Ask Michael anything: Return metrics, partnerships, & expectations

In today's episode, we take on listener-submitted questions. We’ll discuss calculating cash flow, risk-adjusted returns, getting started without large sums of capital with partnerships, and Michael’s personal thoughts on the current housing market. We love hearing from you all and taking on your questions, so please keep them coming. Whether it is through reviews or YouTube comments, we will do our best to get to all relevant questions you all send our way. --- Transcript Before we jump into the episode, here's a quick disclaimer about our content. The Remote Real Estate Investor podcast is for informational purposes only, and is not intended as investment advice. The views, opinions and strategies of both the hosts and the guests are their own and should not be considered as guidance from Roofstock. Make sure to always run your own numbers, make your own independent decisions and seek investment advice from licensed professionals.   Pierre: Hey, everyone, and welcome to the Remote Real Estate Investor. My name is Pierre Carrillo and today I'm with…   Michael: Michael Albaum   Pierre: and today we're going to go over some more listener submitted questions. So let's jump into it.   Good morning, Michael. How are you today?   Michael: I'm good. I'm good man woke up in Washington State this morning on our way up to the San Juan Islands so couldn't be more excited. How about you? I know it's a big day, couple days coming up for you too.   Pierre: I'm doing good man. It's hard to sleep so excited for the weekend…   Michael: Do you want to give our listeners any insights into why it might be hard for you to sleep?   Pierre: Yeah, keep on having dreams that the day is something that can go wrong on the day. I'm getting married this weekend, so…   Michael: Nice man super excited for you and it's gonna go flawlessly.   Pierre: I'm sure I'm just having these weird dreams that are very, very unlikely about like, completely impossible case scenarios, but…   Michael: Pterodactyls are gonna crash your wedding and…     Pierre: Pterodactyls are gonna come down on the altar and knock over the tables. Oh, man, well, it's really stupid.   Michael: It's gonna be an amazing event, really, congratulations and I can't wait to see pictures after.   Pierre: Thank you, Mike. Cool, so we got a bunch of questions here. Let's see how many we can get through. We're kind of in a rush today. So let's, let's knock out what we can. Alright, let's knock out some of these easier ones real quick. First, is cashflow accounting for all the costs for owning a property?   Michael: Yes, I think it should. You'll get different definitions from different people. Some might say, hey, your cash flow is you take your rent, and you subtract out your PI TI, because that's your principal interest, taxes and insurance. Those are the expenses that they're accounted for everything leftover as cashflow. I'm quite a bit more conservative and I say, hey, yeah, that's a big chunk of what you got to subtract out from the rent but there's also prepared maintenance Property Management expenses, if using a manager capex reserves, things that could go sideways and so you want to have money set aside and earmarked for those expenses for not if but when they show up and then anything above and beyond that is your true, free and clear cash flow is what I would say.   Pierre: Agreed, yeah, should operate on its own as its own business. Next question here, thinking about generating cash flow faster? Does it make sense to purchase a portfolio of single family homes versus one unit generating the same income?   Michael: Hmm, that's a really good question. So I think it comes down to personal risk tolerance and personal investment thesis and strategy. So we could absolutely make the argument that hey, that person that has 10 single family homes, has less risk, from an occupancy standpoint than the person that owns one big single family home that generates the same revenue, let's say, because if one person leaves the person, the guy who are the person who has the portfolio, if one person leaves, they're still 90% occupied, they've only got a 10% vacancy, because they've got 10 folks living there. If, on the other hand, are single portfolio or single house person, if they have that tenant leaves or 100% vacant. Now, we could also make the argument that the person with 10 homes has 10 roofs to maintain, and 10 h facts to worry about and 10 sewer systems to keep track of, versus the person with the one property only has one of each of those things, the knife kind of cuts both ways. What I personally have experienced is that's the reason I went to multifamily is because you get the occupancy and vacancy robustness of having multiple properties but you only have one roof, I still might have 10 H facts if it's 10 unit property or 10, whatever 10 systems to maintain.   But geographically speaking, it's all in one place and so it's a little bit easier to manage. Now, multifamily apartments are going to be very different than a single family from an asset class and you're likely tenant base and the stickiness of a tenant. So that's a whole another conversation for another time. But again, I think the knife cuts both ways, so it's tough to say definitively one or the other.   Pierre: Wouldn't speak to the quality of a property if 10 of them are cash flowing or generating as much revenue as one property, we would be talking about 10 lower quality or lower tier properties, comparing that to one higher tier property.   Michael: Yeah, you probably could get there with logic but I think it's really tough to do in the sense of that's a very unlikely scenario unless you were in two totally separate mark gets in once you kind of leave the bounds of the market, a lot of bets are off anyhow. Yes, real estate is contiguous in the sense of how it's built in a lot of instances and the fundamentals and the mathematics. But the specifics is the specifics is the specifics and the nuances of operating a single family rental in New York is gonna be very different than operating one in California, or in any city that you go into in between. So yeah, it's just it's an unlikely scenario that you would have 10 equaling the gross revenue of one unless that one was like a really big Airbnb or something but again, that's a whole different animal unto itself.   Pierre: All right, what is a risk adjusted cash on cash return?   Michael: That's a really good question. So a risk adjusted cash on cash return is basically taking what institutions it's implementing what institutions do and how they rate properties, and how they think about risk tolerance. So if you can imagine, here, if your buy box is targeting a three, two single family home and a three star neighborhood, and you're targeting an 8% cash on cash return, I'm making up numbers here, right? If you found a property that was in a four star neighborhood was in a better neighborhood, you should be okay accepting a lower return than your targeted 8%. Maybe you're okay with a six and a half percent cash on cash because there's a trade off, right? You were targeting this property for 300, you got something that was better than what you were looking for in one category and so there's this sliding scale and we can see I'm a very visual person, right.   So there's this balance the seesaw, if you will, of usually cashflow versus neighborhood score and so that tends to slide or cash flow and appreciation tends to slide and so we are sliding a little bit more onto the appreciation side, because we're in a better neighborhood, therefore, we should be okay giving up a little bit in terms of our cash flow. Now, that scale should absolutely slide the other way. If you found a property that was in a two star neighborhood, let's say and you were targeting again, three and eight, well, hey, you're giving up a little bit on the potential appreciation, or at least we will expect you to because of the neighborhood rating, as compared to the three therefore you should be demanding a better cash on cash return. It's a way to be dynamic with your Buy Box and adjust to the situation that you find yourself in with regard to the physical properties themselves, as opposed saying, okay, I'm only taking a three star 8% cash on cash like, yeah, you're totally welcome to do that but this gives you a little bit of a wider scope, so to speak.   Pierre: Okay, is there a way to what's Is there a formula to use to calculate what your risk adjusted return should be based on different neighborhood ratings or property ratings?   Michael: There is and so yes, and no. So we built that into the Roofstock Academy calculators that we helped give folks to help evaluate them, help them evaluate properties. So we built that in for some folks, if you're doing it on your own, it just really comes down to what your risk tolerance looks like and so you and I keep looking at the same we can have the same Buy Box three star neighborhood 8% cash on cash and if we both find a property, that's four star neighborhood, I might be okay, accepting a six and a half percent cash on cash, you might only be okay at 7% because of what your investment thesis is, and risk tolerance looks like I might be putting more eggs in the appreciation basket, so to speak, where you might be saying that I don't know if it's gonna appreciate that much. So it's more of a concept than a than a true like mathematical formula. So I think it's just important to be thinking about and be aware of as folks looking at properties in, you know, in neighborhoods in areas and markets outside of their direct scope.   Pierre: Let's stick with the cash on cash topic. Mike, in this question here asks, is 8% a reasonable cash on cash return to seek in this market today?   Michael: So you're using my own number against…   Pierre: …a just happened to be just 8%?...   Michael: Our last example? Yeah, it just happened to screenshare. So it all depends, I think is so often the answer, unfortunately, and it depends on a number of different factors. I just underwrote a property that I purchased as a short term rental, where the projected cash on cash was like 15 16%. So is 8% reasonable, totally doubling that. So it really comes down to what's your strategy is cashflow, and long term rentals what we're talking about here, and I'm gonna assume for a minute that it is. Yeah, I think it's still totally possible. We just have to engineer the return correctly, which is something I think a lot of people aren't familiar with or don't know how to do or aren't willing to do from the standpoint of, I think so many of us are trained to go purchase rentals with 20% down and that's it. That's the deal. Well, that is one way to purchase rentals. But if the returns don't work at that threshold, maybe we tweak it, maybe we need to put 20% down maybe had to put 30 40% down and I think people are listening to this and if they're really familiar with the mathematical equation for cash on cash might be thinking, Michael, that's going to drive your cash on cash down, because we're using less leverage and in a lot of instances, it will, but not all of them and so there are very certain types of properties based on the characteristics of purchase price, what they rent for their expense profiles, and what your what kind of leverage you're using, that all goes into this recipe, so to speak, to bake the end result, which is often cash on cash and cap rate and so we can unequivocally say, less leveraged bad in terms of cash on cash return. So we want to run the numbers and look at putting a larger percent down, because that will often give you a break on the interest rate and the larger the property purchase in terms of purchase price, the more impactful that additional breaking interest rate becomes and so if we're looking at an $80,000 property, for example, we're going to finance it, the difference between a 4% interest rate or a 6% interest rate doesn't move the needle a lot. Of course, 4% is better than 6%, because we're paying less in interest over the life of that loan, our monthly payments are smaller. But if we're purchasing a $250,000 property, the difference between a four and six can be quite significant in terms of actual dollars that you're spending on that monthly payment. So I think we just need to be a little more creative on how we engineer properties in terms of the purchase, are we purchasing them, right? Using the proper amount of leverage? That can that can be all that's needed to dictate what our return looks like.   Pierre: Cool and we did a video on this specifically, using a pro forma template and running the numbers and comparing what kind of property would do better with an all cash offer and what one would do better with leverage. So check that link right above here for seeing like break that all down into detail. Like what is the lowest cash on cash return that you would accept all other factors considered?   Michael: Oh, that's a really good question. For me, personally, I'll probably be in the 5% range because I know that that's a that's a point in time. I think we're all thinking about this point in time right now as kind of the whole picture, and as the movie. But I think if we think about, again, my visual brain coming into play here, if we think about a movie, like a movie reel, it's snippets of pictures, right? That's where we get our motion picture from and so right now we're seeing one of those snippets, tomorrow is going to be different, the day after is going to be different in every moment, every day, going forward is going to be different and so I'm not looking at this point in time as the whole movie and so if I'm getting a 5% cash on cash today, I know at some point down the road, the rents will probably go up, interest rates may come down. They may not but they may and if I'm okay with 5% today, and the interest rates don't ever go down. Well, okay, I bought a deal that I was okay with earning 5% and again, my rent should go up over time. So my return should get better with time and if the interest rates do go down, well just refinance, and get likely better cash on cash. So you know, I was probably 10%. Last year, if you'd asked me that question. This year, I'm probably at 5% for long term, very traditional rentals. But I've also pivoted my strategy quite a bit to be more short term focused and so the returns there tend to be quite a bit better than your traditional long term, at, at whatever percentage you're okay, accepting today.   Pierre: All right, Mike, this next one? Is it better to save cash and buy a home every two years cash or by using loans? I find using cash, I automatically save about $5,000 in closing costs?   Michael: Yes, so I would say the answer can be a little bit of both. You don't have to do one or the other exclusively and so what I've done in the past that I've seen work really well and can be a very powerful tool is to buy the property, all cash, and then turn around and get your refinance and cash out 75% of the dollars that you put into the deal and so yes, you save cash, when you save dollars by going the all cash out because your closing costs, depending on the size of your deal, those closing costs might be negligible, or they might be significant and so if you determine that they're significant for you, maybe you do just hold the thing in cash for two years and then go buy something else. But I like the all cash purchase because you get the benefits of quick close, aggressive offers, you can often get the purchase price lower, and they just turn around and refi and for you at the end of the day, it's like an all cash it was a finance purchase to begin with, except for that hold period and you might only be able to cash out 75% as opposed to the 80% that you can often get financed when you go to purchase the property which that I still don't understand. By the way, why you can only get 70% on the cash out after you already own the thing versus you can get 80% leverage on the purchase but I aggress. So I think you can do both and I think you have to run the numbers and figure out what makes sense for you and also think about the risk tolerance that that you have as an individual. Are you okay? Parking money in a real estate asset and leaving it there? Where if the value changes overnight, like your cash evaporates or would you rather put leverage on it and so if the value changes, you're only getting impacted what your equity is in the property, you're 20% and the bank kind of shares in the pain, so to speak with you. Now, if you let the property go, when you're underwater, you're gonna feel the most pain the bank's gonna make you pay for that. But there's, there's again, there's risks associated with doing it either way and so I think it's important to evaluate and determine and just decide for yourself what makes the most sense.   Pierre: What options exist for first time investors, if saving cash alone will not suffice 20% down?   Michael: Another super good question. I would say you got to figure out who has what it is that you don't and, and partner up. So or think about partnering up, if you don't have the cash, but you've got the deal and you've got the know how or the drive to do the deal. Go find someone that wants to be involved in real estate, but either doesn't know how, or doesn't have the time or the will to get involved but has money. Conversely, if you've got money, and you're looking to get involved in real estate, but don't have the time or don't know how to find someone that has those things and so those kind of two personality types are three character traits of having one of the three things you need to do a deal, you either need the deal, or you need the drive, or you need the money, they'll find he'll have what you're missing and start piecing it together for yourselves and I think you'll be surprised at how many people have like one or two of these three things, but not are missing the third and are looking for that kind of unlock, if you will and so feels like oh, well how am I going to find some of money, post about it on Bigger Pockets comm join the Roofstock Academy and network with our investors around the world who are doing the same exact things and I think you might be pleasantly surprised to see what you find.   Pierre: Yep and I was at the Bigger Pockets conference in Denver earlier this year and one of the activities they did at the very beginning was like who has cash but no time, and that those people stood up and then they asked who has time but no cash and everyone sit up and just go into those meetings like that. It's like they facilitate these meetings between people who have to could have a symbiotic relationship. So go to conferences, sometimes they may seem like a lot of money, you might pay five $600 to go to one of these things, but it could open up a lot of doors for you. So that was a cool part that I saw there.   Michael: That's great. That's great. Yeah, I think that's perfect.   Pierre: That's how I got my start. I didn't have any money to invest. But I've consumed all of the Roofstock Academy hundreds of podcasts by now. So I had a little bit and so I teamed up with my brother and that's how we got started.   Michael: Perfect, love it love it.   Pierre: All right, how much money should I have saved up before I decide to get my first rental property?   Michael: A million billion dollars, I think you want to have your down payment plus several months of expenses bank will often require six months of PTI in cash. It really depends on the property, if you're buying a brand new property, like brand new construction, a lot of this stuff is going to be warranted by the seller or builder hopefully and then the appliances are going to gonna likely come with a one year warranty or a manufacturer's warranty at some point. So I'm less concerned about a brand new property than it would be 1950s built, everything's still original. So you have to evaluate, okay, what's my, what's my risk here and the way that you would quantify risk, which I think a lot of people don't look at is, first and foremost, what's your insurance deductible, if you've got a $5,000 deductible, you should never have less than five grand in your pocket ready to go tomorrow because if a snowstorm caves in your roof, you're on the hook for the first five grand to replace that roof.   Similarly, if you have a home warranty in place, for all the major appliances, you need your trade coffee, which can be 50 to 100 bucks, whatever and then hopefully, they're going to cover the appliance, but just kind of look around the house and say, Okay, what's likely to fail, you know, walls just don't fall down on themselves. Garages don't just collapse usually on their own, unless you're in a sinkhole or earthquake zone, whatever. So there has to be something to cause this stuff to fail, versus like your electronic components or your appliances. One day, they might just stop working, you got to turn on the stove, and it just doesn't work and you gotta go replace that thing. So I think it's important to look around your specific property and figure out okay, well, what's old and what is my what is my risk profile and where do I have the cash or cash equivalents? You know, some people would argue that a Roth IRA that you put a bunch of money into could be considered a cash equivalent because you always could pull out your, your additional contributions. I think it's up to like five years or something. So like, oh, Well, that's access to money that I didn't maybe know I had. So if you're okay with that, think about what that looks like if that's going to be treated as your cash equivalent, but I would say at least several months of reserves, above and beyond the PITI that the bank is going to require you to have.   Pierre: Cool, let's dig down on this a little bit more like going to like a personal finance perspective. At what point, you know, before getting into real estate, should someone have their financial house in order? What is a good place to be financially before you know that is starting to save up this first chunk of money to get into real estate?   Michael: Yeah, I'd say someone should have a pretty good handle on what their spend in terms of income and expenses looks like and so they know how much on an average month they're spending, they know how much they're saving and they are cognizant of, like just where their dollars go, because you're gonna want to do that with real estate investing, you want to keep track of okay, where are the dollars coming in? Where are they going and you want to make sure that you can A) run the numbers, right, I find that to be a big thing for folks, if you can, if you're already doing that, if you're already tracking and budgeting, basically what we built ourselves a pro forma in life, right is what a budget is same thing for real estate investing. So that skill already translates but if you're constantly trying to figure out where am I dollars going, and you know, I'm spending a bunch more than I'm trying, real estate investing could be tough, because now you're adding an additional expense and we're hoping that there's income coming in if you do your homework there should be and if you operate correctly, there should be. But I'd say you want to feel comfortable because there are big expenses that pop up with real estate investing, anyone who's been in this business long enough will tell you that and so if that makes you uneasy or on shaky, or you're not in a financially sound position to be able to absorb those hits or those blows, that can be really scary and I would definitely encourage everyone to think long and hard before getting involved in this business. Are you willing to stomach that and are you in a financially sound position that you can absorb those blows, and those can come in all different sizes and forms and so again, that's why I think it's so important to understand what your risk exposure looks like because the exposure on a $80,000 house, run of the mill 1950s, build whatever is going to be very different than a $500,000 house in Manhattan or condo, whatever. So it's really important to get clear on okay, where is my exposure coming from and then quantify it? How bad could it get if it's gonna go bad?   Pierre: Alright, next question here, Mike, when I previously own property, I hit a limit, because my debt to income ratio, how do I get around this to own 36 houses in 10 years?   Michael: So I think my guess is that question is coming from someone who purchased their primary residence and then went to purchase investment property. So investment property, in theory should actually better your debt to income because if you can imagine you've got debt now in the form of your mortgage payment, but and then your taxes and insurance. But then you also have income and so the income if we're cashflow positive, outweighs the debt and so we often see debt to income ratios decrease with time and so, I mean, there's your answer, if you're if you're buying cash flowing real estate, your debt to income is gonna be better than it was before you own it. Now, a lot of banks might not consider or give you credit for that, until you've owned the property for X amount of time, this has happened to me, I just had a lender tell me, hey, we're not going to consider the cash flow on your primary residence because it hasn't shown up on your tax returns yet. I'm like, yeah, but look, here's the lease, and here's all the deposit into my account and like, we don't care, whatever. So that could be a scenario but that's a very short term problem and I think, too, by the time someone is looking to purchase, I get the question too, hey, I can only have 10 loans. How do I buy 36 properties or how do I buy more than 10 properties. And what I found just personally, is that by the time someone owns, close to 10 properties, they they're finding out a different way to finance the properties anyhow, whether that's going commercial or going hard money or private money, whatever or you just bundle up a bunch of the single families into a portfolio note, put it on a commercial loan. Now you've just freed up a bunch of more conventional conforming loans. You're back in the game. So I think there's a number of different ways to approach it but I think to the original question of the debt to income issue, again, if you're buying cash flowing rental properties, your debt to income is likely going to be getting better with time.   Pierre: What are your thoughts about the upcoming housing correction crash? Is it best to wait for a few months to see how the market behaves to possible recession and interest rates hike interest rate hikes later in the year?   Michael: That's another really good question. So without having a crystal with a very hot topic, so it's interesting because interest rates have already gone up over the past six months drastically and yet demand still seems to be at an all-time high with purchasing rates at an all-time high. So if you're someone that is feeling more calm, trouble to kind of sit and pause and take a break and just see what happens, knowing full well that interest rates may continue to climb, and prices might not drop. That's totally cool. I think it's the person that's like, hey, I want to wait and see what's going on, figure out where this is going, rates continue to go up, prices continue to go up and that's not something we've seen before other than the last six months and then you're gonna be pissed that you missed out. That's where I think I want to encourage you all to think differently. I think you have to understand full stop, what are the implications of me doing nothing today? What could happen, and be okay with that?   So I think just, again, getting straight with yourself getting clear with yourself around, hey, interest rates might continue to go up. That doesn't necessarily mean prices are going to come down as much as maybe we think they are, or necessarily at all, because again, this past six months, they haven't really come down much and again, it's market specific. So in some markets, you might listen to like, yeah, I've seen it come down 10-50%. That's totally fine in your market, I think it's important to understand your market. So that was a kind of roundabout way of saying, get clear on what could happen, the likely the possible scenarios, and then decide and also like, if you go back to fundamentals, and you're looking at a deal today, and it makes sense and hits your Buy Box, like I'm, I'm all for it. I just bought a deal back in May and prices were more expensive than they were a year ago but I was like, you know what the deal still make sense? The numbers don't make sense. So I'm going to proceed and getting back to like we were talking about previously, interest rates change with time and so if it makes sense today, and it rates go down, you only got a better deal down the road and if they don't well, then okay, then you're okay with the deal that you bought today and again, the income should go up with time.   Pierre: And it does seem like we are seeing a drop in prices in markets where the tech industry is most concentrated. But you're right. It is not global, that it doesn't happen everywhere all at once but it's happening and anecdotally, I'm we're looking at homes right now and see price cuts on so many houses. So it's not a statistic, but I'm seeing it happen…   Michael: But you're seeing it.   Pierre: Yeah. Have you been looking at all Mike for you? You've been in an acquisition mode at all lately?   Michael: No, not since that last one in May. We've been just trying to get the short term rentals humming along nicely and smoothly. So we've just been focused on that and then also my development project getting that over the finish line, which I am so so close, which I'm very excited about.   Pierre: Awesome. Well, that is it for the questions today. Thanks, Mike for sharing.   Michael: You got it.   Pierre: It's got to go.   Michael: Sweet.   Pierre: Thanks, everyone for tuning into the podcast. Please leave us your questions as YouTube comments or on the podcast app. We love hearing from you all. We will catch you on the next episode. Thanks so much for listening.   Michael: Happy investing…