The Legacy Wealth Code Podcast

Mastering Underwriting and Analysis for Real Estate Investments

July 26, 2023 Michael Notbohm & Andrew Hoek Episode 16
The Legacy Wealth Code Podcast
Mastering Underwriting and Analysis for Real Estate Investments
Show Notes Transcript Chapter Markers

Wondering how to master the intricacies of underwriting deals in the real estate sector? How about a dose of insightful market analysis and investment tips from your friendly hosts, Andrew Hook and I? This episode is a melting pot of our experiences and knowledge, offering a well-rounded perspective on how factors like market trends, tenant expectations, and the right property management can significantly impact a property's value and potential.

We kick off with a deep dive into real estate deal analysis, looking at various metrics to determine a good investment, along with potential appreciation prospects. We emphasize the importance of understanding the local climate, population growth, and industry trends. Moving forward, we explore how to gauge investment opportunities and potential growth, emphasizing tenant expectations and the value of a reliable property manager. The episode concludes with our thoughts on the importance of staying updated on market trends and acting based on in-depth research. So, plug in your headphones and let's embark on this insightful journey into the world of real estate!

Onward!

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Speaker 2:

Hey guys, welcome back to another episode of the Legacy Wealth Code podcast. As you can see, sorry for the delay, but the reason is we are redoing the podcast studio. So here we are, live on TV. A lot of people have said we have faces for radio, but now you're going to have to see us going viral here on the interweb so yeah, I got my partner here, andrew Hook, and today we want to talk to you really about underwriting deals, what it looks like, how it can vary market to market. We get a lot of questions about hey, is this a good deal or a bad deal? So we're going to walk through one that was just presented to us about a week ago that we're going to likely move forward on and just go through how we look at it, what we're doing when we're underwriting it and how it might vary from the area that it's in versus like Miami or Tampa or an area that has huge growth on the appreciation side.

Speaker 3:

Yeah, I think you know and I'm excited for this podcast because I feel like one of the things we talk about with investors, and in the course that we do too, is people get reticent about moving forward on a deal and it's almost like they're excited, they're excited, they're excited now they get presented and they're like get scared to pull the trigger right. So, and I think it's natural, you know you want to make sure that what you're doing is a good investment course, and so I think it'll be helpful for people to see kind of, what are the metrics we look at? Because, at the end of the day, what we trust is our numbers right, and that's the only thing, that's the constant that you can trust. And so I think it'll be helpful to kind of walk through this and see the things that we look at. You know what's important and what's not important. What are good breaks versus bad breaks for us in the deal?

Speaker 2:

Yeah, and I mean I think for me, you know, one of the best parts about dealing you know 99% of my business now in the investment space is that it's not emotional. So, like the numbers is pretty much what we rely on. You know we're looking at this deal and I, you know, I would say the first takeaway on analyzing a deal is understanding the market. Is this a market that five years from now you might see a 20 or 30% appreciation in the value, or is it a market where you might see 2%? You know there's a ton of places in the country the deal we'll talk to you guys about today is based out of Indiana and there's a ton of different places in the country that are similar to rural Indiana. You've got Cleveland, kansas City. You know these markets are great from a cap rate perspective they're not great from. You know it's probably going to be worth about what it's worth now, 10 years from now.

Speaker 3:

Well, it's having a conversation with a lady the other day who is she's got she's got a couple of single family properties here in the Tampa Bay area and she wants to sell those, pull her equity out and buy something that's a little larger that she can. You know she's recognizing her equity. She also wants to make sure that she's getting good cash flow off it. And one of the things we were talking about was I said you know you can go to some of these areas where you might see a deal that we were talking about with Aaron the other day was literally a 40 cap when you ran it on a gross number. That is an incredible amount of cash flow, but you may not see appreciation in that market and that property may increase in value 3% a year, if that you know, and you may even see them go backwards in some markets. It's not typical.

Speaker 2:

Which is crazy too, because, like we're talking about 40,000-hour property to getting $1,200 a month in rent. Yeah, but remember, I ran the crime statistics and there's two more dangerous neighborhoods in the country. Like two out of a hundred are more dangerous than the neighborhood we're talking about. So you kind of you know that's really the driving factor of you're not going to see a lot of appreciation unless you see those things change.

Speaker 3:

So you have to kind of think about what you're buying, right Like you're buying either appreciation in certain markets are really hot, or you're buying cash flow in other markets that aren't. But where you really hit these grand slams are where you can get in front of where's a market that is starting to take off or that is going to take off, because now you're getting not only the cash flow but you've also got the benefit of the appreciation, and that's how you really hyper accelerate your wealth.

Speaker 2:

All right, so, and I totally agree with that. So what do you think? You know, I know what my answer is, but I'm curious to hear what yours are when you think about trying to find those, the unicorn, the diamond in the rough, those areas where you're going to get a, you know, 12 cap or 13 cap, but you're also going to see a pretty solid amount of appreciation. What do you think the couple of major factors are?

Speaker 3:

I mean, to me it all comes back to the number. One thing I think it comes back to is population growth. Right, and what I look at when I see trends of population growth are what's tax friendly, because that's a big promotion of population. Where's the climate? Good, I mean, that seems to be. Especially as the boomer generation is retiring out, that seems to be a big one. Where industry is going, I mean that's huge as well, because whether you follow the tech industry or whether you follow manufacturing or auto, any of those, that type of stuff is going to drive population and is what's going to ultimately create the economics 101 of supply and demand, which is going to increase your prices. What about you? What's your?

Speaker 2:

answer no. I was going to say I think that's the old faithful supply and demand idea. I mean, I know it's crazy, but I think that when you look at some of these, I know years ago one of our real estate mentors had mentioned buying in Huntsville and being from Auburn, I know Huntsville fairly well, been there a few times, and I'm like man Huntsville, why in the world would you do that? But I think it was a Kia or a Hyundai factory going in there and on SpaceX. So now you have this area where you're able to buy single family homes. I think they were like in the low 100s that were renting out for over $2,000 a month, so huge cap rate. And then on top of that they're now worth $300,000, $400,000. This is only like five years ago, six years ago.

Speaker 3:

And again, those are the honey holes, those are the grand slams you're going to find. I mean, I look back at the conversation we were having about Arkansas about a year ago when we started digging into that market a little bit. And what's the town that Walmart's in?

Speaker 2:

Yeah, it's like Northern Arkansas.

Speaker 3:

They have the huge Bentonville, yeah, bentonville.

Speaker 2:

That's where Walmart's based on everything.

Speaker 3:

Yeah but I mean, you look at a market like that and it's those you have, walmart, you have I can't remember the trucking company that's there too and you've got like three multi-billion dollar companies that are headquartered in this area and they're putting so much money back into that market to draw.

Speaker 2:

That's the world's longest like mountain biking trail. So, now Airbnb there is going crazy because people that are into mountain biking they go there and I think it's the Walton family that's behind a lot of that. You know the trail being grown out.

Speaker 3:

And it's I mean, it's that idea of you put money back into the community that you're in. You're going to attract more and more people that want to live there, right, and so those are kind of the characteristics I would say are so important to look at when you're thinking about. You know location and at the end of the day, I mean I think you're right location, above and beyond anything other than your numbers, is the number one thing I think you can look at with real estate.

Speaker 2:

So let's go through this deal that we're looking at. It's rural Indiana. Andrew and I flew up there on Sunday night. It was a delightful experience. You got your couple hour delay, thanks to the it was a wild 24 hours.

Speaker 3:

The.

Speaker 2:

Florida, afternoon thunderstorms and then a couple hour delay on the way back. But I feel like we got a lot accomplished and it's the what we got accomplished. I think I made the joke to you. I felt like we're on one of those reality shows where we have like 30 days to make a million dollars and we have Somebody gave us 50 bucks to start with. So we're going door to door talking to people because that's really what we were doing. We knew no one in this town except for the acquisition guy bringing us the deal, but we know what to look for and I think that that's probably the most important part. Going into an area blind is one thing, but if you don't know what you're looking for, going into that area, that's where I think you can run into some risk. And when I say risk to your point, I think a lot of people end up backing out of deals when they get to a hurdle that they don't feel comfortable moving past, and a lot of times that might not be a hurdle that should have killed the deal, but now you just oh, I don't know about that and I'm out.

Speaker 3:

Well, I think some of it also. It's your threshold right, Like we kid about the fact that you would gamble on almost anything and I'm the other way, and together we have a pretty good voice of reason that meets in the middle and that's part of our success.

Speaker 2:

What's all that? One in a million talk.

Speaker 3:

Exactly. But I think some of that's your threshold. But I think you're right as far as, like you know and you got to have your line in the sand as to what it is, that is a deal killer for you, because not every deal is going to work right and so you have to establish that. But I think as you get a little more sophisticated and as you do more and more deals, that line in the sand can move and that's fine. I mean it can be a little bit of a moving target, but because you can get comfortable with some of those things. But I think maybe the most helpful thing is let's start with the numbers, because I feel like the numbers is where we started on this deal and said, okay, the numbers look good. Now let's dig into the secondary pieces of, let's see the property, let's figure out what the surrounding mechanisms of it are.

Speaker 2:

Yeah, well, we have management. Well, we have insurance. You know the basics that you want to do the numbers. You want me to do the numbers.

Speaker 3:

So this is a package of 28 single family properties that were under contract on Market rents right now are not excuse me, not market rents. The existing rents right now are very low. This is a single owner of these properties, self-manages the properties, hasn't raised rents in a number of years, deferred maintenance on these properties, and so the property is spinning off currently just over $12,000 a month in rent. So our and as is, I believe it comes out to somewhere around a 14% cap.

Speaker 2:

So our goal based on the 820 purchase price.

Speaker 3:

Correct. So our goal is to and yeah, and that's where that number is coming in but our goal is to go in improve these properties, do some maintenance on them, bring them up to a condition that we can increase rents, to market rents, become a better landlord probably than what's existing, and then have these are month to month tenants and have people that are rolling on its annual long-term leases and hopefully continuing to renew annually.

Speaker 2:

Yeah Well, and I, you know, driving around the town and that's kind of the human component that was secondary. You know this checked out on paper, now let's go look at it and I think driving around.

Speaker 3:

Before we jump there, let's finish out the, the, the, the, the, the, the, the, the, the market rent ARV, though, because that's what, that's what took us, I think, stamped it to say let's go look further, right? So, from what we're seeing, we think we can increase rents um somewhere probably on an average of about three to $400 a door, depending on the door, and so where that would take us is, if we can, if we can do that across the board, we'd be somewhere between $20 to $22,000 a month in rent um, and our improvement costs are we're averaging about $15,000 a door to do that. So, um, the numbers work on it pretty well. Um, it's something that uh is also enticing to us from a standpoint of there is um opportunity to buy more doors behind this and grow and grow that portfolio there, so that we some of these secondary items that we'll talk about, we can kind of potentially either bring in house or we can, uh, you know, from an economy of scale perspective, get, get at a better rate.

Speaker 2:

Well, unlike we talked about the other day, like my big vision on this is that Hallmark movie where the town has a Christmas parade and we're in it because we've now taken these properties. That were in such duress and given people an actual the most famous person.

Speaker 1:

So, stay tuned, We'll see if that uh, if that happens.

Speaker 2:

But yeah, I mean, these are, you know, driving around. I think what what stood out to me is we're looking at a lot of different properties, um, in this portfolio that are all fairly similar, but driving around the town when we know the market rent is almost double what these are getting right now. The other properties weren't that much different looking. You know what I mean. So we're not having to pour in, you know, 20, 30, 40, 50 thousand dollars to get these to that market rent. We're having to, in some cases, replace a roof which in Indiana is a fraction of what it costs in Florida. We're having to, you know, paint things just to make it look a little bit nicer, replace a few windows. But you know this, you know people aren't expecting to walk in and see shaker cabinets in courts. I mean, this is, you know, somebody that's paying six, seven hundred dollars a month. You know that expectation is that it's just somewhere that's nice to live, that's safe to live. But they're not. You know their requirements aren't these crazy high-end finishes?

Speaker 3:

Yeah, no, and I think I mean it's important too, because I feel like, you know, everybody always says, oh well, I'm just going to increase rents. But how realistic is that? You know and I think that's that was a big, a big thing for us here on this opportunity is that the likelihood of that is actually very reasonable. It's not a stretch to say you can jump these at a minimum 200 dollars a month and probably more, like three to four hundred dollars a month. And so you know, that's something I think you really have to look out for, because I almost every single property that I see marketed says something about increased rents. But then you dive in and you start looking at it and you're like, you know, maybe they're already at market rent, maybe they're above market rent, or maybe there's no opportunity in that market for rents to go higher anyways, right?

Speaker 2:

So yeah, and I mean, I think that this is one of those that, not knowing anyone in particular in that market, luckily, you know, for us having the industry knowledge of, okay, this deal checks out on paper. Now, how do we make sure that we can pull this off? Yeah, so you know that's.

Speaker 3:

Yeah, and that's exactly why the trip became necessary, right, because you know, ultimately, at the end of the day, you know before, it's tough to make a decision without actually setting eyes on and seeing and feeling it a little bit. And so, and I think it also gave us an excellent opportunity to go up and try to forge some other relationships that are important and so yeah, pulling over, hey, you do electrical cool here, you know, you know, and that's really what you got to do.

Speaker 2:

And luckily for us, we just happened to kind of arrive upon a few of, like the people that have been in the neighborhood for years and years and they, you know, very well established in the community. So for us that's a great you know great contact that'll at least allow us to take it to that next step, which, you know, the couple items that are extremely important in this is property management. You know we're 1200 miles away. You know, venture to say most of these people are probably paying cash. The current landlord is not great with paperwork and you know organization. So I would venture to say that cash is probably, most of these people at least, what they've been used to. So, having somebody there that can collect the rent, make sure that you know, in the case of emergency situation, they're there.

Speaker 3:

Well, I think you also bring the fact to that it's local trust right, like I mean, there's definitely an element of like small town USA where it's like you're an outsider versus you're an insider. And so you know there's, and the goal, of course, is that you get to know all these people and they become very comfortable with you, but we're still an outsider to them, and so I think you have to evaluate it from a perspective of local management and this type of scenario is very, very important. And so you know having the right fit as far as, are these people going to be responsive? Are they going to have good contacts to use from a vendor perspective? Are they going to be good about reporting, or are they going to be timely? But I mean, as we've experienced in talking to probably 10 different management companies there, everybody's got a different rate, everybody's got. You know, either we're have a distance problem or it's not really our bread and butter of what we do. You know there's always going to be some of these answers and you go into some of these smaller towns that are not like. It's not like going to Miami or New York where you're saying, open a phone book and scroll for seven pages as to how many property management companies there are you know. But that's a huge piece of not only. Not only is it a huge piece of finishing your crunch your numbers out to make sure that you know your cash flow positive, but it's also a huge piece of you know if you're doing improvement work, you know that there's going to be a lot of hands on with that.

Speaker 2:

Yeah Well, and you know, what's funny is like this last week has been frustrating, I think, for both of us, with calling these different guys and or guys, girls property managers and them being, oh, you know, I don't know if that's a little too far. And you know, it's frustrating because we're trying to get to who is going to actually do this, but in the same breath it's almost kind of like a fresh breath of air, like they're just staying in their lane. So I kind of appreciate that portion of it. Sure, it's like no, I don't want to overstretch, whereas, like in these in the bigger cities, I feel like people will just take on, you know, absolutely I can do it, and then they just epically fail Well, and then you're mad. These people are very reputation based.

Speaker 3:

Yeah, and that's what we kept hearing was my reputation is all I have and I can't tarnish that. Well, I mean, that's to be respected, right? Yeah, it takes a lifetime to build it and a few minutes to lose it, you know. So I think those are important things. But some of the other things I think we talked about while we're up there is insurance. So we've got local insurance people working on these deals versus we're a little tainted being in Florida. Exactly.

Speaker 2:

You know, insurance scares the crap out of all of us because we're like whoa, they're going to pull out? Is there going to be a hurricane? You know, there it's not. It doesn't seem like it's as big of an issue, which for, I guess, for both of us, it's probably a little bit of a. You know, it's a relief, but we're also still like I don't know. I don't know, you know, because we're just so used to insurance being a nightmare.

Speaker 3:

Yeah. So I think you know, again, trying to find it on a localized level, they understand the product better, they understand the issues better. It's not like you're getting. I mean, could we find a Florida-based insurance agent to write a policy on these? Probably so, but they're not going to understand the dynamics of that town that needs what those people run into from a standpoint of what claims actually look like on a regular basis. So the localized insurance is, to me, is a big thing as well, and I mean I think you end up with better quotes, you end up with more realistic coverages. But again, I mean that all fits back into your numbers too, of course, right.

Speaker 2:

So Well, I think for us you know, just to kind of bring this full circle as to why this deal makes so much sense for us is the purchase price, is we're buying at like a 13 cap, which is good? And going back to the very beginning of this episode, where we talked about markets that are appreciating at a very high rate usually have lower cap rates, and that's why, when you're analyzing deals and markets that may have a slower amount of appreciation, you definitely want to have a higher cap rate. So going in at a 13 cap with the ability to raise it into the 20s is awesome. But for us, I think, one of the biggest factors is the fact that there's a lot of like EV. No motors has something going on there. Solantis is 15, 20 miles away, so you start seeing these huge companies putting in a ton of infrastructure. That's a driving factor. That could be, you know, that drives the property values to go up over the next five or 10 years.

Speaker 3:

Yeah, and I mean again back to that point as to you know, you now have not only the cash flow, but we've got the opportunity for appreciation as the areas stabilize, or whether they're already stabilized and they remain, you know, a flourishing area to come. Either way, you would imagine that your prices are going to increase as your population increases, and so I mean that's the best case scenario on it, and I think this deal, you know, obviously for us great opportunity.

Speaker 2:

But these deals, I think, do come around quite often for people and as you, you know, whether you're a seasoned investor or fairly new understanding like okay. So these are some of the factors I really got to look at and I think there's really only a few that are extremely important, which is the numbers penciling out to whatever. You know everyone might have their own you know box. You know just like a buy box for a hedge fund they have. This is the cap rate I'm going to get or I want. This is, you know, I want to buy in a market that has some type of you know whether it's a manufacturing or tech company. You know where there is an upside. But then you know understanding those other variables that, like the insurance the property manager, do I have a good roofer? Can I get a good handyman? Because those are the things that could ultimately be a deal killer. Yep for sure. You might already have bought it, but your profit margin gets sucked out because you don't have a trustworthy contact that's doing something for you and they're siphoning money, which happens all the time.

Speaker 3:

Yeah, yeah, I mean, and especially in some of these that have deferred maintenance, you know up front those costs are going to be front loaded and it can bleed you heavy early on if you're not prepared for it. You don't have the right people doing it, because all it takes is one bad contractor and you're really in the red on your deal out of the gate. So I mean that's important, but yeah, so just to kind of recap, I mean, yeah, again, we always start with numbers and, as we said, the numbers vary a little bit depending on the market and where we need those rates to be, but the numbers are always kind of the leading point for us. And then, as you get comfortable and solidify your numbers, now we're looking at sort of some of these secondary things that play into your numbers to a certain extent, because they're operating costs, but also, you know, getting to know your locations and getting to know your providers and the people that you're going to lean on. You know whether it's insurance, property management, maintenance, whatever it is. I mean those relationships at the end of the day are going to be very important and then have your exit plan. Yeah, exactly, and yeah, we haven't really talked about exit, but I mean, that's the other thing that I like about this deal is there are so many different exit plans and I think that's the one thing that you know, not the one thing we've done. Well, but when we do vet a deal, I think I can think of maybe one or two deals we've done where your exit strategy is limited to like one option. Yeah, because normally I mean for us, I feel like we look at it and we're like we could flip this thing multiple ways, whether we do a long-term rental or short-term rental, whether we sell or finance it, whether we end up selling it outright. I mean usually there's a variety of different exits on those properties and this is one of those that has numerous different ways that it can be exited out of and they're all beneficial.

Speaker 2:

Yeah, I would think that you know, looking back, we definitely sucked in the beginning.

Speaker 3:

Well, in the beginning, the only exit was to resell Holy cow. We can make 40 grand in a month. This is awesome.

Speaker 2:

Sell it and then now those are worth. You know twice what we would have what we paid for it. But that's just. I think that's part of the learning curve. Which is why we're doing this podcast is just to try to you know, as we've tried, and I wouldn't even say failed, because I mean you buy something and you sell it a month later for 40k more than you bought it for and you didn't do anything to it, is not a that's not a loss, especially when you're talking about, like a hundred thousand-hour property. But we were laughing about it when we were up in Indiana because those same properties now are trading at 300, 350,000. So now it's a 3x return versus. And you know, those are just some of the lessons that we I think we've learned over the years. But yeah, I think this is good because for us, I know that there's probably been a handful of deals we've passed on because we were scared off by something that we didn't have any experience doing. So you know, obviously you got to get the experience by doing things, but I think at least hearing from people that are doing it maybe it'll give some confidence to some of our listeners that you know, as long as you know what you're getting yourself into from. You know a list of these are the things that I need to figure out. You don't have to necessarily know that market inside and out, as long as the numbers make sense and you know what you're looking for.

Speaker 3:

Yeah, I agree and I mean hopefully this is helpful. I mean I think you know when you break it down and you look at, these are the items that we really look at and how we dissect a deal and hopefully there's some good takeaways for you.

Speaker 2:

Yep. So now that we are here in studio, stay tuned for, hopefully, weekly episodes. That's our goal, so we're going to try to film a couple have like a little.

Speaker 3:

I feel rusty right now. Yeah, I know I was going to say, but it's good to be back, so we appreciate everyone's patience and until next time onward.

Speaker 1:

Thank you for joining us for another episode of the Legacy Wealth Code podcast. If you enjoyed this episode, click subscribe now and never miss an episode until next time onward.

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