If there’s one man to ask, it’s your host, David Greene, who’s joining us for another episode of Seeing Greene. David knows a thing or two about buying for different purposes, in different market conditions, with different exit strategies. He’s not only asked about how to do this on today’s episode, he’s also asked questions like who should be on the mortgage when buying a rental with a partner, whether to sell or refi a rental, what to do when your DTI (debt-to-income) ratio is too high, dealing with difficult sellers, and how to get comfortable with being uncomfortable.
David:
This is the BiggerPockets Podcast Show 612. Rather than trying to find a seller and convince them that their numbers don’t work when the market’s probably telling them that their numbers do work, I think you should take those efforts and put them into finding a different seller. This is a mistake a lot of people make as they try to change the mind of somebody who doesn’t have to change their mind. Just go look for somebody whose mind you don’t have to change. You’d be way better to take that same effort and put it into a different property.
What’s going on, everyone. This is David Greene, your host of the BiggerPockets real estate podcast. Here today with a Seeing Greene episode, as you can tell from the green view behind me. In Seeing Greene episodes, we answer questions directly from the BiggerPockets community regarding real estate, what to do about real estate, how to finance real estate, what’s going on in this crazy real estate market that we’re in, and I do my very best job to answer them. If you’re not listening to this on YouTube, consider checking us out there where you can read and leave comments about today’s show.
Today’s show is very good. We get into some very trendy topics that are on the front of everybody’s mind. We talk about if you should get into a cash flow or an appreciation market, what the difference is between the two and how to know which one is right for you. We talk about the fact that you’re not going to get comfortable before you do something. So what a good process is to get comfortable in the process of starting something new.
And we talk about how to understand debt-to-income when you leave your W-2 job and go full-time into investing or a side hustle plus real estate investing. We get into some really good relevant stuff, and a lot of wisdom is shared here. So thanks for joining me. I’m excited for you to hear it.
Before we get into the show, today’s quick tip. Consider getting your tickets to BPCON 2022 in San Diego this year. You can go to biggerpockets.com/bpcon2022. That’s BPCON2022. I’ll be there. Lots of other BiggerPocket personalities will be there, lots of other investors will be there. You can learn from other people about what’s working in their market, what market you might want to invest in, and then meet people in that market that can help you get started.
It’s also a great time. I’ve never seen a person there that had an unhappy look on their face. Everybody is super cool. It’s a lot of fun. There’s tons of knowledge being shared, and it can really get you invested in this community and jumpstart your career. So, consider being there. I’d love to see you there.
All right, let’s get into today’s show.
Ahmad:
Hi, David. Thank you so much for all the knowledge, insight, and information that you share with people every day. It’s been extremely paramount to my growth as a new real estate investor. My question is, my girlfriend and I are both new to real estate investing and we’re trying to build our real estate portfolio. We each have a property in our name already. We want to acquire the next one together.
However, our original plan was for one of us to take in that mortgage separately. That way the other person is freed up in terms of the debt-to-income ratio. And then down the road when we go and get another property, hopefully it would be a little bit smoother because one person still doesn’t have that new debt on their record. Now, with the rising interest rates and inflation and just cost of everything being so expensive nowadays, I’ve been rethinking that and thinking about going in on a new mortgage together, combining our income so that we have more buying power.
Now, my question to you is would that be disadvantageous for us? The reason I ask is I know from your previous podcast when we acquire that new debt, we both acquire it like we’ll both have that new mortgage on both of our debt-to-income ratio. And I wasn’t sure if with that in mind that the rental income would also, if we would both acquire that rental income or if only one person gets to say, “Hey, we’re making $2,000 in cash flow every month,” if I get to claim that, or she claims that, or if marriage changes all of that, so it’s all kind of confusing. And I was just wondering what your take on that would be. Thanks, David.
David:
All right. So thanks, Ahmad. This is a good question. Let’s break it down. You’re thinking about buying with your girlfriend. First thing I want to say, you didn’t ask this, but I would just recommend that you maybe hold off on taking title together with someone that’s not your spouse. I’m sure your relationship is great now. You never know what’s going to happen. And if you’re buying something with your girlfriend and only one of you is on title, if the two of you split up, the other one might not have any protection.
You’re going to put both of you on title. There’s ways to do it without having both of you on the loan. But in general, you’re going to end up both being on the loan. That’s the smoothest way to make it happen. And now you’ve eliminated the ability to have the mortgage and only one of your names. So just in general, whenever you’re buying with a partner, which is what this is, I advise people to probably try to not invest with a partner unless they have to, unless it’s your spouse.
Now, let’s get into the details of what you’re asking here. I like where you’re going. You’re trying to keep the mortgage in one of your names not the other, but you’re realizing you might have to combine incomes in order to get the property you want. That is sort of the conundrum. I think I mix conundrum and quandary together and made up a Voltron word that doesn’t exist, quanundry. Ignore that part. We’re probably not going to edit it out and everyone’s going to see what it looks like when you’re trying to record a podcast and you end up making up a word.
The good news is if you buy investment property together, you don’t have to worry about the debt-to-income ratio taking a hit, because you’re bringing in income from that investment property, just like you’re bringing on debt. So it usually ends up working out more or less to be equal. And in time, it actually helps your debt-to-income ratio because you’re making more income than what you’re spending on the debt.
Now if you’re buying a house to live in, that’s an exception. Usually, you cannot use income from a house when it’s your primary residence. There’s a handful of very small exceptions, but in general, it doesn’t work the same way. So I would say, if you have to combine incomes to get the property you want, make sure it’s an investment property. But you’re probably going to want to buy it in an LLC that you’re both half owners of to make sure both people are entitled. And that brings us back to the issue of buying a house with your boyfriend, girlfriend, not always the best idea.
So I would ask you, is there a way that you can afford this one on your own and you buy it, and then you work with her so that she can afford one on her own? I just think overall, when you’re looking in the future, that’s probably going to be a better approach. The other option you have is a debt service loan. These are loans where you take the income from the property not from yourself, so you don’t have to worry about the effect that this is having on your personal debt-to-income ratio.
The other questions that you ask are this is a good example of, this is best asked to a CPA, a title company. You can ask your agent or you can ask someone like me, but I’m probably going to refer you for the nuance of this to go talk to an expert. So if you’d like, feel free anybody to reach out, I’m happy to connect you with my CPA. If you end up signing up with them, they can answer questions like this one right here, because they have a better understanding of how to do this legally the correct way.
Thanks, Ahmad. All right, our next question comes from Haruka from the East Coast. Haruka says that she has bought a single family home. She’s renting it out. She likes it. And now she wants to expand. She wants to get into 5 to 10 multifamily properties or clusters of single family homes in areas with steady population growth.
The problem is she’s been looking in hot areas like Raleigh and Atlanta, where houses are super expensive that don’t really cash flow much. And then in other markets, which she calls medium like Indianapolis, she sees that she can find relatively decent cash flowing properties, but you’re not getting the growth that you get in one of the hot markets. Should she focus on one market and try to get as many deals as she can there or spread her attention over several markets?
Thank you for this, Haruka. Here’s what I’m hearing behind what you’re saying. You’re very frustrated because it’s very hard finding cash flowing properties in today’s market. And that is a thousand percent true. This is from what I’ve seen in my investing career and from what I’ve talked to some of the older investors, the most difficult time to find any cash flowing asset.
And it helps if we understand why that is, I won’t go into it too deep, but a lot of it has to do with the fact we printed too much money. That money needs to find a home. Real estate investing is the easiest way to deploy a lot of capital and capitalize on leverage without a ton of work. So more and more businesses, companies, hedge funds, institutional capital investors like us, everybody’s flocking into this space because it’s the best place to put money with the lowest overall risk and the highest return.
At the same time, the increase in education in real estate investing has taken a lot of the mystery out of this. That used to be a barrier to entry for a lot of people to get into the game. So now it’s easier to get in than ever, and there’s more people getting in than ever, and there’s more capital getting in than ever. And boom, you’ve got a very hot and competitive market.
Here’s something that I’ve come to understand when it comes to how I look at real estate. It’s a spectrum. But in general, you have cash flowing markets and appreciation markets. Now that does not mean speculating markets. What it means is you’re going to make more money by the value of the asset going up in some markets. We call those appreciating markets. And you’re going to make more money through cash flow in other markets where your property is not going to appreciate as much.
The problem is when we want both, there was a time you could get both and many people set their expectations that that’s what they should get through real estate investing. But I don’t see it like that. Now, I understand that when I’m buying a property, what I’m really doing is buying an income stream. Some income streams are very difficult and take a lot of time and effort to manage. Other income streams are easier to manage.
The income streams that are easier to manage are in higher demand. And therefore, they tend to have a lower amount of income that comes out of them because there’s more people looking to buy them pushing up the prices higher. So what you have to ask yourself is what is more important? Are you playing the long game? In which case, appreciation is usually better because you’re going to make more money over the long term or are you playing the short game where you want cash flow right off the bat?
Now, there is no right or wrong way to do this. Some people like their job or already have a lot of money. They’re able to play the long game. And so they go into the hot markets like you talk about where there’s very little cash flow in the beginning, but over time, they start to develop more cash flow as well as a higher appreciating asset.
Other people don’t have that luxury. They have a need for supplemental income. They just had a baby. They need to get some more money coming in. They don’t have their job. They lost their job. They’re not happy where they’re at. They need cash flow in order to get them a platform to get to the next level in life. So when it comes to choosing what the right market is for you, Haruka, do you want to be in an appreciating market, which is long term or a cash flow market, which is short term, what do you need?
So here’s the way that I’m doing it right now. I’m overall looking for the long term approach real estate investing. I know I’m going to make way more money buying in an area where people are moving to, what you call the hot market. There’s to be more demand there, businesses are going there. People are going there. Over a 5, 10-year span, those houses or those assets are going to appreciate a lot.
So I’m looking in the markets like you’re talking about. The Raleighs, the Atlantas, the South Floridas, the Arizonas, places where I think wealth is going to move and I’m buying there for the long term. Now, to balance out my portfolio, every time I buy a property or a set of properties that are more of an appreciation play, I’m also buying a series of properties that are a cash flow play. So then I may go into some of the, what you called medium markets like Indianapolis. And I’m looking for something that’s going to cash flow very steady, but probably isn’t going to go up a lot.
It’s kind of like if you use a fitness analogy. You need to eat protein for your muscles, that’s long term. But you need to eat some carbs, so you have energy for the short term. If you’re trying to grow, you have to have a balance of both. Now, if you already have massive muscles and you don’t need to work out a ton or whatever, maybe you just eat more protein.
That’s the question you have to ask yourself, where are you in life? If you need cash flow right now, go to one of the markets where you can still get it, the medium markets like you said. Build up a steady stable of cash flow. And then once you’re good, consider going into one of these hot markets and playing the appreciation game.
Also, let me just add this one piece because I always get comments if I don’t clarify this. When I say the appreciation game, I am not saying the speculation game. I am not telling anyone to go buy a property that they cannot afford in the hopes that it goes up and they can sell it later. I am talking about buying a property that you can afford that may produce less short term cash flow for the delayed gratification that comes from more cash flow later in the game or a higher appreciation value.
Jesse:
Hey, David, love BiggerPockets and all you guys do. So I have a scenario. I just kind of wanted to see how you would tackle this. I have a property in Green Bay, Wisconsin. It is a duplex that I used to live in. My understanding of the tax code, I lived in it two of the last five years. I moved out of it two years ago. So I would be able to sell it without paying capital gains, which is very enticing.
The problem is what I’m looking to buy is basically what I would be selling, small, multi, my units in that area, or I could get adventurous and do something different. But that’s kind of what I’ve been looking for, is two to four unit properties in that market that cash flow and also have done well with appreciation.
So how would you tackle this situation? How do you figure out if this is a wise move to sell it or to just refinance it and keep it, but especially with the caveat of the fact that I would not be paying capital gains if I did sell it. So, I don’t have to mess around with the 1031 or anything like that. I look forward to hear what you have to say. Thanks.
David:
All right, Jesse. Great question here. And what I love about this is it is a philosophical real estate question. So I get to break down the philosophy of real estate, not just here’s a tactical answer to a specific situation. First off, your understanding is correct. According to the current tax code, if you’ve lived in a property for two years out of a five-year-period, you can sell it and avoid capital gains. There’s a limit on that. I believe it’s $250,000 is exempt as a single person, $500,000 for a married person. Again, I’m not a lawyer or a legal advisor. This is not legal advice. You should look that up, but that’s my understanding of it.
Now you’re also asking a very good question and it comes to the fact that in real estate, when we sell and then look to buy, we typically are doing it in the same market that we just exited. So if you sell high, you buy high. If you sell low, you buy low. And this gets a lot of people tripped up because what they’re looking for is a situation where they can sell high and buy low.
Now, when I wrote Long Distance Real Estate Investing, this was one of the issues that made long distance investing great, because you could sell high in a certain market and then find a market and then you could go buy low. Unfortunately, we’ve had such a flood of interest in real estate investing since we at BiggerPockets have done such a great job of getting the information out there that now there’s very few markets that you can actually go buy low.
So you have to change the way you’re looking at it. If you’re going to sell, one of the benefits is you can avoid capital gains. But I wouldn’t look at it like you’re making a bunch of money and then reinvesting it so that you can make even more money. That isn’t exactly true because you’re selling high to go buy high. In a lot of ways, you’re just going to get a reset basis on your property taxes. You’re probably going to get a higher interest rate than you had before. I’m not deterring you from doing it. I’m just asking you to look at it differently.
Here’s how I look at it. When I sell in one market and then buy again in the same market, what I’m really doing is I am adding leverage to my portfolio. So if I sell one property and I take a $500,000 game and then I go buy two or three properties with that, what I’ve really done is increase the amount of money that I have borrowed. My equity didn’t necessarily change because I took 500 grand from one and turned it into 500 grand over three others.
My cash flow might have changed some or might have changed maybe not at all. I might have taken $2,000 of cash flow over one property and traded it out to, say, $800 of cash flow over three properties. So maybe I got one from $2000 to $2,400, but that’s largely insignificant. You don’t have a huge, huge bump in your cash flow when you do this. What you’re doing is betting that prices are going to continue to go up and therefore, leverage is in your advantage.
When you’re trading in one house for three, if prices raise, you are making three times as much equity and you borrow money that you’re paying back with cheaper dollars. Now, if you think the market is going to go down, this would be the worst thing you could do. You don’t want to have one house and turn it into three with a bunch more debt. And that’s the question that you really need to be asking yourself. Do you believe the market’s going to continue to rise in the market you’re talking about, or do you believe that the market is going to fall?
Now I don’t believe you mentioned the market you’re in, so I can’t give you any specific tactical advice on that specific market. But what everyone listening needs to understand is when we buy real estate, we’re always making a bet. We’re making a bet that tenants are going to continue to pay. The market is going to continue to go up. Rents are going to continue to go up. Businesses are going to continue to employ people. And therefore, we want to own assets that are dependent on tenants.
And when we’re not buying, we’re also making a bet. We’re betting that prices are going to come down or our money would be better put somewhere else. So what everybody needs to understand is you’re going to make a bet one way or the other. Once you make up your mind, which way you think you’re going to go, that’s where these strategies that we’re talking about today can come into place.
We’ve had some great questions so far, and I want to thank everybody here for submitting them. Please make sure as you’re watching this on YouTube to like, comment and subscribe to the channel so you get notified when BiggerPockets comes out with some new stuff. I got all dressed up for you today. I’m trying to dress to impress. What do you guys think of what I’m wearing?
This segment of the show is where we take comments from previous episodes. And I read them to you, hoping that you will also go comment on our YouTube channel and let us know what you think about today’s show. I want to know. Should I answer longer or should I answer shorter? Do you want to get more commentary from me or would you rather have shorter answers with more questions?
Also, how do you like me to dress? Do you like me more in a T-shirt? You like me more in a realtor specific button-down type of a shirt? I want to know what you guys think. Leave your comments below. We will read them on one of our shows.
Our first comment comes from Giselle Morales. “I totally agree with you on cash flow. To be able to live off of it, two to three properties only is pretty risky. In my case, I had my goal and numbers aligned to get nine houses and that will cover my budget times two. And I was able to do it. So now I cover my budget with half the houses and what I do with the cash of the other half is keep saving to keep investing.”
Thank you, Giselle. This is an awesome comment. And what you’re hitting on is the philosophy that you should buy a handful of properties, quit your job, go full time into investing and figure out how to make it work. For some people that may be the right move. For others, it becomes much more difficult in the market that we’re in.
So 10 years ago, that advice applied to a bigger segment of people than what it applies for today, which is a much smaller segment. And I’ve lately been saying, you shouldn’t be looking at cash flow as a way to replace your income. You should be looking at cash flow as a way to supplement your income in today’s market for most people.
Next comment comes from Miguel Montreal. “Hey, David, great episode and questions from listeners. I just wish, and maybe you can recommend this, that those asking questions can get right to the question. It seems to take forever just to get back to you to give an answer. Thanks.”
Miguel. I really appreciate. And here’s the dance that we’re having. I want you guys to submit questions, so I don’t want to discourage anyone or make them feel bad because they took too long to ask the question. And I also recognize that many of you don’t talk on a microphone like I do for a living, so speaking can be hard. It can be hard to get to your point. Maybe you didn’t think about what you were going to say before you started talking. Maybe you were just super nervous and that’s why it took a long time to get to the point. But I do see it as well.
What we would love would be for more of you to ask questions, but just be a little more succinct. So if what you really want to know is, “Hey David, what market should I buy in?” Start your question by saying, “I would like to know what market I should buy in. Here’s where I’m concerned.” What we typically get is someone that tries to explain the background of what they’re thinking. And then at the very end five minutes in, they get to the question and that’s just harder for the listener to sit through. And so oftentimes, we don’t air those questions.
So Miguel, thank you for offering some advice. When you guys submit your questions to BiggerPockets.com/david, be more succinct. Get to the point. Maybe practice a few times before you record it, and you get a higher chance of getting put on the show.
Jeff Mueller. “David, what is a good return on equity on a property I want to buy and hold, 15%, 35%?” All right, Jeff, it’s very difficult for me to tell you what the right return on equity should be. And what you’re talking about is for the equity in a property, how much cash flow is it generating? Those numbers are huge. 15%, 35% are typically very high because return on equity is usually lower than return on investment.
In fact, it’s almost always lower, assuming a property is going up in value. You can only get an ROE that is higher than the ROI if your property’s actually losing value, which would be bad. And since most people aren’t hitting anything close to a 35% ROI, that wouldn’t happen on your return on equity. But you’re asking the wrong question. Don’t say, “What is a good return on equity?” What you need to be asking is, “Is this return on equity close to the return on investment?”
So, if you buy a property and you’re getting a 20% return on investment somehow, but then the property goes up a ton in value and you’re only getting a 3% return on your equity, that difference between 20% ROI and 3% return on equity, the higher the difference is, the more you should look into selling that property and reinvesting your equity to get a better return on investment. The closer that your initial ROI is to your ROI, the more likely you should keep the property and hold it.
Are these questions and comments resonating with you? Do you like hearing my take on this stuff? Well, guess what? This show is only as good as the questions and comments that we receive. So comment on the YouTube channel. Tell me what you’re thinking. Am I talking too fast? Am I talking too slow? Do you want me to talk in different accents? What kind of close do you want to hear? Let me know. This is for you. And then also, I need you to submit more questions that I can answer on the show. So, go to BiggerPockets.com/david, and leave me your question there.
All right. Let’s take another video question.
Bill:
Hey, David. Bill from Charlotte here. Just a quick background, I’ve got a high paying W-2 job in the tech industry here. And then I’ve sold a couple long-term rentals and I’ve currently got one long term and five short-term rentals through a combination of myself and some partners. Pretty close to being able to pay for my expenses through the rental income and would like to no longer work in my at least current W-2.
Concern I have is my debt-to-income is pretty shot with the loans I’ve currently got in my name. And after potentially leaving W-2, I don’t think I’ll have really any room at all to purchase a new primary home. I’m wondering how others or you’ve seen others deal with this in the past after they’ve quit their W-2 and have lived off their rental income. Thanks.
David:
All right, Bill, great question here. Let me see some different steps I can give you that you could possibly take, paths that you might take. Number one, you don’t quit your W-2 job, but you look for a different position within that company where you can work less hours or work on something that you enjoy more, so you have more time to put towards real estate investing.
Number two, you work in the same industry you’re in. I don’t believe that you mentioned it. You just said it was a high paying job. Can you get a consulting job? Can you be a freelancer? Can you do some way to earn money, but on your schedule where you have more flexibility to focus on real estate investing, but you haven’t wasted all the skills that you’ve built in the industry and now you’re not making money. You’re still making money, but more in an entrepreneurial position. So even if it’s less than the W-2 income, it’s still more than nothing that you’d be getting if you quit.
Number three, you said your debt-to-income ratio is pretty much maxed out from properties you’ve already bought. I don’t quite understand that because if you’re claiming the income that you’re making on your taxes, most lenders will let you take 75% of the gross income that you’ve collected and use that as income for yourself in your debt-to-income ratio.
So when I’m buying real estate, even though my debt is going up, my income is going up with it because I’m collecting rent. And my income actually goes up higher than the debt if they’re making me money. So when you’re cash flowing, you should have more income, not less income. So unless you’re having a specific loan product that won’t let you use income from rental properties, then the only reason you’d be having trouble is if you’re not claiming the income on your taxes and then just start claiming your money on your taxes like you’re supposed to be and that will go away.
I’m not sure if the lender you’re working with is telling you this, or it’s just maybe a false impression that you’re under that you can’t use the income from your properties, but definitely reach out to us at The One Brokerage if you’re willing. And we’ll figure out what is going on with you there.
The last thing is use a different loan product. Use a debt service coverage ratio loan that says, “Hey, this property is going to make this much money. We’re going to qualify him based on the income the property is making not on the income that he is making. We do these loans. They’re third-year fixed rate. They’re not risky. The interest rate is a little bit higher, but if the deal works, it doesn’t really matter.”
What is more concerning to me is when people get into adjustable rate mortgages and what’s even more concerning than that is when they’re short-term adjustable rate mortgages. So if you have one or two-year period before it adjusts, very scary.
You didn’t ask this question, but I’ll throw it in for the audience. I’m not super opposed to an adjustable rate mortgage if it has like a seven-year period or even maybe a five-year period before it adjusts, because the odds are over seven years, you should have seen increased rents and increased profit. You should have stabilized it and had more income coming in so that when your interest rate adjusts, if it does go up, you should be okay because theoretically, you’ve seen rents increasing. I don’t like them over a short period of time like two years. That’s not giving you enough time to stabilize a property, reduce expenses and let rents increase.
So, I think that this could really be solved by having a good conversation with a good loan professional that should be able to look at this and give you some answers. I’m guessing maybe you haven’t talked with one of those yet. So reach out to me, or one of us, or find another one of these amazing people on BiggerPockets that lives to serve the investment community. Get some answers from them and you could be that much closer to quitting your job.
Now, specifically to you saying Bill, “Hey, I want to buy a primary residence.” On a primary residence, you’re not going to use a debt service coverage loan like what I talked about. You’re likely going to use a conventional loan or you’re going to use a portfolio loan through some credit union that you might be involved with, whatever it may be.
But it’s the same fundamentals. If you’re claiming the income that you’re getting from your rentals and your long-term rentals and your short-term rentals are profitable, you should be able to use that income to help you qualify for the primary residents that you want.
Next question comes from Nathan Holt in Ohio. “Hey, David. I’m a 23 year old college student, a full-time worker at Capital University. I’m looking to buy a small multifamily in Central Ohio east area. I had received a tip that there was a guy looking to sell a triplex unit in Johnston. My realtor contacted him with an offer of $200,000. He said he’s looking for closer to 370. I do not have the funds at the moment for that, and the numbers don’t make sense for a house hack. It would only be profitable if I didn’t live in the building and rented all three units, but then I have to put more than the 5% down on the mortgage, which I don’t have. I’m wondering if it might be a good idea to try and sit down with him, the seller, and show him how the numbers really don’t work and see if I could persuade him into moving the price down to more affordable area and go from there. Do you have any ideas or recommendations?”
All right there, Nathan, I do. Your realtor really should have told you this. It sounds like your realtor is not very experienced. If you’re being told to write an offer at the price you did and the seller wants that much more, one of two things is going on. Either he has ridiculously unrealistic expectations, or you do. And that’s really what it comes down to.
What’s the house worth? Whatever the market says it is. Now what is the market? Well, basically that’s all the other buyers. You’re not going to be able to convince this seller that his numbers are unrealistic because what it really is, is they’re unrealistic for you. Your situation makes this the bad deal. It’s not a bad deal for everybody, but it probably is a bad deal for you.
If you’re looking at house hack and you need it to cash flow and you only have 5% to put down, there’s only a handful of properties that are going to work because you got a lot of ands that are in there. There’s some other investor out there who doesn’t have all those ands. Maybe they’re in a 1031 and they need to find a way to park their money. Maybe they’re trying to take advantage of accelerated depreciation. Maybe there’s reasons why they would want to own that property because they don’t have the same situation as you. They’ve got more money to put down and they can make a cash flow.
Rather than trying to find a seller and convince them that their numbers don’t work when the markets probably telling them that their numbers do work, I think you should take those efforts and put them into finding a different seller. This is a mistake a lot of people make, is they try to change the mind of somebody who doesn’t have to change their mind. Just go look for somebody whose mind you don’t have to change. You’d be way better to take that same effort and put it into a different property.
All right, we have time for one more question.
Shiuan:
Hi, David. This is Shiuan. Thank you so much for your videos. I’m from [inaudible 00:29:18], and looking to purchase maybe in or out of state. My question is if I should use a HELOC to purchase or use my cash savings towards a down payment and just trying to understand about good debt. Is that always better to borrow off than to use my own name? And as a part of the question is the variable rate of HELOC. How do I make sure … How do I calculate the rental properties cash flow to make sure that it covers the HELOC well? Thank you so much. Your videos are super helpful.
David:
Thank you for that, Shiuan. Your audio was a little hard to hear, so I’m going to repeat what I remember of what you just said. It sounds like what you’re saying is you’re looking to buy and you don’t know if you should take the money from a HELOC or from your cash savings. And you mentioned that you want to make sure that you’re using good debt, so it sounds like you’re trying to figure out does a HELOC count as good debt.
Now, I can tell your heart is in the right place because you’re asking a good question, but your head might need a little bit of clarity. First off, if you’re going to use a HELOC, I look at that like giving a loan to myself because HELOCs are temporary loans. You’re going to be paying a higher interest rate than normal if you use a HELOC. So what they’re really designed for is to go use the money for a short period of time and then pay it back. If you’re going to be buying a rental property with that money, unless this is a BRRRR or a flip, it’s very difficult to get the money back to pay off your HELOC.
Furthermore, the Fed has announced that they’re going to raise interest rates, I believe, seven more times before the year ends, which means that you should expect the interest rate on your HELOC to continue to rise, making that a less desirable financial vehicle for what you’re talking about.
Now, let’s look at using cash. At first glance, using your cash savings would be a better plan because there’s no interest tied to that money like on a HELOC. So, you don’t have to pay debt yourself to this HELOC. But you need to make sure that you have enough cash and reserves to weather a storm. This is a big way that investors lose money. They end up not keeping enough money in reserves and then they can’t make their debt payments. And if the value of their property has dropped too low or there’s no buyers in the market, that’s where they go to foreclosure.
So, I would say keep 6 to 12 months of reserves of cash flow for yourself and your property in your cash savings. More than you think you need, maybe even more than that. If you have enough cash after you put a lot of it in reserves, use that to buy the house. If you don’t have enough, use the remainder that you’re lacking from the HELOC. But you don’t want to take money from the HELOC unless you absolutely have to because we’re told rates are going to keep going up and HELOCs have adjustable rate mortgages.
And then once you buy the property, get right back in there, start working hard, start saving money again, start working on a side hustle, keep your expenses low, save those reserves back up after you buy the property. This is a great question. I’m glad you asked it, and thank you for doing so.
All right, this question comes from Jason in Atlanta, two-part question. Part number one, “My business partner and I own about 60 doors across a couple states in the Northeast, in the multifamily space. Right now, we’re working on a deal that would nearly double our portfolio. My first question, have you ever heard of a bank calling the note on a commercial loan using the loan-to-value clause? For example, if we’re a 75% loan-to-value and the market dips a bit after we close and the decrease in the property’s value turns into a 77% or 79% loan-to-value, have you ever heard of a bank calling loan do for that reason? I believe in most mortgage, there’s technically able to do that but I couldn’t find any examples of it happening on the BiggerPockets forum.”
All right, let me start with that question before I get to part two of yours. My understanding of the loan-to-value clause you’re talking about is a clause in a note that tells the lender if the properties loan-to-value starts to increase, which means the property is becoming worth less compared to the amount of debt you have on it, then the lender is able to call the note due. Now why would that be in there? Well, my understanding is if you’re a bank and you see that the loan-to-value on a property is going the wrong direction, you should be able to step in and fix the problem by taking title of the property before it gets worse.
Now in multifamily property, as you know, Jason, the value of the property is based on the NOI, which means if you start making less money, the value of the property is going to go down, which is going to increase the loan-to-value. So what they’re concerned about is if you’re mismanaging the property and it’s not profitable, they want to be able to step in before it goes into complete foreclosure.
But something else to think about, do they want to do that? If it’s not because you’re mismanaging it, if it’s just because the market turned around, maybe cap rate’s expanded, maybe the interest rate has changed the value of multifamily property. Your loan-to-value might go up a little bit, but I don’t see why they would want to step in and take it off your hands if it’s something like that.
I would ask the representative at the lender that you’re talking to, “Hey, what would happen if rates jumped up and therefore cap rates expand and the value of the property is going to go down? We could see the loan-to-value increase from 75% to 80%. What would you do?” And they would probably give you the answers similar to what I did, but I would check with them to find out. As far as have I ever heard of that happening, no. I also have never seen this happen.
“My second question, do you have any general tips on getting more comfortable with such a big transaction even if the numbers definitely work on a multi-year horizon? I remember in the olden days of the podcast that’s back when I had a halo over my head, the golden olden days. You and Brandon once said that to grow up business, you should really be doing something every year that’s a little bit uncomfortable for you, and this definitely fits that description. Any tips on getting comfortable with the risk and uncertainty of something that looks good on paper but is bigger than anything else you’ve ever done in real estate? By the way, really enjoying Seeing Greene format mixed in with the traditional deep dive shows.”
Yeah. It’s hard, man. Here’s my advice. You aren’t going to get comfortable with what you’re going to do. You are going to do it and it’s going to be uncomfortable. And in the process of doing it, you will become comfortable. This is something we all have to understand. I want you to look at comfort like strength. You can’t get strong and then go to the gym, right? Confidence often works this way. If you wait to feel confident, you’ll never start. If you wait to get strong, you’ll never work out.
The very fact that this feels uncomfortable is a way of knowing that you’re not yet the version of you that you need to be to do this right. What you have to do is put faith in the fact that going through the process is going to turn you into that person. So I did not wait until I was super good at jujitsu before I went to jujitsu. I go and I suck, and if it’s really hard and most of the time I feel bad about myself because I’m comparing myself to people that are way better. But I’m getting comfortable through doing it. I didn’t wait until I was comfortable and then do it.
The same goes with being in shape, and the same goes with business. When I first started doing this podcast with Brandon, I was not comfortable. It was actually terrifying. At the time we were getting 250,000 downloads per episode, and the entire time I was looking at the camera saying, “250,000 people are listening to every single word that I say.”
And I started worrying about not pronouncing something correctly or saying something dumb or saying something that God forbid, someone could pull up seven years later and say, “Haha, David said something and it wasn’t accurate.” It was really scary. But all I could do was keep doing the podcast more, keep thinking about how to get better, keep listening to the episodes that I did and noticing what I did that was good, what I did that wasn’t good and improving.
And this is what the process is. If the deal looks good and you believe in the fundamentals and you’ve got enough money in reserves, do it. You’re not going to be comfortable. You’re going to make mistakes. You’re going to do things and say, “Ooh, I should have done that different.” That’s literally how I learn in everything. Jujitsu is a great example. I’m constantly making mistakes.
You’re going to do the same thing. Don’t wait to be comfortable before you do this deal. And again, I’m going to highlight, make sure you have enough in reserve. See, the cool thing with jujitsu is when I make a mistake, I don’t actually get my arm broken because I can tap. I can say, “Okay, stop pulling on it. It’s going to break. We’re good.” And they’ll stop. So, even though it’s hard, it’s not necessarily risky. Reserves are your tap. If you’ve got reserves, that means you’re able to tap. You can make through the tough times, you’re going to be okay.
That is it for our show today. Thank you very much for listening. I understand you could be putting your attention everywhere. If you’re watching on YouTube, there are people screaming at you to watch their videos instead of mine. If you’re listening to this on a podcast, there’s tons of people who would like your attention listening to their podcast. So, I want to say thank you for joining me on the journey that we are on and know that I am doing my absolute best. And we here at BiggerPockets are doing our absolute best to give you the best content we possibly can, straight shooting, hard hitting, no BS, no drama. The realest of the real is why you’re here. It’s why we do this.
So please, consider going to BiggerPockets.com/david and leaving me a question. Make sure you like this YouTube channel as well as subscribe to it, and follow me on social media. I’m @davidgreene24, pretty much everywhere. On TikTok, I’m officialdavidgreene. There’s an E at the end of Greene.
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Biden Administration Looks to Reduce Home Prices With Housing Supply Action Plan
Last week, the Biden Administration unveiled the Housing Supply Action Plan (HSAP), a new proposal that aims to make homeownership and renting more affordable. The median home price in the United States has risen nearly 47% since April 2019, and rents have increased by over 21% over the same period, according to BiggerPockets’ internal data.
There are a lot of elements to this proposal, but together they aim to increase housing affordability by reducing the housing shortage in the country. Each piece generally falls into one of four categories: Zoning Reforms, Financing, Owner Occupancy, and Cost Controls. The plan, if enacted, would pay for such proposals with a combination of existing funding (largely taken from the bipartisan infrastructure bill passed last year, as well as Department of Transportation budgets) plus new spending proposals.
Estimates of the size of the housing shortage vary depending on the source. On the lower end, Moody’s Analytics says it’s about 1.5M units. On the other end of the spectrum, the National Association of Realtors estimates it’s about 5.5M.
Regardless of which estimate you look at, a housing shortage is a problem. First and foremost, it creates a situation where many Americans find it increasingly difficult to find a place to live, and existing housing units go up in price, straining budgets. It’s simple economics—if supply cannot meet demand, prices will rise. This dynamic has played a significant role in the rapid property value increases over the last several years.
Of course, many other factors have recently pushed up prices, such as super-low interest rates, demographic demand shifts, inflation, and low inventory. But the lack of supply is one of the long-term trends impacting the housing market since before the pandemic and is poised to continue to impact the housing market for years to come.
As a country, there simply has not been sufficient building since the Great Recession:
This proposal aims to correct that. While none of these proposals have gone into effect, and many more details are needed to understand the impact fully, we can examine the information we have so far.
Zoning Reforms
Zoning in many areas restricts the building of high-density developments. Think of places where only single-family homes can be built, where height restrictions exist, or municipalities that prevent the construction of Accessory Dwelling Units (ADUs). Any real estate developer or builder is likely very familiar with many of these restrictions that make it difficult to build a bunch of units quickly. Proposals in the Housing Supply Action Plan aim to reward municipalities that reform their zoning and land use laws to encourage more building and higher density.
As an example, some independent analysis by the Urban Institute suggests that these types of reforms, along with the improved financing proposed in the HSAP could lead to the construction of 1 million additional ADUs in the next five years. ADUs are an attractive option to boost residential density, as it allows homeowners and smaller investors the chance to add units at relatively low costs, with relatively less permitting and risk.
Financial Reforms
There are many federal programs that can help fund new housing, but the programs are disparate and difficult to navigate. The HSAP imagines streamlining these programs to make it easier to build affordable housing.
Specifically, one proposal calls for $25B to be distributed to state and local governments to create up to 500,000 housing units designed to meet the local community’s needs.
Additionally, the proposal aims to finance the building of 800k new rental units for low-income tenants and expand financing access for building ADUs.
Owner Occupants
Recent data shows that investors, mainly institutional investors, have accounted for an increasing share of home purchases. To help owner-occupants, the plan will instruct the Department of Housing and Urban Development (HUD) to sell their inventory of properties, which is estimated to be about 125,000 units, to would-be owner-occupants rather than investors. Currently, investors can buy HUD homes if no owner-occupant bids are accepted.
Cost Controls
Amid the backdrop of high inflation, the HSAP is looking to curtail the skyrocketing prices faced by builders and developers.
The first part of the plan calls for partnerships with the private sector to improve supply chain efficiency and eliminate any disruptions resulting from the COVID-19 pandemic.
The cost control proposal will promote the construction of modular and manufactured homes, which have become far more cost-effective in the last several years, and could help to bring the average cost of building a new single-family home or small multifamily down in the coming years.
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Conclusion
At this point, the HSAP is just a proposal. Many elements of the plan will likely change before implementation if implemented at all. Even if these policies move forward, none of them offer a quick fix.
The plan is likely to evolve over the coming months and could take years for full implementation. The main takeaway is that there is a concerted effort in the White House to address the housing supply issue and improve affordability.
To stay on top of this news and other investing-related news, check out BiggerPockets’ newest podcast, On The Market, where Dave and a panel of expert investors debate the latest real estate trends, news, and data.
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LOs and brokers, are you prepared for an evolving workforce?
There’s no question that 2022 has seen serious changes to the housing market. Between significantly fewer refinances, rising mortgage rates and housing inventory nearly cut in half since 2020, loan officers (LOs) and brokers face a pivotal time where adaptation is a must for success. In a housing market vastly different from the pre-pandemic period, how can industry professionals position themselves to achieve growth despite these current obstacles?
When it comes to business growth this year and beyond, industry experts agree that 2022 is the year of the non-qualified mortgage (non-QM) loan. With nearly 50% of the workforce today comprised of freelancers, gig-workers, the self-employed and small business owners, fewer borrowers fit the traditional mold required to secure conventional loans. However, not all LOs and brokers are set up to take on an influx of non-QM business.
“Our workforce has evolved drastically in recent years. More people are diversifying their income streams and opting to work for themselves or through real estate investments. While this segment of the population may be completely credit-worthy, they don’t always fit the traditional qualification guidelines to get a home loan,” said Jeff Gravelle, co-head of production at Newrez. “As that sector continues to grow, so does the potential for loan officers and brokers to bring them on as customers with the right type of products.”
“Non-QM loans are harder than other loan products, so lenders must invest the time, resources and education into their sales teams and brokers to learn the intricacies of non-QM products. That way they’re better equipped to sell and serve their customers with these innovative products,” added Gravelle.
From processes and procedures to incorporating the right tech stack, suiting up to start offering non-QM products means first finding the right business solutions. Partnering with a team that understands how to approach home loans for borrowers with complex finances can make the difference between another year of profit growth and the unfortunate possibility of loss in business, making it one of the most crucial decisions for any lender.
Bracing for the challenges of non-QM
With an anticipated doubling in market share in 2022, non-QM products are top of mind for almost every mortgage industry professional. As LOs and brokers prepare to expand their selection of loan offerings, gaining a firm understanding of available products and how to best employ them for their customers will be essential. That means getting acquainted with the challenges common to the non-QM market.
Although the addition of non-QM loan options can undoubtedly end up being a lucrative move, the sector presents certain hurdles that not all lenders are prepared to clear just yet. For instance, processing non-QM loans manually can be prone to human error, cutting into the efficiency of a business. With higher-risk loans like non-QM, the need for optimization needs to be underscored from the outset to avoid costly mistakes.
There is also the matter of efficiency versus increased lending cost. With non-QM in a current transition state, forecasting future demand levels can be tricky. While investing too little in additional capacity and resources could result in difficulty managing increased demand, the alternative could mean investing too much and having demand not meet expectations. In either event, the outcome is less than ideal from a business perspective.
In addition, handling regulatory compliance and risk management will be a big concern for lenders breaking into the non-QM market. As government regulations constantly shift, keeping on top of and adhering to these changes can become a time-consuming task. Juggling their own compliance risks along with the ability-to-repay rule as it applies to non-QM loans means an additional component to be kept up in the air, and dropping the ball could have heavy consequences.
It’s not uncommon for worthwhile investments to carry a certain amount of risk, and non-QM loans are no different. Luckily, when it comes to incorporating non-QM products into your loan offerings, risk mitigation can be as simple as partnering with the right team and learning to understand the needs and trends of a new customer population.
Unique loans for unique borrowers
One of the most meaningful advantages of offering non-QM options is the ability to tap into a market of historically underserved borrowers. These borrowers may have already experienced rejection when applying for more traditional loans due to factors like having less than perfect credit, high debt-to-income ratios, low reportable income and a number of other increasingly common reasons such as being self-employed or freelance workers.
More and more frequently, these factors don’t impact a potential borrower’s ability to repay. They are simply being excluded from the homebuying market due to traditional loan requirements that don’t meet the needs of their unique finances. From first-time homebuyers to those looking for vacation or investment properties, non-QM loans come in all shapes and sizes, ideal for a variety of borrowers in a variety of financial positions.
With so many different types of borrowers beginning to look towards non-QM for their lending needs, LOs and brokers are wise to incorporate a diverse set of loan options. This means partnering with a company that offers non-QM options tailored to satisfy the needs of several borrower types will be crucial to growth in 2022 and the years to follow.
Smart Series by Newrez
The professionals at Newrez understand that borrower needs constantly shift and they are dedicated to providing a product line that evolves right alongside these changing needs. To meet the growing demand of unconventional borrowers, Newrez has focused on creating a series of non-QM products ready to satisfy the unique needs of a new generation of homebuyers.
Providing bespoke products for different types of non-traditional borrowers, the Newrez Smart Series is the perfect solution for LOs and brokers who want comprehensive loan offerings that work for borrowers who don’t fall within the traditional qualifying guidelines. The Newrez non-QM suite is comprised of three different loan types, each designed for a different kind of borrower.
Ideal for the self-employed borrower, SmartSelf is one of three non-QM products that make up the Smart Series. Ridding these borrowers of the requirement to provide a W-2, SmartSelf allows for alternative income documentation to qualify for a mortgage. With the number of self-employed borrowers only continuing to grow, this is a huge opportunity for hopeful homebuyers who have been previously rejected due to their form of income.
Falling outside the eligibility requirements for standard agency and prime jumbo programs due to a credit event or isolated lapse in credit performance is another common reason for mortgage loan rejections. For borrowers in this position, SmartEdge offers competitive financing solutions and a gateway to homeownership even in the event of a credit history that is slightly less than spotless.
Lastly, a non-QM loan explicitly designed for experienced real estate investors, SmartVest is perfect for those seeking to purchase or refinance an investment property that is owned for business purposes. This loan allows borrowers to buy additional investment properties with less documentation than conventional loans. Moreover, borrowers can access equity in a current portfolio of homes to purchase additional properties or use the market rent from the subject property to qualify.
Why partner with Newrez?
To guarantee borrowers and investors financial success well into the future, Newrez has designed a process from application to closing that makes for a seamless and stress-free home buying experience. With knowledgeable non-QM underwriters with specific Smart Series training and certification, a dedicated operations team keeping the wheels turning behind the scenes and the right tech to support borrowers each step of the way, partnering with Newrez will keep customers satisfied and profits growing as borrower needs evolve.
“We are seeing a large number of lenders who are new to the Non-QM market issue their Non-QM products. Non-QM lending and underwriting is a skill acquired over time with experience, as it is scenario-based lending that is significantly different than what any conventional underwriter is used to doing,” said Mike Smeltzer, senior vice president of Non-QM lending at Newrez. “It is important to choose a lender that has experience in this field and the ability to deliver with customer satisfaction. Newrez has the expertise and underwriting knowledge to deliver that type of positive customer experience.”
Newrez is committed to making the lending experience painless and possible for a new type of homebuyer with the help of their non-QM products. To learn more about partnering with Newrez, visit newrez.com.
The post LOs and brokers, are you prepared for an evolving workforce? appeared first on HousingWire.
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GSEs still shun the low end of manufactured housing
The most affordable manufactured homes are financed with private loans with higher interest rates, shorter terms and fewer consumer protections than mortgage loans.
The homes financed by these loans come without land, like a car, and the homeowner typically rents the land beneath their home. The home itself is a depreciating asset, which makes it difficult for manufactured homeowners to build equity or intergenerational wealth. The loans, called chattel, are rarely refinanced.
That means the 17.5 million Americans who live in homes financed with chattel — about 42% of the manufactured housing market — don’t enjoy the consumer protections that long-established legislative bulwarks afford those with a traditional mortgage.
But the government sponsored enterprises may now be on the cusp of entering the chattel market.
The GSEs, which back mortgages on traditional site-built homes, currently do not provide financing for chattel. That’s despite being ordered by Congress, in the aftermath of the Great Recession, to specifically serve manufactured housing.
The enterprises thus far have shunned the affordable end of the market. Instead, they have opted to finance manufactured homes that more closely resemble site-built homes, are titled as real property and cost much more. Both Fannie Mae and Freddie Mac also have backed commercial loans on mobile home communities. Freddie Mac has sought to educate borrowers on options to convert chattel financing to real property.
“Instead of serving the market as it is, they’re essentially trying to change the market to something it isn’t by favoring real estate loans,” said Mark Weiss, CEO of the Manufactured Housing Association for Regulatory Reform, which represents manufactured housing lenders and builders.
Freddie Mac aims to purchase 1,500 to 2,500 chattel loans by 2024, though it does not yet have a product for it. Fannie Mae is considering the matter with its regulator, the Federal Housing Finance Agency.
Freddie Mac’s goal to finance chattel loans also received a prominent shout-out in the Biden administration’s national affordable housing plan. To observers, it’s a clear indication of momentum building for the GSE to finance chattel, for which affordable housing advocates continue to argue.
Proponents of government-backed chattel loans say the sector is not as risky as it has been in the past.
Manufactured homes are no more vulnerable than site-built homes in extreme weather events, industry groups claim. Manufactured housing lenders say the sector has reformed its past risky underwriting practices. A subprime crisis afflicted the sector long before it appeared in the wider mortgage market. Faulty loans on mobile homes led to the downfall of the nation’s largest manufactured home lender in 2002, ensnaring Fannie Mae on its way down, an episode both GSEs remember well.
The GSEs have not yet explained how they would provide liquidity for loans made on a depreciating asset. Also up in the air is whether they would shape the market to fulfill their charter, or act as a passive secondary market participant. The chattel market is still highly concentrated, with the top five manufactured housing lenders accounting for nearly three quarters of chattel originations, the Consumer Financial Protection Bureau found.
Despite potential risks, manufactured homes as a source of affordable housing backed by the government is tantalizing.
Aside from renting, it’s often the only available option for many borrowers who can’t afford to buy the now median $375,000 home. The median chattel loan amount is $59,000, according to the CFPB, versus $237,000 for a site-built loan.
But it’s not clear manufactured homes financed by chattel loans can be an engine for long-term wealth building, as conventional mortgage financing is.
“The public policy purpose behind promoting homeownership is to create an avenue for long-term wealth building. There’s also a public policy interest in ensuring people have safe and affordable housing,” said Ed DeMarco, former acting director of the FHFA. “Chattel can be one form of providing safe and affordable housing. But it doesn’t mean that [type of] housing is going to be a path for wealth creation.”
A little bit jumbled
Fannie Mae has good reason to be cautious about manufactured housing. It’s been burned before.
Years before subprime took hold in mortgage, risky underwriting wreaked havoc on manufactured housing. Now-defunct Green Tree Financial Corp. made loans hand-over-fist in the 1990s, with loose credit requirements on depreciating mobile homes. It was able to conceal the faulty loans for years through creative accounting, however, and sold itself to Conseco for $6 billion in 1998.
But when home prices depreciated, it flamed out, and its parent Conseco filed for bankruptcy protection in 2002. At the time, 70% of Fannie Mae’s $9 billion manufactured housing portfolio were Green Tree loans bought by Conseco.
Fannie Mae waived liens on the portfolio, in exchange for servicing fees and increased servicing oversight, and recorded a loss of $83 million on securities it held, Fannie Mae documents show.
Fannie Mae did not respond to a request for comment.
“A lot of subprime behaviors showed up in the chattel market first,” said Paul Bradley, president of ROC USA, a nonprofit that helps manufactured housing communities convert to resident ownership. “This was classic fog-the-mirror underwriting and lending, invoice-fixing.”
A former Fannie Mae official who observed the debacle firsthand said mortgage finance was not built to address a depreciating asset, and Fannie Mae did not understand counterparty risk well enough at the time.
“We were really good at getting things really wrong when we got them wrong,” the former official said.
Fannie Mae “stepped in right before bankruptcy and wound up taking it on the chin,” said Weiss, of the Manufactured Housing Association for Regulatory Reform.
“The underlying lender had significant problems and was not handling things in the proper manner,” Weiss said. “But that’s not the market today — it’s just a completely different situation.”
Although the underwriting has changed, according to Weiss and other lenders, Fannie Mae still remembers the Conseco debacle. And both of the GSEs are demonstrably cautious when it comes to supporting chattel lending.
“Our friends at Fannie and Freddie who have put boots on the ground and really decided to educate themselves on manufactured housing have been fantastic,” said Cody Pearce, president of Cascade. “They believe in the product, that it’s the No. 1 solution for affordable housing. But then they run up against the credit risk and pricing teams, and it seems to get a little bit jumbled.”
Momentum builds
Regardless of whether the GSEs have an appetite for financing the affordable end of the manufactured housing spectrum, financing for chattel is gaining political traction.
On May 16, the Biden administration released a sweeping affordable housing plan, which specifically called out chattel loans as a vehicle for affordable housing.
The plan bluntly stated it would “Deploy new financing mechanisms to build and preserve more housing where financing gaps currently exist: manufactured housing (including with chattel loans that the majority of manufactured housing purchasers rely on).”
The Biden administration is banking on FHFA’s approval of Freddie Mac financing chattel loans.
That’s far from a foregone conclusion. Freddie Mac, the plan points out, first will conduct a feasibility assessment of whether it can finance chattel, and then it will seek FHFA’s approval. Although the president can now remove the FHFA director at-will, giving the Biden administration much greater authority over the agency, it is still an independent regulator, not a cabinet-level agency, like the Department of Housing and Urban Development.
Freddie Mac declined to comment. An FHFA spokesperson said that “any personal property loan purchases for DTS would be subject to FHFA approval as we explore manufactured housing financing options with the Enterprises.”
The FHFA also said it plans to host a public listening session sometime in the summer, focusing on financing options and consumer protections related to manufactured housing.
The Biden administration housing plan also highlighted increases to Fannie Mae and Freddie Mac’s purchase targets for manufactured housing loans titled as real estate, as well as efforts by HUD to update its building code, to “modernize and expand their production lines,” and help manufacturers respond to supply chain issues.”
A HUD spokesperson said the Federal Housing Administration would look to increase its loan limits to align with manufactured home sales prices to increase usability of the program. The agency will continue to monitor supply chain issues and maintain flexibilities, to help continue the production of manufactured homes “which are necessary to meet the demand for this important source of affordable housing supply,” the spokesperson said.
Despite the Biden administration’s stated plan, the path forward for government-financed chattel lending remains uncertain. It’s a frustrating dilemma for Lesli Gooch, president of the Manufactured Housing Institute. Research her organization conducted based on data from lenders — which it shared with the CFPB — contradict the idea that chattel loans are riskier than real estate loans.
The seriously delinquent rate for chattel loans in the first quarter of 2021 was just 0.38%, compared to 1.75% for manufactured home loans titled as real estate. The delinquency rate also was orders of magnitude lower than that of FHA loans, with just over one in every 100 chattel loans at least three months past due in March 2021, compared with more than one in every 10 FHA loans at the same time.
“We have data showing these loans are performing well — this is not about risk,” Gooch said, of the GSEs’ reluctance. “A lot has been done to get over the sticking points. At some point we have to stop doing research and move forward.”
Here’s an idea
Industry stakeholders have some ideas for how the GSEs could finance chattel loans without taking on too much risk. Affordable housing advocates hope the GSEs would not just provide financing, but seek to improve the market for consumers.
The GSEs already require tenant pad lease protections for manufactured housing communities for which they provide commercial loans. Could the same logic be applied to chattel loans?
Currently, the Truth in Lending Act and the Real Estate Settlement Procedures Act don’t apply to chattel. Mortgages require a detailed loan estimate when a borrower applies for financing, and a lengthy disclosure at closing. Not for chattel.
Site-built homes and manufactured homes with mortgages have foreclosure protections and are covered under the CARES Act. In case of default for chattel loans, they go through repossession, a process with fewer consumer protections.
“We’re seeing what they’re able to do with the tenant pad lease protections initiative,” said Rust. “They’re driving consumer protections with their market power. Why can’t they do the same thing in chattel?“
Freddie Mac protections for manufactured housing communities it finances already include a one-year renewable lease term, unless there is good cause to not renew, 30-day written notice for rent increases and the right to sell the manufactured home to a buyer that qualifies as a new tenant in the community.
But the GSEs could make further demands, given the right leverage. Bradley, of ROC USA, said the GSEs could provide secondary financing that requires longer loan terms, and limit rent increases for the land on which manufactured homes sit.
“If they came in with a mortgage conventional residential rate and term, they would find the industry very receptive to whatever added protections they would need to provide on that product in the community. But if they are going to just mimic what chattel lenders do — 15 to 20 year term financing, 6% to 8% to 10% interest rate — then no, the industry is not going to change one bit.”
But what of the inherent risks in manufactured housing?
David Brickman, Freddie Mac’s former CEO, last month posed a solution: using credit risk transfers as a mechanism to offload that risk and spur affordable housing, including manufactured housing.
“Specifically, the GSEs could work with existing lenders to develop a standardized product for manufactured housing chattel loans, including a single set of loan terms and documents, credit parameters and delivery mechanics, which would create significant value and bring helpful liquidity to an otherwise fragmented market,” Brickman wrote in a piece published by the Urban Institute.
To guard against the higher risk of chattel loans, Brickman suggests the GSEs initially could require lenders or investment partners to take on risky portions of loan pools.
Having an established secondary market is a tantalizing idea for Pearce, of Cascade. But his firm is not only waiting for the GSEs.
In 2019, Cascade, which specializes in chattel loans, went to market with its first private-label securitization. It securitized another manufactured housing loan pool in 2021 of $163 million over 1,889 loans, which were mostly chattel. Fitch rated a $103.2 million notes tranche with a preliminary AAA rating.
Gooch, of the Manufactured Housing Institute, asked, “If you have lenders able to do this with PLS offering, why can’t Fannie and Freddie do it?”
Pearce chalks the GSEs’ reluctance up to their past experience with the manufactured housing sector’s subprime crisis in the early 2000s. After that point, he said, underwriting guidelines changed and the sector was “ahead of the curve” when the single-family crisis hit.
Ultimately, after the Dodd-Frank reforms, the GSEs were able to move beyond the mortgage crisis mindset on site-built housing, Pearce said. But they have not moved beyond past blunders with affordable manufactured housing.
“The GSEs’ memory of that is strong, they’re passionate about it,” said Pearce. “But it’s not fair to hold manufactured housing accountable for such a long time for something that was repaired and changed.”
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Lenders see appraisal modernization as a top priority
A Fannie Mae survey published in mid-May found that mortgage lenders see value in appraisal modernization, specifically in the implementation of non-traditional appraisals and inspection-based appraisal waivers. However, they have several more pressing priorities when it comes to what they’re investing in.
Out of 200 senior mortgage executives surveyed, who represent 188 lending institutions, 94% think that appraisal modernization efforts will simplify the origination process. The main benefit of appraisal modernization, according to the first-quarter sentiment survey, is that it will help shorten the loan origination cycle time.
One mid-sized lender echoed the opinion of others that appraisals still take too long.
“Currently, the appraisal process is the biggest issue facing the mortgage industry,” the mid-sized lender said. “It causes significant delays, higher costs due to involvement of [appraisal management companies], and there are fewer experienced practitioners that understand more complex collateral assignments.”
Lenders surveyed also think that modernizing appraisals could help enhance appraiser capacity and lower borrower costs. With a declining number of appraisers in the field and rigorous requirements to enter the profession, lenders say that appraisers are stretched thin in how many properties they can get to. Implementing desktop appraisals would help alleviate this.
“They cannot get to all the houses we need appraised,” said one mid-sized lender that participated in the survey. “If they can, they want to charge more money for the appraisal. The charge gets passed on to the consumer so it’s hurtful for consumers.”
Despite a majority of lending institutions agreeing that adopting new technology for appraisals would be beneficial, survey takers identified several other priorities that were even more important.
Forty percent of lending institutions reported that a consumer loan application digital portal was either a first or second priority of their investment and eMortgages — eNote, eRecording, and eClosing — came in a close second with 39%. The desire to invest in appraisal modernization came in third place, with 29% of lending institutions reporting that this was a top-of-mind investment.
Lenders also mentioned concerns and roadblocks with adopting new appraisal modernization tools. Some of the biggest challenges listed by lenders include: speed, or lack thereof, of industry implementation and integrating these tools with loan origination systems.
Appraisal modernization efforts in the housing industry have ramped up because of the pandemic.
In March 2022, the Federal Housing Finance Agency (FHFA) made hybrid appraisals a permanent fixture. Both Fannie Mae and Freddie Mac now allow appraisals to be conducted remotely, using public records such as listings and tax appraisals, for purchase loans.
Meanwhile, the Department of Housing and Urban Development (HUD) recently extended its timeline for allowing desktop appraisals for certain transactions impacted by the pandemic. The policy now expires on December 31, 2022.
Concerns remain, however, around whether automated valuation models (AVMs), used in desktop appraisals, have the potential to bake-in and amplify racial bias, in part by relying on historical sales comparison values.
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How lenders can improve business models in 2022
As 2022 proves to be a challenging year for the housing market, lenders are looking to take advantage of potential downtime by improving their internal processes. HousingWire recently spoke with James Deitch, CEO of Teraverde, about the changes lenders can make to their business models in order to remain profitable.
HousingWire: Between interest rate hikes, tight housing supply and geopolitical uncertainty, many industry professionals are feeling the pressure of a volatile housing market. Why is now a good time for lenders to focus on improving aspects of their business, such as customer experience and cost structure?
Jim Deitch: Lenders face constant competition for time and resources. The past two years were all about getting loans closed, shipped and funded. There was little time for customer experience or cost focus. Margins were wide and compensated for about every issue. And justifiably so.
Suddenly the brakes come on, really hard. Rates increase really fast. And most every issue that fat margins used to cover are exposed. Cost per loan and customer experience are two issues, both driven by a common denominator, the lender’s business model.
Every business model is defined by mission, process and technology. I’ll give an example outside of our industry. I spent two days in Dallas at Southwest Airlines Headquarters, just off Dallas Love Airport, for research on one of my books. Southwest’s mission is to “Connect people to what’s important in their lives through friendly, reliable, and low-cost air travel.” The two days at Southwest illustrated the connection of mission, process and technology to their business model. Above all other aspects, Southwest strives for simplicity.
Southwest flies the Boeing 737 platform. Every pilot, flight attendant and mechanic can work on every aircraft since every 737 is certificated (airline speak for licensed by the FAA) as a single aircraft type. American Airlines by contrast currently operates seven different aircraft types, meaning pilots and mechanics can only work on their aircraft ‘type’. Southwest flies point to point routes, not through major hubs. No seat assignments, so Southwest can turn an aircraft around from touchdown to take off in under an hour. Integrated technology speeds the flight and improves safety. Every aircraft has a heads-up display which allows for landing in zero visibility if required in an emergency. As a result, Southwest aircraft fly about 2 hours more per day than their competition. There’s a lot more to Southwest’s business model, and check out my book, “Strategically Transforming the Mortgage Banking Business” for a deep dive.
Southwest is the only major airline that operates this model. The standardized platform makes consistent process and performance possible. It also lets Southwest have a cost advantage of about 15% per revenue seat mile flown. That’s a competitive advantage over other airlines. It’s hard to duplicate their business model. So many interconnected elements that all strive for efficiency and simplicity. All aimed to “connect people to what’s important in their lives through friendly, reliable and low-cost air travel.”
Think about your lending business model. Does your technology harmonize together, or are there siloed systems that serve different employee groups? Are there common processes for efficiency? How many processes require manual intervention? How do you measure results that impact profitability, efficiency, and productivity? How is the customer experience engineered from first contact to boarding the file in servicing? When was the last time you examined the end-to-end process? Is now the time to address these issues? I think so. The landscape has changed dramatically, and what worked the last two years won’t work well going forward.
HW: Lenders are facing a brutal 2022 forecast following two great years for the housing market and are looking to build business models that will profit this year and beyond. What strategies can these lenders take now to prepare for sustainable profitability?
JD: Primarily, a business model should flex to provide profitability regardless of market conditions. This is hard to execute but is conceptually straightforward.
Compensation cost is the largest impediment to sustainable profitability and a flexible business model. According to the MBA Quarterly Mortgage Report, compensation is about two-thirds of the cost to originate and close a loan. Increasing labor productivity is the key to sustainable profitability.
Jonathan Corr, retired CEO of Ellie Mae (now ICE Mortgage) addressed lenders’ tendency to use labor rather than automation colorfully. Corr described it as, “Filling business process holes and leaks with ‘human spackle’ when automation and reengineering are more direct and efficient answers. Lenders tend to fill the holes and the leaks with human spackle, as it’s a quick band-aid. There’s no reason to have all that human spackle cost and inefficiency. Human spackle also adds to the timeline to close a loan. Eliminate human spackle and closing a loan is going to take a lot less time, a lot less cost, and a better customer experience. “
So how does a lender resolve the compensation issue? Many lenders are laying off employees to balance their workforce with the reduction of volume. That’s an unfortunate temporary solution to an inflexible business model that is overly reliant on human spackle.
How do I know the industry has an inflexible business model? Regardless of loan production levels over the past seven years, the labor component is 66-70% of total cost. That is the definition of inflexibility. One would expect investment in technology and rising volumes to reduce the labor component per loan. It hasn’t. Thus, lenders cannot flex their costs as volumes vary, nor harvest the efficiency that should accrue from the technology investment.
So now what? Short term, right-size your employee count. Regrettable, yes. But simultaneously commit to fixing the business model and business process that brought you the 65-70% labor component to begin with. Decide to improve process, build in flexibility and reduce the likelihood of painful layoffs in the future.
HW: How can lenders adopt a data-driven business model that ensures profitability, liquidity and risk management today?
JD: Our team at Teraverde has created a way for a lender to assess and improve their business process. We call this the ‘EAOO’, which is an acronym for Eliminate, Automate, Outsource, Optimize. EAOO is our proprietary data-driven disciplined method to evaluate the entire business process end to end. It is employed as follows:
Starting at the end of your process, identify the smallest definable component of your process and define that component as a task. Then consider if that task can be improved by taking the task through the EAOO regimen. Then move to the next smallest component and work forward until you reach the point of first customer contact.
The EAOO regimen is a waterfall to evaluate each task, as described below:
● First, can you eliminate the task by considering whether the task is necessary, or how the task could be consolidated into another task? If the task cannot be eliminated, consider the next step of automation.
● Can you Automate the task internally using robotics process automation, workflow management or similar automation tool? If the task cannot be automated internally, consider the next step of outsource.
● Can you outsource the task externally to a specialized outsourcer? Outsource doesn’t mean offshore. A lender can outsource to on-s. e or off-shore vendors. If the task cannot be outsourced, then consider optimization of the task.
● Can you optimize the task by finding the most efficient, least cost method to accomplish the task?
Once EAOO is completed for the first task, repeat the EAOO evaluation for each task within the overall end to end process. Invariably we find many opportunities to eliminate, automate, outsource and optimize the components of a lender’s process.
We speed this EAOO process up with some data-driven magic. That data driven magic includes an analysis of about 400 elements that produce ‘metrics that matter’. The data driven magic finds process variations, flaws and inefficiencies. It assesses the productivity of individual personnel and opportunities to improve individual performance. It uncovers hidden opportunities to increase pull-through. It assesses and improves the coordination between systems within your tech stack, and opportunities to better configure your tech stack.
EAOO is a data-driven intentional process to drive human spackle from your process, improve labor productivity, and build more flex into a lender’s business process. It improves the business process to be more flexible and productive. The EAOO process can’t be shortcut. One can’t achieve a sustainable profitable business model by tolerating bad process.
Here’s the key point from Jonathan Corr: Toleration of bad process leads to ‘human spackle’ being used to patch over fundamental deficiencies, with ‘checkers checking the checkers’, and multiple passes through manual process.
EAOO is a different approach to intentionally disrupt and improve your own business process. EAOO is an intentional walk-through of an entire business process, starting at the back end of the process and walking forward.
HW: What solutions does Teraverde offer to help lenders enhance their business models in preparation for a more profitable future?
JD: Our approach is not ‘best practice’ or selling you another technology solution to insert into your tech stack – it is helping you develop the right business processes with the tech stack that you have to deliver your desired customer experience to your customers.
We find that most lenders are using only a fraction of the capability of their existing tech stack. And human spackle is how the lender compensates for not exploiting the full capability of their technical systems.
Teraverde can help in two ways. The first is to achieve transparency and visibility into the opportunities to improve your business. That transparency and visibility arises from using metrics that matter to continuously evaluate your business. These metrics that matter constitute your single source of truth from the appropriate systems of record in your business.
Metrics that matter rarely come from static reports or dashboards. Metrics that matter identify the relationships of processes and systems that drive profitability, efficiency, and productivity. Our clients often describe “aha” moments when the association of processes, systems and data reveal actions that can meaningfully improve your results. The ability of senior leaders and managers to easily explore their data is the key difference of our Coheus® solution.
The second way we can help is to engage in an EAOO project with the lender. We use our data driven magic to analyze about 400 data elements that produce ‘metrics that matter’ together with an automated assessment of the DNA of your tech stack to speed the EAOO process.
The key differentiator of Teraverde is our people. We have experience as CEO, COO, CFO, CTO and CIO of actual lenders. We are not auditors or coders dispensing products or advice about lending. We are lenders with hundreds of years of extensive lending leadership experience. All focused on helping you get the right business process in place.
We help you continuously improve the process through transparency and visibility of metrics that matter from a single source of truth. No other firm offers such a focused and proven approach to a flexible, sustainable business model free of human spackle.
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Opinion: Why we need a mortgage rate reset
When writing about the ’80s banks and passbooks, I started to see a pattern emerge concerning customers and refinance loans and rates. They were so high; then so low. I started thinking about farming. Farmers know that you can’t keep putting the same plants in the same dirt season after season. You kill your soil. You ruin the balance of nutrients. You over work the chemistry. It stunts plant growth and yields. It changes how they grow.
We have overworked our ground and it needs a rest. Housing Wire’s expert, Logan Mohtashami keeps saying we need a reset. He says in a Tweet earlier this month, “I believe some of the confusion around higher rates is that some people expected more demand destruction faster. This is why I stress higher rates need duration to work its magic.”
Crop rotation one: Homeowners stay in their homes for 30 years
Rates have been on the decrease since 1981. It was a rotation of crops back then to adjust inflation. In the early ’80s, rates were above 18% for a fixed-rate loan. Most people paid those loans for 30 years, on time. Some moved and, in that process, got better rates. Refinances were not marketed then like they are today, nor were they the norm for a homeowner.
Back then, the real estate agent found a home and the purchaser went to their bank and got a loan. This is a customer of an agent, and a customer of a bank, conducting a financial transaction and contractual purchase transaction. Most times, the bank relationship was established before the home was found. The customer bought a home to stay in for 30 years. This was viewed as a one-time transaction — one growing season.
Multiple crops per year: Move-up buyers and refinancing
The internet, online banking and more lenders made the word “refinance” one that grew our industry. Look at just one person who purchased a single-family home in the mid-1990s —they outgrew the starter home and needed the ‘forever’ home they dreamed of.
What if that one loan turned into three to six loans? When rates were 8% in 1995, this customer bought that forever home. They went to their bank and get a 30-year fixed rate loan.
By 2004, they heard they could refinance, possibly get some cash out. Some went risky with a popular ARM loan and got a 6.5% rate. It saves them $200 a month, and feels good.
Servicers of the ARM loan start calling them in 2008 for a locked rate or fixed, lower rate. They happily accept 5.50% fixed. This saves them $150 more a month, and it is stable in this wild upside-down market.
By 2017, they figure they are overpaying when their buddies get a 4% rate. So, they go to an online bank to shop rates. Twenty people call them, and they lock in at 4% fixed rate. During COVID-19, rates were 3.25% and with nothing else to do, the homeowner can save money and refi again — rates will never be this low again, right? The servicer called one more time in June of 2021, equity was high, rates are at 2.4% and, man, you must do this one. This is as low as rates go.
Over 25 years, this one person has been a mortgage customer of six different mortgage companies, each saving him over $100 per month. Even if the homeowner moved or made a purchase in the middle of this process, one of the refis would have been a purchase. And, that purchase likely needed more refinances when rates fell.
Some of these people got second homes or investment properties. The rates have gone down over and over since the 1980s. When rates increased, they were nothing but small blips that paused a borrower. Homeowners always had a good reason to refinance.
It’s time for a reset
Now, rates are up. They rose more than the news could keep up. By the time they reported 4.5%, rates were really over 5%. Now, the homeowner will sit tight for a few years.
We need a reset and one that will continue into 2023. To the borrower, rates have always been going down. The borrower has saved hundreds per month every time. We have drained the soil and run out of places to grow our crop. The market has fixed it for us.
But the seeds are still being stored for the next crop. People are still buying homes.
The 2022 inflation market fixed it for us. Homes cost more and rates are through the roof. Refinances are less than half the business being done today. Servicers and refi shops are in a drought.
How do we clean the fields? We wait. After a year or more of these rates, things will be different. For starters, there will be fewer of us — loan officers, banks, brokers. Layoffs, consolidations, acquisitions, mergers and joint partnerships will change the landscape.
Technology, artificial intelligence (AI) and possibly cryptocurrency will change the transaction. Rates will eventually come down, opening the door to the next boom. The hundreds of thousands of homes sold in 2022 and 2023 above 5% will want to save that $200, so the cash-out refinances and ARM loans all need to reset.
The survivors
There are fewer mortgage people doing all the work. The people left are the survivors. The companies that are left are the ones who combined resources and people. The tech they have ready will be efficient and consumer friendly. The relationships will be long term and lead to long-term business partners.
Marketing and customer incubation will involve education, counseling and long-term contact well after the transaction. Processing will speed up with automated VOEs and instant verified bank statements. UW will be easier and faster with day one certainty. Virtual docs will speed up and make disclosures and closings less cumbersome. Mortgages will be easier to do and complete.
The field will be primed for the seeds to grow again. They will grow fast and plentiful. Refinances will take over the market. There will be more loans than we can efficiently process for years.
New business and old business will create a new refi boom. The builders will have more inventory. Home prices should stabilize. The new relationships with Realtors and lenders will be beneficial to all parties. We will make hay when the sun shines. We will reap what we sow, and it will be good for our business.
BJ Witkopf is a mortgage specialist with Assurance Financial.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the author of this story:
BJ Witkopf at bj@witkopf.net
To contact the editor responsible for this story:
Sarah Wheeler at sarah@hwmedia.com
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PLS market is on track to notch record volume this year
Despite the turbulence in the U.S. economy fueled by inflation, international tensions and rising mortgage rates, the private-label securities (PLS) market recorded a strong first quarter, at nearly $43 billion in issuance, and is projected to finish 2022 with record volume.
That $43 billion mark represents the second-highest issuance total since the global financial crisis (GFC) some 15 years ago and also was nearly two-and-a-half times above issuance volume for the first quarter of 2021, according to a recent market assessment by Kroll Bond Rating Agency (KBRA).
The report focuses on so-called RMBS 2.0 deals, defined as all post-GFC residential mortgage-backed securities issuance in the prime, nonprime (including non-QM) and credit-risk transfer (CRT) spaces — the latter typically issued by the government-sponsored enterprises.
“In our view, this [performance] is due to the inherent diversification of RMBS 2.0 deals among subsectors differently sensitive to interest rates, a large variety of issuer types, and a quickly appreciating home-price environment,” the KBRA report states.
Those dynamics lead KBRA to project record nonagency (private label) residential mortgage-backed security (MBS) issuance for the year, though at a declining rate in the coming quarters.
“We continue to expect 2022 will close as a record post-GFC issuance year with almost $131 billon in aggregate [RMBS 2.0] issuance,” KBRA reports. “… KBRA expects Q2 2022 to close at approximately $38 billion, and Q3 to decrease further to $29 billion across the prime, non-prime, and credit-risk transfer segments because of rising interest rates and an unfavorable spread environment for issuers.
“… To date,” the KBRA report continues, “issuance spreads [have] widened rapidly for all sectors as supply and demand volatility hit nearly all-time highs.”
The spread is a measure of relative yield value between two types of debt instruments, such as a benchmark U.S. Treasury bond and a mortgage-backed security. As spreads widen in an unfavorable way for issuers, MBS prices tend to decline. Bond prices, however, move in the opposite direction of yield — with a higher yield (the ratio of a bond’s coupon to its price) deemed compensation to an investor for the added risk in a volatile market.
Among the factors industry experts contend are contributing to the volatility in the MBS market, and consequent deal-execution challenges, are fast-rising interest rates in combination with the Federal Reserve’s tapering of its MBS holdings.
“So the Fed is clearly on a rate-hiking cycle,” said Seth Carpenter, chief global economist at Morgan Stanley, in a presentation at the recent Mortgage Bankers Association’s (MBA’s) Secondary and Capital Markets Conference & Expo in New York City.
“They raised rates 25 basis points in March,” Carpenter continued. “They raised rates 50 basis points in the May meeting. And [Fed] Chair [Jerome] Powell was clear that the next couple of meetings looked like 50 basis points [hikes], so call it the June meeting and the July meeting.”
Carpenter said Morgan Stanley expects rate bumps after July are likely to return to the 25 basis points level until “we get to a peak of about 3.25% [for the Federal Funds rate] early next year.”
For now, the Fed is not purchasing new MBS to hold in portfolio, and it also is allowing a portion of its existing portfolio to run off its books as those securities mature. But what happens if the Fed’s run-off strategy isn’t sufficient to meet its MBS divestment goals?
“They’re going to let their mortgage-backed security portfolio prepay without being reinvested, and there will be a cap of $35 billion [a month] starting at half that for the next three months,” Carpenter explained. “Our forecasts from my colleagues at Morgan Stanley suggest that given what the Fed has in their portfolio, [MBS] prepayments [run-off] are unlikely to get up to $35 billion a month.
“Will they end up then selling mortgage-backed securities on an outright basis to get up to that $35 billion level? I think the answer has to be the following: We’re not sure.”
The Fed’s continuing effort to wind down its $2.7 trillion MBS portfolio is expected to fuel widening spreads in the MBS market because it creates more supply to be absorbed, Bloomberg intelligence analyst Erica Adelberg explained in a recent Bloomberg report. That, in turn, puts downward pressure on pricing,
Regardless of how the Fed proceeds in shrinking its MBS portfolio, however, Mike Fratantoni, chief economist for the MBA — who also spoke at the recent MBA conference — expressed confidence that the MBS market will weather the storm. He described it as the “second most liquid market in the world.”
“There are buyers domestically and abroad for mortgage-backed securities,” he added.
The issue ahead that Fratantoni zeroed in on is investors’ reactions to perceived market volatility, sparked by uncertainty. “Even if it’s not going to result in a [Fed] sale [of its MBS holdings] … every sort of rumination about that has the potential to lead people to change their position,” he said.
Sonny Weng, vice president and senior credit officer at ratings firm Moody’s Investors Service, explained in a recent interview focused on the PLS market that because of inflation and the volatile rate environment, coupled with an abundance of MBS supply — due, in part, to the Fed’s monetary policies — investors are demanding a higher MBS coupon, or the rate of interest paid annually on a note at par value.
The gap between rates on mortgages currently, compared with the much lower rates in 2021, also is creating another layer of deal-execution challenges. A recent market report by digital mortgage exchange and loan aggregator MAXEX reflects that reality.
“…Private-label securitization (PLS) spreads continued to move wider throughout April as issuers digested lower-rate mortgages [3% or lower] that remain in inventory as current market rates rise rapidly,” MAXEX states in its May market report.
Weng added: “And obviously, when your mortgage pool has a lower [interest] rate, and you also have to cover certain fees, a higher coupon translates into a higher funding cost for the issuers.”
There is a light at the end of that pipeline, however, according to MAXEX. “We expect this trend to continue in the short term until issuers’ pipelines stabilize and, over the coming months, note rates closer to 5% migrate to PLS [private label securities],” the company’s report states.
KBRA also indicates that impacts from the pandemic and the war in Ukraine “are important factors in our issuance projections for 2022, and these factors may also influence 2023.”
“Mortgage rates are generally expected to increase further as the Fed attempts to cool down rampant inflation and the housing market, impacting issuance as well,” KBRA’s market-forecast report states. “…We expect the prime sector to decline in 2022, mainly due to sharp interest rate increases that have decreased overall mortgage production….
“Similar themes could continue through 2023, causing prime issuance to be negatively impacted further. The non-prime sector’s expected issuance is projected to increase moderately in 2023 as spreads normalize after rising precipitously in Q2 2022.”
Another bright spot going forward this year for the PLS market, according to KBRA and MAXEX, is the potential for solid non-agency PLS issuance backed by investment properties and other more “esoteric” offerings.
“… We are still seeing an increase in the number of second homes and investor property loans being traded through the exchange to avoid the LLPA [loan-level price-adjustment] increase instituted by the FHFA [Federal Housing Finance Agency] for second-home and high-balance loans delivered to the agencies after April 1,” the MAXEX May market report states.
KBRA reported that MBS issuance backed by mortgages on nonowner-occupied properties (NOO), such as investment properties and second homes, “was strong in Q1 2022, with over 10x year-over-year growth.”
“We continue to expect further issuance in this segment…,” the KBRA forecast report states. “This expectation is partly due to existing NOO securitization pipelines built through the end of 2021 and early 2022.
“… In addition to traditional RMBS 2.0 issuance, reverse mortgage, mortgage servicing rights-backed issuance, home equity line of credit-backed deals, PLS CRT, Ginnie Mae early-buyout (EBO), and other esoteric RMBS transactions are also poised to increase in the remainder of 2022 and 2023 as interest rates rise further.”
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Fratantoni: Why FHFA and GSEs should revisit their pricing framework
Potential homebuyers in today’s market are facing a number of challenges, including increasing mortgage rates and a sizeable supply and demand imbalance that is pushing home-price appreciation to very high levels throughout the country. MBA’s Purchase Application Payment Index (PAPI) has increased by 32% thus far this year, indicating that payments have risen much faster than personal income.
Primary mortgage market rates are a function of several factors. First, mortgage rates are influenced by benchmark rates, including longer-term Treasuries. These rates are impacted by the strength of the economy, the level of inflation, and the expected direction of monetary policy, among other factors.
Secondary market rates, yields on mortgage-backed securities, are determined by factors that influence the supply and demand of these securities. These include expected prepayment rates, expectations of net supply to the market, and drivers of net demand from different investors including banks, Fannie Mae and Freddie Mac (the GSEs), asset managers, global investors, and in recent times, the Federal Reserve.
The spread between primary and secondary rates is impacted by yet another set of drivers, including the level of available capacity in the industry — which can vary significantly over the cycle; servicing values, which are impacted by market demand for MSRs, including any changes to servicing costs; and credit pricing, which includes guarantee fees, loan-level price adjustment (LLPAs), and mortgage insurance premiums (MIPs).
The primary mortgage market is intensely competitive, as I highlighted in a column earlier this year. Lenders are essentially price-takers in this market. If they raise their offered rates much above the market, they will lose the business. If they lower them much below market rates, they won’t be able to cover their costs in the long run.
In this column, I will walk through how FHFA, Fannie Mae and Freddie Mac determine their pricing, and why recent pricing changes to high-balance loans and second homes deserve a review for reconsideration, particularly if the Federal Housing Finance Agency (FHFA) wants the GSEs to use these products to generate sufficient funds to further subsidize loans to “core mission” borrowers.
The secondary market entities face a different challenge.
Fannie Mae, Freddie Mac, FHA, the U.S. Department of Veterans Affairs (VA), and the U.S. Department of Agriculture (USDA) have substantial market and pricing power. When Fannie and Freddie — through their regulator, FHFA, — decide where to set prices, or when FHA sets the MIP, they are not facing a situation of perfect competition, and hence have the ability to set prices at levels that might be different than where competitive markets would go.
However, there are certainly limits to the pricing power of these agencies. While private markets, either portfolio or private-label security (PLS) executions, may not readily be able to compete for agency business, if rates are pushed too high, these alternative executions may offer a better deal for lenders and their customers, particularly for low-risk loans. On the other hand, for some parts of the business that may be higher risk, if agency pricing is too high, these borrowers may not have another place to turn.
I began my career in the mortgage industry at Fannie Mae, helping to develop some of the analytical models that provided inputs into Fannie’s guarantee pricing model. While I have not been at a GSE for some time, by following FHFA’s guarantee fee report and other public information, my understanding is that the conceptual basis for credit pricing has not changed.
On a fundamental basis, the credit price for a loan, the base guarantee fee and the LLPAs, should cover both the expected losses from the loan and GSE administrative costs. The GSEs earn float income for the period of time they hold principal and interest payments, which provide a small offset to these costs. However, the largest component of credit pricing is a function of the capital that each GSE needs to hold against a stress level of credit losses associated with the loan (e.g., the level of losses for that type of loan experienced during the Great Financial Crisis (GFC) as a result of large declines in home prices and a deep recession).
To put numbers on it, while a certain loan might have an expected loss (in normal economic conditions) of 40 basis points (1% probability of default, 40% loss given default), in a stressful environment, that same type of loan might have a loss of 200 basis points (4% probability of default, 50% loss given default). Like an insurance company, a GSE needs to be sure it has sufficient resources to weather an appropriately severe stress event. Setting aside an appropriate amount of capital, and charging enough to earn a market rate of return on that capital, should do that.
You might recall the recent debates over FHFA’s revisions to the GSE capital requirements.
Market participants know that setting required capital for the GSEs too high would artificially inflate credit pricing and could reduce credit availability in the market. Setting it too low puts the GSEs at risk of another failure in the event of a severe recession or housing market crash. Beyond the top-line capital numbers, the precise calibration of required capital for different types of loans can have momentous impacts on how these products and loan-level attributes fare in the marketplace.
Exhibit 1 shows the grid of capital requirements for loans with different loan-to-value (LTV) ratios and credit scores from the FHFA capital rule. Exhibit 2 shows the “multipliers” used in the rule: for a loan with any given LTV ratio and credit score, loans with these attributes are projected to have a multiple of these loss rates in stressful conditions.
(As a quick example of how to read this: the base risk weight for a 720-740 credit score, 80-85% LTV ratio loan is 50%. That implies 4% capital given the 8% capital requirement. Now go to Exhibit 2 for the multipliers: A one-unit purchase loan (1.0 multiplier) for an owner-occupied home (1.0 multiplier) would require 4% capital, i.e., no adjustment. A cash-out refi (1.4 multiplier) on a condo (1.1 multiplier) would require (1.4×1.1=1.54 x 4%) = 6.16% capital).
Exhibit 1: Base risk weights from FHFA’s Enterprise Capital Final Rule, Table 2 to Paragraph (c)(1)
Source: Enterprise Capital Final Rule for Website.pdf (fhfa.gov), Page 263
Exhibit 2: Multipliers from FHFA’s Enterprise Capital Final Rule, Table 6 to Paragraph (d)(2), see: Enterprise Capital Final Rule for Website.pdf (fhfa.gov), page 265.
Economists, data scientists, statisticians, market participants, and others could argue all day about these numbers and the underlying data and models that created them. For example, many view the multiplier on TPO loans may be too high. However, following a notice and comment process and several rounds of reviews, these fundamental credit risk estimates for a wide variety of mortgage loans are generally defensible.
But we have not reached the end of the story.
While these estimates of relative risk that enter the capital requirements are a critical component of the guarantee fees and LLPAs that the GSEs charge, the GSEs and FHFA take another step when it comes to setting pricing, subjectively adjusting relative prices to require a premium on certain types of loans, while cross-subsidizing others.
Exhibit 3 shows a portion of the current LLPA grids for Fannie Mae. Of course, these LLPAs are in addition to base guarantee fees (which include a 10-basis-point add-on which goes to the government, not towards covering credit costs), which are running at about 55 basis points, of which 45 basis points go to the GSEs. Using a 5:1 multiplier, total credit pricing for an 80% LTV ratio, 740 credit score, otherwise vanilla loan would be 45 + (50/5) = 55 basis points.
As mentioned above, due to their market power, the GSEs are price-makers rather than price-takers, at least to some extent. While there are alternative executions available for some categories of loans that the GSEs guarantee, these alternatives may involve more friction, more risk, and/or different regulatory or other requirements. With respect to risk, at least historically, non-agency executions have been more susceptible to financial market disruptions, while the agency channel has been able to remain open given the government support.
However, while these alternatives may typically be more expensive, market conditions combined with GSE pricing may change that comparison. As noted above, if GSE prices are too high, lower-risk loans may go to depository balance sheets or PLS. If pricing on higher-risk loans is too low, the GSEs may take market share away from FHA or other government agencies or they could be adversely selected, winding up with a larger share of higher-risk loans than they had intended.
What does Exhibit 3 show when compared with Exhibits 1 and 2? With respect to credit scores and LTV ratios, both required capital and credit pricing increase significantly with higher risk in both tables. Looking at the drop in pricing above 80% LTV ratios, loans which require private mortgage insurance or other credit enhancement, there is some recognition of the support provided by MIs, at least at higher credit scores. The cross subsidization appears in the relatively flat pricing gradient at higher LTV ratios for stronger credit scores in Exhibit 3, while Exhibit 1 shows a steeper relationship along these lines with respect to stress losses and required capital.
Let’s now examine the most recent set of pricing changes that were implemented as of April 2022. Shown in the last section of Exhibit 3/Table 2, these (large) LLPAs are for high-balance conforming loans and for second homes. However, loan size does not show up as a risk factor meriting a multiplier in Exhibit 2. Typically, default risk is somewhat higher for smaller loan sizes, all else equal, and there is somewhat more risk of higher loss given default for very expensive properties. However, it does not seem likely that the fundamentals would warrant a 50-175 basis point LLPA for high balance conforming loans. If it did, Exhibit 2 would likely show a multiplier.
Similarly, while the LLPAs are 112-412 basis points for second home loans, Exhibit 2 shows second homes receiving the same 1.0 multiplier as owner-occupied properties. For higher LTV ratios, the LLPAs for second homes are now the same as those for investment properties.
These price increases were intended, at least in part, to generate revenue which could be used to cross-subsidize loans that are closer to the core mission of the GSEs, particularly helping underserved markets and first-time homebuyers. These are worthy goals, but the question is whether such price changes, which seem to be very far removed from risk fundamentals, may not be effective at raising revenue if they push lenders to seek alternative executions.
Exhibit 3: Selections from Fannie Mae LLPA Grids as of 4/6/2022
Source: display (fanniemae.com)
So what’s next?
Mortgage lenders are battling through a steep decline in origination volume as the market transitions to predominantly purchase business. More than ever, every basis point will count as lenders and borrowers work to address worsening affordability conditions. As a result, credit pricing may get more attention in 2022 than it has in some time.
The industry is anticipating a reduction soon in the FHA MIP, given the agency’s strong capital position and further declines in delinquency rates. This would certainly help many potential first-time homebuyers. However, given the challenges in affordability and headwinds facing the housing market, this also is a good time for the GSEs and FHFA to make adjustments to their pricing framework, ensuring that their pricing effectively supports market liquidity and helps to fund their missions.
Michael Fratantoni is MBA’s Chief Economist and Senior Vice President of Research and Industry Technology.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the author of this story:
Mike Fratantoni at mfratantoni@mba.org.
To contact the editor responsible for this story:
Sarah Wheeler at swheeler@housingwire.com
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The rising tide of house prices: Avoiding the flood
The old conservative economist’s adage that “a rising tide lifts all boats” was quickly called-out by activists who didn’t see the trickle down effects of a “booming economy” benefit the working people of America.
They changed the phrase to “a rising tide lifts all yachts,” sarcastically suggesting a society with vast disparities in wealth and assets and little by way of fairness. After the Great Recession, the phrase “one-percenters” came into the lexicon, again suggesting that the very few own the vast majority of assets and wealth in America.
While the tide analogy was meant to refer to the entire economy, it works well in the housing sector as well. After all, we are witnessing the rising tide of house prices, in a surge we’ve never seen before.
Some Americans surf on the waves and others just feel the effects of the rising waters. The question before those of us in the housing ecosystem is, “how can most Americans avoid the flood?”
Put differently, how can people who aren’t in very high-paying jobs, aren’t owners of industry, aren’t affiliated with investment firms, and who might opt-out of the traditional economy still become part of the “American Dream”?
There are multiple, connected issues that have to be addressed in order to answer this question. Before delving deeply into them, it is important to get grounded in the numbers:
While these staggering numbers certainly show the “rising tide,” the story is more complex than the aggregate numbers might suggest:
The numbers, when examined at a family-to-family level indicate a more dire story:
There are many more statistics that can be quoted, but the net result is a massive imbalance in the housing sector. In many parts of the country, the rising house prices have made it literally impossible for most families to partake in homeownership, which sets off a cascade of other issues, such as those related to transience, lack of good educational opportunities, and spiraling debt.
The rising tide has created a flood indeed. So, what can be done? Solutions can be found in three categories that might appear distinct but are in fact fundamentally connected:
Supply innovation is a complex issue.
From supply chain issues to zoning rules, from dirigisme to a purely free market mentality, the issues of supply are not given to pat answers. Yes, the U.S. is “behind” by tens of millions of housing units, but there is a perverse pressure on existing homeowners to be unsupportive of new developments, even if those new developments offer homeownership possibilities to a group of people locked out of the current system.
Recent trends toward smaller and more affordable housing units are a bright light in this arena but experts are united in the notion that the need far outstrips the current capacity for development.
Government policy innovation is similarly fraught though offers a great deal of potential.
Governments, whether federal, state or local could require private builders to build more units or control prices, but the laissez-faire ethos of American government militates against a strongly interventionist policy framework. Fiscal stimulus or benefits typically accrue to precisely the populations that require help the least.
Paradigm-change innovation is not a cake-walk either.
This calls for real change in the way we make finance options available to people who do not traditionally have the means to buy homes at sky-high prices or who opt out of the traditional system due to differing economic philosophies.
Polls indicate that people below 40 in the United States are less likely to want to opt for the typical 30-year mortgage and traditional financing means. What is needed is offerings that reflect a new paradigm in home-buying, learning from innovations in other sectors.
Just as each of these areas has difficulties and inertia associated with it, each has enormous potential to help Americans avoid the flood. To get there, we require the will to do so but also alignment across different parts of the ecosystem.
Some fertile areas for change are as follows:
On the supply-side, we need more companies willing to create affordable housing; they need to focus on median economics and not “one-percenter” economics. We also need to culturally socialize smaller houses with better ecological footprints. This requires concerted effort and cooperation between urban planners, builders, local governments, and financial institutions.
With regard to government policy, we need the GSEs with the backing of the federal government to work affirmatively to undo the deleterious effects of red-lining and artificial zoning to create a fair playing field and to regulate financial service companies so that it is less onerous and less credit-score dependent for working families to purchase and finance homes. This requires political will and clear follow-through.
In terms of paradigm change, we need better financial on- and off-ramps for homeowners, more abundant facilities to allow Americans to access and use equity in their homes, and creative ways to help house-poor Americans enjoy shared risk/reward models with investors.
Clearly, there is a lot more that needs to be done, but the conversations must happen and happen soon. With 2022 slated to be another year of high-growth in house prices, we need to intervene powerfully — and soon — before the rising waters prove too much for us to handle.
This article was first featured in the May HousingWire Magazine issue. To read the full issue, go here.
Romi Mahajan is an expert in the fintech marketing space. His previous roles include serving as CMO at Quantarium.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the author of this story:
Romi Mahajan at romi@thekkmgroup.com
To contact the editor responsible for this story:
Brena Nath at brena@hwmedia.com
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Is a Headache Seller Worth Losing a Deal Over?
Cash flow and appreciation are at opposite ends of the investing spectrum. One will fuel your current lifestyle while the other will slowly, silently build your long-term wealth. The cash flow vs. appreciation debate has gotten even stronger this year as home prices continue to rise and cash flow prospects dwindle in formerly stable markets. Is there a way to still get the benefits of long-term growth while also taking home a sizeable rent check?
If there’s one man to ask, it’s your host, David Greene, who’s joining us for another episode of Seeing Greene. David knows a thing or two about buying for different purposes, in different market conditions, with different exit strategies. He’s not only asked about how to do this on today’s episode, he’s also asked questions like who should be on the mortgage when buying a rental with a partner, whether to sell or refi a rental, what to do when your DTI (debt-to-income) ratio is too high, dealing with difficult sellers, and how to get comfortable with being uncomfortable.
Want to ask David a question? If so, submit your question here so David can answer it on the next episode of Seeing Greene. Hop on the BiggerPockets forums and ask other investors their take, or follow David on Instagram to see when he’s going live so you can hop on a live Q&A and get your question answered on the spot!
David:
This is the BiggerPockets Podcast Show 612. Rather than trying to find a seller and convince them that their numbers don’t work when the market’s probably telling them that their numbers do work, I think you should take those efforts and put them into finding a different seller. This is a mistake a lot of people make as they try to change the mind of somebody who doesn’t have to change their mind. Just go look for somebody whose mind you don’t have to change. You’d be way better to take that same effort and put it into a different property.
What’s going on, everyone. This is David Greene, your host of the BiggerPockets real estate podcast. Here today with a Seeing Greene episode, as you can tell from the green view behind me. In Seeing Greene episodes, we answer questions directly from the BiggerPockets community regarding real estate, what to do about real estate, how to finance real estate, what’s going on in this crazy real estate market that we’re in, and I do my very best job to answer them. If you’re not listening to this on YouTube, consider checking us out there where you can read and leave comments about today’s show.
Today’s show is very good. We get into some very trendy topics that are on the front of everybody’s mind. We talk about if you should get into a cash flow or an appreciation market, what the difference is between the two and how to know which one is right for you. We talk about the fact that you’re not going to get comfortable before you do something. So what a good process is to get comfortable in the process of starting something new.
And we talk about how to understand debt-to-income when you leave your W-2 job and go full-time into investing or a side hustle plus real estate investing. We get into some really good relevant stuff, and a lot of wisdom is shared here. So thanks for joining me. I’m excited for you to hear it.
Before we get into the show, today’s quick tip. Consider getting your tickets to BPCON 2022 in San Diego this year. You can go to biggerpockets.com/bpcon2022. That’s BPCON2022. I’ll be there. Lots of other BiggerPocket personalities will be there, lots of other investors will be there. You can learn from other people about what’s working in their market, what market you might want to invest in, and then meet people in that market that can help you get started.
It’s also a great time. I’ve never seen a person there that had an unhappy look on their face. Everybody is super cool. It’s a lot of fun. There’s tons of knowledge being shared, and it can really get you invested in this community and jumpstart your career. So, consider being there. I’d love to see you there.
All right, let’s get into today’s show.
Ahmad:
Hi, David. Thank you so much for all the knowledge, insight, and information that you share with people every day. It’s been extremely paramount to my growth as a new real estate investor. My question is, my girlfriend and I are both new to real estate investing and we’re trying to build our real estate portfolio. We each have a property in our name already. We want to acquire the next one together.
However, our original plan was for one of us to take in that mortgage separately. That way the other person is freed up in terms of the debt-to-income ratio. And then down the road when we go and get another property, hopefully it would be a little bit smoother because one person still doesn’t have that new debt on their record. Now, with the rising interest rates and inflation and just cost of everything being so expensive nowadays, I’ve been rethinking that and thinking about going in on a new mortgage together, combining our income so that we have more buying power.
Now, my question to you is would that be disadvantageous for us? The reason I ask is I know from your previous podcast when we acquire that new debt, we both acquire it like we’ll both have that new mortgage on both of our debt-to-income ratio. And I wasn’t sure if with that in mind that the rental income would also, if we would both acquire that rental income or if only one person gets to say, “Hey, we’re making $2,000 in cash flow every month,” if I get to claim that, or she claims that, or if marriage changes all of that, so it’s all kind of confusing. And I was just wondering what your take on that would be. Thanks, David.
David:
All right. So thanks, Ahmad. This is a good question. Let’s break it down. You’re thinking about buying with your girlfriend. First thing I want to say, you didn’t ask this, but I would just recommend that you maybe hold off on taking title together with someone that’s not your spouse. I’m sure your relationship is great now. You never know what’s going to happen. And if you’re buying something with your girlfriend and only one of you is on title, if the two of you split up, the other one might not have any protection.
You’re going to put both of you on title. There’s ways to do it without having both of you on the loan. But in general, you’re going to end up both being on the loan. That’s the smoothest way to make it happen. And now you’ve eliminated the ability to have the mortgage and only one of your names. So just in general, whenever you’re buying with a partner, which is what this is, I advise people to probably try to not invest with a partner unless they have to, unless it’s your spouse.
Now, let’s get into the details of what you’re asking here. I like where you’re going. You’re trying to keep the mortgage in one of your names not the other, but you’re realizing you might have to combine incomes in order to get the property you want. That is sort of the conundrum. I think I mix conundrum and quandary together and made up a Voltron word that doesn’t exist, quanundry. Ignore that part. We’re probably not going to edit it out and everyone’s going to see what it looks like when you’re trying to record a podcast and you end up making up a word.
The good news is if you buy investment property together, you don’t have to worry about the debt-to-income ratio taking a hit, because you’re bringing in income from that investment property, just like you’re bringing on debt. So it usually ends up working out more or less to be equal. And in time, it actually helps your debt-to-income ratio because you’re making more income than what you’re spending on the debt.
Now if you’re buying a house to live in, that’s an exception. Usually, you cannot use income from a house when it’s your primary residence. There’s a handful of very small exceptions, but in general, it doesn’t work the same way. So I would say, if you have to combine incomes to get the property you want, make sure it’s an investment property. But you’re probably going to want to buy it in an LLC that you’re both half owners of to make sure both people are entitled. And that brings us back to the issue of buying a house with your boyfriend, girlfriend, not always the best idea.
So I would ask you, is there a way that you can afford this one on your own and you buy it, and then you work with her so that she can afford one on her own? I just think overall, when you’re looking in the future, that’s probably going to be a better approach. The other option you have is a debt service loan. These are loans where you take the income from the property not from yourself, so you don’t have to worry about the effect that this is having on your personal debt-to-income ratio.
The other questions that you ask are this is a good example of, this is best asked to a CPA, a title company. You can ask your agent or you can ask someone like me, but I’m probably going to refer you for the nuance of this to go talk to an expert. So if you’d like, feel free anybody to reach out, I’m happy to connect you with my CPA. If you end up signing up with them, they can answer questions like this one right here, because they have a better understanding of how to do this legally the correct way.
Thanks, Ahmad. All right, our next question comes from Haruka from the East Coast. Haruka says that she has bought a single family home. She’s renting it out. She likes it. And now she wants to expand. She wants to get into 5 to 10 multifamily properties or clusters of single family homes in areas with steady population growth.
The problem is she’s been looking in hot areas like Raleigh and Atlanta, where houses are super expensive that don’t really cash flow much. And then in other markets, which she calls medium like Indianapolis, she sees that she can find relatively decent cash flowing properties, but you’re not getting the growth that you get in one of the hot markets. Should she focus on one market and try to get as many deals as she can there or spread her attention over several markets?
Thank you for this, Haruka. Here’s what I’m hearing behind what you’re saying. You’re very frustrated because it’s very hard finding cash flowing properties in today’s market. And that is a thousand percent true. This is from what I’ve seen in my investing career and from what I’ve talked to some of the older investors, the most difficult time to find any cash flowing asset.
And it helps if we understand why that is, I won’t go into it too deep, but a lot of it has to do with the fact we printed too much money. That money needs to find a home. Real estate investing is the easiest way to deploy a lot of capital and capitalize on leverage without a ton of work. So more and more businesses, companies, hedge funds, institutional capital investors like us, everybody’s flocking into this space because it’s the best place to put money with the lowest overall risk and the highest return.
At the same time, the increase in education in real estate investing has taken a lot of the mystery out of this. That used to be a barrier to entry for a lot of people to get into the game. So now it’s easier to get in than ever, and there’s more people getting in than ever, and there’s more capital getting in than ever. And boom, you’ve got a very hot and competitive market.
Here’s something that I’ve come to understand when it comes to how I look at real estate. It’s a spectrum. But in general, you have cash flowing markets and appreciation markets. Now that does not mean speculating markets. What it means is you’re going to make more money by the value of the asset going up in some markets. We call those appreciating markets. And you’re going to make more money through cash flow in other markets where your property is not going to appreciate as much.
The problem is when we want both, there was a time you could get both and many people set their expectations that that’s what they should get through real estate investing. But I don’t see it like that. Now, I understand that when I’m buying a property, what I’m really doing is buying an income stream. Some income streams are very difficult and take a lot of time and effort to manage. Other income streams are easier to manage.
The income streams that are easier to manage are in higher demand. And therefore, they tend to have a lower amount of income that comes out of them because there’s more people looking to buy them pushing up the prices higher. So what you have to ask yourself is what is more important? Are you playing the long game? In which case, appreciation is usually better because you’re going to make more money over the long term or are you playing the short game where you want cash flow right off the bat?
Now, there is no right or wrong way to do this. Some people like their job or already have a lot of money. They’re able to play the long game. And so they go into the hot markets like you talk about where there’s very little cash flow in the beginning, but over time, they start to develop more cash flow as well as a higher appreciating asset.
Other people don’t have that luxury. They have a need for supplemental income. They just had a baby. They need to get some more money coming in. They don’t have their job. They lost their job. They’re not happy where they’re at. They need cash flow in order to get them a platform to get to the next level in life. So when it comes to choosing what the right market is for you, Haruka, do you want to be in an appreciating market, which is long term or a cash flow market, which is short term, what do you need?
So here’s the way that I’m doing it right now. I’m overall looking for the long term approach real estate investing. I know I’m going to make way more money buying in an area where people are moving to, what you call the hot market. There’s to be more demand there, businesses are going there. People are going there. Over a 5, 10-year span, those houses or those assets are going to appreciate a lot.
So I’m looking in the markets like you’re talking about. The Raleighs, the Atlantas, the South Floridas, the Arizonas, places where I think wealth is going to move and I’m buying there for the long term. Now, to balance out my portfolio, every time I buy a property or a set of properties that are more of an appreciation play, I’m also buying a series of properties that are a cash flow play. So then I may go into some of the, what you called medium markets like Indianapolis. And I’m looking for something that’s going to cash flow very steady, but probably isn’t going to go up a lot.
It’s kind of like if you use a fitness analogy. You need to eat protein for your muscles, that’s long term. But you need to eat some carbs, so you have energy for the short term. If you’re trying to grow, you have to have a balance of both. Now, if you already have massive muscles and you don’t need to work out a ton or whatever, maybe you just eat more protein.
That’s the question you have to ask yourself, where are you in life? If you need cash flow right now, go to one of the markets where you can still get it, the medium markets like you said. Build up a steady stable of cash flow. And then once you’re good, consider going into one of these hot markets and playing the appreciation game.
Also, let me just add this one piece because I always get comments if I don’t clarify this. When I say the appreciation game, I am not saying the speculation game. I am not telling anyone to go buy a property that they cannot afford in the hopes that it goes up and they can sell it later. I am talking about buying a property that you can afford that may produce less short term cash flow for the delayed gratification that comes from more cash flow later in the game or a higher appreciation value.
Jesse:
Hey, David, love BiggerPockets and all you guys do. So I have a scenario. I just kind of wanted to see how you would tackle this. I have a property in Green Bay, Wisconsin. It is a duplex that I used to live in. My understanding of the tax code, I lived in it two of the last five years. I moved out of it two years ago. So I would be able to sell it without paying capital gains, which is very enticing.
The problem is what I’m looking to buy is basically what I would be selling, small, multi, my units in that area, or I could get adventurous and do something different. But that’s kind of what I’ve been looking for, is two to four unit properties in that market that cash flow and also have done well with appreciation.
So how would you tackle this situation? How do you figure out if this is a wise move to sell it or to just refinance it and keep it, but especially with the caveat of the fact that I would not be paying capital gains if I did sell it. So, I don’t have to mess around with the 1031 or anything like that. I look forward to hear what you have to say. Thanks.
David:
All right, Jesse. Great question here. And what I love about this is it is a philosophical real estate question. So I get to break down the philosophy of real estate, not just here’s a tactical answer to a specific situation. First off, your understanding is correct. According to the current tax code, if you’ve lived in a property for two years out of a five-year-period, you can sell it and avoid capital gains. There’s a limit on that. I believe it’s $250,000 is exempt as a single person, $500,000 for a married person. Again, I’m not a lawyer or a legal advisor. This is not legal advice. You should look that up, but that’s my understanding of it.
Now you’re also asking a very good question and it comes to the fact that in real estate, when we sell and then look to buy, we typically are doing it in the same market that we just exited. So if you sell high, you buy high. If you sell low, you buy low. And this gets a lot of people tripped up because what they’re looking for is a situation where they can sell high and buy low.
Now, when I wrote Long Distance Real Estate Investing, this was one of the issues that made long distance investing great, because you could sell high in a certain market and then find a market and then you could go buy low. Unfortunately, we’ve had such a flood of interest in real estate investing since we at BiggerPockets have done such a great job of getting the information out there that now there’s very few markets that you can actually go buy low.
So you have to change the way you’re looking at it. If you’re going to sell, one of the benefits is you can avoid capital gains. But I wouldn’t look at it like you’re making a bunch of money and then reinvesting it so that you can make even more money. That isn’t exactly true because you’re selling high to go buy high. In a lot of ways, you’re just going to get a reset basis on your property taxes. You’re probably going to get a higher interest rate than you had before. I’m not deterring you from doing it. I’m just asking you to look at it differently.
Here’s how I look at it. When I sell in one market and then buy again in the same market, what I’m really doing is I am adding leverage to my portfolio. So if I sell one property and I take a $500,000 game and then I go buy two or three properties with that, what I’ve really done is increase the amount of money that I have borrowed. My equity didn’t necessarily change because I took 500 grand from one and turned it into 500 grand over three others.
My cash flow might have changed some or might have changed maybe not at all. I might have taken $2,000 of cash flow over one property and traded it out to, say, $800 of cash flow over three properties. So maybe I got one from $2000 to $2,400, but that’s largely insignificant. You don’t have a huge, huge bump in your cash flow when you do this. What you’re doing is betting that prices are going to continue to go up and therefore, leverage is in your advantage.
When you’re trading in one house for three, if prices raise, you are making three times as much equity and you borrow money that you’re paying back with cheaper dollars. Now, if you think the market is going to go down, this would be the worst thing you could do. You don’t want to have one house and turn it into three with a bunch more debt. And that’s the question that you really need to be asking yourself. Do you believe the market’s going to continue to rise in the market you’re talking about, or do you believe that the market is going to fall?
Now I don’t believe you mentioned the market you’re in, so I can’t give you any specific tactical advice on that specific market. But what everyone listening needs to understand is when we buy real estate, we’re always making a bet. We’re making a bet that tenants are going to continue to pay. The market is going to continue to go up. Rents are going to continue to go up. Businesses are going to continue to employ people. And therefore, we want to own assets that are dependent on tenants.
And when we’re not buying, we’re also making a bet. We’re betting that prices are going to come down or our money would be better put somewhere else. So what everybody needs to understand is you’re going to make a bet one way or the other. Once you make up your mind, which way you think you’re going to go, that’s where these strategies that we’re talking about today can come into place.
We’ve had some great questions so far, and I want to thank everybody here for submitting them. Please make sure as you’re watching this on YouTube to like, comment and subscribe to the channel so you get notified when BiggerPockets comes out with some new stuff. I got all dressed up for you today. I’m trying to dress to impress. What do you guys think of what I’m wearing?
This segment of the show is where we take comments from previous episodes. And I read them to you, hoping that you will also go comment on our YouTube channel and let us know what you think about today’s show. I want to know. Should I answer longer or should I answer shorter? Do you want to get more commentary from me or would you rather have shorter answers with more questions?
Also, how do you like me to dress? Do you like me more in a T-shirt? You like me more in a realtor specific button-down type of a shirt? I want to know what you guys think. Leave your comments below. We will read them on one of our shows.
Our first comment comes from Giselle Morales. “I totally agree with you on cash flow. To be able to live off of it, two to three properties only is pretty risky. In my case, I had my goal and numbers aligned to get nine houses and that will cover my budget times two. And I was able to do it. So now I cover my budget with half the houses and what I do with the cash of the other half is keep saving to keep investing.”
Thank you, Giselle. This is an awesome comment. And what you’re hitting on is the philosophy that you should buy a handful of properties, quit your job, go full time into investing and figure out how to make it work. For some people that may be the right move. For others, it becomes much more difficult in the market that we’re in.
So 10 years ago, that advice applied to a bigger segment of people than what it applies for today, which is a much smaller segment. And I’ve lately been saying, you shouldn’t be looking at cash flow as a way to replace your income. You should be looking at cash flow as a way to supplement your income in today’s market for most people.
Next comment comes from Miguel Montreal. “Hey, David, great episode and questions from listeners. I just wish, and maybe you can recommend this, that those asking questions can get right to the question. It seems to take forever just to get back to you to give an answer. Thanks.”
Miguel. I really appreciate. And here’s the dance that we’re having. I want you guys to submit questions, so I don’t want to discourage anyone or make them feel bad because they took too long to ask the question. And I also recognize that many of you don’t talk on a microphone like I do for a living, so speaking can be hard. It can be hard to get to your point. Maybe you didn’t think about what you were going to say before you started talking. Maybe you were just super nervous and that’s why it took a long time to get to the point. But I do see it as well.
What we would love would be for more of you to ask questions, but just be a little more succinct. So if what you really want to know is, “Hey David, what market should I buy in?” Start your question by saying, “I would like to know what market I should buy in. Here’s where I’m concerned.” What we typically get is someone that tries to explain the background of what they’re thinking. And then at the very end five minutes in, they get to the question and that’s just harder for the listener to sit through. And so oftentimes, we don’t air those questions.
So Miguel, thank you for offering some advice. When you guys submit your questions to BiggerPockets.com/david, be more succinct. Get to the point. Maybe practice a few times before you record it, and you get a higher chance of getting put on the show.
Jeff Mueller. “David, what is a good return on equity on a property I want to buy and hold, 15%, 35%?” All right, Jeff, it’s very difficult for me to tell you what the right return on equity should be. And what you’re talking about is for the equity in a property, how much cash flow is it generating? Those numbers are huge. 15%, 35% are typically very high because return on equity is usually lower than return on investment.
In fact, it’s almost always lower, assuming a property is going up in value. You can only get an ROE that is higher than the ROI if your property’s actually losing value, which would be bad. And since most people aren’t hitting anything close to a 35% ROI, that wouldn’t happen on your return on equity. But you’re asking the wrong question. Don’t say, “What is a good return on equity?” What you need to be asking is, “Is this return on equity close to the return on investment?”
So, if you buy a property and you’re getting a 20% return on investment somehow, but then the property goes up a ton in value and you’re only getting a 3% return on your equity, that difference between 20% ROI and 3% return on equity, the higher the difference is, the more you should look into selling that property and reinvesting your equity to get a better return on investment. The closer that your initial ROI is to your ROI, the more likely you should keep the property and hold it.
Are these questions and comments resonating with you? Do you like hearing my take on this stuff? Well, guess what? This show is only as good as the questions and comments that we receive. So comment on the YouTube channel. Tell me what you’re thinking. Am I talking too fast? Am I talking too slow? Do you want me to talk in different accents? What kind of close do you want to hear? Let me know. This is for you. And then also, I need you to submit more questions that I can answer on the show. So, go to BiggerPockets.com/david, and leave me your question there.
All right. Let’s take another video question.
Bill:
Hey, David. Bill from Charlotte here. Just a quick background, I’ve got a high paying W-2 job in the tech industry here. And then I’ve sold a couple long-term rentals and I’ve currently got one long term and five short-term rentals through a combination of myself and some partners. Pretty close to being able to pay for my expenses through the rental income and would like to no longer work in my at least current W-2.
Concern I have is my debt-to-income is pretty shot with the loans I’ve currently got in my name. And after potentially leaving W-2, I don’t think I’ll have really any room at all to purchase a new primary home. I’m wondering how others or you’ve seen others deal with this in the past after they’ve quit their W-2 and have lived off their rental income. Thanks.
David:
All right, Bill, great question here. Let me see some different steps I can give you that you could possibly take, paths that you might take. Number one, you don’t quit your W-2 job, but you look for a different position within that company where you can work less hours or work on something that you enjoy more, so you have more time to put towards real estate investing.
Number two, you work in the same industry you’re in. I don’t believe that you mentioned it. You just said it was a high paying job. Can you get a consulting job? Can you be a freelancer? Can you do some way to earn money, but on your schedule where you have more flexibility to focus on real estate investing, but you haven’t wasted all the skills that you’ve built in the industry and now you’re not making money. You’re still making money, but more in an entrepreneurial position. So even if it’s less than the W-2 income, it’s still more than nothing that you’d be getting if you quit.
Number three, you said your debt-to-income ratio is pretty much maxed out from properties you’ve already bought. I don’t quite understand that because if you’re claiming the income that you’re making on your taxes, most lenders will let you take 75% of the gross income that you’ve collected and use that as income for yourself in your debt-to-income ratio.
So when I’m buying real estate, even though my debt is going up, my income is going up with it because I’m collecting rent. And my income actually goes up higher than the debt if they’re making me money. So when you’re cash flowing, you should have more income, not less income. So unless you’re having a specific loan product that won’t let you use income from rental properties, then the only reason you’d be having trouble is if you’re not claiming the income on your taxes and then just start claiming your money on your taxes like you’re supposed to be and that will go away.
I’m not sure if the lender you’re working with is telling you this, or it’s just maybe a false impression that you’re under that you can’t use the income from your properties, but definitely reach out to us at The One Brokerage if you’re willing. And we’ll figure out what is going on with you there.
The last thing is use a different loan product. Use a debt service coverage ratio loan that says, “Hey, this property is going to make this much money. We’re going to qualify him based on the income the property is making not on the income that he is making. We do these loans. They’re third-year fixed rate. They’re not risky. The interest rate is a little bit higher, but if the deal works, it doesn’t really matter.”
What is more concerning to me is when people get into adjustable rate mortgages and what’s even more concerning than that is when they’re short-term adjustable rate mortgages. So if you have one or two-year period before it adjusts, very scary.
You didn’t ask this question, but I’ll throw it in for the audience. I’m not super opposed to an adjustable rate mortgage if it has like a seven-year period or even maybe a five-year period before it adjusts, because the odds are over seven years, you should have seen increased rents and increased profit. You should have stabilized it and had more income coming in so that when your interest rate adjusts, if it does go up, you should be okay because theoretically, you’ve seen rents increasing. I don’t like them over a short period of time like two years. That’s not giving you enough time to stabilize a property, reduce expenses and let rents increase.
So, I think that this could really be solved by having a good conversation with a good loan professional that should be able to look at this and give you some answers. I’m guessing maybe you haven’t talked with one of those yet. So reach out to me, or one of us, or find another one of these amazing people on BiggerPockets that lives to serve the investment community. Get some answers from them and you could be that much closer to quitting your job.
Now, specifically to you saying Bill, “Hey, I want to buy a primary residence.” On a primary residence, you’re not going to use a debt service coverage loan like what I talked about. You’re likely going to use a conventional loan or you’re going to use a portfolio loan through some credit union that you might be involved with, whatever it may be.
But it’s the same fundamentals. If you’re claiming the income that you’re getting from your rentals and your long-term rentals and your short-term rentals are profitable, you should be able to use that income to help you qualify for the primary residents that you want.
Next question comes from Nathan Holt in Ohio. “Hey, David. I’m a 23 year old college student, a full-time worker at Capital University. I’m looking to buy a small multifamily in Central Ohio east area. I had received a tip that there was a guy looking to sell a triplex unit in Johnston. My realtor contacted him with an offer of $200,000. He said he’s looking for closer to 370. I do not have the funds at the moment for that, and the numbers don’t make sense for a house hack. It would only be profitable if I didn’t live in the building and rented all three units, but then I have to put more than the 5% down on the mortgage, which I don’t have. I’m wondering if it might be a good idea to try and sit down with him, the seller, and show him how the numbers really don’t work and see if I could persuade him into moving the price down to more affordable area and go from there. Do you have any ideas or recommendations?”
All right there, Nathan, I do. Your realtor really should have told you this. It sounds like your realtor is not very experienced. If you’re being told to write an offer at the price you did and the seller wants that much more, one of two things is going on. Either he has ridiculously unrealistic expectations, or you do. And that’s really what it comes down to.
What’s the house worth? Whatever the market says it is. Now what is the market? Well, basically that’s all the other buyers. You’re not going to be able to convince this seller that his numbers are unrealistic because what it really is, is they’re unrealistic for you. Your situation makes this the bad deal. It’s not a bad deal for everybody, but it probably is a bad deal for you.
If you’re looking at house hack and you need it to cash flow and you only have 5% to put down, there’s only a handful of properties that are going to work because you got a lot of ands that are in there. There’s some other investor out there who doesn’t have all those ands. Maybe they’re in a 1031 and they need to find a way to park their money. Maybe they’re trying to take advantage of accelerated depreciation. Maybe there’s reasons why they would want to own that property because they don’t have the same situation as you. They’ve got more money to put down and they can make a cash flow.
Rather than trying to find a seller and convince them that their numbers don’t work when the markets probably telling them that their numbers do work, I think you should take those efforts and put them into finding a different seller. This is a mistake a lot of people make, is they try to change the mind of somebody who doesn’t have to change their mind. Just go look for somebody whose mind you don’t have to change. You’d be way better to take that same effort and put it into a different property.
All right, we have time for one more question.
Shiuan:
Hi, David. This is Shiuan. Thank you so much for your videos. I’m from [inaudible 00:29:18], and looking to purchase maybe in or out of state. My question is if I should use a HELOC to purchase or use my cash savings towards a down payment and just trying to understand about good debt. Is that always better to borrow off than to use my own name? And as a part of the question is the variable rate of HELOC. How do I make sure … How do I calculate the rental properties cash flow to make sure that it covers the HELOC well? Thank you so much. Your videos are super helpful.
David:
Thank you for that, Shiuan. Your audio was a little hard to hear, so I’m going to repeat what I remember of what you just said. It sounds like what you’re saying is you’re looking to buy and you don’t know if you should take the money from a HELOC or from your cash savings. And you mentioned that you want to make sure that you’re using good debt, so it sounds like you’re trying to figure out does a HELOC count as good debt.
Now, I can tell your heart is in the right place because you’re asking a good question, but your head might need a little bit of clarity. First off, if you’re going to use a HELOC, I look at that like giving a loan to myself because HELOCs are temporary loans. You’re going to be paying a higher interest rate than normal if you use a HELOC. So what they’re really designed for is to go use the money for a short period of time and then pay it back. If you’re going to be buying a rental property with that money, unless this is a BRRRR or a flip, it’s very difficult to get the money back to pay off your HELOC.
Furthermore, the Fed has announced that they’re going to raise interest rates, I believe, seven more times before the year ends, which means that you should expect the interest rate on your HELOC to continue to rise, making that a less desirable financial vehicle for what you’re talking about.
Now, let’s look at using cash. At first glance, using your cash savings would be a better plan because there’s no interest tied to that money like on a HELOC. So, you don’t have to pay debt yourself to this HELOC. But you need to make sure that you have enough cash and reserves to weather a storm. This is a big way that investors lose money. They end up not keeping enough money in reserves and then they can’t make their debt payments. And if the value of their property has dropped too low or there’s no buyers in the market, that’s where they go to foreclosure.
So, I would say keep 6 to 12 months of reserves of cash flow for yourself and your property in your cash savings. More than you think you need, maybe even more than that. If you have enough cash after you put a lot of it in reserves, use that to buy the house. If you don’t have enough, use the remainder that you’re lacking from the HELOC. But you don’t want to take money from the HELOC unless you absolutely have to because we’re told rates are going to keep going up and HELOCs have adjustable rate mortgages.
And then once you buy the property, get right back in there, start working hard, start saving money again, start working on a side hustle, keep your expenses low, save those reserves back up after you buy the property. This is a great question. I’m glad you asked it, and thank you for doing so.
All right, this question comes from Jason in Atlanta, two-part question. Part number one, “My business partner and I own about 60 doors across a couple states in the Northeast, in the multifamily space. Right now, we’re working on a deal that would nearly double our portfolio. My first question, have you ever heard of a bank calling the note on a commercial loan using the loan-to-value clause? For example, if we’re a 75% loan-to-value and the market dips a bit after we close and the decrease in the property’s value turns into a 77% or 79% loan-to-value, have you ever heard of a bank calling loan do for that reason? I believe in most mortgage, there’s technically able to do that but I couldn’t find any examples of it happening on the BiggerPockets forum.”
All right, let me start with that question before I get to part two of yours. My understanding of the loan-to-value clause you’re talking about is a clause in a note that tells the lender if the properties loan-to-value starts to increase, which means the property is becoming worth less compared to the amount of debt you have on it, then the lender is able to call the note due. Now why would that be in there? Well, my understanding is if you’re a bank and you see that the loan-to-value on a property is going the wrong direction, you should be able to step in and fix the problem by taking title of the property before it gets worse.
Now in multifamily property, as you know, Jason, the value of the property is based on the NOI, which means if you start making less money, the value of the property is going to go down, which is going to increase the loan-to-value. So what they’re concerned about is if you’re mismanaging the property and it’s not profitable, they want to be able to step in before it goes into complete foreclosure.
But something else to think about, do they want to do that? If it’s not because you’re mismanaging it, if it’s just because the market turned around, maybe cap rate’s expanded, maybe the interest rate has changed the value of multifamily property. Your loan-to-value might go up a little bit, but I don’t see why they would want to step in and take it off your hands if it’s something like that.
I would ask the representative at the lender that you’re talking to, “Hey, what would happen if rates jumped up and therefore cap rates expand and the value of the property is going to go down? We could see the loan-to-value increase from 75% to 80%. What would you do?” And they would probably give you the answers similar to what I did, but I would check with them to find out. As far as have I ever heard of that happening, no. I also have never seen this happen.
“My second question, do you have any general tips on getting more comfortable with such a big transaction even if the numbers definitely work on a multi-year horizon? I remember in the olden days of the podcast that’s back when I had a halo over my head, the golden olden days. You and Brandon once said that to grow up business, you should really be doing something every year that’s a little bit uncomfortable for you, and this definitely fits that description. Any tips on getting comfortable with the risk and uncertainty of something that looks good on paper but is bigger than anything else you’ve ever done in real estate? By the way, really enjoying Seeing Greene format mixed in with the traditional deep dive shows.”
Yeah. It’s hard, man. Here’s my advice. You aren’t going to get comfortable with what you’re going to do. You are going to do it and it’s going to be uncomfortable. And in the process of doing it, you will become comfortable. This is something we all have to understand. I want you to look at comfort like strength. You can’t get strong and then go to the gym, right? Confidence often works this way. If you wait to feel confident, you’ll never start. If you wait to get strong, you’ll never work out.
The very fact that this feels uncomfortable is a way of knowing that you’re not yet the version of you that you need to be to do this right. What you have to do is put faith in the fact that going through the process is going to turn you into that person. So I did not wait until I was super good at jujitsu before I went to jujitsu. I go and I suck, and if it’s really hard and most of the time I feel bad about myself because I’m comparing myself to people that are way better. But I’m getting comfortable through doing it. I didn’t wait until I was comfortable and then do it.
The same goes with being in shape, and the same goes with business. When I first started doing this podcast with Brandon, I was not comfortable. It was actually terrifying. At the time we were getting 250,000 downloads per episode, and the entire time I was looking at the camera saying, “250,000 people are listening to every single word that I say.”
And I started worrying about not pronouncing something correctly or saying something dumb or saying something that God forbid, someone could pull up seven years later and say, “Haha, David said something and it wasn’t accurate.” It was really scary. But all I could do was keep doing the podcast more, keep thinking about how to get better, keep listening to the episodes that I did and noticing what I did that was good, what I did that wasn’t good and improving.
And this is what the process is. If the deal looks good and you believe in the fundamentals and you’ve got enough money in reserves, do it. You’re not going to be comfortable. You’re going to make mistakes. You’re going to do things and say, “Ooh, I should have done that different.” That’s literally how I learn in everything. Jujitsu is a great example. I’m constantly making mistakes.
You’re going to do the same thing. Don’t wait to be comfortable before you do this deal. And again, I’m going to highlight, make sure you have enough in reserve. See, the cool thing with jujitsu is when I make a mistake, I don’t actually get my arm broken because I can tap. I can say, “Okay, stop pulling on it. It’s going to break. We’re good.” And they’ll stop. So, even though it’s hard, it’s not necessarily risky. Reserves are your tap. If you’ve got reserves, that means you’re able to tap. You can make through the tough times, you’re going to be okay.
That is it for our show today. Thank you very much for listening. I understand you could be putting your attention everywhere. If you’re watching on YouTube, there are people screaming at you to watch their videos instead of mine. If you’re listening to this on a podcast, there’s tons of people who would like your attention listening to their podcast. So, I want to say thank you for joining me on the journey that we are on and know that I am doing my absolute best. And we here at BiggerPockets are doing our absolute best to give you the best content we possibly can, straight shooting, hard hitting, no BS, no drama. The realest of the real is why you’re here. It’s why we do this.
So please, consider going to BiggerPockets.com/david and leaving me a question. Make sure you like this YouTube channel as well as subscribe to it, and follow me on social media. I’m @davidgreene24, pretty much everywhere. On TikTok, I’m officialdavidgreene. There’s an E at the end of Greene.
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