Scott: Welcome to the BiggerPockets Money podcast, Finance Friday edition, where we interview John and Jennifer and talk about how to optimize your portfolio with a high net worth and when you should leave your W two.
Scott: Hello, hello, hello. My name is Scott Trench and with me today is James Daynard from our sister podcast on the market. James and I are here to make financial independence less scary, less just for somebody else, to introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.
Guest: Whether you want to retire early and travel the world, go and make big time investments in assets like real estate or start your own business, we’ll help you reach your financial goals and get the money out of the way so you can launch yourself towards your dreams.
Scott: The contents of this podcast are informational in nature and are not legal or tax advice. And neither James, nor I, nor Bigger Pockets is engaged in the provision of legal tax or any other advice. You should seek your own advice from professional advisors, including lawyers and accountants regarding the legal tax and financial implications of any financial decisions you contemplate. James, this was an awesome episode today. Uh, I want to give everybody a fair shake that this is a little bit more advanced. This is a a a a significantly high net worth couple. They didn’t get there by being particularly fancy. They never earned particularly high incomes until maybe the last year or two. Um, but they’ve accumulated millions of dollars and we’re going to talk about uh, the allocation of a portfolio that is well underway and, you know, some high level choices about how we’re going to, you know, potentially think about shifting those assets perhaps to commercial real estate. and that involves discussion around, um, we’re going to throw out terms like 10 31 exchanges. We’re gonna throw out terms like cap rates. We’re going to talk about net operating income, um, and and that jargon. I think anybody and everybody can learn from this, um, but there may be a couple of terms that we throw out there and, um, those are sprinkled in and, uh, available for you to self-educate on throughout the Bigger Pockets platform. So go look at those up. I hope you like it and, um, look forward to feedback.
Scott: Oh, and by the way, listen to the very end because we present, I think, three very different choices to uh John and Jennifer um for them and they’ll have to kind of figure out what the right approach is for them based on on the a wide array of really good options that they have.
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Scott: John and Jennifer have a rental portfolio in the Pacific Northwest. John has a W two while Jennifer works for herself as a chiropractor and they have four children, all under the age of 10. They’re wondering if their portfolio is optimized to its fullest potential and when John should leave his W two. John and Jennifer, we’re so excited to have you on the show today. Thank you for joining us.
Guest 1: Thanks for having us.
Guest 2: Thank you, have me.
Scott: Awesome. Um, tell a give a little quick highlight about your financial position. You guys are very high net worth individuals. You’ve got a asset balance of over 10 um, close to $11 million. Most of that’s in real estate, about 8 and a half, uh, 8.7 million is in real estate and you’re levered pretty reasonably at close to about 50% on that portfolio, a little over 50%. Uh, that’s that’s across six different investment assets plus your primary residence. And then we’ve got, uh, I see there’s a a nice 401 K and retirement balance, a very healthy cash position, um, and a business that you guys own that’s successful and profitable. And your household spending, I believe is close to what is it? eight, $8,000 a month here. Correct. So, you know, um, we’ve got a very, very healthy financial position. And you know, I think that that that begs the question, um, what a listener might be asking is, how could how can we help you today? What are the things that you’d like us to cover?
Guest 1: So, we’ve been looking at how to optimize the portfolio. We’ve done well and we feel like we’ve managed the the spending. We can probably do better on spending, but we feel like we’re doing well on the spending and investing. We’ve been doing that for coming up on 10 years. And the question is how do you take a strong position and move forward in a smart and sensible way, not destroying the stuff you’ve built, but taking, you know, reasonable risks as the market changes and trying to be to be smart. Again, we have a family and young kids and trying not to, trying not to screw it up when you, when you do well in a game, don’t mess up.
Scott: Awesome. Well, we look forward to chatting about that. We’re going to dive all into that. But before we go go down that rabbit hole and start talking about some, um, ways to begin tweaking or changing, um, parts of your portfolio. Let’s hear a quick overview of your money story. How did you guys get to this position where you’ve accumulated $10 million in assets, um, on incomes that are not crazy. They’re not way outside the norm here.
Guest 1: No, our income’s been pretty normal for the Northwest. We’re not ironically high income earners in the Pacific Northwest um, comparative to the to the tech community. But just starting out of out of college, uh, getting a a first house, uh, which is a duplex, um, you know, two years out of college. Um, Jen’s been, honestly, an entrepreneur her whole life, but she, she really after graduating college went back to, to uh school and and started down the path of becoming a chiropractor.
Guest 2: We actually met, he didn’t say this, we met on a blind date. Ooh. uh in 2007. Yes. And I kid you not, we talked about a funny movie we had seen and um, investing in high yield online savings account. And I had my own business as a massage therapist at the time before chiropractic school. So we were chatting about that and he’s like, well you need to pull this money over and get this 5 point whatever percent. and he was surprised that by date two, I had done that already. Yeah, so I essentially would pull over a third of my income and then I just had it in savings and I started making money on my future tax payment for that year. so and I always said I I didn’t care if I married somebody with money or not. I wanted somebody who was good with whatever they had. $5, $5 million, it doesn’t matter if you can’t do well with it.
Scott: Awesome. So the first date was a money date. This, this is, this is a wonderful.
Guest 1: It was very, it was very purposeful.
Guest 2: It was very good. Yeah.
Guest 1: Then, let’s see here. I guess, uh, I started working for a manufacturing company, uh, here in the Northwest. Uh, that was what, 2006. I went back to grad school and been working a a a higher paying job. During that time, we had the great financial crisis, a great, um, that happened and, uh, honestly, I couldn’t buy any real estate during the time. We had lots of cash, but we didn’t have the education to know how to deploy it correctly into real estate at the time. So we invested in stocks, uh, while I was in grad school. Ironically, 2012, 13, we had the cash from the growth in stocks to get down payments on properties. We bought a personal house, we bought a a duplex. We, we actually ironically bought a foreclosure, um, not intentionally, but it was, it we couldn’t close on it and they took it to the courthouse. So we bought that as a as our, really our first property together.
Guest 2: we found out what, two days before it was gonna hit courthouse steps that, uh, that we were no longer gonna be in contract with it.
Guest 1: So roll down to the courthouse and pick it up. And then from there, we we were actually pretty aggressive over the next few years with, uh, adding properties. Ironically, real estate is very forgiving. So even with all the mistakes and just really not smart things we did, um, the market was accelerating upwards. Uh, if you manage a property well, even if you didn’t do the the smartest due diligence on the on the front end or or necessarily really understand the expenses as well, um, we were able to to manage that, uh, a lot of sweat equity and build that into a a real estate portfolio that’s where it is today over the last, the, you know, those intervening 10 years essentially.
Scott: What would you say your kind of max combined income was over the last, you know, last 20 years that you just talked about the the story and what was the kind of minimum, uh, or average in that during that time period?
Guest 2: Now currently it has fluctuated quite a bit. Um, when I came out of chiropractic school, we had gotten married halfway through. So when I came out, then came, you know, babies and we used to joke with our tax guy every year it was either a baby or a building or both. Um, so and you know, in some of the lean years we basically I was very part-time. I’m mainly on John’s income. so I would say combined was probably No, maybe 100. about 100.
Guest 1: About 100 when we’re for combined income. my first job out of college was at 30 grand. like I in 2002. So very, very low. And then 2006, jumped up to uh 2005, 6, jumped up to close to 50. and then when Jen and I got married, it it got to the 80 uh to, you know, 100 range and um then it’s really accelerated in the last few years.
Guest 2: The current to the max?
Guest 1: Max, uh max is probably gonna be this year and that’s going to be close to between the two of us 340, maybe 350.
Scott: And that does not count your real estate income. That’s just active.
Guest 1: That does not count the real estate. That’s just the two of us working.
Guest 2: At this time we keep our real estate stuff very separate. That just goes back into the business. We live off of our income. um, and so that’s kind of one of the questions is like, how do we make that transition? Do we just keep that rolling? all the renovations and purchases come from from the, you know, the real estate portfolio.
Scott: So I again, just uh congratulations on on on on this and and this is an incredible, incredible wealth building journey that you guys have been on uh and and an incredible financial position that you guys have built. Again, without being, you know, a doctor or a uh a CEO or or any of these high-pro you know, baseball professional baseball player, whatever it is. So, congratulations on that. And and one more point that I want to call out here and just highlight, how how would you classify yourselves uh in terms of spending? How frugal have you been and how important has that been?
Guest 2: I would say on the big things we are we’re pretty darn frugal as far as, you know, we don’t buy the big shiny new things. um, we don’t, you know, the furniture in our house, we we buy a couple new pieces, the rest of it, you know, it’s it’s off up and it’s marketplace because we’re realistic and we have kids and we don’t take the huge vacations. We go to visit his family in Ireland we just got back a little bit ago.
Guest 1: the spending on the personal life has been pretty darn uh tight. It’s the, the where we probably go overboard when you look at our finances is our spending on on the properties because in those, over the last 10 years, we’ve we’ve probably averaged at least uh investing probably about 100,000 every year into the properties, whether it’s, you know, um, usually they’re all improvements, but, you know, CAPEX, those types of things on the front end when we buy a a property. So that’s what kind of skews it. It’s it’s funny our spending looks really high and then you go, oh, that’s actually the real portfolio is spending all that.
Scott: Awesome. And and so again, the story here is one of frugality, uh, middle, upper middle class incomes, a steady accumulation and some really smart real estate bets that you guys have made uh primarily self-managing, I believe these this portfolio um over the past two decades and um building up a really cool position here. So, one of the things that I noticed here just to round out the the financial profile is that the business on about $4 million in equity, it generated last year close to $32,000 in profit earn cash flow. And this year it generated 10 and so 2023, your projection is for $170,000. So can you explain that jump? and I think that’s going to be a critical piece of the puzzle to understand in going to going through how we can optimize your portfolio.
Guest 1: So for those, we, um, we added two properties, uh, that were pretty heavily distressed. Um, ironically, both from the same seller.
Guest 2: in on. Yes.
Guest 1: and they needed a lot of rehab and for that reason, one of them, both well, uh, one was vacant for call it seven months out of 2022 and the other one, the fourplex was vacant it’ll be vacant all the way up until, uh, this coming month where the rents will start coming in for that. And between the two of them, the rents for those units are quite valuable, so it it equates to, um, it was it it’s like 50 almost like 5,000 call it for the for the duplex and for the fourplex, you’re you’re looking at
Guest 2: between eight and 9,000.
Guest 1: Yeah, between 8 and nine for the for the fourplex. So, it it adds significantly to the cash flow every single month.
Guest: Question on that, those properties that you just purchased, those value add, you know, because a lot of times when we’re looking at your analysis, we’re going to be looking at like cash on cash return, what kind of liquidity do you have? How do you how do you increase that? How do you structure those deals when you guys are doing those up front? Do you structure those as a construction loan where you guys are rolling in the financing on the purchase or is it where you guys are just putting down a down payment and then funding all those rehab out of pocket because I know you said a lot of your your income goes back into your portfolio. But how do you structure the initial deal for capital?
Guest 1: So for those, we were we were essentially uh straight uh conventional financing, just purchased the property and then use the cash flow from the existing rentals to fund any any improvements that are are needed. Um, so that way we’re not paying interest on the, you’re not paying the higher interest rate and you’ve got because the rates were so attractive the the last few years, it just seemed like uh, we want to, you know, capture those low interest rates and and uh, not lose the ability to lock them in for the next 30 years.
Guest: Were you able to still get cheap financing on those two before they jumped or was that purchased after? Okay, so you were able to lock that debt at like four and a half to five rather than the eight it’s at right now.
Guest 1: So on across the portfolio because in 2022 or 2020 we refinanced basically everything uh and locked in anywhere from, you know, 3.1 to I think uh 3.65 is our highest.
Guest: Are those locked at 30 year or those on balloons or?
Guest 1: 30 year. Okay.
Scott: Yeah, so so this is like, this is the the problem and why this is going to be such a fun exercise is because like the portfolio is so optimized, right? You you’ve got what? like four four plexes, one duplex and a 10 plex plus your house all at below three three and you know, 3.75, 3.625 is the highest rate you have. All uh that are cash flowing or projected to cash flow at a considerable rate. Yet, um, if we believe your projection model, you’ve got four and a half million, something in that ballpark, $4 million in real estate that’s generating $160,000 and you’re probably like, well, I’m that doesn’t quite feel free uh to me. Is that is that the crux of the issue if I were to put it in a nutshell?
Guest 1: Yeah. And and when we look at next year, when you look at next year, the the income will jump again from uh 100 and call it 170, you know, 180 this year to closer to like maybe, depending on if we keep our occupancy full, we could hit 250 to 260 next year, uh just in the cash flow coming off the rentals. And then, you know, you still get all the principal paydown, which is right now across the portfolio right around 8 grand a month as well. And so it’s like that’s the hard part is like how, you know, like you’re saying it’s like you do this, you optimize it. Now what? Yeah, like uh oh.
Guest: I think you guys have done an amazing job on your portfolio. You’re very well balanced as an investor and because that’s you have cash reserves, you got good cash flow coming in, they can weather any kind of maintenance issues. What you’ve done is you’ve perfected your your portfolio the way it is right now, right? You’re you’re running at full tilt. But one question I have because what you guys like to do is is you like to, a lot of investors like to use leverage, right? Leverage is how you grow faster. Um, and obviously you guys were able to attain the cheapest financing we’ve seen in ever in the history of of the US. Uh, which is a great thing to have. But is there a reason why you guys never set up with, you know, because like setting up with that extra leverage gives you more cash. The more cash you have, you can grow more units in, you know, especially when you guys are averaging roughly, uh, like a 7% return on your true cash because because that that 260,000 you’re talking about, that’s that’s net. That’s not gross, right? That’s, okay. You know, so like on a $4 million equity, you’re making about a six and a half percent return, which I’m sure on your cash, you’re making 12 to 13% roughly. Yeah. That’s usually what we’re trying to give. Okay. you know, 12 to 13%. Is it just because you started purchasing that way in the very beginning, just putting 20% down, funding all the rehab out because I mean, half your portfolio at 50%, sometimes is underutilizing leverage where you can, you know, what you know, that leverage can you can 2X that sometimes by by pulling out more money. Have you guys looked into tapping into that 4 million through other different revenue or is it more like your personal goals are to keep your debt costs down?
Guest 2: Those are the areas that we, we don’t know enough to know enough and so we don’t want to, we don’t want to miss stuff on that. I mean, when the rates went down, we had done a couple purchases and I was poking him like, hey, if we’re gonna pull money, we should we should do a cash out refly now and I’m glad we did because then things quickly, you know, that wasn’t an option, but as far as how to, how to capitalize on that leverage,
Guest 1: Yeah.
Guest 2: it’s why we’re here.
Guest 1: Yeah. And to be totally frank with you, I mean, like the whole thing was like, you know, you always hear the horror stories of leverage kills. And we tried to be smart and stay away from that, you know, not not to because again, it’s that whole thing of like, don’t go bust. So, and but we we realized now you sacrificed you’re you’re sacrificing opportunity and ability to grow by potentially being overly conservative with the leverage position.
Scott: John, what are your goals and and Jennifer, what what are your goals?
Guest 1: You know, I, um, I I want to continue to grow our portfolio and I realize now, especially as we’re starting to have really high income coming in from the the rentals, the where I’m spending my time is no longer it’s it it made a lot of sense early on, have a great W two, really strong, uh, earnings, um, you know, it’s how you take care of your family. And now it’s like, okay, I’m spending, you know, way more hours on a, uh, on a W two that is making far less money for my family.
Guest 2: Way, way, way, way more hours. I’m, while I’m, while I’m hugely supportive, it’s, you know, it gets to be like, okay, what are we getting out of this versus how much stress, what would you rather be doing with your time? I work two and a half days a week in my clinic and you know, it’s a huge blessing to be able to do that and make what I do. And can I amp it up? Yes. Do I want to? Not really. Like that’s not why we’re doing all of this. So, uh, and luckily, both of our goals are pretty similar on that. I, you know, if anyone wants to stay at the W two job more, he’s, I’m trying to pull him away and saying, you know, it’s never gonna feel comfortable, it’s never gonna feel like the perfect time. and the first one, you know, the first, even if you do an interim job, it may not be the final, but there’s going to come a point where where being there doesn’t make sense. Um, so we’re thankfully aligned on that. We know some couples where one wants to invest and one doesn’t and they don’t agree on how much work should be spent where and and we work really hard to make sure that, you know, even with our kids, we’re we’re first and foremost as far as our health and relationship before the kids, before the business, otherwise, whats it all for? right.
Scott: John, do you like your job?
Guest 1: I do. There’s a lot of aspects that are bugging me at the moment, but in general, I do. I mean, I’ve been there nearly almost 20 years. But it’s, it’s you realize you’re kind of, you kind of getting to the point where I know I have a lot less road ahead of me than I with that career than I did when I started.
Scott: So here here’s the good news. You you can do whatever the heck you want to do and you’ve won the game, right? You have, again, $6 million net worth, you’re going to generate $300,000 uh, easily per year in cash flow from these investments on a go-forward basis, it sounds like. Um, your job is irrelevant to the financial uh position here. Uh not irrelevant, but it’s less it’s almost it’s almost like a non-factor. It’s like the it’s not the 80 20 of your position. The 80 20 is managing and growing this business, it’s way more impactful to the overall finances for this. So you have complete freedom. You can keep working that job as long as you’d like. You can cut back your hours uh whenever whenever you want. Uh if you ask me what a strong position to leave your job is, $500,000 in cash and uh $6 million in net worth with hundreds of thousands of dollars in passive tax advantage cash flow is one where I would say, yeah, you’re probably good and you spend $8,000 a month on your household. So, so the so things are good there. It’s a matter of like what what makes sense on a go-forward basis, when do you want to do that? And what do you want? Um, and then from there, we can figure out like is your portfolio giving you all that you want from it. Um, surely it’s eclipsing your spending goals, but we can modify it to either have more aggressive growth targets by adding leverage, for example, and going bigger, or a we can have it yield more cash flow in the near term by reallocating some of that portfolio to higher cash flowing investments if that’s if that’s something that’s interesting, interesting, although that will come at the expense of having to get very creative on the tax front and maybe pay some, some income taxes in a in a tax inefficient way. That would be the high- level diagnosis that I’m bringing bringing to the table here. Um, and then I know that uh there’s other also ways to optimize your existing business and some some uh areas to look at. Which of that sounds most interesting to you? Where would you like us to to dive in first across that?
Guest 1: I guess option A is probably.
Guest 2: I kind of think too.
Scott: When you said option A, do do you think that the the idea of figuring out how to optimize the portfolio for long-term value creation and access to where it’s at is the is the most interesting?
Guest 1: I kind of think so and and don’t get me wrong. I realize the bias towards when you the stuff you own, like you overvalue the things you hold. I wonder if I’m falling victim to that, you know.
Guest: We all do, John. we all we all do. Yeah, and that’s why we’re having this conversation is you get stuck in what works for you because this has worked really well. and I do the same thing and all of a sudden I got to be like, okay, I need to do it a little bit different here if I want to grow.
Guest 2: Many many people have that same thing. these houses have done well for me over the last six years. They want to keep them because it’s it’s a proven track record. But then, we can talk about how to make it even better. because at the end of the day, financial freedom is just about the best financial position you can put yourself in and so those are some important things to think about with your goals.
Guest 1: Well, in the wild card too is, you know, with the interest rates going up and we would have thought, well we would finish this forplex and keep growing and accruing more more buildings, but that’s gotten a bit harder with the interest rates and and trying to get those to cash flow and from the beginning, you know, you can buy and hold and hope that you can refinance in the future, but
Guest: And that’s sort of that weird space where we’re in right now where you, you know, it’s like I know if I don’t, I know that if if Jen and I just sit here and do nothing in four years, we’ll have another million dollars to essentially invest, right? You know, again, it’s really like you’re saying, it’s really hard to let go of that, you know, security.
Guest 1: Right.
Scott: Well, I think, again, it all depends on where you want to go. And I think, I don’t think you guys have quite figured that out yet like like what what’s next here. So I’m gonna I’m gonna start spitting out some, here’s some things I’d be thinking about in your position based on my, my sentiments. They’re going to be completely different than that. Um, I personally, if I was sitting in your portfolio, I don’t know if I would change a thing. I think James will disagree and I want to hear his take on this. Um, I’d optimize maybe a little bit on the expense side. but like your, like there’s this phenomenon going on in the United States where interest rates have risen a lot, people have locked in their 30-year mortgages and they’re locked in to their housing, right? Americans are not going to move, right? Why would you? You’re going to trade your 3.5% mortgage for a 6 or 7% mortgage, right? So you guys have made a decision in the past that has led to a really good outcome. And I agree with the diagnosis. I think you’re going to have to sit on this portfolio and watch the millions trickle in over the next four or five years. Um, I don’t know, you know, who knows about appreciation and those types of things. but it’s either, you’re either going to do that or you’re going to refinance these properties and take on way more crazy debt and take higher risks with the next project. I think that, you know, it from a from a high level like diagnosis, I think you’re kind of stuck. You can’t yes you can get creative, you can sell these properties, you can 10 31 exchange them. But by the way a 10 31 exchange means that you have to get a new property with the same amount of debt on it unless you want to pay taxes on the reduction in what’s called boot. And then you’re going to have capital gains tax to pay. If you sell the property and just harvest the tax the the the the equity that’s in them, you’re going to pay an agent to sell the property for you, um, and and pay a commission there. And then you’re going to and all the closing costs. then you’re going to pay the capital gains on there. And the pile of money that you’re left with after that and your debt is going to be very nice. You still, you still have some spending money, but it’s not going to be, you know, quite as much, it it it won’t feel like very much to you uh at the end of the day when you run that calculation. I don’t know if you have done that math or talked to a CPA about the those types of things.
Guest 1: No. I’m not.
Guest 2: Not really an option we’ve ever considered, so.
Guest 1: It took so much to build the portfolio over the last few years.
Scott: So you you’re stuck with a pile of wealth and plenty of cash flow to cover your needs and you know, uh uh, you know, what what am I gonna what am I gonna you get, I think I think plan A for me is sit on the portfolio and do nothing and manage it effectively, right? And then when when you have the the next, you know, the the the pile of cash flow that’s coming in, what do you do with that? Well, you either continue adding on to this portfolio in thoughtful and creative ways. I love the idea of assssumable or or uh subject two mortgages or those types of things. um, so you can keep buying properties like this with last year’s debt if you find those um those those opportunities. Or, I like the idea of going into lending. I know, I know uh that’s where James put a lot of his extra cash in in in hard money loans and those types of things. And you guys are very well positioned to do that kind of stuff and that would help you get, you know, a 10 plus percent potential yield on that additional million that you’re going to generate over the next three or four years and if, you know, worst case scenarios, you know for close on a property uh that you know how to operate and manage pretty well. So that would be my bias coming in. I know James is going to have a very strong different opinion on that.
Guest: I I’m naturally a trader. So I I you know, one thing I I do believe people get stuck on right now is the low rates. And yes, cost of money, I mean, and there’s a good example right now. I just sold a duplex in Queen An, Washington, great area. All right, no cash in the deal. I was cash flowing 1,500 bucks a month and I had a four and a half percent rate or 4.25% rate. But I just traded it for a property that had that actually for I go from $1,500 a month to break even and my rate now is going to be 7 and a half percent. And I would do that trade 10 times over right now and let me tell you why. it it’s because at certain point, these assets they get into steady growth, right? When we when you guys purchase these properties, you got them at the right time, right? 2012 was when the market was flat, you guys income were up, you could obtain cheap financing and you bought them right. and buying them right gives you gunpowder to explode your portfolio out. And it uh because the equity is really what can grow you rapid. And you know, right now you guys have an amazing portfolio. You’re making a great cash on cash return on it, but your overall return on equity is around 6%, which is 6% is still a good growth, but it also is below inflation at that point. You know, and so for me, I’m always looking at what kind of equity and what can I trade into and even if I’m getting a higher rate down the road, if it’s 6 and a half percent, if I’m getting a higher surplus, it doesn’t matter if my cash on cash return is going from seven to eight with a higher rate, then I’m still advancing my position at that point. You know, things that I would look at, there’s kind of two ways. You can either look at your portfolio like it’s a gold mine, which it is, right? It’s steady, it’s safe. You’re not going to be the Seahawks on the one yard line throwing the interception in the end zone. You’re not, you’re not going to be doing that, right? Run the ball. If you just run the ball in with your portfolio, everything is going to be fine. But, you know, with this quest to financial freedom, you know, like you were saying, you want to get down to two days a week. John might want to stop working to give you that extra padding in your expenses because right now your expenses rates run great. You’re at 30 to 35%, which is amazing. But once John leaves that job, that’s going to go right back up to 50% and that’s going to be trailing with the the average, right? And and then you have to figure out how to increase that. One thing what I would do is, you have property scattered everywhere in, well, they’re all in one central city, but they’re still different properties that come with different expenses. And right now your portfolio is running an average of about 50% expenses. and that’s with you guys self-managing too, correct? Yes correct. And so if you add in property management, you’re going to be running like 60% expenses on your portfolio, which is a little bit higher and that’s what happens when we start accumulating units and they’re spread out everywhere because we did the same thing. I’m a Pacific Northwest investor. I started with single families. We rolled the small multi into large multi. If you took these buildings and you went and sold them right now and they the combined value is 8.7, right? If you took that and you bought a a unit, if you bought that in Everet, you’re going to get that for about 150 grand a door. You’re going to be able to obtain like 70, 80 units in Everet with that pricing at that point with today’s market. And in addition to when you’re buying a big portfolio like that, even if you’re trading into a 6 and a half percent rate, your average expenses or your your expenses on bigger properties actually go down because you’re more efficient and so you can naturally add in 10 to 15% in cash flow just by reducing your expenses on that one trade. Wow. and and that will offset all your debt costs at that point. And so, just by making that one move of selling off the properties and putting them into one, your cash flow would go from annually, if you’re projecting to get to 360 by the end of the year, you’re going to be picking up an additional 54,000, you’re going to be at 415 just by making that trade.
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Scott: What would be the uh cap rate on on this 70 unit apartment complex and what would be the interest rate on the debt for that that apartment complex?
Guest: So with commercial debt right now, so we just and I can this is a perfect time because we just closed on a 58 unit in Everet. so I can I can rattle the cap rates. Stabilized, we are at a 7.9 cap, stabilized when we’re all said and done. So that’s already going to increase your cash on your equity, return on equity right there. We were able to get financing locked at a five years, uh or it’s a 10-year note fixed for five and that’s at a 6.1 rate right now. So yes, you’d be giving up your 3% rates, but then your your overall return and your spread’s going to go up at that point and your costs are going to go down. So naturally you’re going to pick up that extra 15 to 20% even with paying that higher rate at that time. and your life, if you guys like financial freedom, you have one site to manage, it is a lot simpler, a lot easier, and if it’s about that work life balance too, like, okay, well, to run around and manage all these properties with all different areas, that’s different demographics of tenants, it’s, you know, it’s just harder. Um, and whereas if you have a bigger building too, or if your properties are spread out everywhere, typically your property management cost is going to be 8 to 10% because it’s more work for a property manager. If it’s in one, you’re getting 5 to 6%. So all of your costs have go down just like you guys have ran your living expenses. You’ve like built it based on keeping your expenses low. by doing the one trade that will it will match what you do personally as well. Your expenses will match what your life expenses are. and that 15% will almost, that will pay for a third of John’s salary just to stop working. Just by making this one trade would pay for 35 to 40% of John’s salary right when he leaves the door without putting any more money in the deal.
Scott: James, this is awesome. I I have a quick question as well on this. Um, what is the purchase cap on a TTM basis? So you said stabilized, this will be 8%. That’s your cash flow uh for those listening. So your your essentially your your net operating income will be 8%. So you have a million dollar property, you’re making 80 grand a year in her rough rough cash flow before uh allocations for capex and those types of things um and and uh principal payments. But what what is it what are you purchasing it for? Because you’re, you said that’s the after stabilization cap rate.
Guest: Yeah, so we were we were buying it at a 5.8 cap on existing right there. So and and logically that doesn’t make sense when you’re buying with a 6.1 rate, you know, typically your cap rate needs to be above your interest rate. That’s like general rule of thumb to keep. but it was a very cosmetic turn too, which they’ve definitely have done by looking at their portfolio because they they’ve bought some pretty old buildings and those are harder renovation plans. And actually what we have found is going from the small harder renovation plant, like what you described on your last purchase was a great buy. You got it well under market, but it needs a lot of work. That that’s it’s just you know that’s a 6 to 12 month deal to get that thing fully stabilized and optimized. The great thing about buying bigger buildings is you’re buying them a lot newer. Like the building we bought was built in the 70s. So all we have to do is swap out flooring, cabinets, doors, trim, but the overall bones and structures and the mechanicals are good because so it makes it very efficient at that time. So it’s you don’t have to take on when you’re buying bigger, you don’t have to take on the same amount of work either. So it’s just basically you’re getting more efficient at that point. But you have to get comfortable with trading that rate out. And and going back to my example of why I did that deal because people are like, have you lost your mind? You got a lower rate and you’re cash flowing 1500 and now you’re not cash flowing anything. I did that trade because the building I sold was maxed out. If you guys sell these and these are at the top dollar, you it you’re going into steady equity growth at that point. You’re going to be getting your 3 to 4% a year. Whereas if you can buy something where a bigger building where your cap rate’s 5.9, you can increase it to seven, you’re increasing the value of that building, which is going to create that equity pop. And so I made this trade to a duplex in Bellevue because yes, my castlo position’s worse, but that will get better when rates fall. but my equity position once I’m stabilized is increasing by $350,000 over a 12-month period whereas my $1,500 a month in cash flow is not going to get me there for the wealth. And then I can trade that 350 then later for more cash flow because I’m in building you guys have done a great job building equity and then it’s about maximizing your equity to get you to that final space where you’re like, I don’t even need to manage my properties anymore. They all pay for each other because the equity just keeps buying it down, buying it down and getting you more doors.
Scott: I think that’s awesome. What James just said is that’s a business, right? You’re going to go in and and you’re going to buy buy a property and you’re going to turn 50, 60 units. You’re going to take on uh a different type of debt to purchase that portfolio. To to exercise this, you’d need to sell essentially all six of those buildings and 1031 exchange the equity into this new property and then close that debt. This will be a project. um and yeah, you’ll absolutely get better returns um on that if you can drive uh uh rents up in a pretty meaningful way uh in the period following acquisition and uh and property. Probably take you like a year. I don’t know, is that right James you think to to move the property to its post-stabilized rental rates?
Guest: Uh yeah, it takes about a year, depending on the size of building, because what you’re doing is you’re doing a structure that when you’re buying these a little bit more cosmetic, you’re moving out like five people at a time, you’re turning the units. So you still get to keep your debt service going, but yeah, it’s about a year process when you’re you’re moving people. I think on that one, the 58, what will be done with that in about seven months all the way through, but we also had a third of them moved out when we bought it. So we could just tackle those immediately.
Scott: So I think that’s that’s a potential option for you. That’s a business activity, right? So that’s going to be that that would take your existing portfolio, which, you know, probably feels to you fairly diversified even though it’s all in one one place, and concentrating it into a single asset. I think there’s a spectrum of optionality along there. You could, for example, purchase a property, well you have to keep probably about again, four, 4 and a half million dollars in debt on the portfolio, which will dramatically change your debt service. So you’d want to run those those through. Um I would I would run the numbers on on the two things and say, hey, if the, if the uh opportunity size is dramatically, for me, it would have to be dramatically better to go, to go with James’s option there, uh than to just kind of go with the status quo, um, because, you know, you’ve what you’ve got is working there, and it it may well be, um, but you know, so several things, I think, uh, uh, I I I completely love James’ strategy. if you can find a deal, if you can add the value and you’re willing to to uh uh assume the project there. Um, you you will be able to drive a much better return than holding the existing portfolio. Um but the existing portfolio is freedom in today’s sense as well without without any modifications to it. So it’s all about um what the what that end goal is and um the comfort with with that. I think that’s, you know,
Guest 2: I think that’s probably our biggest hurdle is the comfort with the security of it. And that that’s with our portfolio, our current life, his W2. he gets real suck from about three of the best years. He gets real stuck on the the security of like, well this is my salary and we have medical and we have kids. and so we’ve gotta, you know, but but getting past that comfort level and kind of pushing it. I think we’re both interested in it’s just kind of jumping over that hurdle. Um, and so, you know, the the comfort and the security is a good thing, but it’s also one of the things that’s detrimental to us and our future growth. And we do want future growth. um, so it’s, yeah, I mean, the good news is that we can stay with what we’re doing now and and still be okay or we can push to what what James is saying and and accelerate which, you know me, that’s my vote. so.
Guest 1: So she’s generally the I’m generally the conservative one. I’m the I’m the handbrake and she’s she’s the one that’s like what are we balance each other out.
Scott: Another route I might take in your situation is, I might say, what is that number that I’m super comfortable with? Like if if I was just like if I had a pretty safe $200,000 in passive cash flow every year, would you then John be willing to take the remaining, you know, 4 million bucks of your portfolio and go big on a on a James bet here? Would that change things for you?
Guest 1: I think in some regards, yeah, it probably would. And you know, and and I I I uh the other thing I realize too is I I wonder if I’m getting caught in a little bit of uh market timing thinking as well with the portfolio because there’s we still look at deals all the time for for properties and admittedly nothing has been ever as big as like a a 50 unit or any anything deal that size. so we haven’t really considered those to James’s point. but, um, you know, there’s there’s so much assumption that are belief, I guess that, you know, there will be these opportunities later, whether it’s later this year or into 24, you know, are we are we jumping too early? You know, if I if I decide to get super aggressive, am I, uh, you know, am I being overly aggressive and not like, you know, reading the reading the signs?
Guest: And there’s one thing about that. And I get trapped in the same thing because I’m a 2008 investor, so I have bad whiplash. and I I lock up sometimes. But if the opportunities are better in one year and pricing’s less, your portfolio’s worth less too, and it’s an equal trade. It’s about what can you do today and can you increase that return? And and that’s when you want to make those big and that’s what you guys can do to make that big growth jump, but that it is also not for everybody. I’m also kind of a high risk person that, you know, I’m chasing this equity growth. I actually don’t care about cash flow at all right now. I’m just trying to get the biggest equity position and then when I’m ready to kind of settle down, I’m going to sell it all, roll it into one thing and then I’m going to take all this equity, buy a bigger building and I’m going to have one building that’s going to pay for everything. But you guys do have a great portfolio and there’s room to improve too, right? Because you you you’ve maximized it, but you like your expenses are are are high in and just implementing other strategies. like right now, do you guys do utility bill backs?
Guest 2: We don’t. on in the duplexes, they they do their own garbage, but water through garbage is included in the four plexes and the 10.
Guest: Okay, I would implement those immediately if you guys want to start growing a little bit too on your existing because you know, maybe you get to the point where you’re like, I don’t want to make the trade right now. we we don’t want to fumble on the one yard line. but you you really start breaking down your portfolio on how to perfect it, right? And if by putting in utility billbacks which are now standard up in Everet and S King and Pierce County, that’s going to automatically put about three to 5% back in your your your return right there. And then you can take that savings and then what we were talking about was adding more units to your building and, you know, uh, you know, just really going, okay, once we save up a certain amount of cash on this extra cash flow, then take that and invest in our profits into adding that building or adding that unit and as long as you can generate the same cash on cash return that you expect, you know, so if you’re you what we were talking about before that we hopped on was you were going to add a unit for 250,000. It it only makes sense if your minimum, you have to make sure that you can generate $2,500 a month in rent if your minimum return is 10%. And so you just want your build out cost to to to track with what your rent is. And then that will make the decision if it doesn’t, then you want to make your your portfolio more efficient and get your portfolio to pay that overge at that point.
Guest 2: Okay. Now, what’s your strategy with the buildback? Do you do per person or do you do per unit or is it a mixture?
Guest: Uh we do per unit and then units that we do have multiple tenants in one house, we actually do that we make them sort that out. uh it’s in their lease that they’re all obligated to pay the one bill but they got to sort out their own separate billing.
Guest 2: Okay.
Scott: a and I just charge a utility fee. Okay. So that’s another, that’s another, I don’t know if that’s an option in your state, um, but, you know, we here we just I I estimate the utilities on an average basis and then just charge that on top of the rent and so the payment includes rent plus utility fee.
Guest: Okay. Just make sure you’re not cash flowing your utilities, that is not allowed. Right, got it. Yeah. It is, you got to make sure your fee is slightly below actually.
Scott: Yeah, so so James strategy is probably more appropriate more like long-term appropriate. Mine, mine, yeah, so I still cover a small amount of the utilities, but yeah, it’s very simple, you know.
Guest 2: Well, I think there’s also kind of a little more responsibility in utility usage if you’re on the hook for it. so Exactly. versus like, hey, we don’t pay water. Everybody come over and do laundry. So we now have that in our lease that that’s not allowed, so.
Scott: That’s like the no archery sign at the beach, you know, somebody somebody sometime put that into the there was a need for that. Apparently it is. I I’d love to know what that was. So let let me try another one here because again, I think I I don’t think you guys have a math problem here, right? I think I think there’s more of like an allocation and psychological issue to resolve in your your your situation because you’re way past the point in terms of net worth of what you’d need to to actually leave your job uh John or deal with that.
Scott: So I want to go through a couple more exercises here and try a few try a few more portfolio allocation things on. You know, I I think uh if if if I handed you a pile of $2.5 million in cash right now, how would you allocate that John to feel so super comfortable with leaving your job?
Guest 1: I think you have a different allocation than I do. Right. So, um, what luckily? you’ll both be able to go through this exercise because you have more than two and a half million each uh to to allocate if you wanted. I uh, I would keep a substantial amount in cash reserves. I honestly, I’d probably put at least, you know, 300 to 500 in cash reserves. and then truly I would go figure out investments for the others, um, uh I again, I default to buying the the the duplexes and fourplexes because that’s what I know, but that that’s how I would, that’s how I would allocate it and you know, try and find opportunities there to to to buy undervalued assets and that would be my cash cushion would help ensure that we don’t get tipped over and um, you know, pick up one or two properties, start working on them.
Scott: And and how would you allocate it?
Guest 2: Honestly, pretty, pretty similarly. I honestly thought he would keep more in cash reserves. Um, Being aggressive. Yeah. Yeah. Uh, because again, security, security, security. So, um, but no, pretty pretty on on par with that. We’ve been together too long. That’s why
Scott: Can I jump in real quick? So I started stalking all your properties on the internet as we were talking. You know, and you guys have some hidden value on these and so if, you know, for there’s nothing wrong, the plan that I proposed is just the way I do it. I know a lot of people do it that way. It’s aggressive. For, you know, there’s nothing wrong with also being more conservative and keeping you keeping your financing locked in. And what I’m looking at like even on one of your properties, like the one uh four unit that’s on walnut, um you have a big parking lot there. And Washington has just eliminated single family zoning and and they’re they’re allowing for massive upzoning. and you have a very good potential to add one to two ADUs or dus to a your parking lots, your rents would go down a little bit. And then the nice thing about doing that is you have to come up with the cash to build those. They’re going to cost you about 300 grand to build one each each one of those. But then once you condo those off, you can leave your financing in place on your four unit, your cheap three and a half percent rate and you can refinance just those two units at about 6% and once rates fall, then you can bring it in. but it allows you to add more units in, get more rent income and keep your financing in place. and then eventually if you want down the road, you can sell those off later uh if you wanted to, but I’d probably just keep them as one big package. But it allows you to expand out your portfolio without having to reset your loan basis.
Guest 1: And interesting. That’s a good plan. I’ll keep you busy, John. That sounds like a better better value add than the uh the the W two for a year or two.
Guest 2: And that’s that’s just an Evra proper that they’ve been allowing that more?
Guest: And that’s in all three major cities. So Seattle, Abert, Tacoma are really pushing these uh ADU law and DADU expansion. Uh in Seattle, you can condo them off and sell them in Seattle and Tacoma, you have to keep them as rentals, but that works for what you guys are trying to accomplish. And you have a great lot here. we could cut this thing up all day long. So that’s that’s a good thing to hold on to. But the thing that you have to think about is you got to come up with that money to build it without resetting your loans. So I if I was you, I I would network with some private investors, borrow the money and then refy it. It’s going to cost you a little bit more up front, but it allows you to keep that really good rate because that is a great three and a half percent on a 30-year fixed is a is a good thing to have.
Guest 1: There’s um some of the similar properties like uh the fourplex on Chestnut. It also has a a big open area just in front of the the building as well. Um, and then 4510 in Maryville has a large lot that’s currently a car part. Yeah, and I mean, we we use it as as, yeah, it’s parking and storage. Um, so we hadn’t, we hadn’t actually, we really thought at all about the the change in regulation, the the DADU law, we never really considered that. We always thought that was for single family to be totally frank with you.
Scott: I think that’s a bingo, right? I mean I just asked you guys, what would you do if we handed you $5 million in cash? And you said, I’d do exactly what I’m doing currently, but I want to grow my portfolio more on this. like there you go. Like there’s the answer. Now you have the, now you have you have this opportunity to add value to your existing structures that you you know really well and you can pull off these projects, you know, either in tandem or one at a time. you have the cash right now to finance that project completely if one of the projects completely if you wanted to. um and and you’ll replace that entire reserve in one year um without even, you know, like you, you probably would not even notice your reserves dwindling while you tackled one of these projects would be my guess because the cash flow to finance each phase of the construction would likely be replaced by the rental income from your portfolio. Like you’re you’re if you’re just looking at your balance over time, you probably wouldn’t even notice it with your current situation. So I I think that’s a that’s a fantastic uh discovery by James. Great job, man. That that’s off, I had no idea. I would never have gotten there because I don’t know that regulation in in in Washington.
Guest: And you could also take a loan out against your 401KK that you’ve done such a good job just temporarily to build it and then put it back in once you refinance back out because you guys have done a great job saving and that’s that’s usually a lot of investors biggest problems. But you but tapping into those investments, it’s just, you know, I would break out of the, hey, this bucket, this bucket, this bucket. How do you maximize the buckets and maybe you got to mix them for a short amount of time. Um but it still gets you to kind of your end goal.
Scott: I think you got some fun options here. Your portfolio is so optimized is so close to to optimized, uh, for what for in its today’s shape that yes, I think that if you wanted to go big and build a business, um, James’s approach is going to get you richer faster than the one that I that I held out there. The current portfolio though, if you do nothing, is going to cash flow and cover all your needs. So game is one, victory is complete, um, or pretty close to it with your with your current situation. But I think that if you want a blend of both, uh then I think James’s uh uh approach of of just adding value by basically to count that your properties have been rezoned recently without you being really being aware of that. That seems like a pretty good place to go hunting for opportunity there and I’m sure you can um continue with your preferred choice of of paint and floor in those uh new new constructions that you’re going with.
Guest: John, what do you think the back of the NaF can, since you know they area so well, the uh the cost, you said cost 300 and ARV of one of those projects would be?
Guest: So like if that was so you can’t sell them off right now, but the the value on that building, so you’re you’re going to build it for 300, it’s going to be worth about four, 399 to 420. Being next to multi-family, you’re probably going to be worth 3.99. So you are going to pick up an equity position there and then that unit should rent for about 2100, I would think for a brand new two bedroom, two and a half bath. uh, that should be about 2000 to $2200 rental and then John can probably you guys can probably, uh, verify that a little bit better than I can because you’re more, um, so the the issue you’ll have is it’s not going to quite hit your cash on cash return expectations because you’re going to spend, you know, roughly 300 and you can probably build that for 250 there too. if you do more rental grade, the 300 is more for resale, so you you upgrade it. So you’ll be about 250 in and get about 2,200 out of it, but it allows you to start building, if you don’t want to trade out the buildings, you can start building infrastructure behind that.
Guest 1: And that’s very similar to what we were looking at when we looked at the property, the 10 unit up in in Maryville, we’re estimating, you know, the the initial rent on it would be right around 2200 maybe a little bit higher for the town home, um on a build cost of right around 250 for that. And with this is good or bad, um, it served us well. Our strategy has been very patient with regards to the, you know, not trying to get the, not having to get the maximum capital today. Um, uh, to, you know, kind of essentially just lower risk and and make sure that we’re slow and steady rather than, you know, sprinting and realizing we’ve gone the wrong way.
Guest 2: But I I think we both are wanting to, I tell them all the time, we have to get comfortable with being uncomfortable. the un comfort comfort and the discomfort. and so pushing it past what we’re what we’re comfortable with as far as the security aspect, um, I mean, he’s the one that’s like, you know, we should go 12 steps that way and he’s like, I’ll compromise with eight and so we land somewhere in the middle. Um, but I, you know, we are in the scheme of things relatively, you know, in the beginning and we do want to do this long haul. so, it seems riskier to him to do it now that the kids are small and I say, well, now it’s kind of the time to, you know, to to push, I think, to push and and grow at a faster rate.
Scott: Well, John and Jennifer, thank you so much for coming on the on the show today. Um, we we hope this was was helpful and we’re so grateful for you coming on and sharing um a unique and awesome um challenge for us and, um, yeah, we wish you the best of luck. Please let us know what you end up deciding to do.
Guest 2: Sounds good. This was hugely, hugely insightful. Thank you both.
Guest 1: Thank you. Yeah, we’ll have to, uh, have to attend your meetup, uh, two years ago and go ask you some questions in person.
Guest: Oh, yeah, come hang out.
Guest 1: Yeah.
Guest: Absolutely.
Scott: All right, guys, thank you so much.
Guest 2: Thank you very much.
Guest 1: Take care.
Scott: All right, James, that was John and Jennifer. What do you think today?
Guest: Oh, those are my kind of people. It’s cool to see investors grow their portfolio and not get too far out there because that’s a huge mistake a lot of people do. Um, and then I could relate with them a lot about getting kind of locked up, getting comfortable because we all do that and it’s about how do you push to that next thing or figure out whether you even want to do it in the first place.
Scott: Yeah, absolutely. I thought that was really an interesting uh dynamic because you know, I I bias towards and and and the reason I bias, by the way, towards the approach that I took is because I’m the CEO of this company at Bigger Pockets, right? So most of my time and my energy is spent on building this company. and I sometimes kind of get locked into that and forget like, oh, if I wasn’t CEO here, absolutely, I’d be trying to take a more aggressive approach like what you just put together or like what you suggested with the 58 or 70 unit apartment complex and trying to grow to the next level there. So I loved, I loved the the balance of opinions there and I I I really think you hit a home run by when you uncovered the when you stalked the properties and uncovered that they have room for, you know, DADUs to be added to them. So that was an awesome find.
Guest: Yeah, might as well. I mean, if if you don’t want to sell, figure out how to maximize it. So, at the one thing I’ve always learned is you can always improve a deal.
Scott: Do you have any parting thoughts on other things that, you know, you’d have for for investors given that the what we discussed in today’s show?
Guest: No, I just think it’s important that investors don’t fall into that rate trap. at the end of the day it comes down to what are you making, what’s your return, and the debt is just a byproduct of that. And so don’t don’t get locked up because it can prevent growth. um and and for us we’re all trying to get to financial freedom. The more growth you have, the quicker you’re going to get there.
Scott: Awesome. So, yeah, you you’d generally recommend not for me, not doing what I’m currently doing and I think that’s that’s something to think about. I have to go and review that with my business partner on my own portfolio and say, you know, what should we be doing here? Because right now, I I told John and and Jennifer after the show, like that’s that’s what we decided last year. We looked at it, we’re like, we don’t think prices are going to move much in Denver for the next year or two, maybe three. We’ve cash flow just fine. We’ve got this low interest rate debt on here. If we sold the properties, we’d uh, we’d have to pay, you know, transaction costs, and then we’d have to pay capital gains. We refinanced a few. So the amount of cash we’d actually extract, if we didn’t 1031 exchange, wouldn’t be that high. And we thought, hey, we’ll just hold on and and and enjoy the cash flow and slowly deleverage these things. But maybe we should be thinking bigger on that portfolio and uh moving it to the next level.
Guest: We’ll let’s break down your portfolio next.
Scott: All right. Let’s do it. Awesome. Well, thanks so much James and maybe we should do that. We’ll we’ll we’ll we’ll talk with and see if that’s a good episode.
Guest: I’m 100% in. Let’s get you on the on the market podcast. and me and David can we can go through your portfolio together.
Scott: Awesome. Well, James, uh let us know if you if you think that would be a good idea guys and uh maybe we can make that make that episode happen. So James, great uh great catching up with you again today. Thanks for all the great wisdom and the great thought starters and uh we hope to have you back on a few more of these finance Fridays in the weeks to come.
Guest: Anytime.
Scott: All right, he is James Daynard and I am Scott Trench from the Bigger Pockets Money podcast and we are saying be sweet. Parakete. Thank you for that one as well.
Mindy: Bigger Pockets Money was created by Mindy Jensen and Scott Trench, produced by Calen Bennett, editing by Exodus Media, copywriting by Nate Winejob. Lastly, a big thank you to the Bigger Pockets team for making this show possible.
