Subto “Speculation,” Airbnb Automation, & New Build Financing

David:
This is the BiggerPockets podcast show 852. What’s going on everyone? This is David Green, your host of the BiggerPockets Podcast, where we arm you with the information that you need to start building long-term wealth through real estate today in an ever-changing and even more complex market, we are here for you. Today, we cover several different topics, including if a short-term rental is more headache than you wanted, and if you should pivot strategies to switch. What to do when you’ve locked in a new build property but overpaid and the contract is not working in your favor. If you should chase after sub-2 deals, bird deals, or if there’s a different way to look at real estate investing as a whole, as well as your comments, which you definitely want to stick around for, because we’ve got some spicy ones from YouTube that we talked about in-

Rob:
We sure do.

David:
… Today’s show. And to help me cover these spicy topics, I’ve brought in the resident expert on spiciness, cooking like Curry himself, Rob Abasolo to join me on today’s Seeing Green.

Rob:
Right. And then, we also get into the philosophical debate on if Cholula is actually spicy. So, you’re going to want to stick around to find out the answer to that. Spoiler alert, it’s not.

David:
I got Mexican food last night and they had to Tapatio here in Maui and I was so happy.

Rob:
Tapatio, that’s what it was. I mean, Tapatio is delicious. I put it on everything. I just don’t think it’s that spicy.

David:
That’s a bit of a lightweight flex, isn’t it? This is like when people don’t want to tell you they’re skinny, so they just say they’re cold. Or when people don’t want to say they’re rich, so they’re just like, “Oh, I owe so much in taxes this year.” Rob’s over here like, “Tapatio, you consider that spicy? Oh my gosh, I put it on my ice cream.”

Rob:
Well, I am Mexican, so I can handle spice a little bit more than probably the average person.

David:
You certainly are. You, my friend, are a Mexican, not a Mexican. And that is why I have you on today’s show. All right, before we get into our first question, and I promise, you guys are going to love today’s show, it is funny, it is entertaining, and we tackle the things that quite frankly other podcasts are afraid to venture into. I’ve got a quick tip for you, are you doing something that you haven’t heard on this podcast before? I want to hear about your tips and tricks that are working in today’s market that you don’t hear other people talking about. Apply to be a guest on the show at biggerpockets.com/guest, and let us know what you’re doing, and how it’s working. All right, let’s get into our first question.

Emilie:
Hi, David. Thank you for taking my question. My name is Emilie and I’m a realtor and investor in Northern New Mexico. I currently own a duplex that is too short-term rentals, and I’m finishing my first flip in the next two months. I self-manage the short-term rentals because they are in a rural area that does not have a property management company. After paying the cleaners and expenses, I net about $2,500 a month. I have $80,000 invested in the property and $200,000 of equity. When the flip is done after taxes, I will net about $40,000. So, my question to you is what should I do with my portfolio? I enjoy hospitality and the management side of short-term rentals, but it does feel like a lot of work for $2,500 a month. That being said, my ultimate goal is passive or more passive income than flipping and selling houses.
I live in a very expensive area with high appreciation. So, would you sell the short-term rental, take that money, combine it with the money after the flip, and continue to flip in the area I am in with hard money loans? Take the total sum and go to an area that is less expensive and I could fund the flips myself? Or, should I keep my short-term rentals, take the money from the flip, and try to get another short-term rental, and keep growing that passive to somewhat passive income? Thank you so much and BiggerPockets has changed my life. I wouldn’t be here asking this question otherwise.

David:
All right, thank you for that Emilie. Let me see if I can sum up your options here. You can continue flipping in the market that you live in and know well, which, there’s a pro to that, because that market sounds like it is appreciating, which is always good when you’re trying to flip. You want a market that’s going up in value. You could move to a different market that is cheaper and you wouldn’t need to borrow hard money and you could flip there. The challenge with that would be you don’t know what is well, and it’s probably not an appreciating market, which will make flipping more difficult. You’ll also put the exact same time in as the market you’re in, but probably make less money. Or you could continue buying short-term rentals in a market that you also know and manage, but you don’t love that, because the juice doesn’t seem to be worth the squeeze. A lot of work for $2,500 a month. Did I miss anything there, Rob?

Rob:
No, I think that sums it up pretty nicely.

David:
All right, well, there are some good principles for us to get into. And I see a theme here. And, the theme that I’m noticing with you, Emilie, is you’re having success doing the strategies. You are in a market that you know, but you’re not getting massive returns on it. And I like that you’re bringing this question up, because it allows us to expand on this. When you manage a short-term rental that you paid $150,000 for, and you make $1,200 a month, it is more or less the same or similar work to a million dollar property that might make $5,000 a month or $7,000 a month if you can make it work.
We often talk about the ROI only factoring in the money that went into the deal, not factoring into the time, the effort, or the risk, and that’s because it’s very difficult to quantify those on a spreadsheet. And everyone loves spreadsheets, it makes us feel safe. So you only enter the numbers into your analysis that can be quantified, which are financially related, but life is more than that. There is a lot more to it. Rob, you are a bit of a connoisseur of short-term rentals. You’ve built quite an impressive portfolio. I’m going to turn this over to you and give Emilie some advice on if she should continue buying where she is, or if she should look to get into a different way of investing.

Rob:
Well, I’m torn because it seems like… Her thing she says that she feels like she’s working a lot for $2,500 a month. And so, in general, when I say a short-term rental is working, you should never sell it, right? If she’s making 2,500 bucks, that’s pretty solid. $30,000 a year from one rental, that’s like a salary to me. So, I hesitate to tell her to sell it if it’s working. On the flip side of that, no pun intended, if she feels like she’s really good at flipping and that’s where she’s going to maximize her time the most, and selling this property will enable her to flip more and make more money, then I suppose I might lean that way.
But man, honestly, I think, making $30,000 a year from one Airbnb is really, really good. So, I’d really want to ask her the question, why is she working so much in her short-term rental? I definitely don’t feel like I’m working a lot in my short-term rentals. Granted, I’ve got a team and everything. So, is she automating it? Does she have a good team that’s running it for her? Or is she the one that’s cleaning it herself and all that type of stuff? But overall, I think, making $2,500 a month from one short-term rental’s a success story. So I’d hate to touch that.

David:
Yeah, that didn’t sound as bad to me. Emilie, when you’re describing what’s going on, I am getting the vibe that you’ve heard other people’s success stories that were embellished to sound like they’re better than they probably really are. Those of us that are in real estate investing understand it is not passive. You mentioned you want a more passive income, a more passive approach. There’s nothing passive about flips. There’s nothing passive about short-term rentals.

Rob:
No.

David:
There are methods that are passiver, and there are methods that are less passive. It’s never completely passive. And $2,500 a month in today’s short-term rental market for the price points that I think you’re talking about is nothing to shake a stick at. By the way, who goes around shaking sticks at things that are not impressive now that I’m thinking about it?

Rob:
Old people. Old guys are like, “Hey, you, stop that.”

David:
When they can’t shake their fist to the cloud, they shake a stick at something, right?

Rob:
At a dog.

David:
There you go.

Rob:
“Back you.”

David:
You have four of those things, you’re making $10,000 a month. That’s nothing to shake a stick at. Right? So, I think, Rob, you’re giving some good advice here. Maybe Emilie could focus less on trying to get a higher ROI and more on building out a team, so she can get some of her time back. And definitely don’t look into flipping houses if you’re trying to get something passive. I like this dual strategy of flipping homes for income, and then buying short-term rentals for long-term investments. If I was in your situation, Emilie, I would just be looking for ways to make it so that you don’t hate doing it. Are you cleaning the houses yourself? Are you the one checking in with every single question a guest has? Are there things in your system that can be delegated to somebody else that would not end your business? And then, what things do you need to keep yourself?
This is what I found after having started multiple businesses. There are certain things that I have to get right. There are other things that if we mess it up, it’s not going to make a very big difference. If somebody checks into an Airbnb and the cleaner didn’t replace the salt and there’s no salt there, you can have somebody figure that problem out. The person’s not going to have a cow. If the cleaner didn’t show up, if they didn’t… Rob, what are some common things that people just… You can’t get this wrong with a short-term rental stay?

Rob:
Yeah, cleanliness is definitely going to be number one. And then, a stocked house is also another one. You do have to have towels, the right amount of toilet paper, and plates, and forks, and all that stuff.

David:
There you go. Somebody goes to use the toilet, there’s no toilet paper, you’re in trouble. Someone wants salt and the salt’s running low, you’re okay. So, what I always do with every business I have is I do the job myself. I make a list of everything that needs to be done, and then I put all the stuff that has to be done correctly in one color, the stuff that can be gotten wrong, and we’ll have a chance to fix it later in a different color. I delegate all the stuff to somebody else that doesn’t have to be done right, and I do the stuff myself that does, until I find another team member.
That would be a great place for you to start, Emilie. You may be able to get 70% of the stuff off of your plate and realize that other people could be sending the checkout instructions, or there’s a way to automate that, and you’re there to make sure that you get the five star review from the guest, or you ask for a referral from that person, or you look at your listing every day and make sure it’s priced correctly, whatever the case may be. So, I don’t think you need to make any huge changes here, probably just tweak what you’re doing, and don’t stop something that works. Any other advice, Rob?

Rob:
No, that’s good. I like it.

David:
All right. Wonderful. Our next question comes from Matt Hanh in Colorado. Matt says, “I love the positivity and the information. Thanks for the guidance you bring with each show. We’re contracted to buy a new build town home in Naples, Florida that we signed for in March. We plan to move there this year and rent our current home out. Our current home is newer. At the time, we had to bid on the property and one with a bid of 380,000, which was good as resell homes of the same model went for around 400,000. Now, we could go out and buy the same home from the builder for 354,000 without bidding. We put 10% down so it makes no sense to walk away, but wondering how we might approach the builder and lower the price. We’re considering an FHA loan or conventional with 10% down, but not sure if the home would appraise at the 380,000 level and Lenard’s contract didn’t allow for an appraisal contingency. I appreciate the help and the community.”
Ooh, this is one of those ones where you buy from a builder and you’re going in without protections. Let’s see if we could do any damage control. What are your thoughts so far, Rob?

Rob:
So, to recap here, they got a property with a new builder at 380, it’s now going for 354, and they want to approach them and say, “Hey, it’s 30K less now. Can we lower the price?”

David:
That’s exactly right. But, they don’t have the typical leverage they would in a deal, because they put 10% down, so $38,000 when normally you put somewhere between one and 3% as earnest money, and they don’t have contingencies in the contract to back out and get their earnest money back.

Rob:
Right. Unfortunately, it’s a bit of a lose-lose on that one, because even if they walked away and bought the house at the 354, it’s the same amount of money, that $30,000 savings is not going to be worth it. And so, I don’t know what advice we can give if they’re in a contract and they want it, I think they’re just stuck in. I think they’re going to be a little upside down on the equity for a while, but if they own it for 5, 10, 15 years, it will come out in the wash. If they try to sell it in the next couple of years, I think that’s where they’re going to be in a little bit of trouble.

David:
Yeah, this happens when you don’t understand the contract, or maybe you did understand the contract, it just seemed like it was a good deal, because it was. At the time, houses were selling for 400,000, so 380 seemed like a pretty good price. But when rates go up as significantly as quickly as they do, that can decrease demand and it sounds like that’s what happened out there in Naples, Florida. There’s just less people that are buying in that area, so your property is theoretically worth less. When you’re buying from a builder, it is always wise to have a real estate agent who you trust negotiate for you, and they can go to the builder and say, “Well, we’re going to need an appraisal contingency or we’re going to need an inspection contingency.” Something that would protect you. But if there’s a lot of other people that want to buy that property, you’re in that position where you just have to pay what they want.
Looks like the builder is in the position of strength here and you putting 10% down really eliminated a lot of your options to walk away, because I was doing the math in my head. If you just tell the builder, “Screw it. Go sell to somebody else, because you’re going to sell for less.” The $38,000 they would get to keep from you is still more than the difference in the loss they would take if they sold the house for less. So they’re probably not going to let you out of this one.
In episode 847, Rob and I interview Zach LeMaster who gives some financing strategies and one of them when working with the builder is to ask for a lower interest rate. It doesn’t hurt you to ask in this case. You could go to the builder and say, “Hey, I’m buying this thing for significantly more than what it’s worth right now. I don’t feel super great about that. What can you do? Can you give me some financing help on this? Can you kick in to buy my rate down or maybe get me a better rate?” The problem with that is when Zach gave that advice, that was when the builder wants to get you into contract, and so they have to offer you a lower rate to help sweeten the deal. You’re already in contract.

Rob:
If you’re locked in, yeah, it’s going to be a little harder. It’s worth asking.

David:
Yes, it doesn’t hurt to ask, but I’m just tempering your expectations here. I think you’re going to be better off if you go and you say, “We’re not happy about this.” To get them to throw in some upgrades. They’re probably going to give you better cabinets if the house isn’t already built, better flooring. You can probably get them to do some extra work on the property to make you happy about it. Builders tend to give that away because they claim it’s an $8,000 value, but it’s really only going to cost them $1,500 or something to do it. So, it’s relatively efficient for them to give you something like that. Other than that though, this is the risk you take when you go buy directly new home construction. You don’t have the typical protections that you get with a contract that is from the state association realtors. Rob, have you thought of anything else?

Rob:
No, I think, yeah, see if you can get a lower interest rate. I think if you’re locked in at an interest rate… I think it’s possible that they are locked in at an interest rate, then consider, yeah, maybe the creative finance route. But other than that, unfortunately, I think you’ll just have to be in that home and wait out for the equity to go up.

David:
So, there you go. If your rate is locked, that is some extra value that you could consider selling the contract to somebody else, because they may be happy to pay that price if they’re getting a much lower rate. But interest rates usually don’t float for that long, so you’re probably going to have to buy it at whatever today’s rate is. But still, it does not hurt to go back to the builder and say, “I’m not happy about this. What can you do to make me happy?” And see if they come up with some solutions? It doesn’t hurt to ask in this case.

Rob:
Yeah, and for what it’s worth, I mean, I’m building a house here in Houston, it won’t be done for another year, and I locked in the rate when I closed on that one-time construction loan. Different loan product though, but we did lock in the rate at 4.75.

David:
Congrats, Rob. That’s awesome news, man.

Rob:
Thank you.

David:
All right, our next question comes from Mike Apple in the San Francisco Bay Area.

Mike:
Hey David, what’s going on? My name is Mike. I’m here in the Bay Area of California and love your guys’ show. I think you should hang on to Rob on your Seeing Green episodes if you’re still contemplating that. You always talk about lean into your strengths and we felt pretty strong after just recently finishing this detached ADU here at our primary home in the Bay Area. We’ve gathered up about 5 to $600,000 worth of equity here. And, we want to lean into that a little bit more on the next property that we just purchased up in the foothills. We want to try to build at least five or six additional single family homes up there. The laws allow it, the space allows it. We think it’s feasible from our construction experience standpoint. And, much more affordable than hiring it out.
Really just want to know what you think the best way is to finance a property like that. Would you go with your own equity? Or would you just try to cash this property out, sell it, use the cash and build it one house at a time up there? Anyway, love you guys show. Good luck.

David:
All right, Mike, thank you for the question there. It sounds like you’ve got a plan of build to own. And, you want to either cash out some of the equity in your house and use that to build the properties, or get a construction loan to do so. And then, the other part of your question is do I want to build all six at the same time, or do I want to go one by one? You mentioned that you have some construction background, but it sounds like that is just in the ADU that you built for your own property, which is not extensive construction background, and most likely, did not involve development, which is a completely different idea. We’re talking about putting in the plumbing, the sewer, the water, the electricity. There’s a lot that goes into building a new construction home from the ground up. If you’re tapping into existing infrastructure, it can be a lot easier than if you have to try to figure out if you don’t have that and you’re going to put in a septic tank and dig a well.
So, right off the bat, this probably sounds a little more complicated than you may be thinking in the beginning, which leads me to believe you would be better off to do one if you’re going to do this at all and see what goes wrong. Don’t go do six of these at the same time.

Rob:
Yeah, I wouldn’t do that. Look, you’ve built one, but building five at the same time is a whole other level of builder and skillset. I think I’d prove your concept out wherever you’re going. And then, once you have one that’s working super well, and I know that’s not the sexiest answer, because you want to scale and I know you want another five or six units, I’d rather you just go and crush out your next unit and really prove that this is something that you can do and that the business model works. And if it does, and if there’s a demand for whatever it is you’re building, go build those other four or five afterwards. But I probably wouldn’t take a huge swing like that right out the gate.

David:
Yeah, that is a way that you could get in trouble, because you usually don’t know what you don’t know until you get started. Now, Rob, what do you think about if he should use construction loans or the equity from his own place?

Rob:
Well, if he doesn’t have any cash saved up, David, then I think he has to cash out the property that he has, because he has $550,000 of equity. So let’s say he can take a percentage of that, and then use that as the down payment towards his other first bill that we’re talking, the first out of five or six, and then he has to keep rolling his equity over for all the new ones. But I also don’t think he should cash out everything. I don’t think he should take all of his equity out, right? I think he should pilot this and do a small cash out, enough for him to be able to execute on a construction loan, which should be roughly about 20% as a down payment of whatever cost it will be to build this thing.

David:
All right, Mike, that is the theme of our answer to you. Don’t go huge on this one. Cut this into small bite-sized chunks, and only start to cut off more when you’ve proven that you can do this and you know what’s going to be coming. Very easy to get yourself in trouble when you do too much at one time. All right, we hope that you’re enjoying the shared conversation so far and thank you for spending your time with us. Make sure that you like, comment, and subscribe to today’s video and get those questions in for us to answer at biggerpockets.com/david. In this segment of the show, we like to read comments from the YouTube channel as well as reviews from you, our listener base.
Our first one comes from Giovanni Alvarez, 807. “The David Green, a show dedicated to the cashflow versus appreciation bait would be awesome. I have these discussions often and I’m not sure what the right thing to do is specifically with our short-term rental in the Miramar Beach slash Destin area, which we purchased in 2021. We were negative $2,000 for the year and in year two we were negative for $8,000. We did take advantage of the short-term rental loophole and bonus appreciation, so got a great amount back, which was around 20 to 30,000. I love the location, it’s walking distance to the beach, and I love that we were able to use it in the slow season. I hope that the area appreciates, but I’m unsure how long is too long to hold onto a negative cash flowing property. Am I crazy for wanting to hold onto it? Oh, that’s a good one. He’s got a little bit of emotions involved in this deal. What are you thinking on that, Rob?

Rob:
Well, the short-term rental loophole definitely helps on this, because it sounds like they were able to get a 20 to $30,000 refund back on their taxes, so that helps offset some of the losses that they’re wanting. And one of the things that they said is that they love… Even though that they’re losing money every month or every year on this, they get to have a beach house that they get to use with their family. Just same thing for me, I’ve got a beach house in Crystal Beach that’s going to pretty much break even, I think. I might turn a small profit. But, I knew that going in, right? And I do get the tax advantage, but I get to use it with my family and that’s an intangible aspect of the ROI of this property. So, I guess, you’d have to ask yourself, is your love for using this property with your family for personal use greater than the negative cashflow on it? Usually, the answer is no, I think. And I don’t think anyone ever really likes to lose 800 bucks a month.
But, I don’t know, they could be high income earners. It may not hurt all that much. Am I crazy for wanting to hold onto it? No. If you use it a lot, then hold onto it, but if you’re talking about using it one weekend every year, because Miramar Beach and the Destin area, it’s a really nice area, right? And you’re going to make a ton of money in the beach season. So, if you’re only going to use it once a year, then no, you should not hold onto it. But, if your family’s there for half the year, then I could see the case being made.

David:
He does have to consider though, if he sells it, he’s going to have to have a depreciation recapture, where he’s got to pay back, right?

Rob:
That’s big time.

David:
So, he’s up 20 to 30, he’s down about 10. He’s still up 10 to $20,000 in the savings. This is a perfect example of why we were talking about having a debate. So, keep an eye out for a show where we talk about when negative cash flowing property does or doesn’t make sense. All right, our next comment comes from Aaron Murphy. “I’d enjoy it if you all made another show that has a focus on investing for cashflow. This show is great for the focus of people that want to do short-term rentals, equity centric investing, and who want to keep working jobs, et cetera, but there’s obviously a large contingent of listeners who like the previous focus of the show and want to hear about cashflow centric investing. Instead of this being a conflict, maybe you could all just add another show. A lot of people are doing cashflow centric investing in less expensive markets. I understand David doesn’t agree with that as the main strategy, but I feel like you all are missing what a substantial demographic of viewers want.”
That is a great comment. Oh, we’ve got a comment to the comment. Kate Babano says, “There is no cash opportunity in the market and they know that. They can’t sell their products to people who realize this is a terrible time to buy real estate for cashflow. So now they have to convince you cashflow isn’t important anymore.” Ooh, this just got even spicier.

Rob:
I know.

David:
All right, Rob, before I throw a complicated one to you, I will say this. Of course, there is a contingent of people who want cashflow centric investing, especially if it is passive. Who is ever going to be upset about… “You mean that I can buy a property without a whole lot of work that’s going to passively replace the income and I went from having to work to not having to work? Yes, I would love that. Does it also slice and dice and make Julian fries? Can I get it in black?” Yeah, of course, we all want cashflow right now. Everybody is looking for that. Of course, there’s a contingency of that. I mean, yes, obviously.
We are trying to explain to people that whether you would like to have it does not mean that it is there. And that it is very easy to tell you, “Oh, we know how to get cashflow, so come listen to us.” And then, you go spend money to join that group. Or, you spend attention and time listening to that content, and then you realize that it doesn’t happen that way. Or, you’re forced to buy in D-class areas that are terrible for the hope of cashflow, and then it doesn’t actually cashflow, and you can’t get rid of it, and you lose even more money.
The reason that I’m telling people not to stop looking for cashflow but to look for more than cashflow is that’s what the market’s providing right now. There are so many investors that want these assets. We’ve had so much inflation. There’s so much demand for real estate, because of the mess that our economy has been put in. It’s incredibly difficult to find that. So it’s either do nothing and let inflation eat away at your money. Or, think differently, until we get to a market where cashflow could come back. Rob, is there anything that you want to add to that?

Rob:
No, that’s good. I think that’s a good, nice answer. Te Kate who says, “There is no cashflow opportunity in the market and they know that.” I disagree with that. Obviously, there’s an asset class that I like for that. But, I’m not going to talk about that right now.

David:
Well, they said they’re trying to tell us to get into short-term rentals, because they don’t want us to know about where the cashflow is with traditional rentals.

Rob:
Well, yeah, that’s what Aaron says. I’m talking to Kayla or whatever. And then, it’s also like, they sell their products to people who realize this is a terrible time. I don’t know. Most of our education is free. I would say, nearly 99% of it is all free. And then, there’s BP Pro, which is, I don’t know, a product that is actually useful for investors. I think, we give out a lease to every state, and there’s calculators, and all that stuff. So, it’s always a little bit baffling whenever someone’s getting mad about our BP Pro membership, which is really low. It’s a very small price point. It’s not even expensive.

David:
Yeah, it’s around 300, $350 a year to be able to analyze properties.

Rob:
It’s super cheap.

David:
And, by the way, it’s analyze properties to see if they cash flow. So we still do want you to cashflow. We still look for properties ourselves that cashflow. It’s just that cashflow isn’t the only metric that we’re looking for.

Rob:
It’s 25% of the pie.

David:
Yes. My advice is to let go of the dream that you’re going to buy some properties and not have to work anymore. That’s been what motivated most people to want to find that passive income. I think that they were sold a bill of goods, it was a bright shiny object that didn’t actually work out that way. I’d rather see people embrace having a work ethic and find a job they like. Work really hard is something that you enjoy doing, and invest your money into real estate, and over time it will cashflow, because rents go up. It’s just about delaying gratification, rather than immediate gratification. But I promise you, if I do find a market where people can all just go and they can cashflow, I’ll tell you about it. It’ll last for about 14 minutes. All the other investors will ascend upon it like locusts, and then it will be gone before you can get there.
All right. Our next comment is a review from Apple Podcasts from Kay Demsky, “Keeps me informed and motivated. I love this show. It’s so informative and inspiring, and is delivered in a way that is entertaining, accessible, and truly motivating. The topics and variety of guests keep me coming back. David Green is 24 karat gold.” All right, that is very cool. By the way, Aaron Murphy for the comment that we just read, I appreciate you saying that. I don’t want people to not say those things. I like that it gives us the opportunity to explain, we all are trying to find cashflow. It’s just incredibly difficult to find in the market that we’re in. And thank you Kay Demsky for acknowledging the work we’re trying to do here to get people the information that they need to make smart investing decisions.

Rob:
Nope, we’re just trying to help people. That’s all we do. And give people advice. I understand that in a hard market like this, there are going to be some frustrations from people like Kayla and stuff like that. It’s a hard market, it’s frustrating for everybody. All we’re trying to do is provide insight as to how you can be successful in this market. But, it doesn’t mean it’s going to be easy. No one ever said real estate was going to be easy.

David:
Yeah, I’m thinking about starting another BiggerPockets spinoff podcast about how to plant a money tree. And then, you don’t have to worry about all this real estate investing stuff. You just go out in the morning, and you pick your money off of the money tree, and you don’t have to worry about it anymore. So keep an eye out for that. The Money Tree podcast. And if that’s successful, I’m going to start one on the Fountain of Youth. All right, we so love and we appreciate your engagement. Please continue to like, comment, and subscribe on YouTube as well. And if you’re listening on a podcast app, take some time to give us a rating and an honest review. Our next question comes from Shawn Cleary.

Shawn:
Hey, what’s up David? My name is Sean Cleary from Charleston, South Carolina. Thank you so much for taking my question. I started listening to BiggerPockets in 2020 and it’s absolutely changed trajectory of my life. I’ve since acquired 10 rental units across 6 properties all here in the Charleston Metro, and have even stepped into the industry full-time as a realtor. So how I’ve always viewed real estate investing is you buy a property under market value and you rehab it for less than the after repair value. The difference between your cash in and the ARV is the equity that you’ve gained. This is investing 101. You’re building equity through the acquisition and the improvement of real estate. I believe Brandon Turner used to call this stair stepping your net worth, and you call it, buying equity or forcing appreciation. I’m totally sold on that. My question lies into what some of my investor clients are trying to do recently with subject to financing.
It seems to me that folks who are engaged in buying sub-2 deals are paying premiums, because the interest rate and the long-term debt obligation, not the equity stake in the property. The sub-2 argument seems to be steeped in the prospect of long-term appreciation, but I view this as speculative. There are gurus out there who I won’t name by the way, that are telling folks to pay top dollar for turnkey homes, just because of an interest rate. In other words, they’re spending capital on the interest rate, not the equity in the home. This seems to not align with the underlying principles of real estate investing, especially folks who are looking to grow and scale a portfolio and would probably want to offload those properties in the next 3 to 10 years anyway.
I want to know your thoughts on sub-2 from an investor standpoint. Do you think it’s a viable strategy, especially in the current market? While the interest rates are obviously great, do you think banking on the appreciation of these homes and the marginal cashflow is capital well spent? Or would you prefer to see people deploy capital in a traditional bird deal? Thanks so much and looking forward to hearing your thoughts.

David:
Well, keeping in line with today’s spicy topic, we’ve got some Tapatio for you all. Shots are fired right across the bow.

Rob:
I don’t know if I would consider that spicy.

David:
He’s a little bit spicy. He’s bringing up the subject-2 thing, and this is a controversial time to be investing in real estate. I think, a lot of this is due to the fact that people are describing one strategy as better than other strategies. And you’re just getting a perspective that isn’t always a 360 degrees. So, is it speculative to buy a interest rate and pay a premium for the property? Yes. Is it speculative to assume that the equity you force in a property is always going to be there, that is just as speculative? Is it speculative to assume that the property is going to go up in value over time? Yes. It is all speculative and that just makes people uncomfortable when we mention that reality. So, regarding Sean’s comments here, which I thought were well articulated, and do express a pretty legitimate concern, what are you thinking so far, Rob?

Rob:
It’s very fair. I guess, that is one of the underlying issues with sub-2, is that, people are willing to pay a premium. I think you want to try to find the happy balance of not paying… Because this time I was talking to Avery Carl about too where she saw someone that got so excited that they were presented a sub-2 deal and they bought it for 850,000 or something like that. And, the comp next door, after they close on it, closed for 650 or 675. And so, the people got so excited about the premise of getting their first sub-2 deal that they paid 150K over what the market was worth. And she was like, “I didn’t have time to jump in and stop them from making that mistake.”
And so, I think sub-2 and creative financing is an amazing strategy. It’s something that I’m doing as much as I can, but certainly, agree that you shouldn’t really get so excited at the premise that you’re like, “Yeah, I’ll just be upside down walking into it.” I don’t think you should really ever be upside down, right? I think you should be at least break even with what the market value is. And I would even say PACE… I talked to him about this and he doesn’t really feel, he doesn’t ever pay too much over market value as well. I think he told me the most he’s ever paid is 5% over. But the terms were so good, it was amortized over 50 years, the interest rate was 0%, and so he was willing to do it in that specific instance. But I still think it’s even rare for him. So, I don’t know. I think I would caution people that it is this new shiny object syndrome. We’re all excited, but it still has to be a good deal. You still have to inherit and take over a good deal.

David:
This is a case where it’s not a problem with the strategy. It is a problem with people’s understanding of the strategy. So for a long time, we would talk about BRRRR and we would explain BRRRR, you put in X amount of money, you do X amount of rehab, you’re left with an ARV of Y, you can pull out 100% of the money in the deal. And people would run an analysis, or at the end of their BRRRR, 3% of their money was left in the deal. But they have an insane amount of equity they’ve created and they would say, “It’s a failure. BRRRR doesn’t work. I left 3% of my capital in there.” But if they were putting 3% down on a property, they would’ve thought that was an incredibly good deal, even if they didn’t also get extra equity in it.
It’s just your understanding of how you’re supposed to execute on this. PACE is the sub-2 front-runner here, and from what you’re saying is he doesn’t tell people to overpay for properties, but it’s very easy when you’re hearing it from someone that heard it, from someone that heard it, from someone that heard it from PACE to get really caught up in this idea that it’s okay to overpay. And why do they do that? Because they’re focused on cashflow. This comes back to the comment we just got on the YouTube, and why we’re giving them perspective that we do.
When you zoom in and you only look at cashflow, why not pay a million dollars over what a property is worth if you can make it cashflow? Right? It very quickly gets out of hand, and you get away from the fundamentals when you’re only focused on one element of real estate investing, instead of all of it together, which is really how you should be looking at it. What’s the property worth? Is there a value ad play? Is it in an area that’s going to appreciate? Is it going to cashflow? Can you force cashflow? Can you add units to it?
In the book I have coming out that talks about all the ways you make money in real estate, the way that I think you should be analyzing it, much like when we bought our Scottsdale property, we had a matrix of five things that we were looking at. We all balance it together. So, I think that’s some pretty solid advice, that it doesn’t make sense to overpay for a property and then just talk about the interest rate, but it also could make sense in some cases to pay a little bit over to get the better terms. Rob, it looks like your brain is working over there.

Rob:
It’s just a hard one, man. It really is. Because, let’s say, a house is worth 100K, just simple numbers here, and you take over something that the mortgage is 105K, right? Let’s say, you pay that 5% premium, but the interest payment on that property is 3%, versus going out and buying the same property at 8%. You’re paying significantly more anyway. So, it’s a hard one, and I wish we did a whole episode on the downside of this, because I agree that fundamentally it is kind of against real estate investing. But if we’re talking about cashflow, I feel like there’s this high horse mentality of, “I would never do that. Instead, I’m going to pay 8% interest.” And it’s like, “How is that better?” I don’t know. I don’t know.

David:
Well, there’s pros and cons to each, which is what we’re getting at here. When you get more equity in a deal, there’s value, because theoretically, if you had to get out from underneath it, you could sell it easier.

Rob:
Yeah, totally.

David:
When you overpay for a deal and you get a better interest rate, if you have to move the property, if it ends up being in a bad location, even though theoretically it cashflows, what if you have a ton of CapEx that you didn’t account for, and you got to get rid of it, but you can’t, because what you owe on the property is too much. And now, the only person that you can sell to is another sub-2 person who wants to go in there and they’re willing to pay more to get it, right?
But what I’m trying to say is there is no strategy that does not involve some element of that. You give something up to get something, no matter how you’re buying the real estate. So we need to get away from saying what’s the right way to do it? And get into having an overall understanding of the pros and cons of each. It’s very similar to if you said, “Well, we want a really fast football player on our team.” And then, you looked at all the fast players and you said, “But you know what? They’re not very big. I also want one who’s really big.” And then, you looked at all the big ones and said, “But they’re not very fast.” Right? Nobody would actually look at that and think that that makes sense to analyze things from that perspective. You have to ask, “What’s more important, a big person or a fast person for this position or for the team that we have?”
So, I think this is going to open us up to a lot more opportunities to just explain how real estate investing works at a fundamental level so people can have a better understanding of how to underwrite these deals, which is really what you have to know in today’s market. This is the hardest market I have ever seen to invest in real estate. It has been overly simple for a long time and those days are over. We are now moving into a time that owning real estate is much more like running a business. You don’t buy a business and just say, “Well, am I buying a business for equity or for cashflow?” There’s a lot of fundamentals that go into running a business. You actually have to be skilled at doing it, which is why shows like this one, podcasts like this one, content like this is more important than ever before, because you used to get away with being able to be ignorant, and today you can’t.

Rob:
Yeah, I agree. I think you could be a little sloppy back in the day. And now, we’re all tightening the bolts here, right? And so, we just have to be on our game more. And so, I understand the debate. I’m all for it. Yeah, I would ultimately say, nothing is black or white in real estate investing. There’s always like a, “If this, then what?” Rabbit hole you can take. And, yeah, no wrong or right, just what’s right for you.

David:
Yeah. And, you know that someone’s an inexperienced investor when they say something like, “I just bought a house.” “Why’d you buy it?” “Because I got a 3% rate.” Nobody that’s actually good at doing sub-2 is going to say that. That’s a piece of the puzzle. It is not the reason that they bought the property. Just like I don’t think it makes sense to say, “I bought a rental.” “Why?” “Because I have $300,000 of equity.” “Well, is it losing money every single month? Is it something somebody else would buy? What good is $300,000 of equity if there’s only four people in the world that would buy it from you?” So, these are things to keep in mind and why we love you guys listening to the show with us, and we have to take these deals on a case by case basis, which is why we have Seeing Green, so you can bring us your deals and we can dissect and analyze them for you.
All right. I really hope that we were able to help some of you brave souls who took action to ask your questions and I look forward to answering more of them later. Head over to biggerpockets.com/david and submit your question and thanks for everyone who asked the question today. I really liked the comments we got on YouTube. I really liked that last question that we got. In today’s show, we covered how to think through the tasks involved in managing a short-term rental or a flip, how you can create a system and delegate work to make it so that you like owning real estate.
If you have any options after locking in a new build and how to approach a deal where you feel like you’re not super thrilled about it, how to use equity to build five new rental properties and how quickly that should happen, as well as questions about sub-2 financing equity and speculation overall in our market. Check out the show notes if you’d like to connect with Rob or I, and let us know what you thought of today’s show, and please consider leaving a comment on YouTube to let us know what you thought. This is David Green for Rob playing chess like Bobby Fisher up solo, signing off.

Speaker 6:
Pretty good. Pretty good.