Cash Flow Won’t Ever Make You Rich

David:
This is the BiggerPockets Podcast, 837.

Kevin:
My real estate point of view is if I buy a place for 500K and I’m into it for 5 with fix up, I want $100,000 of equity. That’s my goal. Which percentage wise is 20%. So now if I look at investing a million dollars, I want $200,000. I’m actually not the biggest fan of caring about so much what the rent is and the rent cashflow percentages. I want that equity because that’s tax-free money. I hate paying taxes. I paid enough taxes and I’m tired of it.

David:
What’s going on, everyone? It’s David Greene, you host of the BiggerPockets Real Estate Podcast, the biggest, the best, the baddest real estate podcast in the world every week bringing you the how-tos, the stories, and the current events that you need to make good decisions in today’s market. And in today’s show, even though I’m recording this from BiggerPockets’ conference in Orlando, I’m going to be with Meet Kevin of YouTube, Kevin Paffrath. We are in LA at his place, and we’re going to be taking questions from you, our listener base, and we have a great show for you. Kevin and I get into a lot of interesting topics from the greater economy to individual specific deals, a little bit of everything today. And most importantly, we cover a lot of people who should not be buying deals. Not every single situation is something where you should pull the trigger. We have several today where we say, “Hey, you should not buy this deal. You should not partner with this person. This is a bad idea.” You’re thinking about it the wrong way, and here’s why.
Very excited to bring this show to you. But before we get into it, today’s quick tip is simple. Get your tickets for BiggerPockets Conference 2024 now. Many people are trying to get into this one in Orlando, but unfortunately tickets were sold out and the best hotel rooms were taken. If you would like to meet me and other BiggerPockets talent as well as a lot of other jazzed up real estate investors, go to biggerpockets.com/events and get your ticket now. All right, get ready for a great show.
The first question will come from the forums. This is from Don K. in the Woodlands, Texas. Don says, “I target 12% on my passive real estate investments. 20% or more for active real estate investments without taking excessive risks at a maximum leverage of 50%. What is your target for return on investment annual on your passive real estate investments? On your investments, which require a more active participation, how do you calculate that and has it changed as years go by?”

Kevin:
Wow.

David:
So Kevin, target ROI, what do you shoot for?

Kevin:
It’s really interesting. I am not a percentage guy, which is crazy because I’m like Mr. Finance, especially with stocks, and we’ll talk percentages there and growth rates. But when it comes to real estate, I have a really different way of looking at real estate. My real estate point of view is, if I buy a place for 500K and I’m into it for 5 with fix up, I want $100,000 of equity. That’s my goal, which percentage wise is 20%. So now if I look at investing a million dollars, I want $200,000. I’m actually not the biggest fan of caring about so much what the rent is and the rent cashflow percentages. I want that equity because that’s tax-free money. I hate paying taxes. I’ve paid enough taxes and I’m tired of it. So that’s my point of view.
I will say, when I hear these numbers, the question was phrased as this is someone’s target, and then they say, without risk, it doesn’t sound like reasonable. Especially if this is cashflow, it doesn’t sound reasonable. If you got maybe this is a flipper and it’s in an appreciating market, maybe that’s realistic then. But otherwise, I think if we’re talking cashflow here, I think it’s a little loony.

David:
You’re making a really good point. Also to highlight, when you speak with more experienced investors, successful people like yourselves, it’s not that cashflow doesn’t matter, but the conversation trends away from cashflow.

Kevin:
Oh, quickly, yes.

David:
Right?

Kevin:
Yeah.

David:
When you’re new, this is all that people talk about. It’s all they think about. I have a book that’s going to be coming out soon about the 10 ways you make money in real estate, and the natural cashflow is one of them. Well, that’s the only one we all hear about. There’s different reasons why that may be. My gut tends to believe it’s because the influencers, the gurus, the people that want you to take their course, they have to sell you on cashflow because cashflow is how you get out of your job, it’s how you get a girlfriend, it’s how you make your dog like you, it’s how you get on the yacht with the hot chicks. All the things that have nothing to do with the reasons you should be pursuing financial independence are related on cashflow, right? So it becomes this magical carrot that everybody wants to chase. Now, what you’re talking about with equity, great point, not taxed. What’s your take on how you buy properties that aren’t going to cashflow without losing them?

Kevin:
Right. Well, so this is very risky, and I want to finish off also on just one of the last things you said. I think that’s so interesting because you’re right. It’s this idea of selling this goal of financial freedom. I think as soon as people start getting dividends, like in stocks, which I think are a complete ripoff, you shouldn’t touch dividends unless you’re retired, and then cashflow and real estate, the problem is people then take that cashflow but then they spend it on going to the mall or going on a vacation or whatever. And so now you’re paying taxes and you’re not even building your wealth because you’re just blowing it. It’s so stupid. So I wanted to add that part.

David:
That’s a good point.

Kevin:
So-

David:
When you don’t spend equity, it’s hard.

Kevin:
It’s hard. That’s the point. The harder it is to spend your investments, the less likely you are to do it. Harvard did a study. They said if you have cash in a savings account, you are nearly 100% likely to spend it. If you have cash in an investment account, a brokerage account, you are nearly 100% likely not to spend it because it’s psychologically punishing, “Oh, I’m going to rob from my investment to go spend money.” Whereas if there’s a dividend or a rental income coming and it’s going right into your checking account, you spend it. Now, I’m going to have to ask you to repeat your question.

David:
No, no. The question would be, let’s say that we have someone here in this, they’re like, “That makes sense. My take is equity is easier to build in cashflow. It’s very hard to control cashflow itself.” You are dependent on what market rents are and expenses are going to be what they are. You can’t just eliminate expenses. But equity, you do have some control over. You can improve a property, you decide what you pay for it, you pick the market you buy in. You have an easier ability to build wealth when it’s through equity. The downside is, how do you make these payments? So what’s your advice for someone who says, “Yeah, I can understand the wisdom of this, but I don’t want to lose the property”?

Kevin:
Right. So when I bought my first house, we realize the payment was going to be about $1,950, PITI, plus we figured there’ll probably be some things that break or whatever. So add another couple hundred bucks. That was around 2,150 bucks, and we went into that barely making 2,100 bucks. We did not make enough money to comfortably make that, but we’re like, “But it’s a great deal.”
So we were in a situation where I was just starting my real estate career so I wasn’t making money. It took me 11 months to close my first real estate deal. That’s 11 months of no income when you’re making these payments. So it’s really scary, and I would never recommend that to anyone. The reason I did it with my wife is we looked and we said, “Look, worst case scenario, we could rent this place out for $2,500. Next worst case scenario, we could move roommates in. It was a three bedroom, two bath. We’ll be in one. We’ll rent out the two other rooms for 600, 700 bucks a piece. That’ll help offset a lot of the payment, the traditional house hacking.”
So we created these little hedges, we’ll rent it all out if we need to. We’ll rent out the rooms if we need to. We’ll go move back in with mom and dad if we need to, whatever. And I realize not everybody’s as lucky to be able to say, “Oh, we get to be able to have a fallback of moving back in with mom and dad.” But I also realized when you have nothing, it’s really hard to lose. So I was willing to take that risk with my wife. We’re like, “Well, worst case scenario, we’re going back to zero.” We’re like, “We already are at zero.”

David:
Good point.

Kevin:
So now, if somebody has already… If they’re looking at interest rates today and they’re 7, 8%, unfortunately I see people doing this, and this really scares me, as people are saying, “Well, I’m betting that rates are going to come down.” So somebody sent me a message, they’re like, “Hey, I want to buy this duplex and the payments going to be $4,500 was the payment in Florida.” I’m like, “Okay, well what’s the rental income?”
“Oh, 2,500.” I’m like, “This is a terrible idea.” It’s a negative 2,000 guaranteed. With it, 100% rented out, and you have to pay for yourself to live somewhere else. So then the next question is, “Well, what is your capacity to float basically a negative almost…” It’s 24,000, but add in maintenance and other stuff. “What’s your capacity of float?” $30,000 of additional investment every year? “How much money are you making?” Well, so this is where we have to consider individual suitability. If you’re making 5 million a year, who cares, right? Sure, okay. Maybe you think you got a great deal, you really wanted that property, whatever. But if you’re making an average income 50, 60, 70, 100K, hell no. That’s stupid. So I think that’s number one, is what’s your income. And your goal, I’m pretty sure you talk about pretty regularly in your book, which is increase your income, right?

David:
That’s exactly right.

Kevin:
Yeah. So if your income’s low, increase your income first. Focus on that. How could you provide more value to society? Realistically, you’ll probably make more money focusing first on making more money. Anyway, different topic. So for most people, I think big negative cash flows are a very bad idea. If you’re negative 100 bucks or 200 bucks, you ask yourself, “Well, can I float another 1,200 bucks a year or 2,400 bucks a year?” Well, most people can.

David:
Right.

Kevin:
So that’s my line, is what’s your ability to float that as an additional investment? And is that an investment worth throwing more money at? If it is, maybe 100 bucks a month makes sense.

David:
Would you give up $100,000 of equity so you don’t lose 100 bucks a month? Does that sound smart?

Kevin:
No. No, no, no, no. So my thing is I would rather lose 100 bucks a month and have 100K of equity because it’s going to take me 10 years. Or no, it’ll take me like 80 years, you know?

David:
Yes. That’s exactly right. The cashflow method takes a lot longer to build up that wealth, but the downside is you can lose it. So what I hear you saying is focus on ways to manage finances outside of that individual asset.

Kevin:
100%.

David:
The stronger of a financial position you’re in, the less you have to worry about the return on the cashflow and the more you can get into the spaces where big wealth is made and you’re not taxed.

Kevin:
Well, consider the principal paydown as well. If you’re negative 100 bucks, your principal paydown is probably 400 to 700 bucks a month. Well, that’s literally money you’re putting into that forced savings account you can’t spend. So you’re technically not really negative. You’re technically positive.

David:
That’s in this book that’s going to come out after Pillars. That’s the argument I make, is that real estate makes you money in so many ways, but when you only focus on cashflow, you stop paying attention to the money you’re saving in taxes through depreciation and the principle pay down that’s happening and the amortization schedule that favors you the longer you own it and the equity and the rents that go up every year if you buy in the right area, that there’s a chess aspect to real estate investing and when you’re just trying to play checkers, you’re just looking at cashflow. So I think that’s a great answer.

Kevin:
Yeah, it’s incredible because I think that’s the problem though, is people discover us on social media, but the mainstream idea on social media is cashflow. And so then you get the… Let me put it this way, what tweet’s going to go viral? A tweet where you break down, “Hey, if you buy a house, you get these tax benefits principle pay down. You get all these long-term, 10 different ways to make money.”

David:
[inaudible 00:11:29].

Kevin:
Right? Is that going to go viral? Of course not. How about, “Why would you buy stocks or real estate if you could make 5% on a money market fund?” Well, those tweets do a lot better because it’s simple and it appeals to everyone, like, “Yeah. Real estate sucks. I’ll get it in a money market.” Well, how long is that money market going to offer you? 5%. What wealth are you going to actually build?

David:
Great point. So when you’re getting your information from free sources like the internet, expect that you’re not going to be getting the most accurate information. You’re going to be getting the most sensationalized, which is why they’re listening to us because they’re going to get real talk.

Kevin:
And I’m not anti Elon, but it’s one of the reasons I’m so frustrated with platforms like Twitter, is they incentivize how do you get somebody to stop scrolling and interact with your post. Well, the way you do that is with something sensational. Whereas don’t get me wrong, I feel like the sensational title guy on YouTube, but the point is, when you get in the video, you’re now listening to a 20-minute video or whatever it is on real perspective, which you’re not getting in a ten-second tweet that you’re committing.

David:
All right, Don K, hope that helped. Our next question comes from Jaron W. in Indianapolis. Jaron says, “Every one of our single family rentals have trapped capital. They’re all BRRRRs. I believe that’s a fancy way of saying equity. I’ve never heard of trapped capital. That’s interesting.” I think that means he left money in the BRRRR. He didn’t get it 100% of it out. “It’s nearly impossible to not trap capital if you’re buying and holding rentals right now. It’s a good problem, I suppose, but it’s nearly impossible to grow a portfolio without finding more cash. As an experienced investor, what advice can you give to younger people tackling this issue? Should I leverage more? Should I partner up? Should I stop trying and sit on the sideline?” So Jaron here has the issue of he’s doing some BRRRRs and he didn’t get all of his money out and he’s just run out of capital, but he wants to scale a portfolio. Common problem. What do you say?

Kevin:
Well, first of all, look, everybody’s got a different strategy. I hear partners and I think, “No thanks.” I have seen so many partnerships destroy families, friendships, relationships out of stupid things like what color the doorknob should be. It’s absolutely insane. And so if you’re going to ever do partners, you got to have somebody who’s making the decisions and somebody who’s not. If you’re going to have a partnership, please have that relationship established. I have found that I like control. As a result, I have found I don’t work well with partners. I can work myself making decisions with a team of people who are [inaudible 00:13:56]-

David:
Executing your decisions.

Kevin:
Yeah, my decisions and my formula. But yeah, anyway, so I hear partners, I shut down. Stop trying, I think, is the wrong answer. I think you should be trying in a different way. Leverage is, I hear risk.
So my thinking is, what can the individual do to increase their other sources of income to make sure that you can keep investing> this idea of trap capital makes it sound like it’s bad. That’s how you build wealth, is you don’t need to be leveraged to the hilt. I remember just over this last decade post the financial crisis, seeing my properties over time, they get to leverage ratios that would start at 75% on refinance and then all of a sudden they’re at 65%, then they’re at 59%, and I’m like, “Oh, I can pull money out of this.” But what I always told myself is I’m going to leave those there on purpose as little piggy banks, because one day something’s going to hit the fan in markets and then I’m going to go break those piggy banks. I’m going to take the hammer and I’m going to break the piggy bank and then the cash will be there when I need it, rather than always trying to be perfectly leveraged.
And I suspect Mr. Trap Capital, I think it’s Mr. Trap Capital, is a spreadsheet kind of person, and they’re looking and going, “Oh, There’s 20K left in there. I don’t know. Now my ROI is slightly less. If I had that 20K, my ROI would be slightly higher.” Usually, folks who get so in the weeds of spreadsheets don’t succeed long in real estate. I don’t know. That’s just my impression.

David:
Because the spreadsheets are an idealized version of how you want the world to work. Then you get into the business and it doesn’t work the way you’re thinking.

Kevin:
Real estate’s a people business, not a spreadsheet business.

David:
I really like your points there, especially the part about you should be making money outside of real estate. That does not get talked about in our space. It’s one of the reasons that I wrote Pillars of Wealth, is because I was frankly tired of people coming to me and saying, “David, I have no money, no credit, no job, no skills, nothing to offer the world, and I really want to invest in real estate. Can you show me how to do it?” And I’m like, “Look, if that’s where you are in life, we need to have a conversation about how you get money, credit, skills, value, not how you go invest in an asset that can hurt you if you don’t have sufficient capital to weather a storm.”

Kevin:
Bingo.

David:
So let’s say you’ve got a little brother and he comes to you, you love this little brother, and he goes, “Kevin, I keep getting fired from my jobs because my boss wants to be there at 9:00 AM and I like to sleep in. I can’t get a girlfriend because I’m 80 lbs. overweight and I don’t make eye contact with people. I have no confidence. Can you help me get a job that I make a lot of money, but I don’t have to wake up early and can you help me find a girlfriend that doesn’t care that I’m 80 lbs. overweight and have no confidence?” Would you tell him, “Oh yeah, there’s this crypto thing”? Right? “There’s this NFT where you can make all this money and you don’t have to change anything.” Or would you say, “Look, I love you little brother. We need to get you on a treadmill. We need to build up your confidence by doing some hard things in life, or you need to get out of bed earlier”?
What is the answer? Do we give them an easier route or do we say that the problem starts with improving what they’re doing?

Kevin:
I think we have to remember that we’re in a world that rewards capitalism and capitalists. So you have to become a capitalist. And so then we look and say, “Okay, we’ll watch what successful people do and copy them.” What do capitalists do? As much as that word can be negative to people who just want stimulus checks every day, that word comes across as negative when we want to sleep in. But the reality is what do successful people do? Well, they work hard. They work long hours, they wake up early or they have routines, they have systems, they have value that they can provide.
And so sometimes that means if we’re starting at zero, we go, “Okay, well fine. I want to become more like a capitalist. Where do I start?” Well, how many licenses do you have? They’re not that hard to get. Licenses, surprisingly, have very few requisites. Go become a real estate agent, become a lender. Just by going through those tests, you’ll learn so much about… And look, don’t get me wrong, we forget most of the stuff that we study for these tests anyway, but it gets you in the mindset of thinking, “Oh, there’s 10% here that actually really applies to the business of lending or real estate or finance and you learn.” Now when you sit down with somebody at an open house as a realtor and somebody says, “Well, how do I run this amortization or a discounted cashflow or how do I do whatever?”, you know because you’ve actually trained yourself. If you don’t have a skillset and a way to provide value, you won’t make it.
So the beauty though is there are plenty of people who don’t provide value, which as soon as you figure out how to, you can succeed. And there are plenty of ways to do it, whether it’s in finance or real estate. That’s the whole reason the BRRRR method exists, which is buy a place that’s a fixer upper and renovate it. The reason that’s not arbitrage to zero is because it’s hard. You need people skills. You need to be able to work with contractors. You need accounting skills, money management skills. The way you get it is by working in business. And so working really hard and getting underpaid for many years while you build experience will help you in the future be able to work less and be overpaid.

David:
That’s great. It’s investing in yourself. When you hit the ceiling that you can’t get where you want to go, that’s a good thing because it makes you reanalyze what you’re doing. So Jaron, you’re trying to make money through one pillar, which is investing, and that’s great. This is why you need to incorporate other pillars like other ways to make more money just like what Kevin said. All of a sudden these problems go away when you’re not trying to just do it all through real estate investing.
All right. Our next question comes from Albert Knoe out of Boston. “I need a sanity check here if what I am thinking makes sense.” I like how we started this off. “I own two triplex properties, one of which I’m trying to BRRRR. I’m a buy and hold investor and in this for the long game, which means I have to break even for a few years while I still get appreciation, tax benefits and raising rents, then I’m willing to make that sacrifice. A lot of investors I know are pushing me towards cashflow and leaving the current deal as is until interest rates get better, but this of course cuts me off from the repeat and BRRRR.” Here’s the details. So Albert Knoe has a BRRRR here that’s 100% leveraged and is breaking even. Is this a bad investment or is this a good investment?

Kevin:
Yeah, it’s incredible. We’re just looking at the details and we’re like, “Wow.” At first I’m like, “Oh my gosh, he’s 100% leverage because he funded his down payment from a HELOC.” And then we’re looking at it going, “He’s going to be massively negative cashflow.” And then we’re like, “Wait a minute, he’s breaking even, 100% leverage?” Look, we have this rule of thumb, it’s called the buying window. The buying window is deemed to be open when you could borrow 100% and break even or have cashflow. That’s what he has here. I think one of his comments was, “Well, I’m only going to break even for a short period of time and everybody’s pushing me to sell it.” Why? This seems great. It blows my mind. I mean, I think if interest rates go higher, maybe there’ll be some risk, but he’s even got cashflow on top of that. It was like a thousand bucks or whatever. I don’t see an issue here. It looks like he’s got $300,000 of equity. He got a great deal and he’s got extra capacity to be able to make the payments.
The only way I would sell this is if I just got injured in a car accident and I couldn’t work anymore and I was screwed basically. But other than that, if you’re capable of capable of functioning in society, providing value and making money, why? Tell your friends to shut up and go invest in real estate. How much real estate do they own?

David:
Yeah, presumably it’s in a good appreciating market because he bought it for 815,000. That’s not a cheap market.

Kevin:
Right. And a price for what? 1.1 or something?

David:
Yeah.

Kevin:
Yeah. Well, but to triplex, so 300K a door-ish, a little less. Yeah. I mean, look, it’s a great asset. I don’t know why sell it here. I don’t see this friend’s argument at all.

David:
There you go. So moral of the story is cashflow is a thing to look at. It’s not the only thing to look at. This guy basically paid 815,000 and appraised at 1.1. He’s walking into close to $300,000 of equity. How much money do you have to make at a job to keep 300,000 after being taxed, right? 400,000, $450,000. That is a good investment and it’s probably going to get better. But you made a great point. It only works if you have income coming in from other sources to float you during the period of time that you’re waiting for the rent to appreciate and cashflow to grow.

Kevin:
Exactly.

David:
All right, we hope you’re enjoying this shared conversation so far. Thank you everyone for submitting the questions that you did. Please make sure that you like, comment, and subscribe to this channel as well as checking out Meet Kevin on YouTube who came in for backup with me today. At this segment of the show, we like to go back and review comments that you have left on previous shows. So let’s see what some of you said. The first from Julian Kovard8345. Oh, I recognize Julian. “It feels so good to hear this adversity story at the end. I just recently closed on a townhome that was a five and a half month transaction. Sometimes I feel as if I’m the only one going through all the BS. Glad to know that there’s someone else out there who had to struggle as well.” This comes from episode 357, so if you want to know what Julian is referring to, go check out podcast episode 357.
From Donya Salem. “David: when you get a deal, you’re literally getting a problem. You’re getting someone else’s problem.” Oh, this is me. She’s quoting me right here. David says, “When you get a deal, you’re literally getting a problem. You’re getting someone else’s problem. Damn, that’s a nugget of knowledge.”
And then Fine Art on Fire said, “Isn’t it though? That’s wisdom really.” Well, thank you guys for that. Definitely appreciate it. This comes from people that are trying to find a great real estate deal that cash flows and as equity and is in a great neighborhood and is easy. Those things are never going to exist in the same deal.
Jamal Adams says, “Volume over perfection. Fine leads, run comps, make offers. I had to refocus on this concept when I got in a rut.” Good comment there.
From Technically Human GX, “This is the real estate version of when Charlamagne Tha God came onto the Joe Rogan experience.” Definitely check out episode 357 if you want to see what Technically Human GX is referring to there.
And from podcast episode 822, Street King says, “I don’t leave comments often, but you and Brandon have helped change my life. I’ve been interested in real estate investing for some time. I read a few books by Brandon and yourself and finally took the leap and purchased a property in February. It was exciting and nerve wracking at the same time, but had been so much fun with a lot of learning on the way. With your words and knowledge I receive from the BiggerPockets podcast, I feel I have the knowledge I need to be successful. I am thankful for this episode and the info on building equity. I can’t wait to purchase my next property and continue to build my portfolio. Thanks for all you guys do.”
And our last comment from Keith Manseneli. “Wow, I listened to as many of these as I can, but with so many investors in different situations, they don’t necessarily apply to us at this moment. Almost all of the QAs in this episode were directly relevant to us right now. Thank you for all your answers and breaking each subject down for us to understand. Thank you, David, and to all of you on the BiggerPockets Podcast show.” Thank you for that.
As always, we love and appreciate everyone’s engagement, so please remember to like, comment, and subscribe on our YouTube. And if you would like to be featured on the show, go to biggerpockets.com/david. We would’ve had this link set up sooner. We just couldn’t think of a name for it, finally got that figured out. You can submit your video or your written question to be answered on the Seeing Greene episode.
All right, jumping back into this, Kevin, our next question comes from Hayden McBride in Asheville, North Carolina. Hayden is new to investing and saves a good portion of their income. In about a year, they will be moving to Wilmington. “I currently work as a housekeeper for a company that manages short-term and midterm rentals. I think this is a different perspective than most people who come into the real estate business and could potentially be beneficial. I see what types of homes are rented out more often and are more desirable depending on size, type, location, amenities and many other aspects. My question is, do you think that a background in the hands-on work of the upkeeping of rental properties gives me any sort of advantage for getting started in the real estate business, either investing in real estate or in being an agent?”

Kevin:
Oh my gosh, absolutely. I mean, if I had a list of people who were like, “Hey, I want to apply to work with your startup house hack,” and they gave me that background of like, “Hey, I basically am a property manager and I’m doing all these,” I’d be like, “Please, apple.” This is great. I think sometimes people don’t even realize the advantages that they have. They need somebody else to tell them like, “Go do it. You’re good. You’re good.” You got to have that self-confidence. This background, amazing. This is what you need for real estate. You got to have real estate property management background, and you’re either going to get it by learning it yourself when you do it and you don’t have it. Or if you go in, so much easier. And I was listening to some of these comments like, that you’re taking someone else’s problem, the five and a half month transaction, yeah, totally normal. That’s why there’s so much money to be made. If you’re able to solve these problems, you can make a lot of money.

David:
It’s the barrier to entry. People run away from it and they need to be running to it.

Kevin:
Yep.

David:
All right. Next question from Boris Slutsky. “I’m currently looking for private money investors who can help me to fund a portion of the entire down payment.” That’s funny, a portion of the entire down payment. “Portion of the down payment for my next property, and I have a few people who said they might be interested in being debt partners in the deal. My question is, how do I provide a proof of funds for the lender or to the listing agent to even get pre-approved for the loan or to get the deal under contract? Is there a way of using my investor’s financial statement, showing the funds available, plus a broad letter of intent stating that they have general interest in investing with me or something like that?”

Kevin:
I mean, look, as a real estate broker who’s dealt with nonsense offers for 10 years, I wouldn’t touch this with a 10-foot pole. So what they really need to do is cash in the bank, baby. If you’ve got debt partners, then maybe make an agreement that, “Hey, there’s no interest for the first month, or we’ll add that to the back or whatever,” but get that money funded. If somebody is interested in providing debt, you got nothing. If somebody provided you capital and it’s in your bank account and they’re now out of the picture, well now you have the capital. Now you can actually put it to work. But my next concern on that is if you’re asking, “How do I now get pre-approved?”, well now it gets even harder because lenders look for debts if they’re going to count this debt against you, because it sounds like you haven’t gone through the pre-approval process already-

David:
They’re going to source those funds for sure.

Kevin:
They’re going to source this unless you leave them sitting there without making payments on them. But then really you’re not disclosing this debt to the lenders, which is defrauding the lenders anyway. Really, it sounds like somebody got an idea and they’re way ahead of themselves. How about we go back to step one in real estate, qualify, demonstrate, close. Oh, step one, qualify. Call a lender. “Hey, hey, mortgage loan originator.” You literally go to Yelp, type of mortgage loan originator. I used to be an MLO. “Hey, here’s my situation. Here’s how much money I make. What can I qualify for? What do you need from me? Oh, okay, tax returns, W-2s. Here we go.” And if their follow-up is, “Oh, well, I don’t have a job,” well then that’s really where your first step is, is get a job, right?
People are always like, “Oh my gosh, it’s an investing channel, Kevin. How could you say get a job?” That’s like an insult. I’m like, “Well, the easiest way to actually build your investments is have a job.” In fact, there are a lot of people who didn’t like their job and then they got into investing and they realized, “Wow…” I used to be a law enforcement explorer. There were cops that were like, “I hate this. I can’t wait to retire.” And then they get into real estate investing and they’re like, “Now I love it because I take my W-2 with overtime.” Some of these officers, staff or whatever who were ranking, they’re making over 100K. They’re like, “I now milk the fact that I have a W-2, I qualify for real estate all day long.” It’s great. You’re self-employed and you have income. It’s a pain in the butt to get qualified.
But anyway, so the structure of this person’s question somewhat implies to me that they don’t have a job, they haven’t been qualified and they don’t know what they’re talking about, which when those three things come together, I also get really nervous about them wanting to take on debt because I think they’re going to mismanage this.

David:
And it only gets explained in our space as a positive thing. Take on debt, make real estate, make a bunch of money because you only hear about the deals that work. Nobody goes on these podcasts and says that, “I did that and it was a complete disaster.” We did an episode with Luke Carl and he talked about how he worked his W-2, saved his money, invested. That’s the same way that I got started, literally as a cop working crazy over time buying properties. I said we need to rename the W-2, which has a bad connotation and start calling it the down payment generator.

Kevin:
Oh, that’s a great idea. Absolutely.

David:
Yeah. How do you get better at your job so you can make more money so that you can buy more real estate? And I know that this sounds different than what people get used to hearing, but really if you showed up at the gym and said, “I want to start lifting weights, I want to get stronger,” you would quickly realize it’s not just about lifting weights. “I’m going to have to eat different. I’m going to have to sleep different. I have to learn the form.” There’s a whole thing that goes into this. You guys were training martial arts, right? The person comes in, they go to training, you realize, “Oh, I need to improve my cardio. I need to improve these areas of life.” Anytime you want to be successful at something that you start, you quickly realize where you’re deficient, and that’s okay. You just make improvements in those areas. And I don’t think real estate investing is any different.
So Boris, if you’re having a hard time coming up with the down payment money for the house, what if you just use an FHA loan and you house hack and then in a year you go do it again and you turn what you bought into a rental property. You don’t have to borrow money from people and put this complex Rubik’s cube together of how you can get a house or a lender. Just use a primary residence loan.

Kevin:
Yeah, it’s funny. I wrote that down and didn’t mention it. So thank you for saying that because you’re so right. It’s like just borrow from the bank. And if you can’t qualify for an FHA loan, maybe you shouldn’t be in the deal anyway. But I mean, that’s how I got my first property, is 3.5% down. And then the bank will even finance the renovation for you. Now, that takes patience and it’s kind of hard. I don’t really recommend it because it’s a pain in the butt.

David:
The 203(k) [inaudible 00:31:30], yeah.

Kevin:
The 203(k)s, yeah, that’s exactly what we did. And they gave us 50K, but then we borrowed from a second later because it’s so hard to get the draws on those 203(k)s. So we borrowed from another source, used their money to do the reno-

David:
And then replenished it with the 203(k) [inaudible 00:31:45].

Kevin:
Exactly. Yeah, yeah, yeah, because it’s such a pain in the butt, the process otherwise. But anyway, the point is, you only need 3.5%. You know what? On 500K, we’re talking about under 20K.

David:
There you go. All right. Next question is from Wesley Abercrombie. “Hey David, I love your content. I saw you post a video on Instagram about how the BRRRR model doesn’t make sense for every home. Instead, sometimes a flip could make more sense depending on the profits. What would you say that the profit margin is where you decide to flip the house? 50K? 70K? Or do you use a different metric?

Kevin:
I hate flipping. I think there are so many expenses involved in flipping. Flipping makes great sense in an appreciating market because you have less risk. In fact, the appreciation can sometimes offset your selling fees, but that’s just being in an appreciating market.
In this sort of environment that we’re in, flipping, I think, has a lot of risk. There’s a reason a lot of the institutional flippers, the Open Doors, the Zillow, Zillow got out completely, Redfin got out completely, and Open Doors slowed down dramatically, there’s a reason they’re slowing down with flipping. So is there a metric for when it makes sense to flip? I mean, boy, I think if it makes sense to flip, it probably makes sense to BRRRR, unless it was a very expensive property. For example, you go buy a $1.5 million house, it’s harder to justify buying and holding because the rents often don’t catch up. The rents makes a lot more sense between usually that 300K to 800K range. Start going over a million, at least in most markets I see, the rents… I mean your cap rates are like 1.9%. It’s like, what’s the point? Again, you have the equity, you could BRRRR it out, but still, I’d rather have a bunch of 600K homes than keep those.
So I suppose if I walked into a smoking hot, I can make 300K by flipping this on one and a half, would I do it? Sure, I’d rather have the smaller rentals anyway. But generally, that wouldn’t be my goal. So hopefully that answers that question.

David:
That does help. I can simplify this for you, Wesley. You created equity through this fixer upper, which was good. At least that’s the goal. The question is, “Do I get the equity out via a cashout refinance and keep the house, or do I get the equity out via selling it to someone else and get their money?” Like Kevin mentioned, if you’re going to sell to somebody else, you’re going to have some inefficiencies where you’re going to pay closing costs, you’re going to pay realtor fees, you may have to make some repairs on the property. It’s not the most efficient way to get that equity out. Then you’re going to go pay a bunch of taxes on the profit. If you refinance, pretty much you just have the closing cost of the loan as those are the only inefficiencies you’re going to have.
When I’m looking at the situation, I ask myself a couple questions. The first is, is this an area that I want to keep the house? If this is a really bad location and it’s going to be nothing but headaches for you, flip it. Let somebody else buy it as their primary residence. They’ll be happy with that location. Don’t try to rent to tenants in a place that’s going to cause you headache or isn’t going to go up in value.
The next is, is their cashflow? If you’re going to be bleeding 3 grand a month on this property and you’re not in a strong enough financial position to take that on, sell it to someone else, take the money, go invest it in real estate where it is going to cashflow. If you are getting cashflow, in most cases, it makes most sense to keep it as a BRRRR. And then you not only benefit from the equity that you created in the process, you benefit from the future equity that you will get as the property appreciates. But it’s not a hard and fast rule. You can’t put this into a calculator. You have to actually look at all of these dynamics holistically and then decide, “Is this an asset I want to hold and how can I keep my inefficiencies lower?”

Kevin:
That was great added perspective. I think you’re so right. I mean, “Is it even where I want to own real estate?” That is such an underutilized statement or even question, because if you don’t feel comfortable doing a Craigslist transaction there at nine o’clock at night, do you really want to be renting there? Do you really want to be an owner there? I don’t know. Some people do. I mean, there’s a firefighter, he’s a course member of mine. He’s like, “Kevin, the cashflows out here are like 7, 8%.” I’m like, “Well, where are you?” And it’s like Atlantic City and it’s like 30% poverty rate. He’s like, “I deal with all this,” but he’s like, “But the reason I get all the deals is because I know street by street where to buy” because he’s a firefighter so he’s dealing with… He’s on the streets every day. Well, the days he’s working. So again, competitive advantage.

David:
Yeah. And what if there’s no tenants in that area?

Kevin:
Yeah. Well, that’s also true.

David:
If there’s no one to rent to, then it doesn’t make sense to keep it, right?

Kevin:
Also true, that liquidity of renting folks forget. See, the two things you want in real estate are liquidity of sale and liquidity of renting. If you need to sell it fast, can you? If you need to rent it fast, can you? And sometimes folks get into rural horse property in the Midwest and it’s 30 minutes away from the next gas station. It’s like, “Well, how long is it going to take you to find a tenant for that?” If it’s going to take six months to find a tenant, I don’t want that. It’s going to take years to sell it.

David:
Good point. Or maybe in that market, there’s a lot of people that want to buy, but there’s not a lot of tenants that are going to be there. So if you flip it, you can get money out. And if you keep it, it’s going to be sitting vacant for six months. Those are the things you got to look at. It’s not as simple as if I put it in a calculator, the Excel spreadsheet’s going to give me the answer. It can help you with the decision making. It cannot be the thing that makes the decision.

Kevin:
If you need to analyze a deal on a spreadsheet, you should not buy the deal. That’s generally my rule of thumb. If I can’t napkin math or even mental math the deal out, then A, I don’t know enough about the area because I should know the area enough to instantly see a listing and a list price and go, “That’s going to be a great deal. I know how much to spend on it. I know what it’s going to run for because you already have that market knowledge.” If you’re sitting on a spreadsheet, maybe you don’t even have that market knowledge yet. And the second question is, is it so tight that you really have to create this idealistic spreadsheet scenario? If that’s what you have to go through, probably not as great of a deal.

David:
Interesting perspective. So you’re saying sometimes people use spreadsheets to justify a bad deal because the numbers make it look better than it is?

Kevin:
Of course. Spreadsheets are designed to be complicated. Spreadsheets are designed so that when you present it to somebody, you have a little highlighter over the bottom line that’s like, “This is the ROI. It’s going to be 10% cash on cash return every year.” But then you get into the realities. And the realities are, “Oh, you’re dealing with evictions every three months on different units and you’re dealing…” Spreadsheets don’t account for that. And you change these little variables like, “Oh, the market rents are $2,500.” So what do people do in spreadsheets? “Well, I’m going to get $2,700.” And then they realize like, “Oh, at $2,700, I’m getting professional tenants,” basically people who you’re going to have to evict all the time, watch Pacific Heights, as opposed to if you ran the math at slightly under market rent. Market rent’s 2,500, you’re at 2,450. Now you’re getting high quality tenants over 700 credit scores. No headache. Now, the numbers don’t make sense on the spreadsheet, right? If you have to go to the spreadsheet and trick yourself into it, you’re probably-

David:
Yeah, it’s tempting to play that spreadsheet magic, move things around.

Kevin:
It’s what it is. It’s magic, and then it’s a farce.

David:
All right. Our last question here comes from Dan Kelly in Charleston, South Carolina. Dan has some relatives and investors that want to partner buying a short-term rental in the Mount Pleasant area of Charleston. And Dan doesn’t have a ton of money himself, so they’re looking at how to put this deal together where Dan would be the boots on the ground and would handle the day-to-day responsibilities for his contribution while his partners would be providing the capital, and he says, “Do you have any recommendations for how the investors in a project like this could organize ourselves in regard to financials, physical contributions to the properties and the management of the rental?”

Kevin:
Yeah, don’t do it. This sounds literally like cancer, like… Okay, I shouldn’t make that comparison because that’s insensitive. People have cancer. But this sounds miserable. Literally miserable. First of all, this is not the time, in my opinion, to be getting into the short-term market. I think the short-term rental market, at least what I’ve seen in my experience flying around the country analyzing these markets, is short-term was great during COVID because there was a lack of people providing short-term rentals.
Now, there is a surplus of people providing short-term rentals in a time where we’re going through economic difficulties. And hotels have done a really good job at catching up at providing the amenities that were missing previously. COVID’s not an issue as much anymore. Regulation on short-term rentals has gotten extreme. Just last Sunday, I was in Vegas, went through a property, I’m like, “Why are they selling this?” They’re like, “Oh, it’s short-term rentals. It’s a short-term rental. We should show you 12 month cashflows for 2022,” they wanted to show, and I’m like, “How about 2023?” They’re like, “Well, the rules changed and the numbers aren’t as good [inaudible 00:39:55]-

David:
Isn’t that funny? Isn’t that the real estate version of catfishing?

Kevin:
It’s a scam, man.

David:
Here’s a picture of me eight years ago when I was at my best.

Kevin:
Yes. It’s a scam. So first of all, I cringe when he said short-term rental. It sounds like a horrible idea right now. There will be an opportunity again. I wouldn’t be surprised if we go through some kind of little short-term rental reset or little bubble pop or whatever it is. So that made me cringe.
Then I heard partners and then I wanted to vomit, but that’s me personally. We already talked about that earlier. I’m not a big fan of that. Then I heard, “I don’t have a ton of money,” and then I’m like, “Oh my gosh. It’s literally checking off a bingo card of what not to do in real estate,” literally. So you’re telling me you want to get into short-term rentals when we’re possibly peak short-term rentals behind us already. You want partners when you’ve never done real estate before. It doesn’t sound like you have experience. You don’t have the money. You’re trying to set up like, “Well, how do I…” What he wants to hear from you, by the way, is, “So you’re going to set up an LLC and then you’re going to have a contract between all of you and you’re going to do 30% of the work and you’re going to track all your hours, and then you’re going to do 25% of it.” it ain’t going to happen. Don’t do it. This is a terrible idea.

David:
I got to say I agree with you here. This is risk stacking, okay? Haven’t bought real estate before, haven’t invested in short-term rentals, don’t know the market that good, bringing in partners which we always tend to look at the positive of a partner and we always forget about the negatives because they’re probably not super experienced either if they’re considering letting this person who doesn’t do this pick out the property and manage the whole thing, lack of experience, lack of capital. This is a situation where if it worked out, you would’ve gotten lucky, right?

Kevin:
Yes. And it’s important to remember too that most of the folks who were really making money with short-term rentals, the net income they were making was basically just their salary. I see this all the time. People are like, “Oh, my Airbnb business brings in $3 million” and they’re like, “Okay, well that’s gross.” So now let’s take off principal interest, taxes, insurance, cleaning, all the Airbnb… Take off everything. And now all of a sudden you’re down to like 200K, which don’t get me wrong, that’s great. But now, oh wait, you’re working 80 hours a week because you’re basically working two jobs, managing the rentals. So when we actually generally look at people’s financial breakdowns of how much they’re really netting, they’re netting enough to pay themselves a salary. It’s a job.

David:
Yeah. And often a lower paying job than they would get if they took a normal job, right?

Kevin:
Yes.

David:
That’s a great thing to highlight because when it gets shown on TikTok or Instagram, what they say is, “My 25% ROI on this deal.” We go, “I can’t get a 25% ROI anywhere I want to go do it.” And then you say, “Well, we’re assuming that’s with zero work.” If I got 25% in the stock market, I didn’t do anything. That’s 60 hours a week of working that maybe comes out to a $9 an hour wage. This was a terrible idea, unless you got a ton of equity in the deal or something like that. But that is a great point that you highlight. It is very misleading. And I think that Dan here is probably hearing these great stories of short-term rentals and maybe getting sold a bill of goods.

Kevin:
But you know how I doubled my income between 2010 and 2011? I went from making $5,000 a year to $10,000 a year, okay?

David:
Yeah. It’s a great TikTok video how I doubled my income. I was doing this, yeah.

Kevin:
Exactly. I went from working part-time at Hollister to having a full-time job at Jamba Juice, okay? The numbers and these percentages, because you talked about this 25% ROI, it’s so easy to mislead people.

David:
All right, Dan, our advice is maybe don’t jump into this deal with a bunch of inexperienced partners. If you are really serious about investing in real estate, again, house hack. Look at buying a house in a great neighborhood that you can rent out the rooms or maybe you even short-term rental parts of the house. Get yourself some experience with a 5% down loan where you can gain what you don’t have without using other people’s money and getting yourself in a big, nasty, messy partnership. Earn the right to buy those houses later. And then you might not even need the partners because you might’ve made your own money. So that was the last of our questions, Kevin. Thank you for tag teaming this Seeing Greene with me. Anything you want to say before we get out of here?

Kevin:
Hey, I’d like to pitch. We’ve got a startup. It’s actually called House Hack. It’s a little different from the traditional form of house hack, but go to househack.com. You can learn all about it. Make sure to read the offering circular. The SEC will get mad at me if I don’t say it. There are risks involved with investing in startups or fundraising. One-to-one valuation, read about it at the website. And read the offering circular. But that’s it. Otherwise, I’ve got a channel, Meet Kevin on YouTube. And thank you. This has been a blast. I love these questions. See, I sit down and I’m like, “What kind of videos should I make today?” And I bias towards like, “What’s the latest going on with Congress or the Fed?” But these are the real questions where people have these burning desires like some of these scenarios we went through and they need somebody to tell them, “You have a competitive advantage here. Do it.”
“You should not do that. Do this instead.” So this is a great format. Thank you.

David:
Thanks, man. That’s how we do on Seeing Greene. If you would like to be featured on an episode, submit your question at biggerpockets.com/david. And if you’d like to know more about me, you could follow me @davidgreene24 on Instagram or your favorite social media, or check out davidgreene24.com. All right. If you’ve got a minute, check out another BiggerPockets video. If not, I will see you on the next episode. This is David Greene for Kevin House Hack Paffrath signing off. Thank you.