running into the tenant and then after that is what do you mean.

 

John Errico: [00:09:11] You know that sort of maintenance or or more management mode which is mostly reactionary. So it's if something goes wrong which is usually identified by the tenant or possibly by you you're fixing the problem like something is broken something is leaking something is whatever. And then once the tenant has gone you're resetting that process again. So you're repurposing the unit for rental you're refining new tenants successoretc. Along the way you might have things like I want to increase rent.

 

John Errico: [00:09:37] So how would I do that or why would I do that. Basic things like how do we determine what the rent is we've talked about that in previous episodes. But those are those are all components that go into it too.

 

Ryan Goldfarb: [00:09:47] And to Ben's question about preparedness once you get into the management stage and you have a tenant there as John alluded to a lot of it is reactionary and I think one thing you can do to prepare yourself for that is to make sure that you have a lot of the requisite contacts that you will ultimately need when things hit the fan. Whether that's a plumber whether that's a handy man whether that's a pest control company whether that's your SEO. No. Yeah yourself. Or just knowing the contact info of the utility company when you have an issue with the electricity or the gas or the water having all those things handy will save you a lot of headache especially if you have it centralized and something I do is just kind of keep a note on my phone of all of these. Of all this relevant information and so if anything happens whether I'm at home or on the road I have access to most of what I need and can generally handle things remotely.

 

Ben Shelley: [00:10:45] I would imagine that the most difficult thing oftentimes for newer property managers or owner occupiers who are managing their own properties would be during a crisis. What do I do. Who do I call at what things cost and obviously a lot of these things is trial and error right. John oftentimes talks about just doing in real estate investment. I think property management falls under that umbrella of something that you could just try to do just out of curiosity for me. It's kind of a maybe a little bit of a sidetrack but we can look at this from two perspectives right a perspective of an investor looking for a property manager and then for listeners of ours who want themselves to be property managers so just curious.

 

Ben Shelley: [00:11:20] Just out of curiosity for the latter. Obviously if you own a property you have your own affiliated insurance that that covers affiliated issues with that property. But if you are trying to become a property manager what do. Is there any steps you have to take with the city or the state or the municipality. Anything in particular that you can recommend John for people or I'm just curious if you have like different insurance for your property management business or something like that.

 

John Errico: [00:11:45] In New Jersey specifically. There are legal requirements to operate legally a property management business a lot of them are ignored in other states. I think that the the barriers are probably a little bit less so but in certain municipalities you would have to register your management of the building depending on the size of the building so larger buildings are generally more regulated. So I think in certain cities in New Jersey if you have if you're managing a building that's larger than like three units maybe five units you have to register with the state. I'm sorry with the city and the city might impose various things on you. I'm not really even sure because it's very municipality by municipality and honestly these laws are not enforced a lot.

 

John Errico: [00:12:26] Usually I would say you know for if you're if you have like one hundred unit building you have an onsite management team there. If you have a single family home you have not an onsite management team. So there is in the hundred unit building probably has a professional management team and they might have certifications that are not legally required but are nice in the industry like they have taken some course for some whatever it might be versus the guy managing your single family home we just could be your buddy or yourself or whatever.

 

John Errico: [00:12:59] So there is a spectrum in professionalism I would say and as I alluded to before the other space that we operate in is much closer to or identical with a single family small multifamily space. So that's the least professional least regulated kind of least oversight type area of property management.

 

Ryan Goldfarb: [00:13:16] And I would just just caveat that by saying I think this if you're looking at this from the purpose for the purposes of self-management things are getting much less prohibitive in the sense that if you're if you're living at the property I don't even know if that's considered quote unquote property management. If you are self managing it.

 

John Errico: [00:13:35] Yeah a lot of these laws are to the extent they even exist have exemptions. If you are an owner of the property even a partial owner of the property so then all bets are off. That's why a lot of a lot of man a lot of bigger buildings will have on site management is just a part of the owner of the company and they don't qualify under any really laws because they're part of the company that owns it.

 

Ryan Goldfarb: [00:13:57] And this also oftentimes applies as well for rent control and rent control exemption. I know in a lot of cities the statute may be for units that are buildings that are for units of murder they are subject to rent control but there's an exemption if it's a four unit building that's owner occupied.

 

Ben Shelley: [00:14:17] You see stuff like that I think sometimes in Union City where I think there would be new ordinances that are passing both on a short term versus long term rentals and then also registering apartments for rent control and what threshold you cross 2-family for three families to buy where you have to register apartments for that for new investors it's worth looking into.

 

John Errico: [00:14:34] It's a good point to touch on a little bit are the the overarching legal laws that don't have to do with property management per say but just the operation of renting out an apartment. So you mentioned rent control rent control is a big issue in New Jersey and it is to some extent in other other states around here. But I think New Jersey might be pretty singular in its the prevalence of rent control particularly in North Jersey. So rent control is one issue city by city we've actually been ourselves doing a research project to just document what the rent control laws are in every city which there are so many cities in New Jersey and there's so many different laws. It's very very very to many challenging too many cities are agreeing we can. That's a whole nother topic.

 

John Errico: [00:15:14] The consolidation of northern New Jersey. I mean it's like they're trying to they're trying to break California into five states.

 

Ben Shelley: [00:15:21] It's like the opposite it starts getting one of us or each of us on different city councils and we have to beat them from within.

 

Ryan Goldfarb: [00:15:28] In this day and age I think it's probably a daunting challenge to unify people in that capacity.

 

Ben Shelley: [00:15:33] Even in Jersey I feel like Jersey maybe I I doubt it. Well this is one thing or more divided than ever right. This is not a are you talking about. Are you telling me that Bob Menendez can't do the job of unifying the Great White or the great point and end as well as him in Mayor.

 

John Errico: [00:15:50] Big supporters.

 

John Errico: [00:15:50] No it's so you know rent controls an overarching issue and then in New Jersey there's there's state level right. In fact I shouldn't even move on from the municipality level because there is still municipality issues to deal with so there's rent control issues and then there's also Certificate of blank issues occupancy conformity whatever you have call it habitability. Again every city might have their own particular take on what this is. So some municipalities in New Jersey require you to register with the city every time you get a new tenant which could trigger an inspection. Some require you to do it when you sell the property some never require you to do it some required for properties of certain numbers of units and above. So that's a whole nother regime. Again the enforcement of these laws is scattershot. In some cities at best. But it is something to be aware of. Once you've dealt with the municipal level issues there in New Jersey are state level issues in New Jersey there's a state law that applies essentially to units to buildings that have three or more families and that requires its own registration its own regulatory regime and very frustratingly the state and the municipality might be on very different pages about your compliance with various laws. It's not uncommon in New Jersey for buildings to be in compliance or at least nominal compliance with the state law but not in compliance with the city law which is very frustrating because or the opposite or the opposite. I would say that I've seen it more. They have a green card but they don't have any green card is essentially the registration certificate to get from the state. If you have three or more units in a building but I've seen it very frequently where they have a green card or they've registered with the state I'd like the city has no idea what's going on.

 

Ryan Goldfarb: [00:17:37] I'm thinking about it more so from. You just renovated three in a building. You close that all your permits with the city through the building department and then after that you go for the green card inspection and they come up with a whole new slew of things to tackle.

 

John Errico: [00:17:50] Once you've already got got it occupied and you did as Ryan just suggested it can be very frustrating because you have two different regimes. They're not communicating with each other they have no incentive to communicate with each other but you're you're exposed to the burden of both of them and they both carry a monetary and real penalties if you don't comply with them. So that level of expertise you know if if if you're getting into larger buildings and you're getting into municipalities that are more heavily regulated which is like northern New Jersey I would say it's valuable to at least learn about these laws and be aware of them.

 

John Errico: [00:18:23] BiggerPockets is a resource talking to other investors as a resource networking as we said before in a previous episode to this podcast listen to this podcast for sure and we can go more in depth in future episodes in New Jersey specific investing which is its own its own game but in some point we're going to have an episode about short term rentals Airbnb rentals which I think is a continuation in part of this property management conversation.

 

John Errico: [00:18:47] That's it's a whole nother legal regime and legal issues there.

 

Ben Shelley: [00:18:51] So in terms of leasing I realize this may be a quick step back but is there anything you guys can advise or just give some context to. I'm actually curious because I've never seen your guys as leases and I know also Ryan for example some of your properties we should talk about this in a second. Have federally backed tenants so as a Section 8 tenants for example. And I'd be curious to know how that affects sort of the machinations of property management but just generally speaking the standard leases or is there anything in particular you guys like or look for when you are leasing out your units.

 

Ryan Goldfarb: [00:19:24] Well to the leasing question itself a lot of this depends on what your level of interested is in being a part of the process. So for some investors they may choose to quote unquote self manage but if they know they may be more so interested in just kind of dealing with the continuing nature of the management but they want to leave the leasing part of it to an expert so they'll bring in a realtor and that realtor will then listed on the MLS and kind of handle all the showings and in a lot of areas that burden financially may fall on the tenant in the form of in the form of paying a broker fee. So notwithstanding the rich like limiting you know not notwithstanding the fact that you're limiting the pool of tenants who may be interested in paying that biography there's not necessarily a downside to doing that if you don't want to be doing it in the first place. Having said that I think I think this the old adage holds true that nobody is going to care as much about your property as you are. So if you want to get it done right and quickly then the best bet is probably to just suck it up and do it yourself. I know I've actually heard this from a number of investors who have had a property a rental property listed with an agent for a month or two and they were getting kind of like intermittent feedback and they were getting a little bit of traffic and wasn't renting like they thought it would. And then they took matters into their own hands and listed it just threw it on craigslist facebook Zillow and through some combination of those listings they were able to get it listed at the same price within a week purely based on the fact that they were just responding to the inquiries and they were making an effort to get people into the property when they wanted to get in there. So I think a lot of this comes back to the financial incentives here because you're talking about a eighteen hundred dollar a month rental. The net fee that the net commission to a broker might be five or six hundred dollars if they don't bring the tenant. So that's not going to in most cases it's not going to get somebody out of better it's not going to get somebody to forego their showing for a five hundred thousand dollar sale property and make it make them prioritize getting tenants in there.

 

John Errico: [00:21:45] I want it maybe your point then can be addressed through the the lens of tenant identification which is what Ryan was alluding to like the actual lease itself. We can talk about a little bit and it's important to have a lease but I think much more important is the process of finding tenants and identifying who they are. That's it.

 

John Errico: [00:22:00] That's a deep topic and I want to caveat delving into it by saying that it's very important to be aware of federal fair housing laws when you're finding tenants.

 

John Errico: [00:22:13] So I mean it maybe is obvious if you're at all in real estate but you can't display discriminatory preferences to individuals when you are leasing properties or even selling properties based on things like race religion ethnic cultural background. I'm not entirely sure if it's federally mandated but I'd just say logically would be sexual orientation things of that nature.

 

John Errico: [00:22:36] So what that means is it applies to the leasing the leasing realm is that you know you can't put up an ad saying I'm only looking for a person of a certain age or gender or race or whatever. I mean realistically that does not happen anymore because people are aware of this but it means beyond that that if someone of a particular race or gender or ethnic background comes to your property to look at the property you can't disqualify them on that basis. So usually as that is the way that all filters down to finding tenants is that you need to apply objective criteria to tenants. One example is credit score. So you can you can certainly accept tenants. You can say I won't accept tenants below a certain credit score which is an objective criteria that you can apply to them. But it becomes much more. And it's not required but it becomes much more suspect when you have a tenant who comes to with a certain credit score and they might happen to be of a certain ethnic background and you reject them. That becomes more suspicious because you could say Well I reject them on the basis of their credit score of which I have no actual criteria or you could say well maybe I reject them on the basis of some other illegal or impermissible criteria. So that's a very high level overview of it.

 

John Errico: [00:23:52] I don't think it's a lot should have to go into the details of that in this episode but it's very very very easy to find information about fair housing laws for housing acts. There also might be state specific laws as well. But in general just don't display discriminatory preferences towards tenants. I think that that's it's 20 19 so that's probably goes without saying. But having said all that.

 

John Errico: [00:24:13] What I require. When I when I look for tenants one of the most important things to think about is how you're going to price the unit. So one thing I found in leasing is that you will if you your unit correctly you will find normal tenants that are appropriate for that area. If you price your unit incorrectly you will find abnormal tenants for that area. You'll probably still find tenant applicants but they will just not be normal. And one example that I have is if you price your your unit higher than market rent you will still find tenants but they will be tenants that have something wrong with them which disqualifies them for many apartments and therefore they have to pay more but will try to for whatever reason convince you that they are okay renting your apartment. So for example they might have a low credit score. They might have very low income. They would have an eviction on their record. They might have all sorts of stories special conditions that may or may not be relevant to you but are definitely going to disqualify them from the vast majority of apartments. So sometimes people will say oh you know market rent for this area is to offer dollars a month and I'm losing my apartment at 14 15 months just to see well I guarantee that you'll get somebody to come to your apartment but they're probably not going to be the class of tenants that you're going to want to rent to. So that's not that wasn't obvious to me before I started renting but just because you can try to list your apartment for more money doesn't mean that you're gonna just because you list your apartment for more money and you get interest doesn't mean that you haven't listed it for too much money.

 

Ryan Goldfarb: [00:25:48] So one one thing that we've talked about in a number of different contexts is the theme of understanding what your costs are. And in this case I think the way that that applies is understand that there's a cost of trying to get that maybe above market rental number because in this in this area in particular if that is a problem tenant and you need to through an eviction the cost of that eviction both in terms of lost rent and the legal costs associated with going through that eviction whatever that difference is is not going to be enough. You're not could be obtaining a significant enough premium to justify those at added expense.

 

Ben Shelley: [00:26:26] And it's interesting for somebody who doesn't have properties or rents to hear that perspective because you're talking about right if everybody wants try to juice the rents as much as possible but within a margin of what the market is you can have.

 

Ben Shelley: [00:26:39] An extremely volatile different outcome based on the quality of tenant and that poor quality of tenant to both their points. Yes and the immediate might pay a couple of months at two hundred dollars more a month than market. But then there could be all kinds of other issues which may lead to as you know for a variety of outcomes maybe eviction being being the worst case and destruction of the of the unit you have on the topic of pricing.

 

Ryan Goldfarb: [00:27:01] One benefit to underpricing or at least pricing something fairly is that you will get a a wider sample of applicants from which to choose. And if you're looking at this as a long term investment and your goal is going to be to obviously make things a little bit easier on yourself but also to minimize vacancy and if you have tenants in there who are paying a fair rental figure and they're qualified because you know they were the best of the crop from which you are choosing then there is going. There's some long term value to that stability as well. Yes.

 

John Errico: [00:27:39] For sure. Yeah. So I think step one in the tenant identification process is listing you know determining the appropriate rent for your unit and you you can listed above what you think is market rent. But the caveat is what I said before about the quality of tenants and what we just talked about. The second thing for me is I like to you know at some point in the rental process these tenants will be met by somebody who could be by you it could be by your manager it could be by a broker or whatever but that interaction is usually quite important. Not again for determining their you know characteristics that you shouldn't discriminate on but just for determining their possible quality as a tenant. For example if they come into your unit and they bring you know eight family members and you're renting a one bedroom apartment and they say oh it's just gonna be me and my husband you know that's problematic to me because I don't know why you'd be bringing you know your eight family members to look at this one bedroom unit if it's just you and your husband. The biggest thing that I like to do when I when I meet tenants is explain to them what's going on to their reaction and then very importantly is have an application process for your tenants. A lot of landlords for some reason don't really do this or their application process is maybe verbal but it's totally legal and totally appropriate in my opinion to have a written application which alone will drastically remove a significant portion of the tenants that are gonna be interested in your your property. So wherever you find the tenants and I don't know if it's worth while to go into it because it's you know it can be region specific and you could use a broker but whoever you find tenants once they come to your apartment sometimes be interested some won't be interested. Some a waste of time some will cancel on you some or whatever. But if they actually submit an application which is a written application which requires them to actually write something and usually pay a fee which is usually for a credit check or a background check. That alone will remove about 95 percent of people that are applying your apartment and many times. I'll get tenants particularly in in know certain certain areas that say I can't figure out how to fill out the application and I can understand that to an extent. If it's maybe online and they're elderly or they don't have access to a computer. But even if you then provide them with say a written application and they're unable to do it that is a disqualification because if you're unable to. If you're unable to convey to me the information that I request. For example if you can't comply with my request for a credit check or background check because you can't sign an application or logistically get it to me in the amount of time that's required you're probably not going to be a good tenant. And maybe there is an apartment for you somewhere else. But my criteria is that you need to fill out an application in some manner has to be written so that I can submit it to a credit agency and a background agency and you have to pay me a fee so that I can pay the credit and back agency to do it. Normally I use a website called Cosey which I'm a big fan of. Cozy. Also a syndicate you're listening to a certain certain websites online. I don't only use them so much for the marketing aspect of it but their application process I found is great. Their fees are very low and reasonable for tenants and the information that they give you is usually very comprehensive. So they'll give you information like the credit score which will not be just a number but will include things like credit inquiries derogatory factors in their creditetc. They include a background check for the background check.

 

John Errico: [00:31:26] When you say positive or negative it'll include things like. Here is an eviction which is obviously a big negative too. Here is a misdemeanor that they got eight years ago when they were a college student which is probably less of an issue. All these factors are important because you know sometimes you'll find with tenants tenants will come to you and first of all make my favorite tenants are the ones that come to you and say you know I say okay well in order to rent the apartment know there's we do a credit check and we only accept credit scores above x or whatever might be and they'll say Oh great. You know my credit is is perfect. That's fantastic. And then I run the credit score and their credit score is like five something ridiculously low. Really. Wow.

 

Ben Shelley: [00:32:07] Like you know that they always wonder why majors why say it. Every move they're trying to speak it into existence right.

 

John Errico: [00:32:12] I mean that's really concerning to me because it's it's a total obliviousness and is also lying. It's either lying to me or being so oblivious that they have no idea. And on the contrary sometimes tenants will come to me and say Hey I just want to be really a friend. I had a hard time three years ago. You know I had to declare bankruptcy because I got divorced or someone died or some you know I lost my job. Some facts like that happened and then you see their credit score and say you know the credit score is bad but everything stems from this one incident. You know it's like a two month period of time when all their credit card bills relate andetc. and that still is not necessarily good. Their credit score might be low for four for their purpose but at least they've explained it and then you can evaluate that as you might take it. You know that the same is true with background checks like sometimes people say I've never been evicted. No eviction then you go on and then it's very obvious that the reason they're looking for a new apartment is they just got evicted for the previous year. So it's stunning because you'll tell people like look I'm going to do a credit check and a background check.

 

John Errico: [00:33:14] I'm not even saying like everything has to be aware I've just just to let you know what I do and they look and then say Go do and then be proactive and be like they did not ask me about it but I can't tell you how great I am you do the opposite. It's like you got me. Have a nice life. I mean you'll be it's amazing I frequent it.

 

Ben Shelley: [00:33:31] Did you really hear that Joy. So when I graduated from high school I actually originally I worked for a property manager and it's worth noting that every property manager to an extent does some variation of the process that John just described and I know for us like we had obviously a credit check fee and a written application a background check and it's funny now hearing John I never really thought about exactly why we did I mean I just always assumed but hearing that methodology I realized oh that's why we do it. But we also asked for like a good faith deposit which you can do I guess which is was fully refundable for some reason didn't get approved in a certain amount of security which you guys can talk about more being the landlords in the room but that is that is very funny and I think one of the things about property management is you can kind of take some some some kind of role with the funny moments when they come because like I imagine it can be extremely stressful and operational stress.

 

Ben Shelley: [00:34:23] So oftentimes you're going to see people and things that probably you wouldn't believe especially in very specific areas in northern New Jersey.

 

John Errico: [00:34:30] I mean a lot of the stress can be oftentimes people just waste your time. And that's why it's it's sometimes able to have a property manager slash realtor degree adjustments. Yeah because people will I mean they there's so many times and people will say I'm so excited it's department I want to come see it right there I second there you know they never show up or they'll say I'll be there at 1:00 and you rearrange your let's go to be there at 1:00.

 

John Errico: [00:34:53] They're like oh you know I am running late I'll be there at 4:00.

 

John Errico: [00:34:57] It's like how can I be running late. I mean that's insane. Well that's funny because that's it's different.

 

Ben Shelley: [00:35:02] You know it's like if you are a property manager or work for property manager versus being an individual owner as well your time constraints are very different and your time value is very different. So that's that's it that was always a brutal one.

 

Ryan Goldfarb: [00:35:14] A lot of the a lot of the things that you put in place here a lot of things that John just alluded to there are qualifiers and then there they serve as a filter for a lot of the bad applicants that you would otherwise receive. And while they're short while I'm sure there are plenty of applicants who will just outright ignore the fact that you're saying upfront it's going to be a month and a half security deposit the rent is going to be this much the credit score qualification. Is this that you know there are plenty of people who are going to apply anyway and just think they can get around it but they're all also are a number of people who probably don't apply and who you filter out and ultimately you know that they don't waste your time because you're upfront about that stuff.

 

Ryan Goldfarb: [00:35:55] And I think it's super helpful to do that because it's only going to rear its ugly head at some point so it's better to you know filter out who you can still have your process to kind of verify that you're a diamonds are being fulfilled. But ultimately ultimately you're you're only hurting yourself by not having these restrictions in there and being upfront about them. So you may as well throw it out there upfront and you may as well put some thought into what your criteria actually is.

 

Ben Shelley: [00:36:28] Just having some sort of process to to win out. Yeah that's possible.

 

John Errico: [00:36:32] I'm having rules as well. Like if you don't want to have pets in your apartment that's appropriate. But you need to be upfront about that so you can you know you can't. What sometimes happens is that people will try to fool you and they'll say oh you know I'm not going to bring a dog or something and I can bring a cat. But then they actually do. You know that's a violation of your lease and that's so that that's a serious problem it's not a problem to be like Oh it's like we just forgot about it. Like that's a serious problem. The same is true with occupancy. Right. If you have a single single bedroom apartment and you say look I only want to rent it to two or fewer people or three or four people that's appropriate because it's more people can be a fire hazard or a safety hazard than somebody moves in they have six people. That's not OK. That's a serious problem. So being firm about the rules and saying like here's what I expect is we'll set the tone for the entire relationship and also will prevent you from getting into serious trouble possibly even legal trouble with if there's an insurable issue or fire or whatever might happen.

 

Ryan Goldfarb: [00:37:33] And having thought about that and having kind of codified this in your own way also makes it a little bit easier to enforce it down the road because if somebody comes to you and say and says Can I can my daughter and son in law move in here or can I have a dog or a cat or any other number of requests. It's a lot easier to say no I'm sorry we have a specific company management wide policy that prohibits this versus saying you know no I'm just I'm just gonna be the bad guy. I'm just gonna be the bad guy today until you know.

 

Ben Shelley: [00:38:09] So out of curiosity we talked about some of the thresholds of getting tenants in. And what are the kind of standards that you can outline to try to get in the most qualified tenants are paying the maximum rent you possibly can for the area. I'm curious you get a tenant in there and they don't pay rent or they're violating there as we just talked about maybe it's the animal policy or it's again just been laid on rent what have you. What are your processes and what are certain methods property managers can take to try to address these issues very common issues I want to talk about the topic from the sense of.

 

John Errico: [00:38:47] So there are a lot of property there are property manager that operate on both sides of the spectrum on either side of the spectrum can be can be very negative their property managers who are extremely lackadaisical and have no conception of what's happening at their unit or their apartment and literally just show up to collect a rent check that's bad for obvious reasons because you're probably not solving problems you're probably not aware of what's going on in your in your unit to your buildings to that can cause a whole host of issues the other extreme which you might think doesn't happen but I've actually seen all the time and in fact right and I have been talking about this recently our property managers or landlords that are so involved in the lives of their tenants that it's it truly becomes a problem.

 

John Errico: [00:39:33] You have an on both ends of the spectrum. Your behavior will set the expectation of the tenants. So if you're the sort of property manager that doesn't deal with anything then tenants will never tell you when there is a problem because they suspect that you're not going to deal with it. On the flipside if you're the property manager that is really involved in every aspect of your tenants life they will tell you everything that's wrong. Even things that are unreasonable for you to care about or fix and expect you to be involved with them. So like I know landlords that have gotten like roommate disputes with their with their tenants which are totally beyond the scope I would say of a landlord to the extent that you know if they're all in the lease or whatever like I don't care what happens as long as you pay. I don't care if you don't like your your roommate that you yourself picked you to accept a future tenant the landlords that will do things like you know if there is a slight minor issue in some totally irrelevant way to the apartment where they'll move heaven and earth to fix this very minor bizarre issue that is like maybe unfixable or this is not economically viable to fix that nobody really care about you wouldn't care about if you live there. So there is a whole range of spectrums. Maybe. You can. I mean you know people like this also.

 

Ryan Goldfarb: [00:40:53] Yeah I mean I certainly echo those same sentiments. I would like to point out on the larger scale side of things. This is a little bit of a tangent but it does speak to the point of as a property manager having your pulse on the property.

 

Ryan Goldfarb: [00:41:12] I know it's pretty common in the investment space to buy a buy a 50 unit apartment building and to prosper to approach the investment from a value add perspective with the intention of getting rents up and as we alluded to in the last episode bumpingA.I. and improving the property that way. But oftentimes one impediment to that is that you may have a certain cross-section of your tenant pool that is involved in some type of illicit behavior or that is doing something to otherwise stigmatize that building that community that block maybe. And.

 

Ryan Goldfarb: [00:41:55] One thing that one benefit of being a property manager who has your pulse on the property is you know who those one or two bad eggs are in the building and if you nip that issue in the bud then you may not get to the point where your building is only 50 percent occupied because nobody wants to stay there because you know that because they know that the building is a haven for drug dealers or if there's other if there's other behavior there that other that is going to deter your tenants from wanting to live somewhere. All they want is just a safe quiet secure place.

 

John Errico: [00:42:37] Yeah and I think part of the issue one big name the game is communication. I mean this is the case for like it whenever there's problems or conflicts. But in the property management space being responsive to tenant issues is important. Even if your response is No I won't deal with it. So I had a tenant recently that this is in fact in the same building that we had an issue with the heating and the hot water from a flood. And we had to make a small hole in her wall to fix some plumbing and for various reasons we had to leave the hole uncovered for two or three days. And you know this is like a hole maybe six inches by six inches in a corner of a room and the heating was working the water was working everything was on just that there was this hole in the room and she said well you pay for a hotel for me because of this issue and I certainly didn't ignore her. But I just said no like that's not that's not an appropriate. That's not reason well for me to do that and I don't want to be you know she had all these reasons why I shouldn't want to do it and and why I was such an inconvenience for her an ecstatic saidetc. And I said Look I don't want to be inconsiderate to your concerns and your you know maybe unique life history that makes it so that this is very inconvenient to you but from a perspective of my duties as a or to you this is not an appropriate thing for me to do so. No we can't do that. And so so you know being that being the bad guy I guess in that context is definitely a necessary thing to your original point been about like what happens when things go wrong. You know a lot of it is like communication. So hopefully you have tenants and you have relationship with tenants such that they'll tell you when things are going wrong like if they're going to be late if they're going to be late on rent they'll tell you in advance like hey I'm having a problem that still is not necessarily okay or great but at least you're informed. But if you're not communicative or your tenants aren't communicate with you. And you know that the day to collect rent comes and there's no rent that is a big problem. You know the worst tenants that I've had are ones that either don't communicate will lie or stop communicating when things go wrong. So you know we have Ryan and I have a tenant have several tenants right now and I've been a building where we inherited tenants from the previous owner and you know we're talking earlier in the episode about how that can be problematic. You know we have these tenants are our super bad. They're they're bad because the act their expectation for communication set by the previous landlord was totally off. So they don't say when things are wrong or they they will over communicate when certain irrelevant things are wrong they won't tell me about when rents do. They have all sorts of crazy assumptions. I mean I had one one tenant claim that he believed that yes her rent is generally paid in the first of the month for the month that you're in. He claimed that his belief was that rent should be paid at the end of the month for the prior month that you'd already lived in the building for. Which is just I've never heard of that.

 

Ben Shelley: [00:45:44] And it's like Sir how does that have to do with you having not paid rent for three months. Right. So like I feel like usually it's a microcosm of Vallejo as you try to return your initial question like when things go wrong.

 

John Errico: [00:45:53] Step one is communication and just understanding what's happening and certainly there are legitimate reasons why people can be late and rent that are not eviction quality with certainly there are legitimate reasons why people can be late and rent that are not eviction quality events.

 

John Errico: [00:46:11] Yes. But knowing what they are will prevent that from happening.

 

Ben Shelley: [00:46:15] Although I would imagine I think you I think anybody would agree with the sentiment that if you feel like a tenant relationship is going in that direction to probably document as much as you can or keep track of as much as you can in terms of any issues you've had with the tenant.

 

John Errico: [00:46:30] Tech text messaging and email have been great boons for that as opposed to verbal conversations. So a lot of times I communicate with tenants through text and that's a great medium for just keeping information right there. You know the ultimate the ultimate problem with the tenant is when they are a tenant can do a lot of things to make it such that they can't live in your unit anymore or you you won't allow them to live in your unit anymore. And obviously if you just don't like the tenant personally or whatever you you just don't think they're good tenants that probably in alone is not enough to qualify for you to remove them from their property if they're not violating their lease agreement. It might be a justification if you're not in a rent controlled or rent stabilized or whatever situation for you to not renew their lease in the future. However you know that there are overarching legal issues as I alluded to before that might cause it to happen. But generally the number one reason why people get evicted or why leases ended because of a violation with the lease which is usually non-payment of rent or habitually late payment of rent other issues could be you know they are subletting your apartment without your consent. They have other people living in the apartment without your consent. They're violating some rule that you've imposed. Like with animals with doing illegal activities in your unit maybe they're destroying your unit or inconveniencing other tenantsetc. I very rarely ever dealt with the latter but non-payment of rent is or late payment of rent is a reality. If you manage enough properties in any area affluent or poor you will find people that are gonna be late with rent or not pay rent.

 

Ben Shelley: [00:48:15] And so attitude of which I rent. I just want to say I edit Curia or ask out of curiosity now sort of having now gone through most of the rental process and management process for market tenants. I do want to have a quick conversation about rent control rent stabilization and in Section 8 as it pertains to units that we that we have or that you have Ryan. So maybe you guys can take us through a little bit in the same overarching context of what is the difference if there is one between managing at market and tenants and and rent control rent stabilized Section 8 tenants maybe outside of just the obvious fact that there's a certain cap on rental increases cetera.

 

Ryan Goldfarb: [00:48:54] Sure. Well I think it's worthwhile to take a step back and just to think about what Section 8 is and what what that really means. Yes. So the way that it generally works in the context of the two to four one to four family rentals is a quote unquote Section 8 tenant comes to the landlord with essentially a Section 8 voucher. I think it's called a half that area for housing assistance program and that voucher is generally good for a particular amount of money per month generally as there's there's a formula that's generally based on either affordability metrics for the area or a percentage of that tenants income that should be allocated to rent and then the tenant picks up one portion of the rent and the Section 8 voucher covers the rest. So in this context these Section 8 vouchers are essentially a means of the government stepping in and providing housing assistance to lower income families.

 

John Errico: [00:50:10] And just as a quick caveat there are a lot of programs like this section is one particular program that's operated by it's funded by the federal government although it's actually operated by municipalities.

 

John Errico: [00:50:22] But there are many many many programs like this for low income or disabled or other category of tenant where for whatever reason they have government assistance to rent a unit and what Section 8 is the most common one that landlords will deal with. But all of these things that I think Ryan is about to say will apply in a similar manner to a lot of these programs.

 

Ryan Goldfarb: [00:50:45] And sometimes you may find tenants who are using a combination of one or two or maybe three different programs. So to me the overarching theme is the same. You want you want tenants who are going to abide by the lease. You want tenants who are not going to create issues and who have realistic expectations. Whether they're market tenants or whether they are paying through some means of housing assistance the we're also going to go with this. So when it comes to section 8 or other housing programs I think you generally find within the investor community you'll generally find that investors are either really far on either end of the spectrum so they either love it love them and swear by them or they had one bad experience with it and have written off these programs entirely. I think the reality of the situation is that it's it's case by case you're going to have excellent tenants who are on some form of housing assistance and you're going to have some tenants who are quite subpar when it comes to these are on these housing assistance programs and it's on you as the landlord to screen them appropriately and to ensure that regardless of what their means of payment are that they are qualified to lease your space.

 

John Errico: [00:52:08] Right.

 

John Errico: [00:52:09] So in my experience you know government subsidized tenants first of all in general you will find a very wide array of tenants that have government subsidies some Section 8 tenants will be in Section 8 you can just parenthetically your mind for government subsidized tenants some Section 8 tenants will be fantastic and some will be terrible. And as Ryan alluded to they the the voucher which is the amount that the Section 8 tenants rent will be covered can vary a lot. It can be a hundred percent of your rent too much less than that back of the envelope sort of high level talking usually tenants that pay more money even though this sounds counterintuitive are better tenants because they have more of a financial stake in where they live. If you have a tenant who's paying truly zero because the government program of their own pays their entire rent they have really no financial incentive to do or be anything in your apartment. And although this hasn't happened to me I know people that it's happened to these tenants can just trash your apartment because they have really no financial consequences for that happening. So if they for whatever reason don't like you or having a bad day they can really cause you financial penalty without them selves being financially at risk.

 

Ryan Goldfarb: [00:53:37] To be fair there there are the ramifications of their behavior in that situation would be it would be that they would lose their housing assistance payment which is not insignificant.

 

Ben Shelley: [00:53:46] Curiosity does the does the federal assistance cover things like credit check fees and security deposit like if you're renting to one of those tenants what is the price. Is the process different in terms of the source of of funds for those initial fees or no the tenant is still on the hook for for those payments.

 

John Errico: [00:54:02] It depends on the program. Oftentimes as Ryan alluded to before tenants can use multiple programs. So you know I have a tenant in one of my properties that isn't actually a section 8 tenant as in she pays market rent out of her own pocket. However for her security posit she and her security adviser was paid through a program through the city of Newark that provides emergency housing relocation because her building was condemned or something like that. And so she didn't get her deposit back or she might at some point or whatever. So there is a whole variety and yes there is assistance for application fees and whatever else might be relocation fees etc etcetc.

 

Ryan Goldfarb: [00:54:41] Now one other downside to a lot of these programs is they are generally administered by some agency. So in this case I think there's either I don't know that's at the city level or at the county level but there is a local section 8 office that administers the program and each of these locales and those offices will conduct periodic inspections I don't know of it's a yearly or bi annually.

 

John Errico: [00:55:07] I don't know.

 

John Errico: [00:55:07] I think it I'm not entirely sure it certainly depends on the program but it happens not infrequently but just as we alluded to earlier with the state and the city having different requirements. This just adds a third layer of oversight and it's just another body that comes out and will say hey you need to paint this wall or you need to fix this door you need to do that. It's not it's not necessarily that these things are unreasonable. It's it's just that the frequency with which these things happen and the ramifications of not being in compliance whether these requirements are reasonable or not can be significant if they're not cured within a certain period of time they will stop paying the rent. And it's just it's just another source of frustration.

 

John Errico: [00:55:58] It's bureaucracy. And to be honest a lot of these programs are not administered particularly well. Right. And that can be very frustrating from a landlord perspective like one of the craziest things that that we've had to do what I think is we have a section 8 tenant who is very habitually late with her rent show he seems to manage to pay it but it's very late normally.

 

John Errico: [00:56:20] And you know her her income portion her portion of the rent is maybe like a third or something of the total rent for the unit. So most of the rent comes from the local Section 8 office. However if she is late on her rent she will be out of the program which means that we won't get section 8 income anymore. So it's a pretty perverse incentive where I'm actually incentivized if I want to get that two thirds of her rent and if I think that at some point she will actually pay I'm actually incentivized to tell the section in office she's paying her rent on time so that I get the two thirds of the rent which is ridiculous.

 

John Errico: [00:56:59] Right. If I say that she's out of the program boom she's out of the program you know if I say she didn't pay rent this month you know they they want to be helpful to me. Oh great. Well she's out the program. Well okay fine. But now I have to. That doesn't mean that she leaves the apartment. It just means that some sort of a victory just means that I don't get the Section 8 component anymore and so then I have to evict her which in New Jersey is a multimedia process. I have to go through everything else involved it that try to get money from her for those other months without sexy assistance. It is not going to happen.

 

 

Ben Shelley: [00:59:52] Paper. People say that I'm scared to say that on the show because that's going to catch on. I need a trademark that. So more importantly looking at the way that for example rent stabilization grows I know it was usually like mandated between 1 and 4 percent per year of whatever rent it was below a certain threshold in New York. So I'm just curious to know like in Union City for example where there are very strict rent control and stabilized rules. What the process is for a landlord there and what to expect if you're if you're managing a property that has these kinds of controls on them.

 

Ryan Goldfarb: [01:00:20] The benchmark that most rent control programs are based upon is CPI Consumer Price Index. Generally there is a permissible increase of maybe a set a set amount like 3 percent or so. The greater of 3 or greater or the lesser of 3 percent or CPI sometimes it's CPI plus 2 percent. And oftentimes there are other permissible increases.

 

John Errico: [01:05:08] So either ask someone knowledgeable or ask your lawyer to look into it or do the research yourself.

 

Ryan Goldfarb: [01:05:15] All this is not to say don't buy rent control buildings. It's more so to say understand what you're buying before you do. Because at the end of the day there are still some advantages while few there are some advantages to owning these types of buildings one of which is the fact that if you have if you have a tenant who's been in an apartment for 15 years paying a thousand dollars a month in a unit that would otherwise rent for two thousand dollars a month then that tenant is highly incentivized to do whatever is necessary to stay in that apartment. Whether that means prioritizing paying rent or not being a thorn in your side or a thorn in the side of the landlord or just keeping the place in general you know generally good condition. There are some advantages to that when it comes to occupancy or when it comes to stability. But you know at the end of the day the numbers are what the numbers.

 

John Errico: [01:06:10] And very briefly not know about management per say but if you want to be if you want to be a value add investor and you're buying a rent controlled building that's going to pretty significantly limit your opportunities to add value to that building. Because as we've talked throughout in previous episodes. In an ideal world the value of a bit of an investment rental property is a function of your income your gross income which are your rent and your expenses and assuming your expenses are generally going to be fixed. If you can't increase rents increase income then the value of your building is not going to increase. So buying a rent controlled building where there are truly no opportunities to ever decontrol it or raise rents or do whatever else you're either hoping on a law to change which has happened but or b you have no appreciation value at play you're just happy with the cash flow as it is and you're gonna increase it at 2 percent a year and that's it.

 

Ben Shelley: [01:07:08] So excellent gentlemen.

 

Ben Shelley: [01:07:10] Last question before we head out because we all have dealt with this and are dealing with this I'm going to talk about market tenants here not not stabilized controlled or federally backed tenants security deposit. How do you guys operate with that. I think there's always a lot of questions and sometimes that can be the most contentious aspect of the lease period at the end for a market right tenant. Obviously the standard would be if something goes wrong you use that money a portion of that money to fix issues. But do you guys have certain thoughts on it or policies on my website.

 

Ryan Goldfarb: [01:07:40] My one thought on this is that you're bringing this up to bring to the forefront your sterling Rep Ryan is not going to bring it up if I could I promise I wasn't I just was curious and prides himself on having his security deposit return I'm going to soil and I'm going to start that business specifically consulting on how to get your security back. Yes that is true but I I promise I wasn't going to bring in our knowledge in the back of your mind.

 

Ryan Goldfarb: [01:08:04] Notwithstanding that the topic of support of security deposits is an important one in a lot of in a lot of situations your security or the security deposit that you are holding on to maybe your only point of leverage in a dispute with a tenant. That's not to say it's something that you should be holding over their head and exploiting but if you have a tenant who has not paid rent if you have a tenant who has or who may trash the apartment has any reason to be upset with you whether it's justified or not if you're holding on to a month or a month month and a half worth of rent in the form of a security deposit then that's one that's one thing that's at least going to deter them from doing that.

 

John Errico: [01:08:51] Yeah I mean I very rarely have taken people's security deposits or a portion of secured deposit. I mean respect the you know like the idea from a landlord perspective is that there's gonna be reasonable wear and tear. I mean there's is even a legal issue about the legal bases on why you can keep a bigger deposit but in a reasonable way and terrible things like little dings Nicks holes in the wall. I mean I anticipate basically every unit is going to have to be repainted in between tenants.

 

John Errico: [01:09:19] But unreasonable things would be like they've punched a hole into my wall or they've ripped up flooring or they've destroyed a vanity or something like that. And obviously some of it is dependent too on the length of time that has been there like a tenant there for a year. There's gonna be a lot different than a tenant there for 10 years for example. So it's hard to say a blanket blanket statement but for me it goes back to tenant selection again. So if you if you select quality tenants. And then beyond that if you communicate with them you know a one thing I like to do is for a lot of my units I provide pest control services which means that I'm an exterminator goes into all my units and will spray for bugs. And that's a great excuse to just get in you. I mean obviously to the tenants in advance it's gonna happen and set their expectation for it but that's a great rationale for getting in the unit every month to just see what's going on. And so you know it's really clever. Yeah I've gone into units before and you'll see crazy stuff like I was in a unit not too long ago where the tenant had deadbolt or had put in a huge lock to the basement which is a common basement and all the utilities were in the water shut off electricity shut off and didn't give anyone the keys only they're the key you know and obviously somebody's got to figure that out. But I don't think it had happened maybe a few days before or something and I was like you know this is crazy like you would figure that out when you had a leaky boiler in the basement and you had to get in there in an emergency.

 

Ben Shelley: [01:10:48] I mean the response was I don't even think about a bubble or something crazy or like I'm storing my stuff down which is about it you actively brought someone in a deadbolt the door to the basement. It's crazy. So. So there aren't more people in nuts.

 

John Errico: [01:11:01] Yeah more crazy things would be like taking in every smoke detector in your unit or they've like blocked the escape door. They've made it so that every window is an operable you know things like that that are safety issues that could have ramifications on you. But you know also I just I don't want you to die in my apartment.

 

Ryan Goldfarb: [01:11:18] So absolutely this isn't this isn't on the topic of security but it's per say but while we're at it I think John's story there reminds me of a few things that I think are worth touching on just when it comes to setting expectations with what tenants John I don't know how you feel about this but you have anything that you either put in leases up front or or divulged your tenants at the beginning to kind of set certain expectations like I know one thing that we put in that I think it's been recommended to me by a few other investors is to say that as a blanket statement any repairs under hundred dollars or so are on the tenants shoulders so that you're not getting calls about things like light bulbs need to be replaced. Do you have anything like that as a general operating brick by brick do things like dollar amounts.

 

John Errico: [01:12:10] But I will I will do things like Oh we'll have rules about keeping things clear from access ways pets pest control is a big one.

 

John Errico: [01:12:22] Lead paint is a big one and that's a whole nother topic that we can get into but lead paint trash or recycling and we've gotten trash or as I think in the past for new tenants move into a space and we weren't as clear as we should have been about the city's requirements for trash and recycling and so we ended up getting or even just the expectation that they need to be taking their trash out to the curb or not for example.

 

John Errico: [01:12:47] Yeah I'd never heard about the dollar amount and what I think.

 

Ryan Goldfarb: [01:12:51] I mean the obvious downside to it is if you get a tenant who tries to interpret that to literally and they see something that they could probably fix for under a hundred dollars and they take that on and then they do it incorrectly and it either needs to be redone in the future by you or it leads to a bigger problem.

 

John Errico: [01:13:09] And that's and that's obviously counter and I would I would prefer them to call me. And then just for me to say no reason for them to just not even bother because they have then let's be honest people don't realize leases so strict is what it is.

 

Ben Shelley: [01:13:22] But it's like the agreements on i tunes you know you're just you're just clicking I accept that we will not take all my information right.

 

John Errico: [01:13:28] I mean that is problematic because it is there there are enforceability concerns and some of these leases that you can really get into if you have you know litigation relating from it.

 

Ben Shelley: [01:13:37] But I was going to say to to that that last point about reading your lease you know I remember the first lease I signed on on my first apartment the city that deep buried in the you know Section 24 subsection 1 sub subsection 1A or something there was a little note about a no matter what a five hundred dollar move out fee that was just a feeling for no purpose other than to further take money from you as you as you went out there was no stipulations it was literally just to move out. So by catching that before we signed by reading through the lease we were able to have that taken out of the property. You know I'm not saying everyone's trying to get you. But it's worth doing your due diligence when you're signing a lease and as a property manager to possibly going for commercial leases something like almost nothing.

 

Ryan Goldfarb: [01:14:19] It's like going to lease a car and having a thirty six month lease and then I'm charging you a disposition fee at the end. It's like my lease is over.

 

Ryan Goldfarb: [01:14:26] Obviously having a car has to be returned. Why do I ask why am I getting a car like that be built into this.

 

Ben Shelley: [01:14:32] I think the moral of the story here to sum up of what has been a very informative property management episode is first and foremost preparedness making sure you have the right contacts when you endeavor yourself to start out as a property manager understanding and creating a process for identifying and leasing up your units and working with tenants and then also understanding the market around you and what is your thesis for property management. What kind of tenants are you managing and and tailoring and I think your process and processes to dealing with issues to whatever type or kind of rentals you're working with.

 

John Errico: [01:15:07] Yeah. If I can touch very briefly on the team aspect. Sure. Which is so probably the most important person that I used when I was getting started is my handyman whose name is El Chapo. No relation to the more famous El Chapo for Ramon is his. This is a Christian name Jose but he's we actually found him by going to a hardware store locally and we said hey who is who is a guy that chops you a lot. Like is there something that you'd recommend which is a great technique for finding local guys that are active in the area.

 

John Errico: [01:15:45] And we found through that context and he has been instrumental I would say from he. He is what I would say like the definition of a handy man. He also can do larger projects and he actually works for us now in our construction company but he can do a little bit of almost everything and if he doesn't have to do it he probably knows somebody else that can do it. So he's been fantastic because you know it even when I was living in a unit of a building that I rented out if I had a small emergency or a small issue that I couldn't fix like a small leak or whatever. The fact that he was responsive and was able to do it and I didn't have to call a billion different people you know I wouldn't call him like my property manager because I didn't pay him a flat fee. I paid him like per job but just that just as his being there was very very important to me and I don't think it would have had the confidence to expand the way that I did without him. So

 

John Errico: [01:16:38] when you're starting if you're thinking about expanding in particular area finding even not a property manager but just like a handyman type person that you can reliably call on for a range of small issues I mean I'm talking about like the toilet's clogged like whatever else is is gonna be very important. It's been very helpful.

 

Ryan Goldfarb: [01:16:57] One thing that John's point here just reminded me of is another point that we've actually discussed at length in the past and it's the idea of managing of self managing properties at some point in your real estate career I know it's it's actually something that I personally dislike strongly. I would say something I loathe really is is property management but we start our first rental property. I still manage that along with my brother. And while it is frustrating it's been a truly formative experience in my real estate career because it's it's put to it. It's brought to light the reality of owning property both the good and the bad. The reality is that it's it's not as scary as I may have thought but it also does come with with certain challenges and there's no substitute in my opinion for first hand experience and I think regardless of whether you see yourself as a property manager in the future I think it should be a prerequisite for every rental rental property owner owner or future landlord. I think it should be a prerequisite to have some experience managing property first hand.

 

John Errico: [01:18:17] And you might find that you're just not cut out to be an operator like. Like a hands on property manager as a landlord. I mean if you're the sort of person that doesn't like confrontation or doesn't like people being upset at you or angry with you or can't can't figure out that like some problems or more desperate than other Hey I just got a funny text that I share with these guys about someone said there's an emergency at the property the dryer is not trying my

 

[01:18:50] clothing. You know if you're if you're the sort of person that would take that text in seriousness and call over a repair person that moment to resolve the issue and can't contextualize that with an actual emergency which is like hey I don't have heat or there's water flowing through my apartment you know whatever else again that may not be. Is that something wrong with you. It just may not be the type of you know investor that that you should be. So we've dealt with that too on the construction side. We have people that are just as I've mentioned before about to involve people that are just really really really too involved in things that go on the property and they can't they can't figure out when a request is unreasonable or though hypothetically reasonable doesn't need to be taken care of the moment that it is received. So it's not something to learn. I think by going through it.

 

Ben Shelley: [01:19:44] Gentlemen thank you for your time and expertise as always.

 

Ryan Goldfarb: [01:19:47] Always a pleasure Benjamin thank you.

Rents - PITI = Cash Flow?!?!

Nonsense!

John, Ben, and Ryan discuss the real costs of owning and operating rental property.

Here are a few buzz words: cap rate, NOI, cash flow after debt...

Don't we sound smart now?

We'll de-mystify common real estate jargon to ensure you'll know what your broker is talking about when he tries to impress you by offering you "a steal at a 6-cap".

 

(Transcript below.)

Ben Shelley: [00:00:07] Welcome back to the Brick x Brick Podcast. I'm Ben, and I'm here with John and Ryan. And today we're going to piggy back a little off last episode where we talked and identified what might be your first area of investment both to do your first real estate investment and maybe if you're starting to pick up the number of real estate investments you're doing in your surrounding area. And we want to talk about the kind of ways to identify from a numbers and metric standpoint whether or not your deal is viable for you. And it's important to recognize obviously that finding out and identifying different real estate metrics is just part one of the many parts of figuring out whether or not a real estate deal is good for you or not. But nevertheless we want to take you through it. And so Ryan When do we kick off with you.

 

Ryan Goldfarb: [00:00:50] Yes. So the first thing I will... I guess it's just kind of foundationally the goal of buying investment property for me is twofold. The first part is earning cash flow that is passive income over the duration of the investment.

 

Ryan Goldfarb: [00:01:06] And the second part of the second piece of the puzzle is the equity side which is the idea of gaining equity in that property which is something that you do both by purchasing it right but also by holding it over the long haul and by paying down the principal of the loan amount.

 

John Errico: [00:01:24] Yeah I think I think that that's a really good way to frame it because you could buy an investment property and make no cash flow like no rental income but it could still be a good investment because the property could for example appreciate very rapidly either because you do something to appreciate it like going to flip or just because you bought at the right time and the broader market appreciates. So I know primarily at least up until very recently I consider myself almost exclusively a buy and hold investor like a rental investor and I almost always perform or underwrite or whatever you want to call it my investments as if there were no appreciation at all. So the power of doing that is you have to be pretty disciplined to make an investment because you're thinking OK well my rents are this my expenses are this. What if I assume that the value of my property doesn't go up at all. And what if I assume that my rents don't go up at all. Am I still comfortable with the cash flow that I'm making right now that other investors will say well you know my rents will increase at 2 percent a year or 3 percent your CPI inflation whatever and my expenses are going to be fixed my mortgage is going to be fixed to my you know B minus investment right now might turn into an investment in four or five years but that's at least not the approach that I've taken personally.

 

John Errico: [00:02:42] I don't know if you guys feel differently but...

 

Ryan Goldfarb: [00:02:43] Well I think this highlights a pivotal mistake that a lot of beginning investors make. It's that they, it's that they assume that the market will continue to appreciate and they forego what would otherwise be sound investment strategy by looking towards cash flow in lieu of the expectation of appreciation down the road. And I think particularly at a time like today you see this often when we're coming off of a period of six seven eight years of market appreciation and now the hype is strong. The market the real estate market is at its peak arguably and has soundly recovered from 2008 2009. And people are back into thinking that this is going to last forever. When the reality is it's not. If you're buying it with the expectation that you're going to make your money when you sell it because it's going to continue appreciating you're going to find yourself in a bit of trouble at some point down the line. And the way to mitigate that in my view is to buy with strong cash flow and to buy something that you're confident you can hold on to in

 

Ryan Goldfarb: [00:03:55] perpetuity. Based on what your cash flows are.

 

John Errico: [00:03:57] Yeah I think like maybe the riskiest investment that I've possibly ever seen or even was. I mean I didn't consider it for my own portfolio but I was helping somebody in California it was maybe a year ago who was buying a flip or wanted to buy a flip in California and they had this spreadsheet or this deck was really well done deck it was like 15 slides like really professional and you looking at the numbers they wanted to buy for something like 400 grand and they're going to put one hundred thousand dollars into it and they thought they're going to sell it for like 850 in a year. No there isn't. You know not that bad investment but if you look at the numbers like the comps the market comps were all at like six hundred grand right now. And the underlying assumption was that because those same properties had appreciated by like 40 percent or something in the past year or two years that it was going to continue to depreciate or 40 percent it was kind of buried in the numbers like it was really obvious as you actually click through the comps were like wait all the comps are like way below what the ARV is. So this person had reached out to me I was like look I mean if you think it's really going to continue appreciate as it has already appreciated I guess it's a good investment but no. You know it's like that's that's it. That's probably the riskiest type of investment.

 

John Errico: [00:05:11] I think you could make.

 

Ryan Goldfarb: [00:05:11] Well this this I don't want to deviate too much from what I think should be the focus of this conversation which is cash flow but this highlights something that concerns me about investors in general it's the I think there's a misunderstanding between what drives quote unquote appreciation there's there's market appreciation and then there's appreciation that you forced by buying something distressed and repositioning the asset whether that's by bumping rents or by putting capital improvements into the property and the the latter I would feel pretty comfortable assuming going in because that's something that is within your control. But I don't know that I would ever make an investment purely based on in my view speculative market.

 

John Errico: [00:05:52] It's like for me it's micro and macro factors micro factors are your house you can affect the the value of your house by doing something nice to it improving it. But the macro factors are like the broader market and you you individually probably are not going to impact the broader market by your improving real estate that's going to be factors that you control.

 

Ben Shelley: [00:06:16] Well I'll say it quickly in defence of calculating and embedding appreciation in your underwriting it is part of the fundamentals. I think for those people out there they're saying well gosh should I not account for it at all then you know it's fair it's usually standard to account for let's say 2 percent revenue growth maybe 2 percent expense growth over a certain period of time. But I think what we're saying is just be cautious about and especially understand that you need a certain amount of cash on hand at the beginning and throughout the first year of your project to to survive into it. Sorry.

 

John Errico: [00:06:43] No I mean I think that that's fair. My point is that I wouldn't feel comfortable buying a buy and hold property if at the moment that I bought it I wasn't satisfied with the cash flow I might be happily pleased with the cash flow and two or three years assuming appreciation assuming increases in rents. But if at the moment that I bought it it was not cash flowing like I wanted it to that I wouldn't buy it even if I thought in three or four years it might.

 

Ryan Goldfarb: [00:07:07] And if you're trending income at 2 percent and expenses at 2 percent just as an example granted as applies more so to a commercial property and to commercial underwriting then to let's say an underwriting for a 2-family investment property but that ultimately is driving NOI which is going to be the basis for appreciation in that scenario rather than just saying oh we're buying this at a 7 cap. And I think the market's going to be at a five cap in two years. So the energizing to stay the same.

 

Ryan Goldfarb: [00:07:36] But I'm going to see a sizable increase in the value of the property because it's purely based on the fact that I think the market is going to tighten and people are going to be buying more gas

 

Ben Shelley: [00:07:46] Which is a lesson by the way to not just look at these numbers standalone because you see a lot of people and when I when I talk to people in real estate or sometimes say well or brokers will throw those numbers at you like look look at a cap rate look at the IRR look at the NOI but you know it's a bigger puzzle and you want to try to take all of these factors into account because they wouldn't say no-ey.

 

John Errico: [00:08:03] No I said a thing I've never heard that I make that a thing.

 

Ryan Goldfarb: [00:08:06] We can make that if I just don't like and I just I think that's what it is. I think I would really go out and what I believe you're going to do well about No. I mean it's you know there's just no way I could I could maybe get on board with like Noi. But no me no noise to high class I think we're every gentlemen.

 

Ben Shelley: [00:08:28] So I want to I wanted to move the conversation to maybe two of the main types of deals that we do. I know we want to talk about rental properties so maybe for starters. I would love to actually now that I'm talking about this out loud talk about some of our methodology for flips. But for starters when we're looking at two three and four families I think it's important for listeners to understand how we identify those those properties and whether or not they're worth taking the leap. So we talk in the last episode about identifying the geographic location. Once you've identified your property I think the first thing that there is a little bit of a misperception is specifically for newer investors is how much cash you actually need on hand when you go into a deal. You know a lot of people see an investment of $100,000 and think great I just need the ten thousand dollar downpayment for a 10 percent DP but there's there's a lot more equity required I think than a lot of people realize or understand going into a deal and we talk about that a lot. So for example if you're planning on buying a property and renovating the property over the first let's let's say four or five months there are holding costs of fixed expenses that are associated as part of that purchase and so on top of the ten thousand dollar downpayment on top of the closing costs which might include origination depending on the points affiliated with your loan or legal fees which we talk about that are associated with putting together the necessary documentation to transfer the deal and close the deal. You also have taxes and insurance payments that you're going to have to make consistently on your property before you generate even one dollar of income. And so my first recommendation once you've identified that property for listeners is understand exactly how much is the total equity required even outside the downpayment before you move forward and kick that in to what you're going to be making in your calculation moving forward on whether or not it's a good deal for you.

 

Ryan Goldfarb: [00:10:14] Yeah I think one mistake people make is they they say OK I have one hundred thousand dollars cash. I know that generally speaking the kind of norm in the mortgage space is to be able to put 25 percent down. Therefore I have four hundred thousand dollars in buying power because one hundred thousand dollars as a 25 percent down payment is gives you the ability to buy afforded another property as you just alluded to. The reality is is not the case. There are circumstances where your equity requirement can be limited a little bit more to just what your down payment requirement is and that's that's generally if you're buying something that's turnkey something that's already rented and something on which you'll be collecting rental income from day one but in a lot of instances particularly if you're trying to drive value you're going to be dealing with maybe getting tenants out you're going to be dealing with some vacancy you're going to need some money set aside to do some repairs or some renovations and then you're going to need to allocate a few weeks maybe a month or two to actually getting the property tenanted and to get to the point where you are quote unquote stabilized and collecting rents.

 

Ben Shelley: [00:11:22] That is the most common misconception I think for newer investors coming in and just understanding all the kind of cash required. I know when I've talked to people this hour you know that even from from becoming maybe even institutional investors to house hacking they just don't have a full appreciation for how much cash is required on hand for their first investment.

 

Ryan Goldfarb: [00:11:40] So one thing I actually wanted to point on that point out on that front is it can be it can be really sexy to look for those kinds of like quote unquote value add plays where you can buy something and buy a three family with three tenants in there who are each paying $900 a month when you know that the market rents on that unit or $1,200 a month. But if you if you don't properly account for the downtime that you're going to have with each of those units the the upside is a little less attractive. And one thing that I I oftentimes will encourage other investors to do and something that I should probably practice a little bit more often in my own on our own projects is to maybe stagger the vacancies. So if you have those three tenants in there rather than rather than going from having a fully occupied building to a fully vacant building and to have three units to renovate at the same time and three and then ultimately three vacancies to fill at the same time whenever the units come on line to stagger home and say Okay Unit 1 she really wants to get out because she's looking to move anyway. This is just a good time for her to get out. Unit 2 and 3 are a little bit more flexible. I'll keep you in it two and three there. We'll work something out where they're here for a few more months or we'll put them on like a three month lease or whatever the case may be and then we'll do those units one by one it'll make the construction a little bit more manageable because you're just doing maybe you're just doing like a cosmetic renovation and you don't need to do anything that's that pertains to the whole building you're not rerunning plumbing entirely or you're not redoing the entire electrical system. So that's one way to mitigate the burden of sinking cash in every month after month because you'll still have maybe two of the three units paying.

 

Ben Shelley: [00:13:26] And I think that's a particularly important point because when you're underwriting your deal oftentimes people want to just put in whatever the market rent is. And it's really important I understand that even if there is a certain amount of time it takes where you know which is hard to know. But if you even knew that you know eight months down the road nine months down the road you can stabilize at market rents. There is a period of time whether it be because of what Ryan alluded to getting entrenched tenants out or having to put up with maybe below market rents in order to to expedite this process and maybe not have it to go through something like an eviction that you're probably not going to be generating those rents from the word go even after renovation. So you know one of the things to that point I wanted to talk about was sort of the beginning of of the underwriting process and I know this is a lot of what I do for. For Ryan and John so. So I guess for a smaller deal I think one of the first things that's important to do is is try to properly. Well the first thing you want to do is look at your comps right. And we kind of talked about that in the context of finding your geographic location so going to move forward from that and talk more about your revenue particularly as it pertains to rent. I mean it's. Sorry John.

 

John Errico: [00:14:30] No I was just saying maybe we can frame it in the context of explaining some of the terms that real estate investors use like cap rate cash on cash. Ah I think that the cap rate is sort of a unique real estate term that people don't fully cap rate is very broadly speaking that operated net operating income divided by the value of the asset that you buy. Normally people look. So net operating income itself is a little bit of a term of art in the real estate context generally net operating income is the revenue that you're generating from rents or from whoever you use your property minus the expenses that you're generating or that your properties accruing at any given time. Normally you don't consider debt service normally you don't consider debt service in the context of calculating it. So you like your mortgage payment interest principle would not be part of the calculation. And investors talk about cap rate. Normally they say like X cap or X numbers like a six cap would be a six percent cap rate seven capital seven percent cap rate and one of the joys of using cap rates to analyze properties even if you're looking at a smaller like a 2-family or three friendly property is that you can compare properties of different asset classes almost using the same metrics. So if you have a 2-family property in say northern New Jersey and you know that's a seven cap for some reason and you have a 2-family property in New Haven and that's a nine cap well you've essentially analyzed away all the differences and all of the details and you're just looking at one number to compare it at a high level.

 

Ryan Goldfarb: [00:16:06] I say that the general theory behind that is first and foremost the reason that I believe at least there isn't that cap rate is exclusive of debt service which is in this context a mortgage payment.

 

Ryan Goldfarb: [00:16:19] The reason that cap rates are exclusive of that is is that your financing is more specific to the specific investor and to that investors strategy than to the property itself. So the cap rate is supposed to be a means of analyzing these specific property from investor to investor be and that should not be clouded by whatever your investment strategy is like something like the cash on cash return would be or even IRR or return on equity or whatever other metric you would look at.

 

Ben Shelley: [00:16:51] And I was only just going to give a caveat to say that while the cap rate is and is a very effective metric to compare deal by deal it's important to recognize maybe two things one especially when you're working on smaller properties oftentimes in more distressed areas. Oftentimes the cap can be inflated just because the numbers you're playing with are smaller so when you're talking about what you're netting versus the value of the property right. If that number is smaller generally speaking the number the cap rate you're going to see could be eight plus versus maybe like a four to eight and a more institutional area.

 

John Errico: [00:17:20] It's a good point because when you looking at smaller properties you realize that say you're looking at a 2-family property a property with two apartments. If you for example miscalculate the rent by 5 percent that will tremendously impact your bottom line or if you say well I'm assuming that it's a 2-family but one of the units you know is a lot smaller or one of the units I just can't run for five months of the year that has an enormous impact on your bottom line. But if you had a 50 family building and you had one year that you couldn't rent for five months. Well it doesn't we have a huge impact. So in another way to look at it is so you have a 2-family building and you have two boilers and one of the boilers breaks. That's a pretty significant expense that that will very severely impact your bottom line which is if you have a 50 family house 50 unit apartment and you have some history that say costs five thousand dollars which would be like the cost of a new boiler that's not going to be severely impact your bottom line. So it's it gets into a larger question about why do large hedge funds and whatever else invest in very large multifamily properties as opposed to like a 2-family property and why the management challenges of owning a portfolio of say 10 2-family properties might be different than a 20 unit property but generally speaking one idea is because the sensitivity to expenses and incomes are way different on a two year 15 year property.

 

Ryan Goldfarb: [00:18:46] It's also important to bear in mind that these numbers are generally based off of performance they're estimates. So on paper if someone is talking about a property buying at about buying a property at a 10 cap they're generally talking about based on their projections and those projections as John just alluded to will vary a lot more for a smaller property than a larger property. Year one you may see a 2-family if you get hit with a lot of maintenance you may effectively operate at a five cap and then year two once you're stabilized if you have no tenants move out you might be looking at an 18 cap. So it's important to understand the volatility in these numbers and to ensure that your expectations are in line with that. The other thing I want to point out is that the cap rate the cap rate itself is effectively the unlevered rate a rate of return on the asset. So if you're looking at a 10 cap what that means is if you buy a property if you buy that property for a million dollars at a 10 cap with no debt whatsoever. So you don't get a loan on the property. That means that you should if it performs at a 10 cap you should earn a 10 percent rate of return on your money. And the idea is that if you're able to get a loan on top of it to get a loan on the property the cost of that loan is going to be less than the cap rate which is going to increase your returns because you'll be buying you'll be borrowing money at let's say a rate of 5 percent interest and the property will be quote unquote earning money at a 10 percent rate. So when you look at your blended rate of return it's going to be much higher than the 10 percent cap rate that you would be seeing if you bought it all cash and two to bookend that conversation on cap to both of their points right.

 

Ben Shelley: [00:20:39] If you as an individual investor are looking at a smaller project and you see in a cap and you see a 7 cap it's important to again understand that there are other factors in play so for example maybe the the property with an a cap is generating more cash in the next year two years even three years. But the seven cap property might be new construction which for whatever reason is taking time to to bring in tenants or what have you who knows what the reasons are might be in better shape for the future and that's where understanding appreciation and also not looking too closely at only one metric can be really.

 

John Errico: [00:21:12] I mean yeah it's it's a fair point. I mean with all these metrics like cap rate cash or metric yeah you're you can make amazing returns but you could have a like a 15 cap and only be quote unquote cash flowing like two or three dollars a month. Yeah. And your because it doesn't take into account the debt. Well it also meant taking the cash the properties were 30 grand. So it's different than absolute returns.

 

Ryan Goldfarb: [00:21:35] But the other thing is that these I think John alluded to this earlier this is way more of an art than a science. So you can have you can have two experienced brokers or two experienced developers underwriting a similar deal or an identical deal and one could come out to a seven cap. One could have a nine cap and when you're dealing with larger numbers that's a huge variance and it could be for various reasons it could be because one of them maybe has more experience managing that asset class. One of them may see a way to increase expenses or decrease expenses or increase income but I think that's a good segue way to the next topic which is how you arrive at the NOI and ultimately how you underwrite cash flows.

 

John Errico: [00:22:22] Know very broadly I would say cap rate is not the only way to analyze properties. So there is cash on cash return. There's I would say monthly cash flow which is maybe not like I'm like a form of formal analysis but it just a way to look at it and there there's IRR which is basically was not relevant to not particularly useful to calculate unless you're very aware of what your exit might be and when it might be. But I mean we could talk very briefly about what those are before we go on this but I mean they all use the same inputs but they have different results for you cash and cash return is very broadly a measurement of the sort of year. I'm not actually sure at a high level the best way to describe it.

 

Ryan Goldfarb: [00:23:10] It's cash on cash return displays. It's the relationship between the cash flow so the amount of money that you are clearing on an annual basis and the amount of cash that you have invested in a particular property. So if you bought this the straightest way to look at this is for something that's stabilized. So you buy at a turnkey 10 family that's already rented and already stabilized and your plans upon purchasing it are to just kind of like continue operations as they are. So it's a you buy it at a 10 cap. So you put 25 percent down so you put $250,000 down obtain a mortgage for 750 with closing costs and whatever reserves you need to put in maybe you're all in at three hundred thousand dollars invested into the property and your cash flowing thirty five three thousand dollars a month. The way to calculate the cash on cash return in this context would be the three thousand dollars a month over 12 months.

 

Ryan Goldfarb: [00:24:20] That's thirty six thousand dollars a year divided by your three hundred thousand dollars invested in the property. It's a little over 10 percent return cash on cash which is a pretty good for.

 

John Errico: [00:24:34] Pretty good depending on risk adjusted for risk strategy in the area and the advantage of cash on cash returns as Ryan alluded to is that it takes into consideration debt and leverage. And so your cash and cash return can change substantially depending on it.

 

John Errico: [00:24:50] So one common strategy in buying whole investing that we get into would be the you know the BRRRR strategy or whatever you want to call it which would be buy renovate rent refinance and then repeat. So the idea is that you buy a property you have a fair amount of equity in the property to begin with. You spend money on renovations which is even more equity than you read it out and then you refinance refinance meaning that your property is appreciated in value because of all the work that you've done for it and maybe you got a good deal anyways and you take a bunch of equity out that will very very significantly impact your cash and cash return because all of a sudden you go from say having one hundred grand hypothetically the property to maybe having no money in the property or 10 grand in the property. You can have like you know quote unquote infinite cash and cash returns because maybe even got money back just to buy the property. So those are that and will not necessarily show up in it in a cap rate analysis and we'll maybe have negative impacts in a cash flow sense because now your basis and now you're the value of property is higher and your mortgage rates going to be higher in excess of your mortgage amount is going to be higher but it will impact in a huge way your cash and cash returns.

 

Ben Shelley: [00:25:57] And I think it's just important to quickly to note that the distinguishing difference here from an actual calculation standpoint for people who are underwriting their individual deals right is for example cap rate which is dividing your NOI by the value of the property versus here where you're I'd like to turn in net cash after debt because you're also accounting for your debt service divided by the total cash invested which gives gives you a different slightly different metric and a different look when you talk about sort of your blended results assumptions and returns for how you want to approach analyzing the deal.

 

Ryan Goldfarb: [00:26:28] Yeah. Just to add a little more color to the last example the So you buy if you buy that same property at a 10 cap and you buy it all cash the 10 cap means that you're effectively going to see a 10 percent cash on cash return as well. Whereas in this scenario with leverage the thirty six thousand dollars a year cash flow and cash flow on a three hundred thousand dollar investment yield about a twelve percent return. So the idea there is you're using leverage you're using debt to juice your cash on cash returns. To John's point before about the bird strategy the idea there is to achieve those kind of infinite returns but that also kind of highlights the deficiencies of cash on cash return as a metric because what that doesn't necessarily take into account is when you receive the cash it it doesn't. It's agnostic to the timing of cash flows. So IRR is one metric that a lot of investors like to use because that quantifies in some way whether you're receiving that refinance cash whether you're like pulling your equity back out in month one or in month 13 or in month 9 or not until the very end of the project and Year 5 or whatever it may be.

 

Ryan Goldfarb: [00:27:47] So that's going to be a huge driver of returns when you're looking at things from an IRR standpoint in.

 

John Errico: [00:27:53] IRR is the easiest metric I think to compare real estate returns with returns from other types of investments. So cap rate is pretty generally only used in the real estate context. Cash and cash return I suppose could be used in different contexts but I've never never really seen it used outside of the real estate context personally but IRR you could say well I can make x percent on my my my bond or in return from the stock market or on my Treasury bill or whatever I invest there or investing in a private equity fund or any space or invest in a private equity fund absolutely or you know I can compare it to what I would make on a property investment. So IRR the only way to calculate are truly is retrospectively after you've already disposed of the asset or received all the cash you can receive. But it is possible to prospectively guess that well I could receive this cash flow at this point and I could exit the property at this amount at this point. So when we do that type of analysis which we do for the purposes of our private equity fund we just guess and say Well I think we're going to exit the property what would it be if we exit the property in a year and two years three years whatever educated guess.

 

Ryan Goldfarb: [00:29:02] Of course of course. And then to turn us back in a little bit with how it applies to I think most of what we do. The kinds of rental property that are in the two to four families base frankly in my opinion it's overkill to do a real deep dive into the numbers in this way for let's say a 2-family rental because as John alluded to before there's so much variance between between what your quote unquote cap rate is going to look like between what you're IRR is going to look like and so on and so forth. When you're dealing with such a small property and you're dealing with such swings from there a vacancy or from some kind of repair and maintenance or cap ex. So. The way that I actually like to approach most of these is to kind of I guess more subjectively the way what the cash flow is against what the equity is against what the kind of quote unquote risk and effort required is for any given deal. So just to give you an example of how how that might look. We have some stuff with some property in Montclair New Jersey which is an affluent suburb with a nice downtown big community commuter population. We also have rentals in a rental property in Newark New Jersey which has a much different reputation. So. High level I might say I'm looking for. I'm looking to clear a thousand dollars a month on this on any given rental property purchase because if it's anything below that then it's a not worth my time and b I don't feel safe enough knowing that there are going to be there are going to be weeks or months or years. And I want to make sure that I have enough cushion to weather any kind of storm but that's also factored in with a lot that's also factored in with where the property is located. So if I'm in Newark let's say I know that that is not as strong of a real estate market and in a downturn values there are going to suffer. And and there's going to be you know not as much of a pool of buyers and long term. It's a different it's a different tenant profile it's a different I would say like operational burden from a management standpoint whereas something in Montclair you're dealing with a different class of tenant. You're not generally dealing with higher income earners. So in my opinion you have a greater likelihood of achieving some kind of rent growth there because you're dealing with a population that is generally seeing wage growth which is ultimately what's going to support rent growth. And then from an operational standpoint while you may be dealing with as John and I often kind of joke about you're dealing with a lot of people who don't want to be plunging a toilet or changing a lightbulb. So sometimes you have to provide a little bit more of a white glove service when it comes to management but at the end of the day you have less concerns that they're not gonna be able to pay their rent or that they're going to stiff you on the rent or that they're going to trash your place when they when they leave. So there is an economic value to that.

 

John Errico: [00:32:11] Yeah it brings up a larger point maybe we can get into right now which is what are the inputs to all of these forms analysis and I would say the very very top level input would be rents or rental income. That's generally the you know revenue or income side of the equation. So why do we talk a little bit about how to figure out what rents are and how to figure out vacancy rates.

 

Ben Shelley: [00:32:36] Yeah sure I mean I mean just very quickly but base level right once you when you're looking at an area you know it's sort of the same way that you're identifying from last episode where you're going to invest the next step would be to look at comps to try to determine what the average rents are in the area for your specific property and unit. So I think it's worth mentioning. I know this sounds simple but obviously there's a difference between renting studios first one bedrooms or two bedrooms or three bedroomsetc. and even within that context you want to know OK are you renting individual units are you renting the property out as a whole home as a single family versus multifamilyetc.

 

Ben Shelley: [00:33:12] And then also take into account what is the unit mix within your property. So some units I think a lot of people say oh you either rent two bedrooms or you rent three bedrooms well just as a case in point I was looking at a property the other day in New Haven and these two properties were all one one bedroom and one three bedroom. So understanding your unit mix as well as important. So once you determine through comps et cetera what your average rents are going to be for those different types of units then you want to take into account I think any other factors that might make you revenue. So for example does your unit have parking space. And if it does do you rent that out to tenants. So if you're renting out you can additionally add those types of revenue streams to at least I like to to your total revenue as it pertains to rental income because I consider that again you're probably paying a parking space by month. And then as John and Ryan alluded to you want to try to discount that rental by a certain vacancy percentage which is really just a guess to how long per unit would any given unit on a given month or any given year be vacant because as we know every day you have a unit that's vacant in his day you're losing money. So it's very very important to not just include a vacancy rate but to try to be as close and as accurate as you possibly can.

 

John Errico: [00:34:23] I think it's really important what you said shouldn't be glossed over it's important to include a vacancy rate because a lot of people would say oh I have a great you know that the rental demand is really high. My area and I'm always going to find a tenant that may be true but if you have a tenant leave who just doesn't wanna renew their lease. Maybe you can line up a tenant who's going to come in right after the person leaves. But more than likely you're probably gonna have to get in there paint the unit. Do something fix it up whatever you have to do so that at the absolute minimum you're gonna spend half a month maybe more likely a month just to get the unit turned around. So even in a very very high demand market you might still have a month of vacancy. Even per year. So at the very minimum I would say include a vacancy rate in some way and then adjusted upwards if you think that the rental demand is lower.

 

Ryan Goldfarb: [00:35:13] Other factors are at play not to get too in depth there and to kind of lose sight of the topic at hand which is understanding the income and expense but there's also a difference between physical vacancy and economic vacancy. So economic vacancy is also intended to keep and to take into account other factors like not just how much money you're losing because a unit is taken but also oftentimes it's kind of embedded. It also has like a bad debt number embedded in there which would be bad a bad debt write off from an accounting standpoint is the amount that you are foregoing because of an inability to collect. So if you're in an area where you have if you have a 20 unit building in just about any market it's going to vary depending on where you are but chances are you're going to run into tenants who are not going to pay. We're dealing with this right now and one of our properties actually with arguably multiple tenants in one of the properties we have one eviction ongoing which means obviously that tenant is not paying. We have another tenant who is I would say paying habitually late and is somewhat somewhat troubling to deal with this.

 

Ryan Goldfarb: [00:36:30] Well at the generals we thought we were a white glove service but that's a separate issue but this actually highlights the importance of screening your own tenant and not inheriting tenants.

 

John Errico: [00:36:43] To be clear we didn't choose any of these tenants.

 

Ryan Goldfarb: [00:36:45] They they came with the primary vote shows us the economic vacancy kind of takes takes these things into account.

 

Ryan Goldfarb: [00:36:53] The other thing I like to think about is what does a 4 percent vacancy mean so that in most in most contexts a four point four percent vacancy is indicative of any of an extremely strong market. But when you take when you think about it in the way that John just described 4 percent economic vacancy essentially translates to I think about two weeks of lost rent quote unquote over the course of a year. So if you think about one full month one full month of vacancy is about 8 percent of the year. So if you divide that in half that's 4 percent. So essentially what that means is if you're underwriting a 4 percent economic vacancy that means that you're expecting that on average you're gonna be seeing about two months of lost rent over the course of the year which when you think about the logistics and you think about things from a practical standpoint if you have a tenant leave I would say two weeks to have one from the time that one tenant leaves to the time that you clean the apartment that you make any repairs to the time that you lease it out to the time that that person moves in is extremely optimistic and probably a best case scenario.

 

John Errico: [00:38:03] And it's another you know a lot of investors rag on rent control and rent stabilized buildings which is you know a whole different time may be warranted. Yeah but one thing that you will have in a rent controlled or rent stabilized building assuming it's controlled or stabilize below market rents is that you're probably not going to have a lot of vacancies as long as you pick tenants that are going to pay rent. So just you know other a lot of things go into the rents and the vacancy rate.

 

Ben Shelley: [00:38:31] So I guess just just to sort of go back to you know general income an expense. Right so let's just say your total revenue including rents and any other affiliated income streams are added up to one hundred thousand dollars and you had a 10 percent vacancy so that's $10,000. So you're your net revenue from rent if you proportion that altogether is about $90,000 and then what you tend to want to do is go through your expenses. So obviously there are closing costs affiliated with purchasing the property and then there's holding as well but for the purpose of just rentals probably want to start by talking about fixed and variable expenses. So for your fixed expenses as an example you're talking about expenses that no matter what happens you know through through a lot. So what's the expression like hell and high water you're gonna have to pay these and those things include taxes insurance your mortgage payment. I tend to like to include utilities as a fixed expense because even if you are passing through a lot of those expenses to tenants you're going to have to pay some proportion of that or at least that might amount of money is owed to somebody all the time.

 

Ryan Goldfarb: [00:39:33] Point out that if we're looking at we're looking at deriving NY mortgage expansion B Well that is going to fix that.

 

Ben Shelley: [00:39:41] Yeah and I at the end I was gonna maybe make a caveat. I don't know he doesn't believe me but I promise. This is how I look when you send us you're like Deal somebody right.

 

Ryan Goldfarb: [00:39:51] I know that you have it in there but I know that when I when I think about it or when I think about it and it's gonna expert anyway for anyway purposes it's tricky.

 

John Errico: [00:39:58] One the major caveat one major thing to say is that everything that we're talking about is a yearly just people that get used all these calculations that done on a yearly basis not a monthly basis or whatever.

 

Ben Shelley: [00:40:07] And this is something that I that I took from from Ryan and John but oftentimes what we'll do is we'll separate the periods even refinancing aside let's just take out of the picture where we'll calculate the cost right. Equity required and just general affiliated costs up until the time that we lease up and then extrapolate out over the course of a year to see what the property looks like stabilized for one full year which may or may not be helpful for. For you guys out there but putting that aside once you calculate your fixed expenses and will take out the make sure to take out the mortgage for the NY thank you then you would look at your variable expenses these are expenses that can change year to year.

 

John Errico: [00:40:40] So things like just to touch it if you look we're going to talk about utilities as a fixed expense so the utilities are I think a I think a big a big one to think about. A lot of investors grossly miscalculate what the utility costs will be. And they also change depending on the nature of the property. So as an example used before he might have a property that has separate heat and hot water that is not super uncommon for smaller multifamily properties particular the northeast. So each property has their own boiler or furnace or whatever and they each have their own say hot water heater. In that case you generally as a landlord will pass the cost of heating and hot water through to the tenant because there is a separate meter and system for each tenant in a larger building or in a different building. You might have one central heating system like one boiler or one hot water heater and in that case you as the landlord will almost always pay for the cost of heat or hot water. You may be in a good great world would be able to in some way pass the costs along to the tenant but if you're looking at comps online oftentimes it's not entirely clear if the unit has heat and hot water included in the unit or the landlord pays it or whatever. Having said all that that calculus is significant also because you might even though the tenants say pay for heating hot water use the landlord is responsible for servicing the boiler and the hot water heater so you might though you might gain on the fact you don't have to pay those types of utilities every month every year for tenants that pay their own heat and hot water. You might lose because you know all the sudden you have say three or four boilers to maintain as opposed to one boiler and the costs of replacing a boiler for a four family unit and the cost of a boiler for a one family unit might be a little bit different but it's not way different. So there are pluses and minuses to having separate utilities in larger buildings particularly in the Northeast. It will almost always be the case that there will be one central heating unit and one central one high well positioned say that I love.

 

Ryan Goldfarb: [00:42:52] I've seen them separated pretty pretty early and even when there's one they're not separated even when they're not separated.

 

Ryan Goldfarb: [00:42:59] I think a lot of landlords have transition to a rub system ratio ratio utility billing system I think it's called where they essentially pass the costs through to the tenants and just kind of build them build them back in a pro-rata fashion.

 

Ryan Goldfarb: [00:43:16] So regardless of whether they are metered separately or not.

 

Ben Shelley: [00:43:19] So this is from by the way I mean we got John here unbiased top property manager probably in Hudson County. I mean I I take it it's so important. I'm glad you stopped me there because it really is important like all of these calculations matter. You know if you and like John alluded to earlier as well it's like OK let's say you pass even if you pass all your expenses. If a boiler goes down you are responsible as the landlord for that payment so you also want to allocate certain capital resources to those emerging nations.

 

John Errico: [00:43:46] The overarching point is just understand the utility expenses. There are also a hidden utility costs in Hudson County as you just mentioned but you have to pay sewerage costs which is not the case in other counties in New Jersey and across the country.

 

Ben Shelley: [00:43:58] So Mayor Stack we're totally okay with it. Really.

 

John Errico: [00:44:00] I promise I love it. I love it I love it at the North Hudson Sewage Authority. One of the greatest utilities on Earth. So to the bank one way to figure it out just ask.

 

John Errico: [00:44:11] I mean you could ask the prior owner the chances of you know for a smaller multifamily property them having great records to give you are low but conceivably or you could just ask another property investor in the area like hey need to see your utility bill for a two or three family property to be able to get.

 

Ryan Goldfarb: [00:44:26] You may be able to get it from the utility itself to maybe.

 

John Errico: [00:44:29] Yeah I don't know. I mean you could try but yeah. So when you're doing your due diligence make sure to figure out that no because even in a 2-family property say you're off by a thousand dollars for utility costs are per year. That's the law. Yeah that's going to really impact your bottom line.

 

Ben Shelley: [00:44:47] Yeah I mean especially where our numbers are so when you're talking about again multi-family properties. Any discrepancy even you may think it's just five hundred six hundred dollars. That makes a big difference in your bottom line and it makes a big difference in the totality of calculation you have for a lot of the metrics that we talked about which I'll I'll get into when we finish the breakdown. So just again to quickly run through it we talked about some of our fixed expenses. So just some of the variable expenses again these are expenses that would change potentially year to year as you're you're managing your property so things like admin expenses which might be fees affiliated with filing taxes or any kind of documentation you have to go back and forth that you have to pay for things like supplies things like maintenance costs something that's also really really important to try to allocate correctly probably best to be conservative when it comes to to maintenance costs and also very important which we're very familiar with a management fee right. If most people aren't. Well I would say in the multi-family sphere you see this more often especially if you are for example a house hacker. But most people are going to pay an outside company or source to manage their property. So is there a management fee. And if so what is the percentage of your gross rent that you're paying out to that manager. So it's usually I think somewhere between 5 and 8 percent. I know for a lot of the properties John that you work on you charge a percent but that depends on some sort.

 

John Errico: [00:45:59] I think it's probably between five and twelve percent but really it really depends on the market and the property for sure.

 

Ryan Goldfarb: [00:46:05] And it could be a lot lower even for say a multi hundred unit building it could be lower three to three to five and that is I say is more more of the norm but the as a practice whether you plan to self manage or not it's it's good to put a management fee in there when you're underwriting a property because whether it's because you continue to acquire and kind of grow out of self managing or because you grow tired of self managing it's highly likely that at some point you may consider hiring or outsourcing Robert property management. And if you do that you want to know that your property can support it.

 

John Errico: [00:46:42] Yeah. And management is a whole other sphere that we can get into at some other point. But just to touch on it very briefly beyond the numbers that we're talking about just having. Either the ability yourself to manage the property or having a good property manager is very very very important and very very valuable. And I have used third party property managers that have been great some that have been really bad and it is a large component that goes into buying a property and thinking about how to rent it out and even to our previous conversation before about location. Sometimes just having a good property manager that you can trust in an area could be a factor as to why you might want to invest there and what other side too is if you buy a say 2-family property in the middle of nowhere or someplace where you don't have an infrastructure setup it's going to be hard to find it's often to be hard to find a property manager who just going to want to manage your 2-family property. A lot of property managers are interested in managing portfolios bigger properties know whatever it might be.

 

John Errico: [00:47:45] So just take that into consideration if you're investing not in your own backyard where you can't actually manage it yourself.

 

John Errico: [00:47:50] How you like think about how could I find a good property manager how much is that going to cost how it's going to be set upetc.

 

Ryan Goldfarb: [00:47:56] And that property manager is also likely going to be your gateway to a good plumber or a good electrician or a good carpenter or a good pest control company and that's going to truly inform your experience probably more so than anything outside of buying the property.

 

John Errico: [00:48:11] Like for some properties that I manage it's really like I am essentially the owner of the property because everything you know for that property will flow through me like I might be responsible for making sure that the utilities are paid that the taxes are paid. Collecting rent to have access to the bank account everything else. So to the tenants of that property I am the landlord. I manage the property they have no idea that I don't personally own or have any equity interest in it. So think about that too. You know this property manager the sort of person that you want your tenants to deal with all the time is like the face of the property to really manage to operate the the logistics of the property.

 

Ben Shelley: [00:48:51] And I think again to their point it's worth first taking into your calculation just for for both conservative purposes but also for purposes of it's likely that you'll end up using a property manager if this is one of your first investments and particularly if you're going somewhere further away from you. So if you're talking about an hour drive two hour drive or even further it really is essential but also understanding that it may well may be difficult to find a property manager for an area that you're unfamiliar with that it can be essential and can also actually in the long run cost the side help increase help juice your bottom line because if they're the ones consistently handling maintenance issues collecting rent that can be a boon for your for your total rental revenue.

 

Ben Shelley: [00:49:31] And so the only thing left to do once you have your revenue and income and expenses is to do the calculations to get you your final assumptions so you know for us these are smaller deals so we can talk in the second but what.

 

John Errico: [00:49:45] Maybe one less thing on expenses not to totally gloss over it but would be I think you mentioned too that repairs and sort of highlight the same thing.

 

Ben Shelley: [00:49:54] I'm doing the overhead.

 

John Errico: [00:49:55] You guys get into the weeds so that's another thing that property investors will often miscalculate or under overestimate the way. So I'm thinking you have a great great is maybe not the right word. There is a property manager in New Haven that we've used in the past is a real character a great guy and he was trying to sell me a property a couple of years ago that he had owned for about seven or eight years and so he was walking through those properties for five family property and he said well I said to him like why do you want to sell this property.

 

Ben Shelley: [00:50:32] And I said I juiced it and I think we've talked about this on a previous ad before. I think so. Now to talk about it again it is very relevant here.

 

John Errico: [00:50:41] Well you haven't caught that episode just yet.

 

Ben Shelley: [00:50:44] We're listening John. Thanks.

 

John Errico: [00:50:47] So yeah he said he juiced it which means that he had the everything that you have in the property has an economic life a useful life. You under describe it including the property itself but aspects of the property that have defined life terms would be the roof your boiler your hot water heater maybe some of your fixtures in your bathroom. These are the things that you install and you know that at some point you gonna have to replace them. So maybe like a cheap roof might last you 10 years a hot water heater is probably not gonna last you more than 10 or 15 years. So what he meant in that context was that he put money into the property. Day one that he bought it and now seven eight nine years later all of the stuff that you put in now needs to be replaced. So all of a sudden there's gonna be a big cost to replace the roof and the hot water heater and the boiler and whatever else. The way to look at that in the context of what I was saying with with repairs and maintenance is that those expenses that you have to pay for a hot water heater whatever are not going to be born every year like in year to year three or four you're going to have to pay money to replace a hot water heater but you're going to have to pay a lot of money after Year 10. So the way to to underwrite it or to think about it is women look at that expense and then just divide that total expense by the number of years that I have. So I might put in my budget that my repairs and maintenance are twenty five hundred dollars a year. But there might be two or three years I don't pay a dollar to that or pay ten dollars and there might be one year where I pay eight thousand dollars. So over the lifespan over the three or four year period of time and I'm looking the average might be that number. But in any given year it might not be that exact number and it's important if you look at a property you know say the owner might say oh I didn't spend any money on maintenance last year. Okay great. That does mean that the cost that you should underwrite is zero dollars. It just means that maybe you know nothing bad happened that year but next year you know this year to replace a boiler for our properties cost me a boiler and hot water heater cost me seven thousand dollars. But last year I didn't have to do anything so cost me five bucks there.

 

Ryan Goldfarb: [00:52:45] I'd like to have a distinction between repairs and maintenance and capital expenditures. So repairs and maintenance are generally classified as maintenance of existing fixtures maintenance maintenance and overall maintenance of the property. So that might be things like going and unclogging a toilet or patching a hole in the drywall from somebody who took down a picture. Little things like that that are just more so upkeep than a true replacement. I think a lot of things that John alluded to are more so classified as capital expenditures which also as you alluded to have a pre-defined lifespan and it's just an inevitability that there's gonna be concern that those are going to have to be addressed. So when you're looking at your quote unquote repairs a maintenance number it's important to take both sides of the equation into account. And oftentimes as this this also comes back to the idea of applying context to your investment. So if you're buying something that you're maybe getting a little bit of a deal on but it's an older house it hasn't been renovated needs a little bit of love. Need some cleanup maybe hasn't been lived in for a little bit. You can. You can bet that in the first year or two you're going to find out where the leaks are you're going to find out where the warts of the property are and you're going to be spending on both repairs and maintenance and probably some capital expenditure items if you didn't pick them up immediately anyway. And on the same token you may buy something that is perfectly that is turnkey and that was renovated right. And it may be reasonable for you to assume that in year one year to year 3 your repair maintenance number is gonna be pretty low because most of those items that John alluded to earlier have already been addressed and you shouldn't need to deal with them again. Let's say that John you also know manager property that was recently renovated but was not renovated to the standard that one would expect and so despite the fact that it's renovated I think there's been a fair amount of expenditures on the repairs and maintenance side just to address some subpar renovations.

 

John Errico: [00:54:50] Yeah I think the way to look at it. I think we even talked about this in the previous episode is that even though there are events that happen infrequently it doesn't mean that they'll never happen. So even if you have a property that's been recently renovated everything is OK. You could still have a pipe that will leak but just the way that it is. So I I could probably count it. You know I manage quite a few properties. I can probably count less than maybe there are one or two of the properties that I manage which is like over 10 properties each of which have multiple units that has never had a pipe leak in the time that I've managed it. And doesn't matter if the pipes are new or old or whatever it is just the way that it happens. So does it happen every day. No but it does happen. So even things that are infrequent are going to happen sometimes. Doesn't matter how old how young what the status is whatever. So the only way I mean if you really really really want to control your maintenance issues is to do preventative maintenance and I would say do it yourself. Don't rely on a previous property owner to have done quote unquote preventative maintenance because as Ryan mentioned even properties that are newly renovated you have no idea the standards that the previous construct. Contractor construction person whatever used to apply to it if you want to get it done then be preventative yourself. But I would say do it yourself and make sure it's done right.

 

Ben Shelley: [00:56:11] Yeah I mean it was crazy not to mention the idea of cap ex capital putting aside a capital reserve you know a lot of the things that we're doing here when they're smaller deals we're looking just a year one so renovation to lease up through through a full year year and a half. But even with something as small as that to looking at something over a 10 year 10 year exit you got to have some sort of proportion put aside of your of your income put aside to address these possible concerns.

 

John Errico: [00:56:35] Yeah. So that's that's a great point to bring up as well that the way that I always think about properties whether I own them or manage them is that they're that there will be a pool of money and you can call it like an emergency fund or a capital reserve fund or repair fund or whatever want to call it that is usually at least equal to the deductible of the the insurance that you have in the property but oftentimes is larger. I would suggest to be larger because for various reasons you might not want to make an insurance claim or whatever it is you want to be covered insurance but long story short is that for the first year or two of the property if you're thinking about a property as like a cash flow machine I the way that I operate and what suggest operating is taking the income that you're generating from the property you're your net operating income and putting it into a separate fund or a bank account for the property and waiting until that reaches a certain amount maybe it's 1 percent of the purchase price 2 percent of the purchase price the value whatever you want to use for me and a lot of 2-family properties it's often like 10 grand or something around there and don't touch that money at all until it gets that point once it matures beyond 10 grand start making distributions to yourself or to investors or whatever might be but keep the money in there so that you know on a rainy day if you have like and like what happened to me this year I had a seven thousand dollar expense just come out of nowhere. Well I had ten thousand dollars in my account so yeah my accounts now down to three thousand dollars but I didn't have to go into a credit card saving you know whatever might be. I just had the money sitting right there and I didn't make an insurance claim for other reasons that we can get into at some other point but but it's nice to have the security so that's I think I would highly advocate it touches back to the point before about not being undercapitalized and buying a property. This is not being undercapitalized when maintaining a property going forward.

 

Ryan Goldfarb: [00:58:22] That's a great point. And I think if you want to understand why we don't always believe in NOI when we see one or we don't always believe the numbers that a broker or a wholesaler or another investor is showing to us me then you want to understand why we're maybe skeptical about the numbers that we see it's because if you go through each and every one of these line items there is a certain artistry that goes into arriving at a particular number and that doesn't mean that there is a quote unquote a right way to do it. It just means that there are different ways to do it and whatever way you choose should be supported with with the right assumptions and the right support. So to recap on the income side we have rents, we have vacancy. Rents are going to vary based on what your rental comparables suggest. Vacancy is going to vary based on what you perceive as market vacancy and market economic vacancy. And then on the expense side we've got real estate taxes which may or may not be under assessed which may reassess at some point. And every investor is going to have a different every investor is going to have a different interpretation of what quote unquote market taxes are going to look like. We've got insurance which is going to consist of general liability may consist of flood insurance may consist of builders risks lower risk umbrella coverage. So that's going to be different depending on what your risk tolerance is and who you get your insurance through and what kind of limits and deductibles you want. We have management which can vary just on the surface based on who your property manager is but also the. Management is directly correlated to what the income is. So you can see a variety of ways that different investors will have different management numbers underwritten. You have utilities including both gas and electric and water and sewer. That's going to depend on not just what the mechanical setup is today but what it will look like in year two year three year four based on that investors plan. We've got General and administrative expenses which will vary across the board. I mean it's quite common that an investor won't even underwrite this at all. You have repairs of maintenance and kind of like tie up tied into that you may have capital expenditures. So everyone's going to have a different rule of thumb for how they underwrite that they make off of historically they may have a benchmark that they use for a specific type of asset in a specific market.

 

Ryan Goldfarb: [01:01:03] Am I missing any others? You may have payroll if you're getting into a larger property. Generally 50 units or above you may have an onsite an onsite manager maybe a full or part time maintenance person. So payroll numbers are going to be determined by that.

 

John Errico: [01:01:18] You have like snow removal trash and rental.

 

Ryan Goldfarb: [01:01:20] That's right. Yeah. We generally roll that into repair the maintenance but there was that pest control. All of that is kind of discretionary to an extent. And if you tie all of that together you have you can see how investor a may have a very different interpretation of what both revenue and expenses and ultimately NOI are going to look like and those same two investors may have a very different interpretation of what the quote unquote market cap rate is for that for a property like that in a specific market and thus may have may arrive at a very different valuation of a particular property.

 

John Errico: [01:01:55] One funny thing to mention too is I think before it got into real estate and people from afar think this perhaps is that when you look at a property an investor for the pope is going to be able to tell you all these numbers are off the haven't got you have to this and my captures this and I spent this.

 

John Errico: [01:02:10] But in reality it's not. I mean that these numbers get so fudged and messed up and also these exceptions and weird things that even a well-intentioned property owner might not have very good numbers for this stuff and even looking at the numbers for a year might not be very relevant because that year could be for whatever reason exceptionally bad or good. So even if you like even if you were to say oh I could just get all these numbers from the prior owner or just ask some investor what the numbers would be even that alone is not going to necessarily tell you the full story.

 

Ryan Goldfarb: [01:02:44] I've always looked at income and expense forecast or pro forma as an exercise and in highlighting each and every one of these line items that ultimately inform how your property operations are going to look and to be able to say hey what's going to drive taxes what's going to drive insurance maintenance utilities each and every one of those line items and kind of audit them on a more granular level and then use that to not just come up with numbers but to come up with an action plan for how to add juice that property to juice it.

 

Ben Shelley: [01:03:16] One of things I appreciate you having worked with John Ryan for a little bit now is exactly that is.

 

Ben Shelley: [01:03:21] And we'll talk very quickly to book the segment about what the numbers are at the end for for one of these smaller deals but this idea that even when you generate cash on cash and cap rate and your NOI in some ways just by delineating your income and expenses as as as specifically in as closely as you can that may actually be more helpful to inform your decisions on where and when you execute your purchase. And that's something that I've appreciated as we've tried to make action plans for investing both in places we're experiencing and in New Frontiers. And so just quickly as a bookend. So once you have everything calculated right usually what I'll center to Ryan and John is something very very simplistic actually something very basic just to give a snapshot of what the quality of the deal looks like you'll take to get there and why obviously we talked about it you'll take your rental and your net rental Rev and you're subtracting your fixed and variable expenses excluding your debt to get your NOI. And Then I like to put a net cash after debt or sometimes people just say cash flow after debt service which is the same calculation except including your debt. As part of the subtraction to see what the actual annual dollar income is for that year. And it's funny for these very small deals you know your cap and your cash on cash tend to be inflated to the point where I oftentimes don't even include it. But for the purpose of just an example let's say you know you netted your NOI is 10k and you want to get your cap rate right. Then if the value of the property is a hundred thousand dollars then you've got a 10 percent cap and for your cash on cash let's say your cash well after debt is five thousand and your total equity invested is twenty thousand and you've got a 25 percent cash on cash. So that's just a quick snapshot to tell you that it sounds pretty healthy frankly when you when you look at it suffer from an overhead picture. But as you just learned from this episode when you look at it line by line item that will help to better inform whether or not the deal is really good for you at your turn.

 

John Errico: [01:05:11] Just very briefly on debt service. So we've talked I think in previous episodes about finance but not all financing is the same. And it depends a lot on the. It could depend on your personal credit. Credit and borrower portfolio could depend on the market could depend on the type of property that you're buying. So when we're talking about multi-family properties there's residential debt there's commercial debt there's no private hard money type dead all sorts of stuff. So those numbers may not impact the anyway calculation that we just talked about but they do have an impact on your your pocketbook like your bottom line the amount of money that you're taking home per month and that that in itself could be a very important factor in the investment so like we just talked about these numbers and we're talking about as though it's a given that you would really care a lot about anyway and whatever else. But I know a lot of property investors that although maybe they're there in a way calculating anyway all they care about is the amount of money that they put in their pocket every month. And to that end it's really important to think about your debt service and all these other payments that might be the case because if you don't really care about what you're what your turn is but you just want a property that gives you five dollars a month because to you that means financial freedom or that means a vacation or whatever else then definitely absolutely look at debt service and everything else to come up with that number for you.

 

Ben Shelley: [01:06:30] And just to that point me I remember I went to a real estate program and I had professors who would just I mean hammer home you know basically the only thing you should care about is covering your debt service and if you're covering your debt service your quote unquote making money and it's obviously not that simple but that's where you get into other metrics like equity multiple and IRR on on bigger deals which could help inform your opinions. Guys I appreciate it as always. Always a hoot and a half to get together at John's apartment two to record. We got the pups and animals around us. And can we to continue on with to the next episode. Thanks guys for your time and expertise as always.

 

Ryan Goldfarb: [01:07:02] Thanks, Ben..

 

Ben Shelley: [01:07:14] He was really upset that there's more equity required than a down payment.

 

Ben Shelley: [01:07:19] He's like what I everybody got paid by my.