Unlocking Multifamily Real Estate Investing: A Hands-On Guide with Justin Brennan

Episode Transcript
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(00:00):
Music.

(00:10):
Welcome back to another episode of Back to the Basics with Jeff Fenster.
Today is a very special episode.
We have Justin Brennan from the Brennan-Poley Group in studio.
And instead of him interviewing me in a normal Back to the Basics fashion,
I'm going to ask questions and we're going to get an education on multifamily
real estate, how to analyze a deal, how to see if it's a good opportunity and

(00:32):
potentially even make an investment.
This is something that has been been very interesting to me over the years.
And I've been very reluctant to dive in because there's so much information I just don't know.
And I had the privilege of meeting Justin about four or five months ago now.
And he's an incredible wealth of information in this sector.
This is what he does every single day.

(00:54):
And he was grateful enough to come on and be our professor.
And so we're all going to learn today from Justin. And we're going to actually
go through a specific specific deal.
It's not some arbitrary example like in a textbook. This is an actual opportunity
that someone put in front of me.
I passed it to Justin and said, Justin, will you help me understand if this
is a good opportunity? And so I know very little.

(01:16):
We're going to get down into the basics and hopefully we all learn how to analyze
and potentially invest in multifamily real estate. So welcome to the show, Justin.
Thanks, man. No, I didn't. And I think this was pretty amazing when we did our
podcast a few weeks ago and going through your story of starting with the payroll
company, growing that, selling it, and you had no idea about payroll,

(01:37):
which I think was hilarious.
And then you said, then I got into digital agency and marketing,
and I had no idea about digital marketing and agency, but I built that company
with Neil Patel and sold that and did very well.
And then now you have Everbull and doing what you're doing with that as a passion
project that's now become greater.
And in all of that discussion, you said, well, and I want to be this real estate

(01:58):
guru and investor, and I want to do all this stuff. and I've been buying single
families and I like stopped you.
And I was like, wait, wait, wait, wait. No, no, no. Stop. Stop.
Like why do single family when you can go buy one apartment complex?
Cause you're like, I'm buying six or eight single families. I said, why would you do that?
Why don't you just go buy one building in one location that has eight units

(02:20):
in it and save yourself all the headache of eight different roofs and eight
different walls and eight different yards and eight different this and eight different that.
And you said, well, just cause it feels safer. Well, it's scary.
Yeah. It feels more understandable. And I understand how a house rents and that
process and all of that. And I said, that's great.
I totally understand that. And most people feel the exact same way, but

(02:42):
let's maybe talk about how you could grow and scale into multifamily real estate
and do much better and have tax benefits and depreciation and all these other
things that are extremely valuable to entrepreneurs if they're trying to avoid taxes,
is right but which we all are right and then grow wealth and generational wealth passive income.

(03:04):
All of these things. And so that got us off on connecting on apartment buildings. Yes.
And so here we are. And we said, hey, what a great idea. You threw out the idea
of why don't we bring you in studio?
Let's talk about a deal specifically. I'll play student, you know,
dumb little student, and then ask a bunch of questions and you play professor

(03:25):
and we'll go over a deal and help a lot of people too.
Yes. Because we're going to answer a lot of questions as though they would maybe be asking.
And hopefully we'll get some things answered and be
able to provide a lot of value so yeah and this is an actual deal
that was sent to me that i am very
interested in so whether or not i move forward on it we're going to learn if
this is a good opportunity and we'll play this out

(03:47):
but this is exactly what i'm hoping everyone is going to learn from this is
that when you have opportunities that you understand what all the vernacular
means how to analyze a deal properly How does an expert who lives and breathes
this multifamily opportunity and real estate daily, how do they look at it?
So I'm excited, Justin. Thank you. And for everyone, this is,

(04:09):
again, a special episode of Back to the Basics.
So instead of interviewing me on entrepreneurship, I'm going to interview you
on multifamily. All right.
So yeah, I think to kind of start for people so they understand if you were
to buy or look for an apartment building, and we're talking about anything five or more units.
Because under five is not considered multi. considered residential.
And the biggest difference between, say, a duplex, triplex, or four-unit property

(04:35):
and something that's five or more units is that when you're going to get a loan to finance it,
the bank is going to underwrite and look at the property's financials versus yours as a borrower.
So if you go buy a home or you buy a duplex, the bank, to give you a loan,
is going to look at your financials. They're going to underwrite you.
They're going to make sure you you can pay them back, right?

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Versus if you go buy a 5, 6, 10, 15, 20, 100 unit property, the bank is going
to look at the property's financials to see if the property can pay them back.
And the property's on the hook. And five is the threshold. Correct.
Because that steps into what they consider commercial.
So that's the great part because it's actually much easier to get financing.
And you're not limited by a certain number of loans you can get because under

(05:19):
residential, the most banks will limit you to i think five or six properties
you can get loans on so the commercial space it's unlimited,
and they're going to underwrite the property. The only thing they're going to
ask from you is just a financial statement, but that's a piece of paper it's on and away you go.
And then they're going to look at the property and make sure the property can
pay the mortgage every month, make sure the property can pay them back if you

(05:41):
can't or stuff like that.
So it's all about the property, less about you. Which is important because I
do own a lot of single family stuff, a couple of duplexes and you're right.
It is ideal in residential financing world. Yeah.
It's completely looked at differently by the banks. So, but if you're going
to buy apartments, it really steps into one of these five categories.

(06:01):
And that is you got to find them. You got to locate the deal.
Number one, you have to analyze it properly to make sure it doesn't make sense financially.
You got to be able to raise the capital. That's both get a loan and then raise
the equity for the down payment.
Okay. And then you got to be able to close escrow on them.
And then last but not least, you have to be able to manage them.
And even if you have a property management company managing them,

(06:23):
you still have to do asset management as we call it. Okay. And that's managing the managers.
Managing the manager. So you have the property manager managing the property
and then you manage them.
That's right. And making sure
they're doing their job. You're looking at kind of from a higher level.
It's kind of like a CEO looking down at, you're not looking down,
but looking at their people doing the job to make sure they're doing it.

(06:44):
How hard is that part? I mean, it's technically not that hard,
but it's like anything else.
You just, you got to stay on it and you have to make sure nobody's going to
protect your money like you. Sure.
I mean, that's rule number one is nobody will protect your money.
No matter how good the property management company is, no one's going to watch
your money like you will.

(07:05):
That's a good rule. And it's something we all need to realize real estate or any investment.
No one is going to protect your money like you. That's right.
And you can't expect them to. And you can't expect them to have the same level of urgency and focus.
I mean, they're doing their job, getting paid, and they're doing the best they
can with the resources and information, everything they have.
But without a leader essentially leading them and kind of guiding the ship,

(07:26):
which is what the asset manager does.
They're just going to do what they do and just do it.
But sometimes they don't know that certain things need to be written down in
a certain way. Right. And that's where you come in.
So this is kind of the five category steps to buy an apartment building.
So that's just from a glimpse.
People can take a peek at it. There's nuance in each one of these.

(07:48):
But from a high level, this is the five steps you would need to buy an apartment.
And today we're mainly focusing in number two.
Correct. So we're going to presume we found a deal. Yep.
And that's what we're looking at
here. and this is a potential one in the Phoenix, Arizona area, 33 units.
And some people say, well, that seems so, so big. And to be honest,
when I sent it to you and I know we had said anything over five.

(08:10):
And so I was looking for something over five and then I'm like,
well, 33 is a lot bigger than five. I know that. And I would have thought the
same thing had I not know what I know now.
And that is whether it's five or technically 50, because I kind of put things
and categories, five to 50 units is literally almost the same, just more zeros.

(08:30):
Sure. But the process of running them and manage them and the size kind of aspect,
it's not a major difference.
So the big next step is over 50? 50 to say a hundred and then a hundred plus. Okay.
But you also realize the bigger you get in really the economies of scale in
this multifamily area is, I call it a hundred units plus.

(08:52):
And the reason why is because that way most properties
that are 100 units plus will have a dedicated on-site team i
mean if you think about the apartment buildings you go to today the bigger complexes
yeah they have a leasing center they have a maintenance staff they have an on-site
everything's dedicated specifically to that property the property can afford
to have payroll expenses they can manage it and control it that's right and

(09:14):
until you get to a certain point, it makes it tough.
I mean, 33 units in San Diego is a lot different than 33 units in,
say, Kansas City, Missouri.
So you got to look at it a little bit differently, but let's presume it's called
the middle part of the country where we can go buy an apartment unit anywhere
between $100,000 to $200,000 per unit.

(09:36):
And Arizona is a perfect example. Anywhere in the Midwest from Texas to Oklahoma, Missouri, Tennessee,
Alabama, Arkansas, any of these kind of markets give or
take you can probably do that yep and so with that
in mind this the scale is going to come in getting
more units so let's take a
unit i mean say it was 100 000 for this property you're looking at 3.3 million

(09:59):
yep right obviously this one's more than that at least what they're asking but
we're just going to see if it makes sense financially based on the financials
of the property and that's the cool thing about commercial and multi-family is that it's zero motion.
The numbers either make sense or they don't. And they have to make sense because
the bank won't give you a loan.
Why? Because the bank is looking at the property. They're not looking at you.

(10:21):
So if basically the analysis is not just, is it a good deal for me?
You're also analyzing it, will a bank actually finance it? Yeah,
because that's all that matters.
Because will they finance a bad deal for me? No, they won't let you.
Because they're not looking at you.
I mean, if this was a residential property, they wouldn't care about the property's financials.
They just say, you're on the hook, not the property. They don't expect me to be on the hook?

(10:42):
No, it's non-recourse, which means you're not on the hook unless you do really
bad stuff like fraud. Fraud. Right.
But the property's on the hook for paying the mortgage. The property's on the
hook for everything. All I'm on the hook for is the initial down payment. Correct.
Yeah. And you're going to sign on the loan, but it's a non-recourse loan,
non-personally guaranteed loan in most cases.

(11:04):
And the property is going to operate itself and the property is going to pay the mortgage, right?
And it's going to produce the cashflow
and it's all about the property's financials, not yours. All right.
So this property, the Oasis. Yeah. So let's start with, I guess,
questions because that's the best way to go through this.
You're a novice, interested, like what initial questions did you have about it?

(11:24):
Well, I got the pretty deck. I went through the deck, which you guys can see on the screen.
And I believe it's called an OM.
Yeah, an operating memorandum. So anytime you go to look at a multifamily property,
typically you're going to get a pitch deck or an OM, operating memorandum,
which is basically a marketing piece, marketing flyer that's 10 to 30 pages about the property.

(11:50):
Everything from what it is, where it is, financials on it, on and on and on.
And it's just giving you a fluff piece about the property. And you're going
to look at that initially, and you'll take that information to start analyzing it.
And then you can dive into the actual financials soon thereafter.
So having now read, I don't know, 20 of them, just in preparation of finding

(12:13):
an opportunity for us to go through and looking at them,
I've seen everything from, a lot of time you'll see, I've been reading,
and I say a lot of time, from 20 of them, limited experience.
But what I saw was a majority of them talk about how you can increase the rents.
Value add. Value add. Of course.
And my first question is, why wouldn't they do that to then charge me a premium for the property?

(12:34):
Why are they telling me, buyer, come buy my asset and guess what?
You can make it worth more by just simply increasing the rents. Sure.
Well, I mean, imagine if they came to you and said, this thing has no value add.
You can't increase rents at all and just buy it as is and take it.
I mean, you wouldn't sell it very well.

(12:55):
It's an offering memorandum, meaning it's a fluff piece, no different than if
you were buying any property or business, they're going to make it sound great. Sure.
So your job is to look at it. But why is that great? Because as a novice real
estate investor, if I could buy it and I can look at the economics of it,
and the rents are where they should be, let's say market.

(13:16):
Yep. And I don't have to do anything to improve it because I've limited experience doing that.
And it's fully occupied. Yeah. And the cash on cash return checks the box.
Wouldn't I prefer that over do a bunch of work and hope to increase rents? Well, and there are.
So it depends on the class of the asset you're buying. So when I say class of
asset, there's typically A, B, C, and D.

(13:37):
Okay an a-class asset is your newer construction
turnkey there's no
capital improvements or improvements you need to do to it physically and it's
ready to go and it's operating prime time so any kind of new construction properties
high rises mid-rises anything you see out there is typically class a investments
class b is going to typically range from about 1980 a year up to maybe

(14:03):
2000 at this point, maybe 2005-ish.
Where it's a nicer property but has meat on the bone. Maybe it needs some improvements.
Maybe you can renovate the interiors because it's dated.
Maybe you can add amenities to the property because it needs some nicer things for the tenants.
And by doing that, it allows you to increase the value by increasing the rents.

(14:25):
Okay. By being able to do those. And it's a subjective grade.
In a way, yeah. You might grade something an A and I grade it a B.
Or vice versa? Possibly, possibly, but industry-specific, most people would
have, they do it by vintage, like age.
Age. Okay, so age is the number one criteria for grade.
Normally, normally, because you could take an older Class A if it were really

(14:49):
well done and no improvements needed to it, but that's typically rare because
the older it gets, typically it needs updates.
So usually when you fall into the age categories, when you start changing from an A to a B to a C.
But if it was a 1990 building and I updated it, it's now an A?
You could. Yeah, which is why you can move it.

(15:10):
But if I was selling it, it would then be an A from 1990. Correct.
That's right. It's no different than if we take a C-class property from 1970.
Renovate the heck out of it, make it look amazing.
We can move it into a B category. Can you get it to an A?
That's tough because of age. Because of age. So a C will never be an A?

(15:31):
No. I mean, you'd have to take it down to the studs. And rebuild the whole thing.
Pretty much. Okay. And then it's built.
Right. And then you might as well just tear the whole thing down.
Okay. So no, you typically, you're going to just move one category usually.
So for this opportunity, the Oasis on Devonshire, what would you, so this would be a.
This is a class C asset. Class C. Yeah. Based on the age, which I think was, if I'm not mistaken.

(15:55):
1963. Yeah. 1963 age. This is a class C asset.
And you're going to see kind of where it's at and what you can do to it to improve it. Okay.
And raise rents. They've done a pretty nice job so far, but there's still some
movement on it where you can do some interior renos, take the rents from where
they're at by adding a certain dollar amount to the units and interior finishes

(16:16):
and bump the rents. And they're asking $7 million.
Yeah, normally they won't even put a price on these things. Normally they'll
just put it out to the market and say offers are due on or before X date.
And they don't even give you what they want. No. They just say,
do your analysis and give us an offer based on your analysis.
And then they collect all the offers.
And then they do what they call a second round, like a best and final.

(16:39):
And then whoever's still left, and then they get down to like a couple phone calls.
And if you get into this tough or maybe a little larger properties,
then the seller and the brokers and everybody will get a phone call at the top
two or three offers and weed you out. Yep.
Trying to get the highest. It gets competitive. Yeah. It can be.
The market's changed a bit in the recent, but that's in a good hot market.

(17:01):
That's what would happen if you're down to like three or four offers.
So is it a bad thing that they put the price here? No, they're just trying to
set, you know, kind of, Hey, this is what we'd like to get. Yeah.
Which is what? 212,000 per unit. Correct.
And you're, I don't really care what they ask. That's irrelevant. Okay.
I care what will the financials tell me and can I get a loan and certain metrics

(17:22):
such as cash on cash return, annual rate of return on my money,
stuff like that, that I'm looking for to make sure it fits certain criteria.
So, okay. So going through this, because here's where I started.
So T6 cap rate, what does that mean?
So anytime you see T6, T12, T3, T1, that means time. So T is time.

(17:42):
And then whether it's six months three months right stuff
like that 12 months okay so when you see a
t12 like you'll hear this term t12 thrown out
that means they're going to show you the profit and loss statement for
the property for the last 12 months for the last 12 months up until now back
12 months okay so in this example it says they're saying t6 so they're saying

(18:03):
for the last six months on this property that's what the cap rate looks like
this is what the cash on cash return looks like and for For all of us, cap rate is?
Cap rate is basically telling you what is the return on the property if there's no leverage on it.
If you have no debt. If it's just cash purchase, what would that be on my money?

(18:24):
And what's a, I know it changes, but what's a good cap rate?
What do you want? I mean, for this market, for Phoenix, for example,
in this case, this is good. 6% is good? Yeah, this is almost 8%.
Call it cash on cash return. Yeah. Okay. If you buy it with no leverage, right? Right.
Is that, well, cash on cash is also with no leverage? Correct.
Because if I just bought it cash. Yeah. So let's say I had $7 million in this deal. Yep.

(18:49):
And I'm getting X net operating income on the property. Yep.
That ratio is the 7% or 8%. So why is cash on cash different than cap rate?
How are they calculated?
So the cash on cash is after you pay your debt service, your mortgage.
So if you have, this is where, so you said, what is a cap rate and what does it mean?

(19:11):
If you put no debt on the property, and it's just straight cash,
that is what my annual rate of return is on the property.
The cap rate. Correct. Now, if you start to put leverage, 50% loan,
60% loan, 70% loan on it, now you're able to increase your return on the property.
Because you put less cash in. That's right.
So your cash on cash is typically going to go up and your annual rate of return

(19:33):
will go up because you're using bank money versus your own.
So your cash on cash shows when you have leverage and your cap rate is if you just paid cash.
Correct. And what, as an investor, since most times you're not buying at 100% cash, cash.
Do you care about cap rate? And do you only look at cash on cash?
No. So I look at a few metrics. I look at what is the cash on cash return?

(19:55):
What is the IRR, internal rate of return, which is like an annual rate of return
in a way. There's a little bit of a difference.
We can get into that if you want. I don't know how much weeds we want to dive
into, but I'm looking at that.
I'm looking at the equity multiple on the property.
Meaning if I put in 100 grand to this property, by the end of the investment, what do I get out?

(20:15):
And is that two times, three times my investment? So if I put in 100 grand,
do I get 200,000 back out?
If I put in 200, do I get four? Is that when you sell it, irrespective of how
much you made in between?
No, it includes all of it. Includes all of it. Cash plus the profits.
So if you buy the building for 100 grand, you make 10 grand a year for two years,

(20:35):
so you have a 20,000 profit,
and then you sell it for 200 yep you're going to take all of that together
profit that's right and then you
that's right so then your equity multiple you're going to
get your initial investment back yep plus that extra 120 you're talking about
yep so you're like a 2.2 on your equity multiple okay and where do you like
your equity north of two and what is your time horizon traditionally three to

(20:56):
five years three to five years north of two yeah so that's part of your analysis
and then you mentioned IRR. How do we calculate that?
So the difference between an ARR, which is annual rate of return,
and an IRR is velocity return of the money.
So what I mean by that is if you just take all the cash flow,

(21:17):
what you were just doing, all the cash flow plus my profit and average it over
the five-year timeframe, that's my annual rate of return.
The IRR is going to tell me how fast I get that money.
So it's the velocity of that return. So the faster I get the money,
the higher the IRR is going to be.
Okay. So that's why if you have to wait longer.

(21:41):
If I have to wait five years to get there. Versus three years to get the exact
same amount of money, your IRR will be higher. And that's what you want.
You want the velocity of return on the money to be higher. Sure. Okay.
So you can average it out, which is ARR.
Or I personally look at the internal rate of return, IRR. Okay.
And for a property like this, you're looking at this one. See how it says down here?

(22:07):
23.7-year hold. If I hold this thing for seven years, my IRR is 23% a year.
Is that good or bad? Very good. But you don't want to hold it for seven years?
No. I mean, let's say I did a three to five-year hold.
This may go up, right? It depends. We'd have to look at it.
But that's a heck of an annual rate of return. I mean,
if you told me i could get 24 a year

(22:29):
on my money for the next seven years right here's my
money right so it's just once again this is a fluff
piece it's a marketing piece by the broker sure they're not here to make the
property look bad yeah no but but this none of this would turn you off no this
is great you based on these but now we need to kind of throw it in and see what
what's real so because nine times out of ten this is all bs yeah of course kind

(22:51):
of but i guess my question is for For us novices,
we're looking at our first 100 OMs, operating memorandums, and we're looking
at the fluff before you have to look at the fluff so then you can decide are
you going to even analyze it. Right.
What here, what numbers would you see here that would make you throw this off
and move on to the next one without even going to the next phase?

(23:13):
Well, if I'm knowing the Phoenix market, I would want to make sure some of these
metrics were in line with what we're seeing in the marketplace.
Place. So if this showed a cap rate of a current cap rate of 5% or 4% or even 3%.
I wouldn't buy that. You just pass. Correct. Because even in the fluff piece of it. Yeah.

(23:34):
I mean, if you were buying two years ago, meaning in 2021 or even 2022,
you could buy something at a super low cap rate, renovate the property to a
higher cap rate, and then sell the property back down at a lower cap rate.
And let me explain that to people so they understand.
I just got confused. So the lower the cap rate, the better if you're a seller. Why?

(24:00):
Because it means you are selling it at a premium to the marketplace.
Whereas if you're a buyer, you want to buy it at a higher cap rate,
a higher return on purchase, and then be able to sell it back down.
And I could show you how these numbers work if we look at the financials,
but the lower the cap rate, the better for the seller.

(24:21):
Because that means that I'm making a- A bigger profit. Correct.
Because you're selling it back down at a premium to the marketplace. place.
Whereas if you sold it higher, and we'll show you the financials,
you're not doing as well.
So you'd always like to be able to take something from, say,
a five cap rate, move it up to a seven, and then sell back down at a five again.

(24:44):
Because if I move it to a seven, it means I made that- You made the value add.
Annually. Correct. During my hold window. Correct. And now you're going to be
able to sell that back down, because you built it to a seven,
but you get to sell it back to the marketplace at a five.
So it means if I bought it for $100,000 and I increased the rents and made more
money, let's say I made my $10,000 a year, but then when I sell it to the market,

(25:06):
now if it would have been $10,000.
Your profit is built into that 2% difference between the 5% and the 7%.
That's why it's so critical that you're able to move it up as high as you can.
We're going to have to sell it back down as low as you can.
I'm still not there yet. Semantics. But when you see it on live paper,
you'll understand. Yeah, sure.
And then, okay, so now they have this proposed financing.

(25:28):
What is that about? Because they're not a bank. No, what the brokers are doing
here is they're saying, hey, here's some options.
You can either one, get a new loan, which is where they're saying new loan over
here, new first trust deed. Okay.
Or you can actually assume the existing loan. So there's an existing loan on
the property that you could just assume. Okay.

(25:48):
And here are the terms of that existing loan. So it's at 3.71%, which is awesome.
But the max loan amount you can get is 3.364 million. That's the existing loan.
You can't put any more debt on it. Okay.
So that just means you have to come in with more equity. More cash.
More debt on payment, right? More cash.
Yeah, more cash, which is if you look over here, if you put a new loan on it,

(26:11):
you can get a loan maybe up to 5.1 million.
So that's less cash out of pocket. Yep. More bank.
Now your interest rate's higher because you're going on current interest rates.
Which I see 5.26, but- Which is not bad. I don't know if that's even real.
Yeah. You can get 5.26? Probably 5.75 right now. Okay.
Yeah. 5.75 on, if you did a, what they consider agency debt,

(26:35):
which would be from Fannie or Freddie Mac, you could provide that financing.
You may get lucky enough with a local commercial bank because people ask, where do I get the debt?
Where do I get a loan on a multifamily property? It's going to come really from two sources.
One, a local commercial or regional commercial
bank in the market in phoenix or in san diego or

(26:55):
wherever you're at or you're going
to go national to a freddy or fanny agency lender
there are other kind of debt funds
and hedge funds and stuff you can go through brokers to get but that's kind
of maybe for another discussion and more expensive yeah more expensive debt
you're typically doing those types of loans if you are doing a value-add deal

(27:16):
and really pushing construction and all these things on the property where you
need a bunch of you need to To acquire the property,
plus you need renovation dollars, right? Big chunks. Okay.
So that you'd go to that type of financing for that.
But these are the two options they're kind of giving you just to kind of set the stage. Sure.
And then we'll use these to kind of plug it into our little pro forma to see which option's best.

(27:40):
So should we jump to the pro forma? Yeah. Let's squeeze through kind of just
the OM real quick to kind of give you an idea of what you're going to see.
So once again, it's just a marketing fluff piece.
They're going to give you info about the property, about the offering.
They're going to show you investment.
Hey, this is where the current property's at. Here's what the units look like. Here's some photos.
Here's things you can do to the property. They're giving you market data.

(28:04):
It's a nice marketing piece. They're basically saying, hey, look,
if you come in here and you put in $15,000 a unit, you can bump the rents on
average $200 per unit per month.
And you get a return on, it should be ROC, return on cost of 16%.
Ideally, I'd want to see 18% or more on that.
So you don't like to reno without getting an 18% return?

(28:24):
ROC, return on cost, ideally.
It's not perfect, but ideally. Would you do 16%? Maybe.
Once you put in that number and you start looking at everything and you say,
okay, my cash on cash is there,
my interim rate of return is there, my equity multiple is there,
and I'm not over leveraging the property with too much debt,
and we can get a nice return on this and it's relatively

(28:47):
safe then yeah maybe
we'll go with a little bit of lower because that's not a main metric that's
just a nice one to have yeah yeah so but they're basically showing your what
they consider what they call a classic unit meaning non-renovated non-touched
versus hey here's what a market renovation looks like and you can see they put
in new vinyl they added washer dryer connections and you added stainless steel

(29:09):
appliances they put in what they call shaker doors.
Nice little modern finishes. They got Formica countertops on there.
So they're just updating it. And they're showing you what you can do.
Kind of breeze through here showing common areas aerials all
this fun stuff then they get in and they start showing you some financials this
is the information that you're going to use initially to plug into your pro

(29:32):
forma okay you're going to go and just take the broker's info and just plug
it in see what it looks like to start and then you can start manipulating it
okay okay so in their case you're gonna they're showing you the unit mix they're
showing you 33 units 21 of a two-bedroom one bath.
You got 12, two bedroom, one bath classics. Classic meaning unrenovated.
Correct. And then they're showing you the rents that they're currently getting

(29:53):
for each type on a monthly basis and then total rents for the month.
And then they're showing you, hey, if you renovate, this is what you can get.
You can go from $1,450 to $1,550 and you can take these other classics and go from $1,350 to $1,550.
So you can bump them $200. So is that telling us that the ones that are renovated will be at $1,550?

(30:16):
Correct. Or could be at $1,550? Both. Okay. So they're basically saying,
hey, your market rents are $1,550 for these units, fully renovated.
But we're at $1,450 right now. And $1,350.
Yeah. Depending on which ones are renovated, some versus none. Okay. Yeah.
So we'll throw these numbers in. They're giving you an income and expense summary.
And we can kind of see how it says like T6 up here. Yep.

(30:39):
And then they're showing you current that's what that means t6 versus
post renovation so after you renovate here's what
your profit and loss may look like currently this
is what it looks like and it's the last six months annualized yeah
because what they're and the reason they're giving you probably this t6 is
because the t12 looks like crap yeah but but

(30:59):
now the income is t6 but the expenses are
t12 correct yeah because they're they're trying
to show you we're making improvements on the property yeah from rents
so this is what really is going
seven months ago don't worry about what we did
seven months not as good yeah you can
see a trend it's cuz Shane look at our trend and that doesn't scare you no it's

(31:20):
not playing a game of hide the ball no you're just gonna trust but verify okay
so I'm gonna come in here I'm gonna take a look at the rent roll I'm gonna take
a look at the t12 and the t6 and what I really care about is not where where the property is at.
But where it could go. All I care about now is making sure the current operations,

(31:43):
can service the debt payment properly on the property. Because you can make
it better. Because I can move it.
I just need to make sure today we can cover the mortgage, all the debts,
everything, and get this property operating.
And then we go to work on improving it and we'll get it to the future.
But if you're running negative on every month, I mean, you're buying this thing

(32:05):
that's not paying for its debt service, number one, you're not going to get
a loan from the bank because the banks can be like, this doesn't work.
Sure. And if they do give you a loan, you're going to be in a negative,
what they consider negative leveraged position where you're going to have to
have an interest reserve because the property doesn't pay the mortgage.
So now you need an interest reserve to pay the mortgage until you get it to the future.

(32:27):
That's running a little bit risky to do in today's market. You could do that
in the past, and a lot of people did, but today you got to base it on today's underwriting.
And then presume it needs to cash flow day one, pay the debt service day one,
and then that way everything from here north is great. So even if we don't do
anything, we're fine? Correct.
That's right. And you can just sit tight. If the market does some changes,

(32:49):
you're like, okay, well, but we're paying the debt service, we're paying the
mortgage, like we cannot lose the property. Yep.
Okay. So that's really, really, really important. Because in the past,
people were banking and going after things and being a bit too optimistic,
and then things can change. Sure.
We were chatting about commercial stuff, office buildings, and other things
that there's a big cloud of issues potentially.

(33:13):
Yeah. So yeah, you're looking at it right now. They're saying,
hey, the gross potential rent on the property is $560,000 a year.
That's fully occupied. Fully occupied. So when they say gross potential,
that means this is the potential on the property. This is the max potential
currently on the property. Okay.
In loss to lease, what that means is the difference between what they could

(33:34):
get and what they actually are getting.
Okay. So you need to take another $9,600 off.
Because they're not getting full market rent, because Jeff wants to sneeze.
Jeff wants to sneeze at that nonsense.
Vacancy loss, that's just physical vacancy loss on the property,
some units that aren't occupied.
So $9,600 because they have under-market rent, $33,000 because they have empty units. Correct.

(33:58):
So fully occupied. For the year. That's right. It's annualized.
And then other rent loss could be due to concessions that they give to tenants to move in. Free month.
Right. Or bad debt, meaning tenants don't pay.
Right. So that's where you get to your total economic loss of about $50,000
a year off of the total potential.
So then they're showing you the net rental income, also known, well, I guess.

(34:22):
What's a safe vacancy loss percentage? It's by market.
So Phoenix, you're probably looking at 3% to 5%. So do you always go conservative and put 5%?
Yes. I always will underwrite to a 5%. And the reason why is because the bank's
going to underwrite to a 5%. It's a good reason to do it. Yeah.
I'm going to stress test the property based on what the bank's going to look at, not what I think.
Because the market may be much better than the bank, but the bank's going to

(34:45):
underwrite a certain way. And then what do you use as this other rent loss category?
That's going to be for concessions. So for example, vacancy, let's call 5%.
Loss to lease, maybe 1% to 2%. Other rent losses like concessions and bad debt, 1% to 2%.
So total, you're looking at, say, 7%, maybe 8% off gross potential. Okay.

(35:05):
So in your calculator, you would... Somewhere in there. 7% to 8%. Yeah.
Okay. Maybe, and depending on the market, could be upwards of 10% to 12%.
So you just got to... Every market's going to be a little bit different. Okay.
In this case, you see how they're coming off 8.9%.
Off of the gross to get to the net income potential.
Then you have other things. You have other income on the property.

(35:26):
You have utility reimbursements where tenants pay a portion of the utilities,
water, sewer, trash, pest, pent, pet, all that stuff, pet, rent, stuff like that.
And that's where you get other income coming in too. Because you could have parking income.
You could have laundry income, maybe cable income. You have a bulk package on
the property, cable incomes coming in, stuff like that.

(35:47):
So other income gets added in. And then you have this number called effective gross income, EGI.
And that's that number there. And that is the last number before you get to
taking out your expenses.
And the type of expenses you're going to have on a property like this,
you got your real estate taxes, you have property insurance,
you're going to have utilities.
Some properties have a payroll. Some do not, depending on the size of the property.

(36:10):
This one does. Yep. You're going to have repairs and maintenance.
And what do you, how do you factor that?
Is there a percentage? There is. is because the banks will usually,
and when you say repairs and maintenance, that also includes turnover,
like meaning if I have to go make a unit ready because a tenant just moved out,
I got to turn it over. So you add that in here too as well.

(36:31):
Every market's a little bit different, but somewhere between $550 to $750 per
unit per year would be a decent number.
Regardless of size. Correct. So if I had a, in this case, this is $700 a unit.
Okay. Okay. So they're in line with the marketplace for 23,000 bucks a year.

(36:52):
Okay. That's what they're saying. So that I would know when I just having experience
in this, having seen that number, I'd say, okay, the broker's not being a moron.
It's an appropriate amount. It's appropriate. Okay. It's in line. Okay.
And utilities seem a bit high. So just once again, you got to verify all this stuff.
Marketing promotion seems fair. Contract services, you'd want to verify this

(37:14):
stuff, but that doesn't seem to.
That's lawn care, landscape, a pool maintenance guy. Contract services. Yeah, trash.
Contract service where it's a monthly recurring consistent. It's a contract.
General administrative. This is just office stuff. You know, admin, phones.
The computers, stuff like that. You got a management fee in here of three and a half percent.

(37:38):
It's in line with the market. And then reserve replacements. This is a little bit low.
The bank's going to want to see probably $250 to $350 a unit.
This one's sitting at $200 a unit. And this is?
This is a reserve replacement. So you take this every month,
you add it up into a reserve account.
So that way, if you have to go replace the roof- You have this money.
Correct. Or the air conditioner.
That's right. Okay. You have a little extra CapEx money, improvement stuff to

(38:01):
go fix big ticket items. Okay. So you put it into a reserve account.
So total expenses, they're running at about $150,000, which is about 27% of
this number up here, the EGI.
Seems a little low. Where do you normally look? I would project this thing probably
above 30% for a property of this age and category and vintage.

(38:25):
What about over 40%? It depends. Depends. So typically a class C asset would
be, yeah, in the mid to upper 40s into the low 50s. Wow.
So the fact that this is 26 is low, but that doesn't necessarily mean anything
because you have these numbers in here for payroll that we'd have to look at.

(38:45):
And then the other thing is property taxes and insurance.
The three biggest numbers that typically affect your expenses,
property taxes, insurance, payroll, obviously repairs and maintenance.
Those are the big categories that take huge chunks and every market's different.

(39:06):
So Arizona is going to be different than texas texas insurance
and property taxes are massive so it takes it could
take up 40 50 percent of your expenses yeah it's
nuts whereas in california or arizona and other places it's a much lower percentage
in this case it's 20 000 of your 150 000 right pretty low but it'll go up once
i buy it because it's a new property price depending on how the county values in reassesses,

(39:33):
properties so that's why i say every county is different you want to verify this.
To make sure how does the county reassess property when you sell it,
because every county's different. Okay.
And that's kind of one of the kickers, and insurance is different.
So you want to have an insurance broker that you can run this by before you
would actually, this is part of your due diligence, to make sure that the insurance

(39:54):
number's within reason, because every market's different.
And your property taxes, same thing, big, big, big numbers.
So it's just, it's verifying all this stuff.
But let's presume that number's accurate. We'll plug this stuff in and see how
it goes. and you get this number of net operating income.
So this is the number before you would pay any debt service or mortgage on the property.
So I've got $418,000 in my bank. Before you pay any mortgage payments.

(40:17):
But I've got to still pay the loan. I've still got to do all these things. Okay. Yeah.
Then they're running through a seven-year model for you, showing you,
hey, here's what year one can look like, year two, year three.
So they're giving you a projection.
Do you pay any attention to this? Yeah, I look at it, but we're going to do
our own. Yeah. Right? So this is what... Trust and verify.
Yeah, that's right. Right. This is a fluff, but it's good to see it and just

(40:38):
trying to see, does it make any sense?
Because then they're coming down there and they're actually giving you debt
service based on a new loan, which is fine.
And so you're just trying to see, does this actually make sense?
You know, they're giving you cash on cash return numbers, pretty healthy.
Yeah. What do you want to be it? I mean, these are great numbers if this is
true, but once again, we're going to throw it into our projections and see if that's accurate or not.

(41:01):
So anyhow, more info about the property, market data, comps,
rental comps, sales comps, et cetera.
This is your OM. You're just going to go through it. Nice little marketing piece.
So that is that. All right. Now we'll jump into the dirty.
This is a little basic pro forma that we can use. I kind of use two different
ones. For a 30-unit property, this would absolutely work.

(41:24):
If you're doing a hundred unit or much bigger property, we have much more detailed
pro formas that provide much more detailed analysis.
But for the case of this, we can jump through this basic one. Okay.
So this is a lot of plug and play, all the blue stuff you manipulate,
all the black numbers are all coded with formulas.

(41:45):
Right. So all we're going to do is edit all the blue stuff, which I've already
pre-done on this property.
So we'll just kind of run through it. And then we can start asking questions
and editing numbers to see what works.
So I put in their sales price that they'd like to get. I'm presuming we're going
to get a new loan and put 30% down and get a new loan over here of 4.9 million.
You see this number here, 4.9 million. We're going to put 30% down and we're

(42:09):
going to run it out of 5.75% interest rate.
And we're going to go ahead and put in a repair budget of an improvement budget of $250,000.
So I'm presuming it's $15,000 a door over X amount of units.
I'm just using that as a number.
So we're going to add another $250,000 in improvements to the property.
So on top of the 2.1 cash, we also need another 250.

(42:31):
That's right. So we're up to 2.35. Correct. And then you have some closing costs and stuff in there.
Get baked into the loan on these deals or is that cash out of pocket?
It depends. So some loans will give you some renovation dollars.
No, the closing costs. No.
Closing costs is equity. It's cash. you pay cash so on top of the 235 we're
going to need an additional 70.
Right okay that's right so when you get to the total equity amount it's showing

(42:54):
you here at 2.4 that's not nice i'm trying to do math in my head you got it
i already got it all right so that's taking your down payment plus your repair
budget plus your closing cost okay gets you your total equity requirement okay,
and then you got your loan amount here and here's your terms it's showing you
your debt payments on a monthly and annual basis it's showing you principal and interest that's,

(43:15):
So $28,000 a month or $343,000 a year, interest-only payments.
So sometimes with these loans, typically, you can have a period,
maybe one, two years, sometimes full term of a five-year or seven-year loan
where it's interest-only.
And you would do that just to help cash flow? Yeah, because if you're putting
30% down, you have a pretty good chunk of equity in the deal.

(43:36):
Yeah. So I don't really care.
I'm going to pay off the mortgage when I sell it. Right.
I don't really need to pay it down during the term of the loan, per se.
Sometimes it's nice but that yeah i'd rather put
the cash in my pocket or put it in the investor's pocket because it
doesn't get re-am it's not like a traditional loan right yeah
i mean it's five or seven year loan maybe a 10 year loan you're

(43:57):
paying the same amount it's not like i'm thinking of a traditional mortgage
where year one most of my money goes towards interest yep and then it changes
it starts to flip-flop later yes and it would here if you fully amortize it
but you're not going to keep this property 30 years you're keeping it yeah what's
the point so you're You're only paying interest basically anyway. Correct.
I mean, I don't, right. I'm never going to get to that point.
So would you prefer an interest only loan? Yes.

(44:19):
That's your preference. As long as I'm putting down a good chunk of equity,
in this case, we are 30% down.
So the longer term of interest only I can get, the better the cash flows are
and the better it's going to be for investors.
Got it. So that's why I'd go in to say, if I got a seven year loan or a five
year loan on this thing and I could get two or three years of interest only, awesome.
Because that first two or three years is going to help push up the cash flow

(44:41):
for us. Yeah. and not give it to the bank, it's going to go to us.
And if you can get the entire term, you'll take it? Yes. Okay.
Yeah, absolutely. And DCR, debt coverage ratio. Correct.
So what that means is, and this is where it comes in to where the bank is going
to qualify the property.
So the bank is going to make sure, at a minimum, you have 1.25 DCR,

(45:02):
which is debt coverage ratio, which means you have 125% or 25% more net operating income.
So if you remember when we had this little number here on the financials,
see this net operating income number? Yep.
They're going to want to make sure that number is 1.25 times more than your debt service. Okay.

(45:24):
At a minimum. So easier math, if the net operating income was $125,000,
then my debt better be $100,000 or less. Yes. Okay. Correct.
That is exactly right. Because they want to make sure there's a buffer. Yep.
Makes sense. So in this case, right now, this is great. You have a 1.79 debt
coverage ratio, which means you're 79% more than your debt payment, which is great.

(45:51):
Is that based on the interest only, or is that based on the P&I?
That is based on the principal and interest, because if you look at this for
me, if I click on this guy, it's highlighting your P&I payment.
So it's even better if it was interest only? Correct.
So then I'm coming down here, and I'm going to just plug in the rents just like
they did. Right from the form. Right from the form.
Current rents versus projected pro forma rents. So if you remember,

(46:14):
they were at $1,350 and $1,450. Yep.
And then we're going to move them all to $1,550. Okay.
And then this kind of comes down here, and it puts in your gross numbers for the year.
$46,650 current, $51,150 projected. Yep.
And then we're going to go ahead and come in here and plug in their expenses, just like we saw them.

(46:34):
Pretty similar. And I'm going to manipulate a couple of these numbers because
I think some of their numbers may be wrong. So we're going to manipulate a few of them.
But I made sure the taxes were in line. The insurance was in line.
Maintenance and repair was in line. Most of their bigger numbers,
the utility numbers, I'm going to use theirs.
Admin, contract services, payroll, the marketing expenses.
And then I'm going to bump up the management because I think their management was a little low.

(46:59):
So we can bump that up, tweak that a little bit, and add some reserves and stuff
in there. Now, you have nothing for turnover.
I use their maintenance and repair number. See, it's all built into here.
Yeah. I mean, here you could add in a little bit more. If you want to add maybe
50 bucks, you don't necessarily need to. I just want to see how these numbers work. Yeah, sure.
So these are their total expense numbers.
Still running at 27 to 24%. And EGI is what again? Effective gross income.

(47:25):
Effective gross income. And what do we want that number to be? What's our floor?
On the percentage, the ratio? I mean, realistically, the property should operate
like a 30%, 31% on a smaller deal. So 24 is low.
Yeah, it's low, which is good. It's really good. It's just whether or not that's
accurate. Wait, wait, wait. Why is it good?
Because your expenses are lower. So you want the number to be as low as possible.

(47:48):
Correct. So what's the highest before you throw this thing out and move on? Ooh.
Like what's your, I won't go that high? I mean, if this thing were over 50%,
that'd be a meter problem. Okay.
So EGI, the lower the number, the better. Well, this is showing percentage of EGI.
This is your really what this is is your expense ratio
okay so if i change that that's

(48:10):
really what that means what is my expense ratio got it of effective gross
income got it so this is saying this is 27 of my effective gross
income so if i did this formula and you see it highlighted yeah right it's taking
my total expenses minus my over my effective gross income just to see what is
my percentage okay yeah so that's 27 on that one and it shows me per unit and

(48:33):
then per square foot okay.
Rsf residential square footage or a rentable excuse me rentable square rentables
actual rentable got it right so then this is going to kind of show you your pro forma down here,
kind of summarizes it all for you and it's showing you once again gross potential
income like we were seeing before, taking out all of our vacancy and credit

(48:56):
loss, which is right in line with what they were giving it to us.
We're adding in our other income numbers, which they gave to us.
And then we get this effective gross income number, which is identical to the
financials. Okay. And then we take out our expenses.
We get to this, remember it was like 418,000 on their numbers. It's 415 here.
Then we're going to take out our debt service, which is based off our loan,

(49:20):
Our new loan at $343,000, full payment.
This would be much better if it were interest only. Sure.
But I'm going to underwrite it based on principal and interest payment.
That gets me a cash flow annually of that. This is current. Yep. This is current.
And then you take the pro forma. So this is projected. Okay.
And the biggest difference you can see is mainly in your income number.

(49:44):
I'm going to adjust some of the vacancy and credit loss, so we're not going
to have as high. And we're going to get a little higher effective gross income.
Similar expenses. Now our net operating income is a little bit higher.
Take out the same debt service, and our cash flow is almost double.
Almost double. And your debt income ratio, your debt coverage ratio is 1.42,

(50:06):
which is good. Yeah. Yeah, much better.
So this is if I buy the property at $7 million.
Okay. And I take all of their numbers perfectly as they're giving it to me.
So we're going to tweak a couple of those because right now this won't work.
Like the bank won't give you a loan based on 1.21. Yep.
So I need to fiddle with that a little bit. Now, below there,

(50:27):
I see 3% cash on cash year one. That's current.
And where would you want that to be? On current, I don't care as much. I care about future.
As long as I can pay the debt service and cover the property and everything's good today, then great.
If I believe we can get the property to where we believe we can go, I care about the future.
What is the number you want it to be in the future? This is not bad for the Phoenix market.

(50:49):
An average cash on cash of 7.5%. That's good. That's pretty good.
Because I'm looking at it like my bank will give me 4.15 to 4.2 interest on a money market account.
Correct. So I'm looking at current at 3%. Why not just keep my money in the
bank? Well, because you don't just look at cash on cash.
You want to look at the total annualized return on the property.
Including the debt, the principal. Including the appreciation and everything

(51:11):
that comes with it. Okay.
Because it's not just the cash I'm getting, that's nice.
But as this property grows three to five years from now, what can I sell it for?
So I take all that cash I've made plus the profit from the sale, put it all together.
What does it come out to annually? Okay. Yeah, that's what I'm really looking for. Okay.
And you'll notice this. Remember I mentioned where can you take the cap rate

(51:33):
to? Yep. And where can you sell the cap back down to?
And the importance of that. So we're going to take this thing up to an 8.2 cap rate.
And then we're going to sell this thing back down at a six. Which is good.
Which is very good. That's a 2% spread, which is pretty good.
And we'll show you what happens to the numbers.
Okay. But right now, based on these numbers, the future look at this property,

(51:53):
you're going to produce an average annual cash on cash of 7.5, 7.6%, right?
You're going to build it up to an 8% cap rate, and you're going to have a 2.15
equity multiple. It's over two, not bad.
And I'm going to have about a 19% internal rate of return on my money,
which is good. Very good.
Yeah. Anything kind of in the upper teens, it's pretty good. Yeah.

(52:15):
Because you have to think about your opportunity cost of money, right?
Where else would I go and get this kind of return on a relatively lower risk asset.
It's a multi-family property. It's producing cashflow day one.
Tenants are in there, it's fully occupied. It's running itself.
I'm getting tax benefits from it on top of that. That's not even calculated into this yet. Right.

(52:37):
And I'm getting a 19% annual rate of return on my money.
Pretty good. Pretty good against a real estate asset that's building wealth.
Yes. And getting all these other benefits that come along on top of these actual numbers.
So right now this looks great, but I'm sitting there going, eh,
I don't really want to pay 7 million. Right.
Let's say, what if we got it for 6.7? So I'm changing it.

(53:00):
That's going to change my total equity in, which is also going to change down payment.
It's going to change my loan amount, which changes my debt service and everything.
Okay. So now expenses are the same.
Rents are the same. I haven't changed any of the revenue or expense numbers.
I've simply changed the price, which changes my down payment,
money in, and it changes my monthly payment to the bank.

(53:22):
So by doing that, you start to see these changes, right? So I'm not so much
worried about the current. We care about the future.
Right. So now we got cash on cash of over 8.5%, which is really healthy. Yep.
Cap rate of 8.5%, which is really good.
2.4% almost on your equity multiple and over 20, almost 22% in a rate of return
on my money. So this would be a deal you would be interested in?

(53:44):
Yeah, if you can purchase it at 6.7 and these numbers, meaning your expense
and your revenue numbers are legit, you can verify those, then something like
this makes absolute sense.
Now, what happens if you change the interest rate to 6.5? Yeah, let's do that.
Yep, let's change it to 6.5%. So now, see what happened to your current debt coverage ratio?

(54:05):
Yeah. Move down to 1.17. The bank won't give you a loan. So I need to give,
I have to make sure the bank's going to give me a loan. So now I need to change
this to 6.4 million, maybe. Let's see what happens.
Now we're there. Because 1.2 is the minimum? 1.2 to 1.25.
Let's say it's 1.25 because the bank gives you a range typically.
So this means maybe it's 6.2 million. I just got to keep moving this thing until

(54:28):
I see the numbers actually get there. So there we go.
So based on if interest rates went up to 6.5%.
I can only pay $6.2 million. Presuming the rents are what they say they are. Yeah.
And the expenses are what they say they are. But I kind of feel like that is
the interest rate today. Well. As of the date of this recording.
Maybe. It depends on where you're getting your loan from. Okay.

(54:49):
Like if you went to a local commercial bank, probably.
If you were able to go get a Freddie or Fannie loan, an agency debt,
as they would call that. Direct to them?
You'd go through a broker to get there, but it's an agency debt.
Yeah. and Freddie or Fannie Mae would give you a loan somewhere in the high
fives right now. Okay, so let's do six.
Let's meet somewhere more and go change the purchase price to something that

(55:13):
may actually happen, because I doubt they're going to sell it for six too.
You never know. You never know. Once again, this is not emotional.
That's the best part about this entire process is you're not sitting here going,
ooh, like... No, but I mean, do you think a seller who listed at seven would
sell for six too? It doesn't matter what they want.
If they want to sell the property, they're going to have to sell it for what
the market's going to allow you to buy it for. That's fair. It's not about opinion.

(55:36):
Yeah. The seller could want clouds.
Sure. But if the interest rates are 6% and 7% and the bank has to give me a
loan, no one is going to buy it.
They can't. They can't buy your property for what you asked because the financials won't allow it.
They might choose to hold it then in lieu of selling it. Then don't sell the
property. Then don't sell the property. So what would happen here?
Yeah. So in this case, if we move it, interest rates are 6, buy it for 6.5.

(56:00):
Half this would still work so you could buy it now you could pay six and a half million versus 6.2.
Okay okay right and if and let's just for simple
math let's say interest rates get amazing again and go back to five percent
right now i could come in here and pay this just goes to show you the power
of interest rates if you're just tweaking a couple little things now it's we're

(56:20):
up to 7.1 million what you can and what you want to are two different things
correct you want to pay as little right because keep in mind i'm still going
to be looking at some metrics for the market and blah, blah, blah.
You know, I want to be able to make sure I have ideally a 2% delta between where
I'm building the cap rate to and what I believe I can sell back down to in the future.
Okay, now when you say that, because I think now I need clarity,

(56:41):
how do you sell back down to it? Let's say we do all this, it's five years from now.
Yep, let me show you this. So on the next little tab, I'm doing my little five-year projection, okay?
And what I'm saying is, is if we project, if the market right now is 6% in Phoenix,
for a cap rate. And the brokers would help you understand this.
And you'd be able to see what is the general cap rates for that market.

(57:03):
And every market's different.
San Diego's like three or four, maybe five.
Phoenix is going to be somewhere around, somewhere between five to six right now.
So let's presume a 6% cap rate on when I sell this thing. And again,
we want it lower the better when we sell. Lower the better.
And I'm going to show you exactly what happens here. So look at this number right here.
This is five, six years from now.
Based on the financials of the property.

(57:25):
And a 6% cap rate. So I'm going to show you how this works. So if I click on
this number here, that says $9.477 million.
See the formula up top here? It's going to highlight that.
What that's doing is it's taking my net operating income divided by my cap rate
of 6% to give me my valuation of 9.477.

(57:45):
That's how you value commercial property.
It's net operating income divided by my
cap rate gets me my value so in 2028 i'm
selling this property for 9.5 9.5 million
bucks okay now let's say that that cap
rate in the market's five you're like oh yay shit watch watch what happens now

(58:06):
we sell for 11 11 3 so we want it to be a five yeah and let's see like the market
went crazy boom and if it goes i mean if you could buy this property for 6.7
million and sell it for 14.
I mean, look what happens to your internal rate of return. It gets stupid. Of course.
You're making 36% a year on your money. Let's not hit a grand slam.
Let's say we squeak it out because it's our first deal.

(58:28):
5.5%. Let's say it's 6.5.
Well, yeah, things are going to change pretty drastically.
Yeah, but let's say it goes against us. Okay. 7% cap rate? 7% cap. Okay.
I mean, you know. Still not bad. You're making 12% on your money,
you know and you're getting tax benefits i mean it's not the end of the world
but once again you run sensitive better than the stock market yeah you run sensitivity analysis.

(58:52):
On stuff like that you're stress testing you're stress
testing it was what we're doing right now we're just manipulating numbers to
stress test it i mean what if interest rates go to six seven four three two
and you're just because i mean project projecting the world in five years five
years ago good luck yeah exactly it'd be like somebody saying 18 months ago
no the fed will We'll never move the rates 4%. Right.

(59:12):
Five. And we said that. I mean, we did our projections on some of our deals
and said, yeah, we knew interest rates were going to go up.
You didn't expect it. But not like that. Yep.
Right? They weren't going to hockey stick from 0.25 to 4.5. But I mean,
the stock market, the annual rate of return of the S&P is 8.2%.
So anything north of that, you're still doing better.
Yeah. And this is also regardless of the fact that you're getting the tax depreciation.

(59:35):
Which we haven't really talked about. And I think this is important because this is very powerful.
Very powerful. Meaning if you do not want to pay income tax for the remainder
of your human existence. Which I do not.
You can use real estate. It's one of the last major things available as a major
potential write-off to you that's available in the tax code legally.
So explain how we would use this to write off.

(59:58):
Yeah. So if we bought this deal. Give you an example. So we'd be buying this
thing at, say, $7 million. Yep.
We're going to do a cost segregation study.
Done by a third-party company would cost about $5,000 to $8,000. Okay.
What that's going to provide is an analysis on the property to show to a CPA that.
How fast we can accelerate the depreciation on the building,

(01:00:20):
not the land, the building, in the components within the building.
Under normal real estate and tax law, you would depreciate a real estate asset
over 27 and a half years under normal terms without doing anything.
A cost segregation study allows you to accelerate that depreciation over typically
the time of the investment, three to five years.

(01:00:41):
And a vast chunk of that write-off is going to come in year one,
with a little bit in year two year three year four and so so let's say the building is what
percentage usually is the building versus the land so on something like this
we we would probably expect of a seven million dollar building depending on
how they value land versus building let's say it was a 50 50 okay three and
a half million three and a half million dollar,

(01:01:02):
write-off and that would probably come in year one the entire thing yeah so
now i bought it for seven.
Yep. I put down 200 or 2 million and some change.
And I write off three and a half. So now even if I made half a million dollars, I made nothing.
I lost. Correct. Because you're going to get a paper loss coming over on a K-1 statement. Yep.

(01:01:23):
That's going to allow you to offset capital gains.
And in some cases, ordinary income, depending on how you're classified. If I'm an active or not.
Real estate person. Yep. If you're an active real estate professional,
then you can write off ordinary income and capital gains, which is why I always
tell any W-2 person, if you're a doctor, an attorney, a dentist,
and you're making like crazy W-2 money.

(01:01:46):
You need to also own a couple of real estate properties yourself, manage them yourself.
Yep. So you can tell your CPA, hey, I need to be classified as a real estate
professional, half my time or a certain amount of hours.
So that way from your tax standpoint, you're a dentist,
but you're also a real estate professional so now

(01:02:06):
i can take this k1 loss that's coming through from this investment
apply it to capital gains as well
as my ordinary dental income yep and pay no income tax
now it's the greatest thing on sliced bread here's the only negative i see yeah
when you go to qualify for a loan you don't qualify you make no money ah but
there's a good way for that see i want to buy a car i want to i want to the

(01:02:30):
car is not the problem they just go straight off credit But you're right.
If you were going to go get a home loan, if you went under a traditional lender,
they want to see tax returns, they want to see this, right?
So you have to ask yourself this question.
Is it better to...
Pay Uncle Sam a bunch of money, or is it better to go get a bank statement loan

(01:02:52):
from a lender that doesn't require tax return?
What's a bank statement loan? Meaning rather than using my tax returns and all
the other traditional underwriting that a lender would do to go buy a house,
they're going to look at your bank statements and give you a loan based on income
that's coming into your banks.
So that if you made $500,000 coming into a bank, they're going to use that and
take a certain percentage of that to show your income, not using your tax returns

(01:03:14):
to show your income. And that's a doable option. Absolutely.
So you can take- And most entrepreneurs, self-employed people will use those
because by design, if you're doing your entrepreneurship correctly,
you should have the worst tax returns on planet Earth. Yes.
I mean, you should be showing like I'm losing a bunch of money on paper if you're
doing tax returns correctly as an entrepreneur.

(01:03:34):
Now, the negative to doing the accelerated depreciation, when we sell this building.
It does get recaptured in a certain way. So we now owe the tax.
It can come back, correct. But you're getting all the benefits for those three
to five years leading up to it. So you're getting to take this money and do other things with it.
But let's fast forward just to round it out because I'm curious.
So I take the depreciation. I lose $3.5 million year one. I start making my returns.

(01:03:57):
I don't pay tax because I've lost this money. And it's carryover.
I don't have to use it all in year one.
Now I sell the building for that $14 million. Yippee, hooray. Correct.
So you got a big profit number. Yeah, and I have no basis. And I only have the
$3.5 million that wasn't depreciated in the deal.
Basis meaning originally I bought it for $7. Yep. So I'd only pay tax on anything
north of seven. Correct.

(01:04:18):
But because we depreciated it down to three and a half, I pay tax on $3,501,000
that first dollar over 3.5. Right.
Now what do you do? So now you can take this money, and as long as you're doing
more deals, right, you can now put it into other things, do accelerated depreciation
again, do accelerated depreciation. But do you pay the tax or can you do a 1031 exchange?

(01:04:40):
You can if all the partners want to do that or if you're the sole owner,
sure. But if you have investors and you pay, then you can't.
You'd want to make sure the partnership wants to move all of that into a new
deal. Because if one person takes money, it's broke. Correct.
In which case, everyone has a tax liability now on that new gain.
Correct. So the key would be in that tax year. No, there's creative ways,
and this is more CPA tax talk you want to talk to a CPA on, but there are creative

(01:05:03):
ways. Justin is not a CPA.
There are creative ways to minimize that recapture, as they would call it,
on the accelerated depreciation at the end. So, but you'd have to talk to CPA
on that. Okay. That's way above my pay grade. Fair.
But it, the point being is it's much better to take the benefit now.
Opportunity cost of money. It'll allow you to do things with that free cashflow

(01:05:26):
because now you have a lot of savings to then go do other things to build the
wealth faster than not doing anything and just taking normal.
Is it always better to sell a property in January so you have 11 months to figure
out what to do before you pay the next tax bill?
Yeah. I mean, yes, in a way, because if you're selling it towards the end of
the year, your tax is coming up soon the next year.
So yeah, you'll see that happen a lot where they'll say, hey,

(01:05:47):
we're going to close escrow on January 1. Yeah.
Not December 30th. Right. We're going to wait an extra day so that way you have
this full time to be creative.
Absolutely. So looking at this deal, what is your... I think it's a fair deal
and it's something to consider because let's say this was a 6% interest rate
and I think you're buying this thing around 6, 7, maybe differently. Whoops.

(01:06:12):
With all other things being equal and the rents being what they say they are,
expenses being what they say they are, you know this is a nice little
deal you know nice would this qualify in your
world if this was on your desk and
you would you make an offer on this deal yeah because i
i think you are not at a seven cap you're definitely in a six or lower for the

(01:06:33):
phoenix market yeah because there's a huge nice little prop to be made over
21 projected annual returns on your money you're cash flowing it nicely you're
cash flowing at day one you're servicing the bank debt so you're not under any pressure.
The only way this thing goes south is if you're a really bad operator and you
don't know how to operate a property.
But that's why selecting your markets is key.

(01:06:57):
This is where all the market due diligence comes in when you're selecting a market.
The first two things is jobs and population growth, jobs and population growth,
which is why we only buy in one of the top 75 metropolitan statistical areas
in the country, MSAs, as they call it.
MSAs. Yeah, metropolitan statistical areas. Jobs and population.
Jobs and population growth.

(01:07:17):
Because if you think about it, what does population follow?
Jobs. Right. And if you don't have a diverse economy where different jobs can
come in and different job providers, then during recessionary periods,
because I don't care when markets are great.
I care about what can happen in a major recession. Yep.
Because then everybody starts to consolidate into the job sectors, into the job regions.

(01:07:42):
And you'll see that happen. Which is why we typically won't buy properties that
are way out in tertiary markets or suburbia markets where people have to drive
long distances to get to and from work.
Because that's great when markets are great, but when markets shift in your
major recessionary periods, you're going to start to have major vacancy issues.

(01:08:04):
And then you can't service the debt. Correct. Correct.
So I want to look at when S hits the fan and everybody cultivates to the job
centers, how do we ensure we stay occupied?
Keep heads in beds. Heads in bed, baby.
Which is what we're doing right now, where we're making sure we're keeping heads
in beds, even if we're not having to take rent growth and stuff like that.

(01:08:25):
We want things occupied right now just to ensure stability of the asset.
It's coming into what is a little turbulent time. Yeah. And it's a lot of uncertainty.
It's so weird what you're seeing right now, right? You see job reports,
good, but then you see inflation here.
So there's so much pressure to where like one little movement in the economy

(01:08:45):
is causing normal people to not be able to pay their rent or not be able to
pay this because costs are going up.
Yes, their job, they may have it, but we're seeing incomes not rise as fast
anymore and then inflation. So it's just, it's a very interesting dynamic.
That's why they need to get inflation under control or trying to do that.
And we'll see what happens.
You know well justin this was extremely helpful and

(01:09:06):
i hope you guys got to learn as much as i did about how
to start to assess a deal i don't know that i'm ready to
pull the trigger on this property yet we will buy
tomorrow man yeah we'll tune back in to see what happens but this was fascinating
for me because i learned a lot about how to analyze and so yeah i'm going to
take you up on what you offered i'm gonna i'm gonna do my own analysis on some
deals send them to you and see if we get across the finish line and then when

(01:09:30):
we do finally buy our first multi-family we're going to have you back.
Yeah. And the thing is too, is people would be sitting here saying on a deal
like this, you may be saying like, oh crap, I can't come up with 2.3 million.
Well, there's investors.
Correct. And under something like this, you would do what's called syndication.
And me as the general partner or the main person putting it together,

(01:09:52):
I would only really need to come up with five or 10% of that 2.3 million.
So let's say it's 10%. That's 230 grand, 5%, maybe a hundred and something on a bigger deal like this.
So, and then I would raise the rest and you'd say, well, I can't raise the rest. Yeah, you can.
You'd be surprised. You put a deal like this with these numbers in place and
put this into a nice little pitch deck that gets presented out to your investors and say, Hey, Mr.

(01:10:13):
Investor, you give me a hundred grand. I'm going to give you 22% a year on your money.
Yeah. I'd be interested. You'd be interested.
I mean, cause one thing that people with money understand is in order for them
to To keep money and keep growing money, they have to move money.
Yes. They can't just sit in the bank.
Pointless. It's pointless. You might as well just light the sucker on fire.
Or go just go buy something. And someone like you knows this.

(01:10:33):
Someone that invests and has money and wealth and wants to continue to grow
wealth, they understand they have to move their money.
Yes. So you just need to present something that makes sense to them,
and then they need to like and trust you, and they will give you $100,000 to
get 21% of their money all day long if they believe in the deal. And that's your job.
Sell the dream, baby. Sell the dream. Sell the dream. Well, thank you for tuning

(01:10:56):
in to another episode of Back to the Basics. This was a very special one.
One we'll do sporadically from time to time. Bring in experts like Justin to
help us learn, to help me learn.
Because while I'm good at what I'm good at, I am ignorant in a lot of areas.
And there are areas that I need to improve.
And real estate investing, wealth creation is something we all have to do,
whether you're a dentist,
a doctor, a restaurateur, a financial planner, a CPA, or whatever your craft

(01:11:20):
is, as a student, learning how to make your money grow and build generational
wealth is a requirement in a capitalistic society like the United States.
And I'm an avid learner. Question based on seeing a 33 unit multifamily versus
the single family little fund you've been dealing with.
Where are you at now? Where's your mind? I'm looking. My next one is going to be a multifamily.

(01:11:40):
I don't know about 33 and I don't know about the oasis, but it'll be north of
five units. Yeah, exactly.
Start with 10. I mean, think about it. If you went and bought a 10 unit property
that was 100 grand a door or even 150,000 a door in one of these markets that
are good markets. That's 1.5 million.
Even if you didn't have the 30% down on that, you could go syndicate that and

(01:12:02):
bring in 10%. There's absolute ways to do it.
So I tell people, don't worry about the money. Go find the deal first.
Then you'll get the debt and the equity. Yeah.
If you guys are looking for more information on multifamily,
reach out to Justin directly because not only is he an expert,
he also is a GP and he syndicates deals all the time. So maybe you're not ready
to pull the trigger on your first deal yourself.

(01:12:23):
He has deal flow. He has opportunities, ways that you can help make your money grow.
Because like he said, putting in the bank and looking at it is not going to,
you might as well light it on fire. Go buy a nice car.
But if you want to build generational wealth and you're not ready to be the
GP and manage your own multifamily, but you want exposure, Justin's a great resource.
You can find him at? Instagram man maybe just follow me there Justin C.

(01:12:45):
Brennan on Instagram Justin C. Brennan on Instagram and thank you for tuning in take care thanks man.
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