The Fastest Way To Build A Six Or Even… Seven Figure Real Estate EMPIRE!
With multi-family investment prices down as much as 7% in the last year, even in markets with expected growth and stable rents, you may be asking yourself, “What can I do to de-risk my deals?”
We’re navigating a looming recession, economic conflict with China, and nonstop inflation, and the last thing you need right now is to have to refinance or sell at a loss.
Today’s episode is all about how to prevent that worst-case scenario. I’m excited to share with you nine things we’ve done (or learned the hard way) through our deals that have made a tremendous difference when it comes to our performance in tough economic times. I’ll show you how you can use these strategies with your own investments to de-risk your deals and portfolio.
The Forever Passive Income Live Virtual Event
The next FPI Live Virtual Event is coming up on May 19-21, 2023 where I’ll be sharing the step-by-step blueprint on how we raised tens of millions in capital and acquired over 4,300 units. Buy your FPI tickets today by visiting ForeverPassiveIncome.com
Key Takeaways with Josh Cantwell
- Why it’s so important to invest for the long term–and why I won’t do any deal unless we can get long-term, fixed-rate financing.
- How knocking out CapEx in months instead of years protects you from dropping property values.
- The power of having secret shopper asset managers on the ground.
- Why you need to review your financials every month, without exception, to be a good operator (and share this information with your partners, good or bad).
- The benefit of underwriting deals at 70-75% occupancy to account for cash bleed.
- The value of long-term vendor relationships.
- Why you should keep your investments in one or two submarkets–or very close to home.
Josh Cantwell Tweetables
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Josh Cantwell: So, hey there, guys. Welcome back to Accelerated Investor. Hey, it’s Josh and I’m your host as always. Thank you so much for being here. Listen, in light of this looming recession, in light of everything that’s going on with China and the dollar and inflation, I thought we should specifically talk today about ways to de-risk your business, ways to de-risk your investments, and ways to de-risk your deals. So, today I’m going to talk to you specifically about nine ways to de-risk your investments. Here we go.
Josh Cantwell: So, let’s talk about it, 9 Ways to De-risk Your Business. You know, I’ve been thinking a lot about some of the different ads and some of the different articles and some of the different conversations that we’re having, investors and operators that we’re talking to, some of the webcasts that I’ve seen and just digesting all of that. And I’ve just been thinking about some of the different articles like, for example, CoStar just came out with an article this morning that said that multi-family investment prices are down 7% since a year ago. So, that’s pretty significant. I mean, if you bought a $30 million property and you haven’t done much to it, you haven’t done much CapEx or haven’t raised the rents and you just were in a market where there is a significant amount of decrease. And let’s say it’s 7%, that’s $2.1 million that you just lost. If you’re in a certain market where there was expected growth and rent growth and upside growth but all of a sudden these interest rates have hit and now you’re like, “Wow.” Like, I have a bridge loan or some sort of floating rate debt with an interest rate cap, and not only do I have to recapitalize the deal and refinance it or sell it but the value is now down 7%. That’s a problem. That’s a problem.
And so, I started thinking about, well, what are different things that we’ve done? How have we de-risk the business? What would I do differently? Or what have we done right in order to de-risk the business and really came up with nine different things that I think we’ve done right, nine different things that I think everybody should do in order to de-risk their business? So, here we go. Number one, first of all, always invest for the long term and always get long-term fixed-rate cash-flowing financing. Always. Even when everybody else is getting bridge debt, even when everybody else is getting SOFR loans, just like everybody else did in the last one to five years and they’re overpaying for properties. Guess what? Here comes the piper. And we got to pay the piper, right? So, the piper is coming. Some guys are going to get caught. They’re going to need to sell because their debts are going to balloon out. And then what? “Oh, wow. And then my real estate is actually down 7% and I can’t sell and I can’t refinance and I can’t return my investors’ equity.” Why? Because they didn’t invest for the long term and they didn’t get long-term fixed-rate cash-flowing financing. So, how do you do that? Like, what kind of financing is considered long-term or at least midrange to long-term?
Number one would be seller financing. Seller financing, that’s 5 to 15 years that you can negotiate with the seller and that you could lock in for the long term. Number two, you could get a bank loan. Maybe that might require some personal guarantee but I’d rather have a personal guarantee with five to seven to nine-year financing, that mid to long-term financing than three-year money with a non-personal guarantee. That’s just me. That’s just what I would rather do because I know if I invest for the long haul, my values are going to go up over time. They might not go up in the short term. They may actually even go down in the short term. But over the long haul, it’s always going to go up. And then number three, which would be Fannie Mae, Freddie Mac, HUD, the agencies. Agency financing is always long-term. It doesn’t have a seven-year or a ten-year or a 12-year balloon. It’s truly long-term. And the way they lock it in is of the short-term prepayment penalty. And so, there’s really three different types of long-term fixed-rate financing, seller-financing, bank financing, and then agency, which includes Fannie, Freddie, and HUD. When we buy properties, we always get long-term fixed-rate financing. That is a rule. We will not do any deal unless if we can get long-term fixed-rate financing.
Number two, although we get long-term financing, another way to de-risk the business is that we actually force the appreciation by forcing the capital improvements. So, let me explain. A lot of operators and investors will have a 5 to 7-year plan and they’ll say, “Hey over the next 5 to 7 years, the rents are going to go up 4%, 5% per year, and we’re going to do the capital improvements out of the cash flow or we’re going to do the capital improvements over the next 5 to 7 years.” Well, you’re not really forcing any appreciation if you’re allowing your CapEx to take 4 to 7 years. And so, what I believe and what my firm does and what we focus on, and what I believe that you should focus on is jamming all of your capital improvements into the first 12 to 18 months. So, if you’re planning on turning units, we force vacancy, we force people out. We quickly turn the unit and then we release it within no more than 60 days. So, it might be vacant for 60 days but we take a unit that maybe was previously renting for $800 and now it’s renting out for $1,100 or $1,200. And we’ve forced true appreciation in the property versus organically kind of doing it out of cash flow or organically doing it slowly. By doing it that way, you’re not really pushing the income.
So, if you bought a building today and you bought it for 15 million and it’s got a certain amount of cash flow, maybe it’s got $1.5 million of cash flow, well, a year or two from now, if you’re just kind of slowly doing it, you bought it for 15 million and maybe you’ve raised the income by $50 per unit. Big freakin deal? Maybe you’ve raised the rent. The value then from 15 million to 16 million. Big deal? Who cares? Versus what we’ve done like at our Stuart House Apartments or Brookside Oval, Brookside Way, Shady Cove, all these different properties, we jam the capital improvements in the first 12 to 18 months. We force the income to go up through aggressive renewals, which sometimes creates vacancy, which is fine. I would rather have that vacancy in the short term and underwrite for that vacancy and have a cash bleed so that within 2 to 3 years, I’m done. And the value has gone from 15 million to 22 million. So, the way you de-risk the business is by knocking out the CapEx very, very quickly and forcing the value to go up fast. That way if there’s a downturn, there’s a recession, you’ve already forced the value up. It’s worth a lot more. If you need to sell, you make a profit. If you need to refi, there’s room.
Number three, the third way to de-risk your business is to always have an experienced boots-on-the-ground operator that is a partner in the deal. And that partner secret shops the deal at least a couple of times a month, shows up unannounced, walks around, secret shops the property manager. That boots-on-the-ground secret shopping, that is asset management, and a lot of guys don’t do it. So, one way to de-risk the business is to show up unannounced, is to show up at your property manager unannounced, walk units unannounced, walk the commons unannounced, walk the grounds unannounced, call the phone number, visit the website unannounced, and see what the experience is for those residents. Asset managing is critical. Number four, review the financials every month without exception. We will look at our financials every month, the P&L, balance sheet every month without exception. We make sure everything ticks and ties out. We review it versus last month and the month before, review it against their P&L, against that balance sheet to make sure there’s no mistakes. Look, accountants are human. They make mistakes. Well, if they make a mistake a year ago and you wait and wait and wait until the end of the year to review your financials, and then finally you review the financials and finally you find a mistake, it becomes much harder to go backwards and to fix that problem.
So, when we review our financials, we have a set of key performance indicators, KPIs. And when we review the financials, the first thing that we look at is our cash position this month versus last month. The next thing that we look at is our capital improvement position, how much CapEx have we done this month versus last month? We also look at how much money does the bank owe us in a draw, if we’re doing CapEx, if it’s a bank loan, and there’s construction dollars in the loan, how much CapEx have we spent? When was the last time we got a draw? How much does the bank owe us? We have in our business what we call a draw ceiling. And so, every time we hit that ceiling, we apply for a draw reimbursement. Some properties it’s $450,000, some it’s 250, some it’s 150. It depends on the size of the deal. But when we hit a certain number, then we know, “Hey, time to go apply for another draw from the lender to get reimbursed.” So, we have the capital that we can cycle the capital back again. Obviously, we’re also comparing the rent roll. How much rent do we have on the rent roll this month versus last month versus the month before? Where’s our total income this month versus last month? What are our collections this month versus last month? What are our expenses this month versus last month? What are the expenses especially the variable expenses?
There are some expenses that are non-controllable. You cannot control the property tax. You really cannot control the cost of insurance. You really cannot control the cost of your utilities. Obviously, we can negotiate the utilities in certain circumstances, but once you negotiate them, then they’re pretty much fixed. But what about the controllable expenses, the repairs, the maintenance, the maintenance tax, things like that, the marketing leasing, the general administrative expenses? We got to review those every month without exception to make sure nothing gets out of whack. Because, guys, once the money is spent, it’s gone. You can’t go just operate better than next month and make that money up. Number five, the fifth way to de-risk your business is then to take number four, which is to review the financials every month without exception, and then go to number five, which is commit to sharing everything with your limited partners. If you want to be a good operator, you want to de-risk your business, commit to sharing everything with your limited partners, good, bad, or otherwise, through video updates, PowerPoints, the P&Ls, the balance sheets, your cash position, your CapEx spend, everything I just described.
Because if you know that you have to share that with your investors and you know that you’re going to be transparent, you’re not going to hold anything back, you’re like running your business naked like they can see everything. And if you’re not going to hide anything, you’re going to share every single thing about your business, you’re going to make sure that you do it right the first time. So, if you compare to sharing everything with your limited partners, I guarantee that you’re a better operator and you de-risk your business because you only want to share good news. So, you’re going to work really hard to make good news, right? But even if there’s bad news, you’re going to share it anyway, which is going to make you realize what you should have done differently and what you can do better. The sixth way to de-risk your business is to over-raise capital and keep at least six months’ worth of operating capital in your bank account. A lot of guys, they buy a multifamily property and they raise the absolute minimum. They raise the minimum. Well, they’re like, “Well, we don’t want to give up any more equity to investors.” Yeah, but what if you run out of cash? Then you’re going to give the whole deal back to the bank. And all your limited partners are going to get wiped out. So, over-raise capital, give up some equity, keep at least six months’ worth of operating capital sitting in your bank account.
Number seven, the seventh way to de-risk your business is to underwrite your deals at 70% occupancy or 75% occupancy and see how much cash bleed you’re going to have. Look, if your deal is going to make money but it’s only going to make money if you’re 95% or 98% occupied, you probably are adding risk, not de-risking. You want to be in a situation where even at 70% occupied, you can still pay all your expenses, you can still pay all your debt service, and preferably still pay all your investors. But at least if you’re 75%, 80%, 85% occupied, you pay your investors but if it were to drop down below 75%, 70%, maybe you can’t pay your investors but maybe their preferred return. But maybe you’ll still pay it anyway because you underwrote for it. You put the money for cash bleed in your operating account, and you’re expecting that bleed. And then, of course, if you operate at a much higher rate, 90%, 93%, 95% occupied, then of course, at that point you’re not bleeding any cash and you’re not spending and you can pay your investors their preferred return. But one of the things that we do as we underwrite our deals at 70% to 75% occupied and see what that looks like. I’m baffled by how many guys don’t do that and then the stuff hits the fan that they’re in massive, massive trouble.
Number eight, the number eighth way to de-risk your business is to use the same vendors over and over and over and over again. We’ve got four different property managers but we really used two over and over and over and over again. And those portfolios are absolutely operating the best. Why? We’re building relationships with those property managers. They know what we want. They know how we talk. They know the language. They know what our KPIs are. They know what our budgets are. We use the same contractors over and over. We’ve got about four different carpenters, carpenter crews, that turn units. We use the same roofer almost every time. We use the same electrician almost every time. We use the same plumbers almost every time. They give us good pricing and they give us reliability because we give them a lot of work. So, you actually de-risk the business by using the same vendors over and over and over. Now, again, at the beginning, you might use a couple of different vendors to figure out which vendors are the best. And then when you figure out which ones are the best then keep using them over and over and over.
And number nine and the final one, the final way to de-risk your business, which I think this one is absolutely huge, maybe the most important outside of invest for the long term and get long-term fixed rate cash flow, long-term fixed-rate financing, number nine, the number ninth way to de-risk your business is to buy all of your properties in one or two submarkets and/or stay extremely close to home. You do not want to diversify into multiple markets with one asset or maybe two assets in each market and then have like nine buildings in eight different markets. That’s really, really hard. You’re really asking for trouble if you do that. To me, I would pick one or two submarkets and I would own 500 to 1,000 units or more in each submarket. Because then it’s easier to use the same vendors over and over and over again. It’s easy to review the financials. It’s easy to use the same property manager over, over, over. It’s easier to execute your CapEx in 12 to 18 months. It’s easier to get long-term fixed-rate financing and not have to worry about it because you’re in the same submarkets. You know, those submarkets like the back of your hand, you know what you’re doing, you know the areas. Your property managers know the areas. You know what the problems are. If you buy again nine different buildings and you buy 1,200 or 1,500 units and you buy them in seven or eight different markets, man, you are spread so thin, you are asking for trouble.
And so, as I kind of wrap up here, a couple of things. If you’re a limited partner, if you’re an LP and you’re looking to invest with operators, these are the nine questions that I would be asking the general partnership, that I would be asking the GP. Like, what kind of financing do they get? How fast do they turn the CapEx? Who’s going to be the boots on the ground? How often do I get the financials? Are you going to have six months’ worth of operating capital in the account? What if we go 75% occupied? Do you use the same vendors over and over and over? And how many different submarkets are you in? Those are great questions. If you’re a limited partner and you just sold a technology company and you just made $10 million or you just made $2 million or you just made $50 million, and I’ve talked to all of those kind of people, those people are investors in our deals, the funny thing is, though, they don’t even know to ask these questions. And so, now I’m giving you the ammo. I’m giving you the questions to ask so you can be a better-limited partner. Now, if you ask me, I’m totally fine with that because I recorded this episode and I’ve already given you all my answers. I’m going to win there. I’m going to recruit a lot of money that way. But I can’t even tell you how many limited partners I’ve talked to who are all of a sudden telling me, “Oh, man, I invested some of this money, Josh, with somebody else and their preferred returns have shut off because the cost of their mortgage tripled, their interest rates doubled.” Man, tough spot to be in.
And so, if you’re a limited partner, those are the nine ways to de-risk your business. If you’re an operator, make sure you incorporate this into your underwriting. Make sure you incorporate this into your analysis. Make sure you talk to your mortgage broker about long-term fixed-rate financing or negotiate seller financing. Make sure you have your contractors in order to knock out the CapEx very, very quickly. I would rather go from 95% occupied down to 80% occupied, knock out all my CapEx, and then go back to 95% occupied. I’d rather do that over 12 to 18 months and knock out my business plan than just constantly be bleeding a little bit every month waiting for units to turn. No, thanks. And so, if you’re an active operator, make sure incorporate these nine ways to de-risk your business into your underwriting, into your business plan, and to your private placement memorandums. Because if you do that, you’re never going to lose the asset. You know what people say is they say don’t wait to buy real estate. Buy real estate and wait. Or you can’t buy real estate and wait if you get the wrong kind of financing. You have to look long-term. So, make sure you incorporate these nine ways to de-risk your business.
Josh Cantwell: Guys, listen, if you enjoyed this episode and this training, I would be so, so grateful. I mean, literally, it’s so meaningful to me to hear your feedback, and I would be so grateful if you would like, subscribe, rate, review, and share this all over social media. I would just be so grateful, man, to now we build our community and build our investor base and build our joint ventures for me, for my own reasons, but also to help the rest of the marketplace do better deals, be smarter investors, to take on less risk. That’s very, very important to me. Now, if you’re an active operator like I talked about and you want to buy more buildings of your own, make sure you grab a ticket to our upcoming Forever Passive Income event, Forever Passive Income Live. They’re online. They’re virtual. The next one’s coming up here in a few weeks, and you can get a ticket for just a few hundred bucks at ForeverPassiveIncome.com. If you’re an intermediate to advance investor and you are looking to partner with us or share deals with us, JV with us, be part of our mastermind coaching and partnering program, make sure you visit JoshCantwellCoaching.com. Those are the things. Those are my pet projects, things that I enjoy doing, being around other investors, helping other people be smart investors. I hope you enjoyed this episode and we’ll see you next time. Take care.