The most powerful way to convert your primary home into a rental

David Friedman has more than 15 years of experience starting and leading technology companies in the real estate industry. In 2018, he co-founded Knox Financial, which offers a smart and frictionless way to turn a home into an investment property, manage that investment property, and secure the appropriate financing for a new home. Prior to Knox, Dave founded Boston Logic, and served as the company’s CEO for more than a decade. At Boston Logic, he led the company in becoming a leading provider of real estate brokerage software. David sold Boston Logic in 2016 and continues to sit on the board. Today, David shares how his company facilitates the converting a primary residence into a cash-flowing rental property while allowing you to tap into your equity to purchase a new property. Episode Link: https://knoxfinancial.com/ --- 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.   Michael: What's going on everyone? Welcome to another episode of the Remote Real Estate Investor. I'm Michael Albaum, and today I'm joined by David Friedman, who is the co-founder and CEO of Knox Financial, and David's going to be talking to us today about anyone who's considering moving out of their primary and converting it into a rental, all the things you need to be aware of, and some of the revolutionary products that Knox financial is putting out to help assist with that process. So let's get into it.   Really quickly, everyone, before we get in today's episode, I wanted to give a shout out to the Roofstock Academy, and encourage everyone to come check us out at roofstockacademy.com. It is a one stop shop for Investor education. Whether you're just getting started or you're scaling up a crazy big portfolio, we probably got something for you. The Academy consists of both automated lectures, access to private slack forums and dedicated one on one coaching sessions, depending on which program you opt to leverage, come check us out roofstockacademy.com. We look forward to seeing you in there.   David, welcome to the show me and thanks so much for taking the time to come on and hang out with me, I appreciate it.   David: It's a pleasure to be here, thanks.   Michael: Oh, of course, so I know a little bit about your background. I know a little bit about your company. But for those of our listeners who are just joining us and maybe don't know the name, David Friedman, can you give them a little bit of background, who you are, where you come from, and what is it you're doing in real estate today?   David: Sure, so my name is David Friedman. I'm originally from New York, where I live in the Boston area, I am the father of three kids, the husband of one woman.   Michael: Important to clarify…   David: That’s the picture I got, buddy… wasn't worried wondering, I'm a skier. I'm a cyclist, I like to hike. I like it when I swim in a natural body of water as often as possible. Other than that, what am I doing today? So I'm a CEO, and one of the founders here at Knox financial, and we are trying to change how homeowners build wealth. When you move, you have the best investing opportunity of a lifetime, which is to keep that home as a long term investment and we've built Knox around making that investment opportunity possible for millions of families.   Michael: David, that's awesome and it's funny because it's something we talk a lot about at the Roofstock Academy about how so many landlords became like accidental landlords. So tell us a little bit about a why you think it is so advantageous for folks to keep the rental property to keep their primary home as a rental property and what is Knox doing to help facilitate that transition from?   David: Sure, so it's not why we think we're a data company, the data just tells you the story. So when before we launched Knox, I lived a life experience and then I will, I'll tell you the experience, I'll tell you that the data supports that. I'm like, in the majority, I'm just a normal dude, which is. So when I got engaged my wife who I mentioned earlier…   Michael: Just the one wife…   David: Just one, and it wasn't random, like we didn't just like you know, I didn't arrive in the mail, right, like, like we dated and stuff. So we get engaged one day, again, wasn't random and we realized we have too much stuff to fit in her place or my place, we need to buy a bigger place. So we go and do that and I go to put my 20s bachelor pad on the market for sale and I think to myself, this is the worst decision I've ever made. What am I doing? Why am I selling the best investment I've ever had. So just the math, I put down $100,000 When I bought that property, and I was going to turn that $100,000.10 years later into $350,000 when I sold it that I'd never ever in my life made that much money on any investment and I know that as the south end of Boston, which is a downtown neighborhood if you're not familiar with the City of Austin, and I knew the value is going to keep going up I am going to turn this into a an investment property I'm to keep it as a rental and at the time I was building another software company that made software for real estate brokerages and I thought I know enough people who do this professionally I can figure this out, I can turn this home into a rental and I thought about all the things that have to do and it gave me a headache can pass every five and I need new insurance.   That's fine a renter probably need to open up a new bank account and probably a credit card to make sure my expenses are really like walled off from like, like, you know, take my wife out to dinner. All that stuff as like alright, screw it and I sold it. So four years later, that same property sold again the new owners only held it for four years and they sold it for another $200,000 more than I had sold to them for. And I saw this because Zillow sent me this evil email about it and when I saw that I was like, oh my gosh, Somebody sold $200,000. To me, I was gonna keep that property as an investment. What the heck did I do here and I'm a kind of guy who likes to make fun of myself and I told all my friends that I made this huge investing mistake and they all said, same exact thing happen to me, I am new to them. I own this home in Seattle, I don't own this in Brooklyn. I lived in DC, I lived in Houston and everybody said, yeah, every time I searched that home on Zillow, I get depressed and I said, this is exactly this is my life. So I'm a data nerd. So we pulled the data and we learned two things in the data. First of all, this is true. For the vast majority of homes in America. If you look back, we look back 10, 20, 30 years, 40 years, took the average home in America and you index into Case Shiller and you can't look back much further than that, because Case Shiller didn't exist. Case, Shiller had to invent it chipchase actually was down the road here in Wellesley, the guy. You look at the data, and every the vast majority of homes in America, when people move out of them, they keep them as long term investments, not only are they great investments, they vastly outperform public markets. Alright, so you index that home with some very, I shouldn't say vary with some conservative leverage, right?   So the nice thing about real estate is that the latter allows the average person to get a levered return, which you can't get the public markets. So when you index that home with some mortgage on it, not a crazy mortgage to some mortgage on it, too and the performance of that principle, to that same principle invested in the public markets, the real estate, absolutely clobbers, the public market. So that moment when you move, these people have this opportunity, we figured out to have own a better investment than then the alternative they could do with their down payment overseas with the principal there and then the next question is, do they have the money for the down payment? The next step is this transaction possible and the data shows once again that the vast majority of families in that home upgrade when they moved from, say, the first or second home they've ever owned into it, their second or third primary residence? Do you have more than enough equity and or savings to make the down payment on their new home and not sell the home, everything, so it's so long way of answering your question, I don't think this is this is a great investment. The data says this is a fantastic investment and we're in the business of showing people how it's done and making it possible for them and we've created some lending products around it and a whole bunch of other services, so that's how we do it.   Michael: That's awesome. So getting back to what you said a moment ago, and talking about your own personal story, you were saying that in order to convert, if you wanted to keep your initial place as a rental, you would have had to refinance, get new insurance, yada, yada, yada, was the purpose of the refinance to grab that equity for the new down payment because you didn't have that savings in cash…   David: For a lot of people… So I was in a very lucky position, I just created a new family with my fiancé soon wife, and we pooled resources and had enough to make the down payment without having to sell or refi, the old home. But the other thing is, I had actually lived at home for a while I bought it my 20s, I lived in it for a decade, if you look at the holding patterns of people who buy homes in their 20s, that's actually a pretty long hold and when you, when you when you hold the home for that long, it's very common for people to have an awful lot of equity, but also that their financial position has changed, right? So that marriage to my wife is a common change in financial position, the amount of w two in the household with, you know, more than doubled, because my wife, my wife's a successful woman, but also like we can combine our savings. She at one point in Oklahoma prior to meeting before we met, she didn't anymore, she'd sold that so she had a down payment. So there's all sorts of reasons why one's financial position might change. But there's, the longer you're holding that home that you're living in, the more likely you are to have plenty of equity in that in that property that you can tap…   Michael: Makes total sense and how do you chat with people around because I know you said in the vast majority of instances it like it makes sense for people assuming they have the down payment, like keeping the home as a rental or as a long term investment. What about everyone out there that says, you know what, David, my monthly mortgage is five grand a month I use 20% down and my home is only gonna rent for 3500 am I going to be in the hole 1500 bucks a month, like how does that make sense?   David: That doesn't make sense. So, so we walk people through this math all the time we build proprietary investment analysis software. If you have a $5,000 a month mortgage, and then you got to pay taxes, insurance maintenance, you know, allowance for vacancy all that on top of that, and you're only going to make $3,500 a month in rent, we would not recommend you put that home on our platform. There are, I would say, some edge cases like some people are looking for tax advantages and some people are looking for. There's markets like, I can look at the Austin market or let's take Tampa set the curve for the fastest growing market last its 12 month and a 12 month look back. In the last year, prices are going up 30% a year. So if you're losing 1500 bucks a month, over 12 months, that's 18 grand if the home went up in value 100 grand in that year, that's not a bad trade off.   The question is, can you shoulder that or one things we do is we offer a sort of specialized flavor of a home equity line of credit, where you can actually tap the home's equity over time to cover that negative cash flow. So this is part of the alchemy we do with people is can we make this property not impact your day to day spending habits or your quality of life while keeping it and realizing the benefits of owning that property. If it was net negative cash flow by that much might not work. That's a pretty rare scenario, though. If you have a $5,000 month mortgage and $3,500 in income potential, there's something weird going on in that local market, we rarely see misalignment that numbers that large effect, it's usually the other way around, just that we see $3,500 a month and carrying costs and $5,000 a month in rent projected. That's a that's a pretty standard scenario on our platform.   Michael: Love it, so talk to us a little bit about what the platform does and how it all works.   David: Sure, so you put your you set up your home for the platform and first of all, we package everything into one simple success fee. So we don't charge you for a place a tenant, we don't charge you to collect rent, we don't charge you for renewals, we would charge you for legal, none of that. Before it comes on the platform I should have mentioned we're going to help you tap that equity, so we might be writing what we call a keep loan, so that's a that's our own lending product that helps you tap the equity in your home in a flexible way. It's kind of like a HELOC but you know, if you sign a HELOC, before you move out and you move out, you're technically violating the paperwork you just signed. So we've got sort of like a HELOC. That will you don't mind if you move out or even if you have already moved out. So we can give you a second lien flexible line of credit against the property you're no longer living in, which is a hard product to find, so we can get some of that equity, it turned into the down payment on the new home, use it for prep work, or just keep it for writing up the ups and downs of cash flow, that's fine and then we're going to turn that property into a passive investment. So we're going to put a tenant in there, collect the rent on your behalf into your account in our system, pay out your expenses and if the tenant has a problem, they're gonna call us and we're going to deal with it. So we're basically doing the financial side of things, the welfare, the finding the right insurance, that's important. So risk mitigation is incredibly important. Our insurance team is going to find you the right policy, because the policy had when you live in it, they'll work no more. That's a homeowner's policy, you know, landlords policy, and, you know, the KNOX Insurance Services Division of our company is going to put that in place.   Michael: And so what is that all cost someone because I mean, it's like what you said that you don't charge for rent collection? I mean, you don't charge that, like, it's mind boggling, because that doesn't exist anywhere on the marketplace anyone who invested in a property will tell you the same. So what do you charge it, it's got to be something…   David: We work on… Yeah, we've worked on a success fee, it's 10% of rent that actually passes through our system. So it's kind of like a payments model. It's kind of like working with stripe, where like some percentage of the payments that go through stripe, they keep we do the same thing. So we collect $1 of rent, we keep a dime and then in full disclosure, we make our money off of the market for the financial products that we do. So like our loans are bought by third parties, and they pay us for that our landlord policy is our we're representing larger carriers, we're not an insurance carrier. So representing, say, travelers or somebody like that, they pay us for that, just like they would pay any insurance broker and then also some of our clients are actually decent percentage of them work with our lending team to not only tap the equity in the home they're moving out of but also find the mortgage for the home they're moving into. So that's another way that we make money. So we make money as an insurance brokerage, selling or brokering normal mortgage transactions.   Michael: I love it, David, this is so cool like anyone who's watching this and see me like getting giddy smiling ear to ear. So question for you. Do you only work with folks that have moved out of their primary residence or do you have a market for just your traditional landlord that owns property that wants to utilize your services?   David: So we do work with traditional landlords. We're kind of picky on it, to be honest. So your home actually has to pass an inspection by us as a virtual inspection. So you'd have to like you know, open up your door, but you'd have to walk us around and we're going to need to take a look at the foundation and we're going to need to take a look at the major appliances and system. So we are careful about which homes we actually accept in our platform because we find that a lot have traditional rental units are? Well, they're expensive, they're expensive to operate and we would generally not recommend that our clients keep those units as long term investments. So we look at them and tell our clients very honestly, this is a good investment or it's not and if it's not right now, we try to advise them on what investments need to be made in order to turn that home into a good long term property investment. So actually happy to talk to any landlords out there who are like, oh, I like what Knox is doing and I want to tap my equity and all that good stuff. Just be aware that we, we don't, you can't just sign up any home to the KNOX platform. It's not Airbnb, for example, you can't just come along and put a home up there.   Michael: Got it, got it. Okay, well, I mean, in your experience, what are some of those things that you have seen or advise folks against in terms of what makes a great rental property? If someone's listening to this? It's like, oh, man, I totally want to sign up. What are some things that they should be aware of that they can do practically?   David: Oh, gosh, the first thing I would say is deferred maintenance. You know, we're not big fans of deferring maintenance way out into the future, you know, invest in the property now make it livable, it'll get better rent, you'll be happier. As an owner, fewer surprises. Yeah, that's absolutely bullet number one. The next thing is, I should have started this health and safety, just like, you know, we will absolutely get will actually take properties and incident off our platform. If the owner won't authorize a repair that we think impacts health and safety. That's just not a that's a, there's no, there's no exception to that for us. The next is, yeah, so if you've got like, really old floors, like smudged walls, cracked windows, things like that, you know, definitely better off doing that as soon as possible and ahead of time, and certainly, as they come up. You know, we have a client who said, you know, I bought this property 15 years ago, that time, they told me, I needed a new roof, they were wrong, I've patched it five times it works out, we're like, no, we're gonna, that's that's just…   Michael: It does doesn't work…   David: I know, you know, I know you've had this, this is lucky experience with all the patching, you've been dumped. That's not how we would want to run things, it's really what's gonna happen is one day, the people in the top unit, that building, you're gonna go on vacation, and they're gonna come back, and there's going to be like, you know, $100,000 of damage to the building and you've, you've just been lucky, you've been on the, you know, the edge case here. So that's, that's deferred maintenance is obviously number one. The next thing is, if it is a landlord own property, who are the tenants and what have you done, to make them happy? Sometimes they're just unhappy, like, the tenants are unhappy with what's gone on and not only that, the property, what we find all the time, we inherited properties from landlords who've been self-managing the property is that they, the tenants are underpaid and rent, the tenants know it too and then you go in there and say, okay, we're going to turn this into a performing asset for you and the tenants sort of balk at the, the rate that they should be paying and so we try to like the market, oh, you're just totally unaware of what market rent is and the major mistake that's made by so many, so many owners is they become friends with their tenants and, you know, let's be honest, money is a touchy subject for most of us.   So going in there and saying, yeah, I know, you've been living in this piece of property they own and I think there's sort of a parental aspect to being a landlord, like you're putting a shelter over somebody's head, you're responsible for that shelter. So it's kind of a, you know, a little bit of a parental role you're playing and they have to go in and ask them for more money. So you're touching on these two touchy, touchy subjects? So yeah, we look at these portfolios like a deferred maintenance. You you've had tenants in there a long time. They're not paying market rent. Oh, when they're month to month on their leases. Oh, yeah. You signed a lease originally a long time ago, but now you haven't raised rent and the lease is like totally lapsed and now we want to go put those tenants through, like, hey, we're going to make this official we're going to put you to market rent. Oh, but by the way, we've got the owner refusing to upgrade the place and make it nicer. We avoid those situations we actively avoid them.   Michael: That sounds like a losing recipe.   David: Yeah. You look at the let's look at the exact opposite institutional owners, right. So you look at the guys like tricone or pick your favorite. The first thing they do is go in and renovate almost every single unit and they also they standardize them. The other thing I could go on nothing that landlords do is they, you know, they, when they get in, they try to find like cheap units and all those guys, the big institutions are actually looking for premium units they want. They want families that move in, and, and stay and plant roots and send their kids to school and care about the property. Because they get to know the neighbors and they want to plant the flower bed, you know that that's the tenant that they're going for. Versus Hey, how can I, I want to own eight units that are all, you know, half the price, the average in the market and turnover every other year, right, yeah.   Michael: It's yeah, it's a totally different investment thesis overall.   David: Totally.   Michael: Yeah, David, so if someone is right, on this transition point, what makes Knox a better alternative to just a local property manager? Why would someone reach out to you?   David: Yeah, so we use local property managers to be clear. So we don't actually employ actually, we have one guy on w two, who like, you know, carries a hammer route. So the vast majority of what we do is local maintenance. Right, you know, we operate in seven states, like there's no, there's no way well, it's not No way. But like, we did not have all those people on our staff. So you know, with us, as far as that goes, like, we are using local people, and there is actually no difference between us and the political person to swing a hammer drive in this group. When you look at all the pieces it takes to make this investment work. Knox is providing it all under one roof in a way that aligns our incentives with the owners, and we're actually putting risk behind it. So we're actually putting our own risk on the table along with yours, in that, for example, with the lending. So we're making it possible for you to access your equity to make the investment work and we're also doing you know, find the insurance. We're doing the bookkeeping, making sure you're deducting things on your taxes properly. I think a lot of not so, a there's a vast difference.   Michael: It sure sounds like it. So what states do you all operate in?   David: Massachusetts, Georgia, Texas, with three major cities in Texas, actually and then Florida and Arizona. Love it and I should say Massachusetts, we also I forgot to the Boston Market also includes Southern New Hampshire and all of Rhode Island.   Michael: Okay, okay, perfect. When are you coming to California?   David: That's a great question. It's on our list, I'll tell you it's we actually, to be honest, expand by Metro. So when we, when we expand into Texas, we did you know, to three cities of Dallas, Houston and Austin, and then with Austin, San Antonio is basically a first cousin market. So we do San Antonio as well, sort of considered that the whole the same media market. So California would be like, hey, let's pick a city in California. That's expanded to there but as we do it, we're gonna get the licensure for real estate insurance and lending in the state and then we'd probably go from, let's just say we started with, yeah, LA, we then do San Diego, and then the Bay Area, and Sacramento and the major markets California   Michael: Love it. Well, I know you'll have a waiting list. Whenever you ultimately do get out here, my name will be right there on it.   David: Appreciate it.   Michael: No, of course, that's awesome. So for all the folks out there that can't take advantage of Knox. What are some things that they can be doing looking out for as they're looking to make this transition or considering the transition? Do they have to go piecemeal it together for themselves or are there other Knox like folks out there that you could recommend?   David: No, you have to piecemeal it that's like the big part of it is what we are doing is putting a lot of this under one roof and then the lending is sort of our unique sauce, because it is a loan that you can't really get elsewhere where you can't get elsewhere. What are some things they should look out for, you know, I own several pieces of investment property myself, only one of them did not have to make some cash investments in in the first year or two. So the first thing I always tell people is just be aware, there's like a period of turning that property into an investment. Even if you've lived in it. Somebody else is gonna move in your property and they're gonna they're gonna use the space in a different way and they're going to discover things that are not up to 100% and they're going to call us and say hey, this is an outlet that doesn't work and one outlet that didn't work well was behind the bed when you were living there. Now there. It's where their desk is where they're working from home, right so be prepared for some upfront maintenance costs that is totally to be expected and tenants often You will just pick up the phone or you know, go on online and say, hey, this is broken, expect it to be fixed. Whereas you when you were living in the house might have just lived with the, you know, that problem, whatever it was for a while and said, I'll deal with it later, just expect that there's going to be a few things that are going to happen, things will come along. Yeah, it's very normal for a property be cash flowing less in years one and two than it is down the road. That's the that's the one surprise that I try to make people aware of ahead of time.   Michael: That's a great, a great tip. Something that I heard is, is kind of a good way to go about it too, is to actually go pay for like a home inspection as you would when you're selling or buying a piece of property as you're moving out to just see, hey, what are the issues that are going to be found, because like you mentioned, you're not going to notice the outlet that's not working behind the bed, to the inspector, that's what they're looking for.   David: Oh, man, if an inspector actually tested every outlet in the house, that would be one heck of an inspector. So here's what I'll say. So we do this, this video in intake of a home. So we actually collect 200 points of data, we get everything down to the year making model of your dishwasher. So what I recommend doing, if you're doing this on your own is really go and look at all of the major things in your home and there aren't that many, right. So every major appliance, every major system, the roof, the foundation, you know, a dozen things, right? Fridge, dishwasher, hot water, heater H back, things like that and just look at when they're hot, close, they are the end of their useful life, right roof last 25 years founded, I mean, the foundation and look, there's no cracks are probably good hot water heater decades and just on a piece of paper and a spreadsheet, just put the name of everything the model number, and when the warranty runs out, or when it should expire, right, and you'll just get an idea of what is coming down the road and don't be afraid of that because remember, it really you're investing in this for the long haul, you're investing in it because you think the home is going to keep going up in value every single year or over a long period of time, it's highly, highly likely to continue to go up in value and because the rents gonna keep going up what your costs are fixed inflation, hedges, all those good reasons, don't be afraid of it, just be aware that those things are gonna happen and say, okay, I'm actually expecting in the next five years, this extra $12,000 in expenses and just put at the back of your mind set.   Okay, here we go. Done and if you're really good, an ear market and say, okay, I'm gonna have the hot water heater replaced and nine and a half years instead of 10 and I'm not going to wait for it to like, spring a hole and have water over the basement. That would be that would be the plan I would I would make. The last thing I would say is really I would say is if you're doing this on your own, be really careful about your tenants. You know, do the background checks, don't just trust your instinct. Look at what their employment is not just how much they make, what do they do for a living. There's a big difference between having people who have non steady employment versus I don't know, a police officer who's in the union has incredibly steady and flip employment. So don't rush into the tenant selection. It's a little bit of work but again, if you're doing it yourself, set yourself up for the long haul pick somebody who you think's gonna be around a while, who has very steady employment next year when you raise the rent three, five in this market seven 10% they're going to be able to afford it because they're gonna get a they're gonna get raised.   Michael: Yeah, no, that's such a good point. I was just on a podcast this morning and someone asked me like what the biggest mistake was and I said exactly that rushing intended decisions, because you're like, oh, crap, I gotta get these expenses paid for with the rent, and you can end up in painting yourself into a corner very easily.   David: Yeah. Sometimes our team will tell an owner, hey, I have an application, I can show it to you. I don't think you want to take it. Now, this does mean that I don't have I don't have a backup for you today but you know, waiting another 15-30 days it could be to for somebody else better is a recommendation and here's why and we have that conversation with the customer and say the owner and hopefully they are … got along, yeah.   Michael: No, that's great. That's great, David, one final question for you. Okay, so two final questions for you ones like information. One was a real question. What are your thoughts on Home Warranty?   David: What are my thoughts on Home Warranty, that's a great question. We hear more complaints than we hear praise is my answer to that. I never bought one myself and right and all that said, we have considered offering one that we create. So that is, you know, I like it. I like the concept of a home warranty. I think the execution for most of the major home warranty companies as anecdotally has been is…   Michael: …less than…   David: …doesn't live up less than thank you.   Michael: Yeah, perfect. David are people that want to learn more about you reach out find out more about Knox, where can they do that?   David: https://knoxfinancial.com/   Michael: Easy enough. Well, David, thank you so much for taking the time. I really appreciate you coming on and can't wait to see you out in California, man.   David: Pleasure, thanks. Appreciate your time, Michael!   Michael: You got it, take care…   All right, everyone. That was our episode a big thank you to David for coming on. Super, super, super, super cool stuff. After we finished recording he and I were chatting a little bit more about some of the products that he's working on and there is a lot more to come. So stay tuned, of you are thinking about moving out of your primary or selling it definitely consider keeping it as a rental and potentially Knox financial might be able to help you out with that. As always, thanks so much for watching, and we look forward to seeing on the next one. Happy investing…