In this episode, Cynthia Meyer and Veronica Woods discuss four questions to ask yourself to know if you are ready to scale your real estate portfolio.
In this episode of the Rental Property Café™ Video Podcast they cover:
“What is the future we're trying to create for ourselves and how are we going to get there?” - Cynthia Meyer
“...besides the liquidity, the experience of the investor really weighs in more heavily than a lot of people think. So they want to know, what have you done in the last three years? How much do you own outside of your property that you live in? How have you been managing? Do you have a property manager?” – Veronica Woods
About the Rental Property Café™
The Rental Property Café™ podcast offers a real estate tool kit for busy professionals who are building a real estate portfolio. In each episode, co-hosts Cynthia Meyer & Veronica Woods explore ways to grow a successful real estate business while growing your career.
About Cynthia Meyer
Cynthia Meyer is a financial mentor, CERTIFIED FINANCIAL PLANNER™, CFA® Charterholder, real estate investor, blogger, and the founder of Real Life Planning. She offers unbiased financial planning and learning resources to real estate investors. Cynthia is a first-generation rental property owner, who built a rental property portfolio with her husband, Steve, while they were both building their careers. She lives in NJ, where she balances teenagers, her financial planning practice, and a rental property business.
About Veronica Woods
Veronica Woods of Daniel Woods Real Estate, real estate advisor and investor, is passionate about helping her clients create wealth, legacy, and lifestyle through real estate. She works with people to buy, sell, rent, and develop residential and small commercial real estate in Delaware County and Philadelphia, PA. An MBA in finance from the Wharton School, Veronica also shares her real estate wisdom with new investors on her YouTube channel.
Transcript - Rental Property Café™ Episode 8: Are You Ready To Scale Your Real Estate Portfolio?
[00:00:11] Cynthia Meyer: Welcome to the Rental Property Cafe. I'm financial planner, Cynthia Meyer, of Real Life Planning and I'm here with my co-host....
[00:00:17] Veronica Woods: Veronica Woods, real estate advisor from Daniel Woods Estate.
[00:00:21] Cynthia Meyer: The reason that Veronica and I really wanted to dive into this question today is because clients are asking us this question every day. They want to do more. They want to do more now. The reason that people want to grow their real estate portfolios, over and over again, we hear that people want to be financially independent. They want to be work optional. They're active investors. They've set up a good foundation for themselves. They wonder what the next step should be.
[00:00:49] Veronica Woods: I hear that all the time of once you buy a few properties, you want to think about what's next? "Am I moving fast enough?" " I'm afraid I'm going to get in [00:01:00] over my head." And they really want to do things the right way not thinking about real estate investing as some kind of quick rich scheme, but really want to have a thoughtful approach to really scaling a portfolio.
[00:01:14] Cynthia Meyer: Tell us, Veronica, cause we talked a lot about this over this past week preparing for the podcast. What do we mean by scale?
Complexity of Your Assets
[00:01:20] Veronica Woods: Yeah, that's a good question because scaling doesn't mean the same thing to everyone. There are a lot of dimensions that you can scale by. I'll go over one, complexity of assets. A lot of times people start with a single-family home and then they want to graduate to maybe instead of buying one at a time, maybe buy 10 at a time because there are seasoned investors who may be selling a whole package. They may want to up their doors. Staying in residential, you can buy a four-unit property and it's still technically a residential property. Once you get over five units, then you're talking about commercial-grade properties. There's lots of mixed-use. The [00:02:00] storage units, office buildings, to some extent. There's a variety of assets that you could buy.
Condition of the Properties
[00:02:05] Veronica Woods: Second thing is the condition of a property is a big deal. I say to my beginners, " You guys should probably start on kind of basic cosmetic upgrades." Then there are different stages into a gut rehab, which is really a complex project and there's a lot of room to make mistakes.
The Loans to Fund Your Properties
[00:02:22] Veronica Woods: Third, I would say, I'm getting beyond like the Fannie Mae, Freddie Mae conforming loans and getting into non-qualified or QM loans. That's a whole different ball game as far as the requirements from you and the requirements for the property.
[00:02:40] You recently have gone through the process. You know what that means of the non-conforming loans. You want to jump in and talk about the different ways you could fund?
[00:02:50] Cynthia Meyer: Sure. Interestingly, in our real estate business, my husband, Steve, and I have been tackling this question over the past year.
[00:02:58] We had some properties that have [00:03:00] highly appreciated since we bought them and we were trying to increase the overall rental return on that use of capital. We did one 1031 Exchange, a reverse 1031 Exchange last year from a single-family home to a duplex. And now we're in the middle of doing a 1031 tax-deferred like-kind of exchange from a single-family home into a small apartment building. And it really has been a whole different ball game. The requirements from the lender, what they want to see for us, it's a different type of application process that dives a little bit deeper into our real estate business than previous conforming loans that we've taken.
[00:03:37] We are hoping to do what's called a portfolio loan with a bank. It's not going out to the capital markets. It's not that big of a property. But it's just been a totally different process. Everything is more complicated and expensive, there are multiple buildings to the property.
[00:03:50] The inspection was more expensive. The cost of everything to fix the things that need to be fixed is more expensive. So it's really been an interesting learning process for [00:04:00] us. We've had to ask ourselves like, how big we want to scale is really defined by our goals and our goals might be different from your goals.
[00:04:08] That's the most important question to ask yourself, right? What are we really looking to do in the long run? What's the future we're trying to create for ourselves and how are we going to get there? So I tell clients, don't box yourself in to the number of properties that you own. Really aim for the number of cash flowing doors or just general net cash flow in total when you're thinking about scaling it and leveraging.
[00:04:30] So answering these four questions that we have today will really help, if you're ready.
Question #1: Can You Show That You Are Financially Ready To Do This?
[00:04:37] Cynthia Meyer: And the first question we want you to ask yourselves is one, can you show that you are financially ready to do this? I talked about my example of non-conforming loan underwriting is different. You're going to have to produce more financial information. You're also going to need to have more liquidity.
[00:04:56] Every property you need down payment funds for rehab, [00:05:00] initial cash reserves. But if you're scaling up to a much larger property, larger number of doors, more expensive property, or perhaps a different type of property, you're going to have to build cash reserves on a larger scale. So it's a little bit harder to bootstrap.
[00:05:15] On the insurance front, you may need a commercial insurance policy. It may be time to stop working with a direct agent and to work with an insurance broker on a more customized strategy for insurance. Veronica, do you have anything you'd add to that?
[00:05:31] Veronica Woods: I think it's also important to know that you have to show this to the professionals that you're working with because a lot of the times I'm working with people who have the: "Trust me I've already had this thought out on how I'm going to finance this investment. Yeah, I know I haven't done this before, but someone has promised me they'll either loan me the money or that I'll be able to qualify for a loan when it goes through." I had an offer last week where the guy put together a [00:06:00] personal financial statement before he got his term sheet from the lender. It really shows his sophistication from a financial point of view that he knew that showing his financial strength was important.
[00:06:13] Cynthia Meyer: Yes, and showing the resume too. That's an interesting thing that we had to do during this process. Even though here I am live on the podcast and on the website. My husband has a professional profile. We actually had to summarize it and submit that as a requirement.
Question #2: What Is Your Investing Resume?
[00:06:27] Veronica Woods: So that gives us in a number two, if you want to scale up, you need to be conscious of what is your investing resume in being able to show that to someone else. Maybe a year or two ago, I wanted to increase my network of lenders that I work with. So I interviewed a bunch of them about how they make underwriting decisions.
[00:06:49] I was surprised how, besides the liquidity, the experience of the investor really weighs in more heavily than a lot of people think. So they want to [00:07:00] know, what have you done in the last three years? How much do you own outside of your property that you live in? How have you been managing? Do you have a property manager?
[00:07:11] They want to get a sense of, are you running this like a business? Or are you going to just hope and pray that it all comes together after they get their loan? They really look into your experience directly in real estate. If you've partnered with other people or have professional experience, let's say you are a property and casualty insurance person by day, and you're getting started investing, those people who have direct experience in their day jobs it does count. But even then, they're looking at the total picture. So if you have no experience and a shoestring budget, it's really hard to level up by yourself because it's hard to show that experience.
[00:07:54] The good news is once you get the experience, those conversations with the [00:08:00] portfolio lenders are a lot easier because you're building a relationship with them and they know your experience. It's not just on paper, but they've seen it.
[00:08:08] Cynthia Meyer: Oh, that's a really good point. Is there anything that you'd suggest to folks who are looking a couple of years down the road and they think, okay, I'm going to want to level up in the future. In a practical way, how should they be building their resume now?
[00:08:22] Veronica Woods: I think it's one property at a time, to be honest. There's no shortcuts to it. I do think I've had clients augment their resume by showing that you're building a team of experts. You're not going to replace 20 years of experience, right? You're not going to have it until you walk that walk. But if you bring in partners or professionals to augment your experience, that does tell a different story to the lenders, which goes into number three, about having the right team.
Question #3: Do You Have The Right Team?
[00:08:54] Veronica Woods: So it is important when you have the aspiration to go up the food chain, think [00:09:00] about, do you have the right team at the table? Even for yourself to feel comfortable of just even going through the due diligence process.
[00:09:07] I had a client who aspired to turn a four-unit property to have the space to maybe a five unit and maybe add a bedroom here and there. And I'm like:
[00:09:17] " That's really a complex project. Who's your contractor?"
[00:09:20] " I don't have anybody yet."
[00:09:22] I don't know if that would be my first project with a contractor if you didn't have experience doing smaller things before. That's usually the first question I ask people who want to buy bigger assets, Who is your contractor? Are you talking to the right lender that can understand your options? Are there any tax or other financial considerations that this investment may impact? Sometimes it's really important to have those people upfront because maybe you need to write some specific terms in the contract to give you time to do certain things. If you do it on the backend, you're just putting yourself at a disadvantage. If you're thinking about scaling up, start [00:10:00] interviewing that team that can allow you to go after more complicated deals.
[00:10:05] Cynthia Meyer: And just to piggyback on that for a second, you may have to change your team or make some tweaks to your team as you grow and scale. The tax advisor, for example, that can just help you with your schedule E when you have one or two properties, may not be the tax advisor if you're doing a complicated cost segregation study. The contractor that can help you renovate a bathroom or a basement may not be the same contractor that you need for a full gut job. The insurance broker that you use for your personal car insurance may not be the person that's going to get you to understand and implement the best policy for a large commercial property. So thinking about what is the kind of team that I need to have in place in order to get bigger and to grow, is obviously going to be super important.
[00:10:48] The other thing I would encourage folks to do is to set some criteria for how much leverage you're going to use. Scaling typically is going to involve leverage.[00:11:00] Not just what type of loan you're going to take, but how much of a percentage of the total portfolio are you going to try and maintain and leverage so that you're using your capital to its maximum effect.
[00:11:11] Thinking through that carefully, depending on your goals and your risk tolerance, your liquidity, and also your life stage is going to be helpful and important.
[00:11:19] Veronica Woods: You mentioned that to me earlier. That's why you want to involve your financial advisor early on. It's not something after the fact. It's a lot harder to plan to relever before certain financing loans are structured after the fact.
[00:11:33] Local knowledge is also important. It might be more costly even to have someone travel two hours because the contractor you really like is two hours away from the property you want to invest in. That just might not be practical. As you think about expanding to different geographies, then you have to replicate some members of your team. Your financial advisor probably could cover you in the broader geography. The operational side, you have to stand [00:12:00] up local teams in each geographic area that you want to invest in.
[00:12:04] Cynthia Meyer: Yeah, that can take some time and some research to put in place. It's not something that you're going to be able to put together in 24 to 48 hours and be super confident that you've done it correctly, right? That's something that you want to do in advance if at all possible.
Question #4: Do You Fully Understand The Opportunity And The Risks?
[00:12:18] Cynthia Meyer: So our fourth question that we want you to ask yourself is, do you fully understand the opportunity and the risks? It could be that your assumptions are unique to the property and that they're hard to estimate. One of the things that I often do in practice, if there's a unique investing opportunity, is that we'll try and build a possibility or "what if" model. What if interest rates change? What if contractor rates go up or down 10%? What if taxes move in a certain direction? Try and capture more of a range of best possible outcomes, but also worst possible outcomes to see if it makes sense for you. When something is hard to estimate, maybe use some mighty math powers to examine a [00:13:00] broader range of possible outcomes.
[00:13:02] This is something that you brought up to me a couple of weeks ago, Veronica. I've been thinking about it since you brought it up, is that if you're taking over a property that has not been professionally managed and needs work, there could be a whole boatload of additional issues to address.
[00:13:15] Do you want to talk about those a little bit?
[00:13:17] Veronica Woods: Just because it's a larger asset doesn't mean it was well-run. If it wasn't run by someone that probably was working with people like us, they're not going to have crystal clean financials going back three years, on a monthly basis for you to review. You really do have to rely on more assumptions, even if it isn't really a complex asset. That's why you want to have as many professionals that help you assess those assumptions. Like maybe, your property manager can help you validate some of the expense items that are a little gray that you got from the sellers. Depending on how it's occupied, it might be harder to [00:14:00] fully inspect the properties before you buy it and so you have to make these assumptions about the deferred maintenance. I would always assume on the higher side. In this case, you definitely have to be more conservative. By the nature of the beast, you're going to probably have to make more assumptions to go forward.
[00:14:16] If you're new in a particular market or even a particular block, you may not be as familiar with the maintenance or repair issues that come with that particular micro-niche, microgeographic niche.
[00:14:27] That's where doing investing, more than one property in a particular area, can sometimes be helpful because you use the knowledge of the first property to make better decisions on the second property. You know, try not to spread yourself too thin across the scaling of the portfolio, so you can leverage your knowledge, not just your money.
[00:14:44] Cynthia Meyer: There may be more due diligence to buying a more complex or larger investment. Some of that you're going to get help with professionals, but some of it may be just digging through financials that weren't well kept by the previous owner. We coach you to [00:15:00] keep your real estate books like a business. Treat your real estate like a business, even if you're owning it directly and not in an LLC. A separate set of books. Separate cards. Separate checking account. Use a digital bookkeeping tool, so that you can readily produce this information on demand for yourself and for lenders. Not everybody is doing this, so there may be a level of opacity that's going to be hard to dig into.
[00:15:23] Veronica Woods: It's just not there. I've worked with people on both sides. I've worked with sellers like that who may have inherited a property. The property had been in the family for 30 plus years. You're not going to in a few months, automatically, retroactively, put systems in place. I think it's important to also just asking benchmarking from other income statements or similar properties in the area.
[00:15:48] Sometimes you could look maybe on a, another listing of a similar property and that may have better financials. As a professional, I look at that and try to benchmark. OK, If I [00:16:00] see the typical utility costs for a building of this size is this, that will help validate some assumptions if I can't get absolute assumptions. Just keep in mind that there's more due diligence on the financial for larger assets. That's what a lot of people aren't used to. They're used to, I got to inspect the property. Or maybe you have to do a gut rehab and you throw the right contractors out, but there are some limitations on the financial due diligence. Everybody has a different kind of financial savvy, but depending on how financially savvy you are, you feel more comfortable in not making assumptions.
[00:16:37] Cynthia Meyer: Yeah, that's an excellent point. There are areas that we frequently see that folks are underestimating in their real estate budgets, particularly maintenance and capital expenditures.
[00:16:45] That's something that you learn over time. Sometimes we learned the hard way. But that is really an excellent point.
[00:16:50] Just to summarize our four questions that we want you to ask yourself as you're getting ready to scale is:
[00:16:57] One, are you financially [00:17:00] prepared and ready to do this?
[00:17:01] Two what's your professional resume?
[00:17:04] Three. Do you have the right team?
[00:17:06] And four, are you prepared for both opportunities and the risks of what your trying to do?
[00:17:12] If you want more information about that, I really want to invite you to watch episode four which is called, Stick To Your Fundamentals and episode three, What's In A Rental Property Budget? They're going to queue up after this video, if you want to keep watching, to make sure that you have a strong financial foundation in place before you start thinking about scaling.
[00:17:30] If you liked this podcast, please subscribe on this YouTube channel. Leave us your comments. We really want to hear from you and check out Veronica's other YouTube channel. She makes great real estate videos. Veronica. Do you want to tell us what that is?
[00:17:42] Yeah, it's Real Estate Wisdom of Veronica Woods on YouTube.
[00:17:46] Yes. Excellent. So email us your topic ideas or leave them in the comments below. We are at email@example.com and if you'd like to chat with either one of us, we've dropped our contact information into the show notes.
[00:18:00] Veronica, thanks very much for joining me and the Rental Property Cafe this morning as always you're one of my favorite and most interesting people to talk to. I hope you have a really fabulous weekend.
[00:18:08] All right. See you next time.
☕ See more financial planning guidance for real estate investors from Cynthia Meyer on the Real Life Planning blog: https://reallifeplanning.com/blog
Connect with Veronica Woods of Daniel Woods Real Estate: dwoodsrealestate.com/letsconnect
☕ Do you have a topic suggestion or want to be a guest on future episodes? Email your ideas to firstname.lastname@example.org.
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