Multi-Family Investing with Scott Price
If you’re a reader rather than a listener… you can enjoy the written show notes below!
Joe Bauer: Welcome to another edition of the Seattle Investors Club podcast. My name is Joe Bauer, and I have my cohost Julie Clark. How you doing today, Julie?
Julie Clark: All good over here, Joe.
Joe Bauer: Oh, yeah. Today, we have Scott Price from Bonvolo Real Estate Investments. Scott, how are you today?
Scott Price: Doing fine. Thanks for having me, Joe and Julie. I appreciate it.
Joe Bauer: Oh, yeah. We love having you on the podcast. We’ve had you at the club before, and it was fantastic. So I’m excited to dive in today and hear more about you. That leads me to our first question. Really, Scott, how long have you been doing real estate investing, and how did you get started? So this kind of first formal question for you just to let people know who you are.
Scott Price: Sure. Yeah. I had a very brief touch with real estate investing right after college. I wouldn’t consider that to be part of my real real estate investing. That has been going on for about 14 years that I’ve been actively investing. Started out in a somewhat unique development deal, and then rolled that into multifamily immediately. Since then, I’ve been gradually growing my portfolio with a combination of multifamily, some singles, and then got into some office, medical, and retail as well.
Joe Bauer: Okay. Really interesting. What did you do before real estate?
Scott Price: Yeah. Well, actually I’ve mostly been in program management and team management positions, primarily in technology companies. For the past 14 years, while I’ve been actively investing in real estate, I’ve mostly been in those roles as well. In other words, I wasn’t full time in real estate until just recently. I actually gave my resignation letter. I am officially full time in real estate now.
Julie Clark: Woo.
Scott Price: Yeah. Exactly. Very, very happy about that.
Julie Clark: Nice.
Scott Price: I got to the point where we were completely covered and comfortable with me leaving my prior job. Actually, three years ago, we had set everything up so that my wife also left her job at the time. So she’s been full time in it for three years.
Julie Clark: God, and you’re still married.
Scott Price: Actually, yeah. It’s actually been going really well. We have a specific division of responsibilities that goes to each of our strengths. It actually works really well. We work it at home together out of our home offices and have been doing that for three years now.
Julie Clark: Great. Because we’re going to have you back on the podcast to tell us all how a husband/wife team works effectively, efficiently, and stays married.
Scott Price: Sure. Karen can come on board for that.
Julie Clark: For sure. That’s a great topic. Don’t you guys think?
Joe Bauer: Yeah.
Julie Clark: There’s a lot of husband and wife teams out there. So, Joe, mark the calendar. You guys, let’s get that one on the books. That’ll be our followup podcast after we crush this one today.
Joe Bauer: Definitely. One of the cool things that Scott said was that they focus on what their strengths are. That’s something that Julie and I always focus on ourselves is focusing on your strengths and not trying to do the same thing as the other person. Then you get a lot more done.
Julie Clark: So, Scott, I have a question for you. Now that you have quit the old J-O-B, do you sleep in in the morning, or are you-
Joe Bauer: I get better sleep, let’s put it that way. I don’t sleep in. The big thing is that I’m more in control of my time. It’s not that I’m completely retired and don’t do any work. I, obviously, am working on my current portfolio, and intend to expand it. At the same time, I’m not working two jobs like I was for a while where I was working a full time job and then in the evenings and weekends working my real estate job while at the same time my wife was working full time during the time on our real estate business.
Now, my time is just expanded so much. It’s not just about real estate, of course. I’m more available for my family. We have an eight year old daughter, and doing things with friends, and we’re building a home right now. So I’m available to work on that. Hobbies are coming back to me that for a while there really had been put on the back burner, and have some things in the background that I want to do that I’m already restarting. So it’s a really good space to be in, because I’m still active and actually intend to be even more active in real estate investing, but it’s on my own time and own schedule.
Julie Clark: Exactly. You know what, I have twin nine year old girls, and you have an eight year old. It’s such a good age. They are starting to be fun. They can carry their own luggage. To me, I am in the same mode you are. I’m in let me get some money in the bank, and let’s hit the road traveling. You know? I think I heard you say one time that you like to take a month off and just go traveling. Obviously, with a job, you can’t do that. Now with a passion, and you’ve already paid your dues. I call it rites of passage. You know? Rites of passage, you got to go through that double timing it, slogging it all out, and then you keep your head down and you come up on the other side, and oh my god is life beautiful or what.
Scott Price: Absolutely. It’s the combination of, basically, delayed gratification. In other words, okay, we basically made due without of some things that we could have done and spent more money on and all that, but early on we said, “No. We’re going to invest our money back into more properties.” Then after a period of time, that snowball of properties and more income and more net worth and things like that keeps growing to the point where it grows on itself. Then that’s a point where, basically, we’re at right now. That’s also a point where things become more comfortable, and then you can even grow the business more. It just gets bigger and bigger.
Julie Clark: Right. I mean, so you skipped all the flip this house stuff. What I tell people is is flipping houses is a fee based business full of tax problems and ordinary income. Right?
Scott Price: Right.
Julie Clark: That’s great for when you’re getting started to stockpile cash. Then you take that cash and you buy multifamily or income producing properties. If anybody takes anything off this podcast right now other than how smart Scott is, it is that you are working and flipping houses, I’ll tell you you’re going to regret it. You’re going to be like, “Oh my god, I’m so glad she said that so I can think about that now.” Flip houses to get a stockpile of cash. When the market corrects, go buy the hell out of rental properties.
Scott Price: Completely agree. The model that I’ve always thought is interesting for other people, again, it’s not my model, but for other people who might do flipping, is to also as they’re flipping to look for that occasional one that they may keep along the way. They get a really good deal, and they flip one, they flip two, they flip three, and the fourth one they keep. And they flip one, two, three, and they keep one, that kind of thing.
Julie Clark: Exactly. Right. That’s right. Set a rule and a goal that every fourth one you keep or whatever. Right? Always ask for that seller financing. You never know when somebody’s going to say yes.
Scott Price: Sure. Or one that just cash flows very well if pumped from a rental perspective. Looking at it not just market value, comps, and things like that, but if one in particular stands out that it cash flows well, then, hey, that’s the one to keep.
Julie Clark: Exactly. So let me recap here. So you’ve been doing this what is it? 14 years you said?
Scott Price: Correct.
Julie Clark: You went straight into the multifamily pretty much.
Scott Price: Mm-hmm (affirmative).
Julie Clark: You left your day job in the tech world, right? Am I right?
Scott Price: Yes. Mm-hmm (affirmative).
Julie Clark: Tech world behind, and you are now investing in multifamily, maybe some commercial office and medical product, and some retail, and so forth like that. Does that sum it up pretty good?
Scott Price: That does. Mm-hmm (affirmative).
Julie Clark: Let me ask you, do you have a favorite book like on multifamily investing or a favorite podcast, aside from ours after this, wink, wink?
Scott Price: I have listened to every one of your podcasts.
Julie Clark: Oh, thank you. I know we all get educated. Even if people are doing well, even the top, I’m sure even Tony Robbins has his go to mentors and educators. Of course, he does, right? So who are your favorite podcasts about multifamily or commercial or any books that you feel you can share with our every growing audience here?
Scott Price: Sure. Well, of course, there’s this podcast. Then the other ones that I generally listen to are the Bigger Pockets podcast, the Michael Blank Apartment Building podcast, and Old Capital, which is actually one that’s based out of Texas. It is very Texas focused, but it has a lot of really good information that’s all around apartment buildings. So it tends to be very informative not just to Texas.
Julie Clark: Awesome. I haven’t heard of that one. I’ll check it out. Old Capital?
Scott Price: Old Capital, right. Yeah. Basically, they’re lenders, and they interview people that they work with. It’s very informative.
Julie Clark: Nice.
Scott Price: As far as books, I’ve read a lot of books. I think that’s really important for anyone to do. My perspective on books isn’t necessarily a specific book, but it’s actually your mix of books. What I mean by that is when I first started, I was reading a lot of real estate books. That was good. They were all about generally about the mechanics and the terminology and the processes going all the way from beginning to end on how to purchase and run multifamily or whatever the asset class is.
Then after a while, I would occasionally hear about a recommendation for non real estate books, but they helped a real estate business. It became apparent after a while that there are really three categories of books that I was reading. What I do is I actually skip between them as I read books. So I read real estate books, as I mentioned. Then I read general business books, which are not specific to real estate, but can help me run my real estate as a business, so best practices from a business perspective. Then the third one is what I would call in general personal development, mindset kind of books.
As I’ve gone over time, I’ve really realized that the mindset books are the most important books that I read. The business books that I read help me set a broader structure in terms of how I approach my investing as a business not just as an individual property and how I’m going to scale up and things like that. Those are those kinds of books. Then the real estate books are always informative just to help me on the mechanics. So I literally go between each of those. When I’ve read a real estate book, I generally am looking for my next book to be a mindset book, and then I flip back, those kind of things.
Julie Clark: Share with us a mindset book that you like. I got to tell you before you tell me that, that answer that you just gave us is one of my favorite responses anybody has ever given us on a podcast. That was awesome, dude. Right? Oh my god. Joe’s probably over there doing pushups right now he’s so happy.
Joe Bauer: I’m like, Scott, I didn’t know we were so alike in our reading style. It’s fantastic.
Julie Clark: Yeah. So lay it on us. What do you got on mindset books? We can all find the real estate. Everybody talks about that stuff. I’d love to hear it.
Scott Price: Sure. There are a lot out there. The ones the come to mind would be books like The Magic of Thinking Big by David Schwartz. Also, some around essentially habits and basically running your day effectively, and some that come to mind for that are Mastering the Rockefeller Habits. That was written by Vern Harnish. The Seven Habits of Highly Effective People. I’m sure you’ve heard of that one, very famous, Steven Covey. Then The Miracle Morning is also a very interesting one by Hal Elrod just kind of how to start your day in a very productive but repeatable way to set you up for success for the rest of the day. Then other ones that come to mind would be things like The One Thing by Gary Keller, and just really focusing on what’s important. Getting Things Done by David Allen, that’s another one that’s really oriented a little bit more at the task level, but getting your life organized in what you want to do. So things like that. Those are ones off the top of my head. I’ve read a lot more than that, but at the same time, that kind of genre I think’s important.
Then on the general business books that are not specific to real estate, but are really fundamental to scaling up a business, some that come to mind would be The E Myth Revisted, The Four Hour Work Week, Think and Grow Rich, and another one that I really liked was The Millionaire Next Door. That’s not necessarily business per se, but it’s more lifestyle, just teaching how to think and truly be a millionaire not just look like one.
Julie Clark: That is spectacular. Joe, are we able to somehow put a link or something to Amazon books on the podcast for hooking up people with all this stuff easily?
Joe Bauer: Heck yeah, Julie. Everybody can find all of these show notes that Scott is talking about at seattleinvestorsclub.com/27. That’s seattleinvestorsclub.com/27. There will be a list with links and all that fun stuff.
Julie Clark: Awesome. Because I am headed out for spring break. I don’t know, Scott, you got an eight year old. Spring break is coming up.
Scott Price: Mm-hmm (affirmative).
Julie Clark: You have just required me to extend our trip by a few days to add on some of these books.
Scott Price: Well, great. Hey, that’s a good thing to do. Good thing to do during your vacation.
Julie Clark: Heck yeah. That is awesome. So I guess we can wrap it up now, guys. No. I’m just kidding. That was spectacular. So thank you for all that info. I have butterflies in my tummy I’m so excited right now. So I’m going to get back to the multifamily or the investing in commercial and other buildings. So do you prefer multifamily investing over other types, like office or other commercial, medical office, or office, or retail? I know there’s a big buzz right now the new construction of apartments is starting to get at least in our area a little saturated. I know some of the big developers are looking to repurpose retail centers that have better or higher use zoning maybe. Some of the mid sized retail strip malls that have a good size footprint to them, but not like a major mall even though they are redeveloping Northgate Mall. What’s your favorite out of multifamily, medical office, straight up office, or retail?
Scott Price: My favorite is multifamily. However, I do invest in the others on a very selective opportunistic basis. So I really like multifamily, because there’s so much at a macro level that supports multifamily as a long term investment. Like you said, there are certainly pockets, including Seattle, where there’s the high possibility of over development or getting saturated, or if things go down, then rents may go down, things like that. I, in general, invest in smaller markets. Still in Washington state, but at the same time, smaller markets that do not have as much development going on yet have a lot of demand. So I always start at a very high level, and start with the actual town or market itself and decide if I want to invest in it, and then go down from there.
So the supply and demand in terms of the demographic shifts, at least with some people, there’s a renter culture that is somewhat expanding. I’m sure you’ve heard that the home ownership rates have actually gone down. Although, it seems like millennials are now getting to an age where they’re getting back into buying homes. So that fluctuates. It goes up and down. But there is an expanding base of people who have two things going on. One of them who just want the convenience of renting. They don’t have to repair things. They don’t have to put in their own reserves when the roof goes, and they have to replace it, and those kinds of things. There’s that segment. Then there’s also the affordability issue, and rentals, in general, are going to be more affordable not only in terms of the lack of a need for a down payment, but also just with the high prices right now. So that’s an ongoing thing in support of multifamily.
Then on top of that, there’s an expanding population in a number of areas. There’s a lot not just on the single family side, but also on multifamily side of an ongoing need, and there’s not enough being built in general across both those asset classes at a national level, at a larger level. That’s a good thing to be in on that side of the supply and demand equation. You want to be in something where you’re on the supply side when there’s high demand and growing demand. So because of that, I generally prefer multifamily.
When I’m opportunistic about office and retail, it’s usually because I’ll always buy something, except I made one exception, just because it was incredibly inexpensive and it was a really good deal, but other than that, I’ve always bought office and retail with an existing really solid tenant in place, longer term lease, and also I’m always thinking about, you really got to think about it in office and retail, is who’s your next tenant, even if it’s a really solid tenant. They may not be there, which is very different than multifamily. You want to make sure the demographics and the supply and demand supports multifamily, but you’re not thinking of the specific who’s going to be that next tenant. You’ve really got to think about that in office and retail. What kind of business would be there? Otherwise, you run into the risk of either office or retail sitting vacant for quite a long time. That’s one big difference between multifamily and office.
Julie Clark: Right. I mean, well, the cash flow model is more fluid on multifamily, right? I’ve also owned office and retail myself. You get into leasing commissions on turnover, tenant improvements, and all that stuff, especially in retail. You want to avoid those specialty build outs or having it contribute to the TIs. It’s like when the building is full and the tenants are all great and everybody’s in place, the cash flow is awesome. But you got to really plan for the future on lease expirations. You got to really do tight asset management to pay attention when your loans are maturing to make sure none of your big tenants are also having their lease come up at the same time, so it doesn’t affect if rents have gone down for some reason like has happened in the past for people.
All of a sudden, you put your loan on 10 years ago, and 10 years go by or however long your loan term is on office or retail, and for some reason rents have gone down or something since you put your loan on. Now you need to get a new appraisal for your refinance, but your rents are lower. I mean, you could get whacked. Right?
Scott Price: Right.
Julie Clark: You really got to understand the dynamics of, I’ll say, asset management on those bigger assets. I spend a lot of time in that world myself. I enjoy it. I like to geek out on figuring that all out, but it is a different animal. Multifamily is more, I feel, more fluid, I guess I would say, with the cash flow. Right? More predictable, I guess I’ll say. Right?
Scott Price: Right. The interesting thing about office and retail is you not only have to project out into the future, which you do with multifamily as well, but you’ve really got to project out in terms of what’s happening around the particular property with other like buildings. It’s not just the simple competition that you may get in a multifamily where, okay, this one place is advertising at 750, and it’s a similar square footage, and that kind of dynamic. It’s more of, okay, well, there’s a coffee shop over there. There’s a coffee shop over there, so I’m probably not going to get a coffee shop here, that kind of thing. You’ve got to be very specific in terms of thinking what could come and replace it.
There are some benefits though, and that’s the reason why I do consider it. For instance, several of our properties are triple net. For those who haven’t heard of triple net, triple net essentially is where the tenant is paying for the insurance. They’re paying for property taxes, and they’re handling their own maintenance. So if something goes out on, let’s say, the water heater, they actually take care of it. So it can be pretty hands off. The other big benefit is it can be very long leases. In general, multifamily, at most you’re going to have a one year lease, in general. However, with commercial, office, and retail, five year leases are pretty frequent. One of my properties just got a 10 year lease, for instance.
Julie Clark: Nice.
Scott Price: That’s pretty convenient. Now when that lease is up, then if they don’t renew, then I’ve got to scramble. But during that time, it’s pretty low maintenance, low management, and easy to just do the classic mailbox money kind of stuff.
Julie Clark: Right. Exactly. Love it.
Joe Bauer: Say, when you have a long term tenant like that, Scott, do you have a timeline that you start renegotiating to see if they’re planning on staying?
Julie Clark: Great question.
Scott Price: Yeah. About a year out, I’ll start asking what their intent is. About six months out, we’ll really start getting very clear and start writing up the new lease if they intend to stay on. If they don’t intend to stay on, then about six months out, I’ll start actively getting it advertised and marketed. But if I know even earlier, a year out, I may start spreading the word at least with local commercial real estate brokers who may be able to bring in tenants just so they know in case. It’s in the back of their mind. If they have somebody who has a longer range need and not immediate lease, it’s there. But then six months before, get real serious on ramping up the public marketing.
Julie Clark: Yep. I’ll say the one thing about investing in maybe markets outside of Seattle, let’s say like the Tri Cities or something like that, a little bit of a boom and bust. You got to be aware of the boom and bust nature of at least in Washington or any, we’ll call it, second tier market, wherever you guys are located around the country, that has room to expand. When the times get hot, people go in and start building new apartment buildings, and then they over build it. Then there’s an absorption issue. You guys got to pay attention.
Same thing in retail. You own a retail strip center. Well, you better be paying attention. If the market’s going well or project forward thinking about how long your loan term’s going to be or what might happen, because all of a sudden, if there’s room to build new product, new retail center, new apartment buildings, and you’re in a market like that, people will go in, because they get so excited. They’ll over build the market, and it will impact you, because they’ll start giving concessions or deals on their rent. It will trickle downhill. Right? You just have to be aware of that kind of second tier market investing to always keep your eye on what’s in the new construction pipeline before you buy something so you’re aware. You don’t get smacked and spanked around, where you get a temporary maybe you have to give concessions or drop your rent, because the new kids in town are in their lease up. Does that make sense to you, Scott?
Scott Price: Absolutely. Yeah. It’s very true. That’s one of the things that I look at when I’m looking in secondary and tertiary markets is what is the local economy? What’s it based on? What’s its basically resilience or resistance to down turns? If it goes down, what might the impact be? What would be left? That kind of thing. Like you said, also, the pipeline. It is interesting that in some of these small markets they get exactly what you’re talking about where they get some interest. There’s very low vacancy. So people come in and say, “Okay. Well, I’ll go fill that need.” There are also others that have low vacancy, but at the same time, they’re not as much on everybody’s radar, and there is exactly the concern that you’re talking about. It’s not even in some cases with the developer. It’s also with the lender. So some places, they’ll have trouble getting financing anyhow. So it acts as a-
Julie Clark: A buffer.
Scott Price: Yeah. It’s a balanced system so to speak, kind of helps prevent it. That doesn’t happen as much in Seattle where there’s-
Julie Clark: Right. You got the opposite problem in Seattle where you’re buying for appreciation at this point not-
Scott Price: Not cash flow.
Julie Clark: Not cash flow. Right?
Scott Price: Absolutely.
Julie Clark: But I have some ninja ideas on how to take advantage of even that that we’re going to be talking about at Seattle Investors Club and on some future tips of the day that we throw out weekly for you guys. If you go to YouTube and just search Seattle Investors Club, we have tips of the day dropping every week on little mini nuggets. One of the topics I’ll be covering in this next few weeks is how to take advantage of still being in the Seattle market in the low cap rates and stuff like that as a wholesaler and investor. We’ll see how you guys respond to that, but I’ll save that for another time. Let’s see.
Let me move on here. So you got your experience. You’ve been in the game for a while. What is your least favorite part of the investing in multifamily or commercial?
Scott Price: I really enjoy a lot of it, which is why I am in it. There are a few things that from time to time can become a problem or become not as enjoyable. The one thing that pops to mind is especially as I grow my portfolio, financing is an interesting dual edged sword. What I mean by that, the financing process. It becomes easier for me to get financing, because I have a track record. All my projects have been successful. They can see that. So I come in, and it’s not a question in the minds of the lender in terms of whether or not I can perform on the particular property and whether or not they trust that I understand it enough to buy it and run it for years. The complexity of getting the financing gets more and more onerous. It’s interesting. They have more questions, because there’s more properties that have questions about in my portfolio. That’s one thing.
Julie Clark: We used to submit something called, with a huge portfolio, called the schedule of real estate. It was, basically, just keeping track on a spreadsheet a schedule of real estate of all the assets owned, and whatever information a lender is going to require. You just keep that on your schedule of real estate, and you update it quarterly. So when you go to buy your new building, you’re not having to start from scratch and recreate. That’s how we used to roll with that problem. I hear what you’re saying.
Scott Price: Yeah. We have that. We have something along those lines. It’s in Excel. We have a whole bunch of columns. We actually hide and reveal certain columns depending upon what the particular lender asked for. So we have that already. The complexity comes in after that of, okay, we got all these line items. It’s when we purchased it and how much we bought it for and what’s the estimated current value and what’s the monthly payment, blah, blah, blah. Then however, there’s the follow on questions. That’s what the complexity comes in of, okay, well, we want to see the leases for that office building. We want to know more about the tenant. What is the condition of the building, and things like that. We get those kinds of questions. So there’s the schedule and of real estate owned, but then there’s the questions that come from everything on the schedule.
Julie Clark: Right. But you know what? It’s a good problem to have isn’t it?
Scott Price: Absolutely. It’s part of the business. Yeah. For instance, right now, I’m doing a Fannie Mae loan. Fannie Mae loans have several advantages. They can be nonrecourse. They can be assumable, and they can have longer fixed terms than most commercial loans. So those are the advantages. The disadvantage is that, especially because they’re nonrecourse, and partly because they’re assumable, the depth of the process is a full time job, at least it seems like it is.
Julie Clark: No pain, no gain, Scott.
Scott Price: Exactly. Yeah. Exactly.
Julie Clark: Can you define nonrecourse for our listeners who might not understand? I got what you’re saying, but that’s an important little nugget, that definition there.
Scott Price: Sure. So basically, for people who are familiar with a home loan for themselves, it’s going to a loan that’s full recourse to them. What that means is they got the loan based on their income and their credit scores and whatever other factors the lender is looking at, but it’s partly about the property and the value, but it’s especially about your ability as the borrower to pay that monthly mortgage for that property that has some given appraised value. That’s for singles and buying single family homes.
Then in the case of commercial loans, in most commercial loans most are still recourse, meaning that if I have a commercial property and I stop paying the loan on it, I’m still personally responsible. My LLC is not only responsible that might own a commercial property, but I personally in my personal name am also responsible for it.
Julie Clark: That’s recourse?
Scott Price: That’s recourse. Yeah. I’m going through the three different things. So that’s recourse. There still are a lot of commercial loans like that. When you get into commercial, they’re looking more at the property and its income than the borrower, which is why I’m talking about this middle one, because as opposed to how I described somebody buying a home, they’re looking more at the property in commercial but the borrower’s still on the hook personally.
Then the third group, which is the one I’m talking about here, nonrecourse, that one they still look at the borrower, because they want to know that they can trust the borrower. However, they do not hold the borrower personally responsible for the payment of that loan. It’s all based on the property, the property’s ability to generate income, and the income being sufficient over the long haul to pay for that loan. If for some reason that particular property should go bad in some way or the sponsor or the borrower, the person behind it should stop paying, then it goes back to the lender, but there’s nothing on the person borrowing.
Julie Clark: No personal guarantee.
Scott Price: There’s no personal guarantee, and there’s nothing on their credit report. There’s no responsibility for that individual to pay it. The LLC still has to pay it that owns it, but you just keep everything contained with the LLC.
Julie Clark: Right. Is there a minimum loan amount to be able to get to the nonrecourse?
Scott Price: It depends upon the lender. Usually it’s a minimum of a million or above. However, there are multiple scenarios, and there are multiple lenders, and there are multiple deals that are out there. It’s usually a million or above, and that’s on the low end. It’s usually for things that are higher than that. It also depends upon a lot of factors, if they’re willing to do nonrecourse in certain markets, in certain asset types, and things like that. So there are a lot of boxes to check as to whether or not they’ll provide that.
Julie Clark: So in a nutshell, if you are looking to buy multifamily properties, and you are buying smaller buildings, right, and you’re putting debt on those buildings, you should plan on and understand that those will be recourse, guaranteed loans unless you’re getting some sort of awesome seller financing where maybe you can get away with not having that. Is that fair to say?
Scott Price: That is. Occasionally there are exceptions with local banks that you may have an existing long term relationship. So it’s not 100% black and white, but for the most part what you said is true. In the case of myself for instance, even over a period of time, this is actually my first Fannie Mae loan that I’ve done, even though I’ve had others that are certainly in that price range. At the same time, this is the first one that I’ve done. It’s been an interesting educational experience. I would do it again, but you definitely got to work for it.
It’s interesting, because it sounds nice. It’s a nice to have. But somebody like me, I’ve always paid my mortgages on everyone of my properties. So it actually has very little practical value, but people like to have it just as it’s almost like insurance and risk management. That’s actually not the main reason I pursued this one. I pursued this one to get a longer term fixed rate, because the fixed rate on most commercial loans is usually five years. Frequently, actually, it can balloon in five years, meaning that after five years, you’ll have to pay off the mortgage. Now sometimes, the same lender will refinance with you, but frequently, after about five years on a lot of commercial loans, you have to have a plan. You either got to refinance with them or refinance with somebody else or pay it off all cash or whatever.
In other cases, after five years, it just resets, which means it stays with the same lender, but the interest rate changes based on an index, like 10 year treasuries or something like that. So in an increasing interest rate environment like we have right now, in five years, you have a higher likelihood of your interest rate going up. That’s why they do that so that they have the chance to make more money in five years.
Julie Clark: Heck yeah. Everybody wants to make a buck.
Scott Price: Yeah.
Julie Clark: So let me ask you, let’s take it down, step it down just a little bit, because there might be people listening to our podcast today, and we hope there are, that are just kind of dipping their toe or starting to focus on multifamily investing that might be buying the smaller buildings, maybe 10 units and under. I know that four units and under is a residential products, right, as a loan?
Scott Price: Correct.
Julie Clark: But let’s say somebody’s buying a smaller building or even like a 10 unit building. The question that they probably want to know is how much of the loan process relates, how does it work with their personal credit? How is that looked at as far as the process goes when getting a loan?
Scott Price: Yeah. They do. The lender will look at that. Again, they’re more interested as soon as you go five plus units, they’re more interested in the property and its ability to support the loan. But since there is a combination of recourse plus it’s more of a smaller deal where they’re really looking at, okay, how is this individual going to manage it. When you have smaller properties, you’re less likely to have a big team involved. You may even have the classic mom and pop operations where, basically, they self manage. They might not have a professional property manager. They might not have a maintenance person, things like that. So they’re looking at the individual’s abilities, the individual’s background, and certainly their credit score, because it’s at a lower loan level that’s more analogous in some ways to a home loan. I mean, they wouldn’t say that, but I mean, that’s kind of what’s going on there. In other words, it’s analogous to being a home loan except that you actually have an income stream coming in.
Julie Clark: What if, let’s say, what if the building, there’s good debt service coverage, which means debt service coverage means that your NOI on the building is, let’s say, your net operating income on the building is, make sure I’m saying this right, Scott, we’ll say, 1.25 times the amount of your debt service. So your annual NOI is 1.25% times higher-
Scott Price: 1.25, yeah, 125%.
Julie Clark: 125% higher than your annual loan payment.
Scott Price: Yeah. Just to clarify. So it would be 25% higher, so it would be 125% of your debt service, or your debt that you’re paying on a monthly basis. Then you need to have your NOI, your net operating income, to be 25% higher in the example you gave. Yeah.
Julie Clark: Right, in order for the bank to be happy with calculating their loan amount and stuff like that. Right?
Scott Price: Right. Exactly.
Julie Clark: So it’ll adjust if your debt service coverage ratio isn’t hitting what the bank wants to see on their debt coverage ratio, and that number moves around a little bit sometimes. Then they will lower your loan amount until you hit it.
Scott Price: Exactly. There are actually several other factors that again don’t really apply to residential loans. One of them is that they will do something called stress testing. What that means is you may get a current loan at, let’s say, 5%, but if your loan is going to reset with them in five years or you might even get a shorter term, let’s say three years or five years or whatever it is, they may then say, “Okay. How does it do if the interest rate resets to 6.5?” There’ll be some principal pay down by that point, but at the same time, how is it doing then. They may, and I’ve seen this happen, they may actually say it doesn’t meet their criteria based on a future potential interest rate. So that can actually happen as well.
Julie Clark: Right. So in a nutshell, whenever you’re looking at an apartment building deal, Scott, would you advise people, so let’s say you’re able to get it under contract off market ideally. That’d be awesome. Of course, on multifamily, maybe you’re finding great deals in second tier markets that are listed or with brokers. That’s fine, too. The point is you’re going to have a due diligence period once you go under contract, right?
Scott Price: Mm-hmm (affirmative).
Julie Clark: Do you typically, I mean, you’re experienced enough where you’re underwriting probably your loan yourself. You have enough information, right? So experienced people, just like if you’re flipping houses, you have your deal analyzer. While you’re plugging in a loan amount as part of your deal analyzer on your assumptions, because you know the borrowing terms that you can get with private money or hard money or whatever. Once you get rolling in the multifamily or commercial investing, you learn the same. You learn how to analyze your deals based on the loan underwriting. I would say even more so on commercial and multifamily. You got to back into the deal based on your loan that you can achieve.
Scott Price: Absolutely. Yeah. That’s really critical. I do that at a quick high level even before making an offer. I start with what the seller and listing broker provides. It’s rarely realistic. It sometimes is, but it’s usually either missing information that would really come down the line or it’s very optimistic or it might even be real numbers. But for instance, if you have a very low expenses, that’s actually not a good thing in some cases. That might mean, okay, there’s deferred maintenance.
Julie Clark: Well, then a lender is not necessarily, you get a proforma from a multifamily or a commercial broker with these low expenses or maybe in reality the actuals are very low. The lender is not necessarily going to underwrite your expenses at that number.
Scott Price: Absolutely. Yeah. That definitely happens. When you get into larger properties, there’s a range, but frequently, whatever your gross income is the actual expenses that you’ll be paying are frequently at least 45%, meaning you’re only left with 55%. That’s not including your mortgage.
Julie Clark: Right.
Scott Price: That’s before your mortgage.
Julie Clark: Do you have a rule of thumb on your expenses that you use for your underwritings? Let’s just say not in 100 unit buildings, because that’s a different animal. Let’s say in a 10 unit building, would you use 40%?
Scott Price: Well, for let’s see, for smaller buildings, it really depends upon who’s doing to management and if the owner’s going to be doing any of the work.
Julie Clark: If you’re self managing?
Scott Price: Yeah. If you’re self managing, then, yeah, you could do at a quick just rule of thumb kind of thing 40%. Usually what I do when I’m looking at a larger building is when I see the gross income based on real rents, based on a rent roll that they’ve provided, so it’s not just proforma, but it’s real rents, what I’ll do initially just to say, “Okay. Should I look at this even anymore,” is I’ll usually just cut it in half, in other words, 50%. There definitely are properties out there where the expenses are more than 50%. So 50% can be a good real quick number to use.
Then if it looks like, okay, well, this is in the realm of reason in terms of the return that I’m looking to get, then my next step is to actually do a line item analysis. I’m never going to apply just a percentage, and say, “Okay. This is 45%,” which is what it always is. I’m never going to do that. Initially when something comes across my desk, so to speak, I’m going to do that real quick just to say is this thing even worth looking at for a next step. Then I actually do have a complicated spreadsheet, and I got line items. Then I use rules of thumb for every element, and then I calculate.
Julie Clark: What does the lender use, which is almost even more important? I mean, there’s what the lender uses so you can get your loan, which backs into what your down payment’s going to be and how much money? Then there’s the reality of what you can operate it at, might be better.
Scott Price: Right. Yeah. They’ll take into account a couple things. They’re almost always looking at T12, which is trailing 12, meaning trailing 12 months of income and expenses.
Julie Clark: Actuals.
Scott Price: Yeah. They are exactly. They are actuals. They’ll very rarely, although I have personally had some expenses where lenders would take into account the fact that the property was not being managed effectively. The rents were under market. They actually did add a factor in my favor, but that’s the exception rather than the norm. They’re generally going to go on actuals. They’ll even request, and I’ll request, actual Schedule Es. In other words, they’ll actually request tax returns from the seller. So people can put whatever they want in an offer memorandum or a marketing package, but unless they’ve doctored up their tax return, usually people are going to claim all their expenses. They’re going to try to minimize their income. So if their tax return says something different than the marketing, then you can ask are real questions of, “Why exactly is that?” There’s all things that people tap dance around for that answer, but it really brings out a much clearer picture.
Then to answer your question directly in terms of the lender, they will have their own rules of thumb. They use that information, but they also compare it to their own rules of thumb. That can come from the people that the loan officer works with in their group. It can also come from some information that the appraiser may provide as well.
Julie Clark: On the smaller buildings, let’s say a 10 unit building, the lender’s going to underwrite their expenses for whatever, a combination of reviewing everything and whatever their own guidelines are. Do they always on the smaller buildings, I know on the larger buildings when we’re talking about Fannie Mae loans and stuff like that, they have a line item that they apply a minimum of capital expense number per unit.
Scott Price: Mm-hmm (affirmative).
Julie Clark: It used to be 200. Maybe it’s you know a unit that you would have to budget when you’re underwriting your loan for a larger property that you know the lender’s going to include. Plus you’re going to have that anyways. Right?
Scott Price: Absolutely.
Julie Clark: That is beyond your NOI. That’s after. Line items comes after your NOI would be your capital expenditures, which is replacing appliances and replacing carpets and bigger capital, replacing roofs, and things that like that you can amortize. On the small buildings, because we don’t want to get too ninja detailed today, because of who are mixed audience here, but I’m curious for these people on the smaller buildings, do the lenders underwrite a capital expenditure per unit?
Scott Price: They’ll take that into account. They generally will. It’ll depend upon external factors such as the reserves that the individual borrower has. In other words, they’re less concerned about it if they can see that the borrower, meaning the person, because a lot of times the borrower on these loans is actually an LLC, but there’s a person behind that LLC, and if the person has good liquid cash reserves, that goes a long way. It doesn’t mean that it’s a necessity, but if they don’t have a certain amount of cash reserves, then the lender is going to be much more concerned about making sure that reserves are factored in their analysis.
Julie Clark: Right. Again, why we’re honing in on this guys is because in multifamily and commercial investing, really your loan, we’re talking big dollars, bigger dollars than just a house, your loan is so important to understand that piece. You got to become a financing expert, right, because it really dictates your cash flow and your loan amount. You got to know this stuff. So all right. Well, we’re talking about financing. I could talk to you all day long about this sort of stuff. Let me ask you, Scott, do you normally, is your MO like the value ad place. You buy something. You reposition it? You buy at one price. You got your loan, right, your initial acquisition loan. Then you reposition it through some sort of value ad repositioning, raising the rents, or increasing other income, lowering expenses, bringing your stellar management style. Then you what? Get a new appraisal and refinance and hold long term? Is that the MO?
Scott Price: Our general approach is we buy properties that are already pretty well, they’ve already got a pretty good occupancy rate to start, so there’s cash flow from the beginning. So we don’t go in and purchase boarded up level of apartment complexes. We start with an existing base of cash flow. We start with a property that right off the bat will meet the minimums for financing, will meet the minimums for us.
Then we’re looking for incremental opportunities that are on both the income and the expenses side beforehand, before we buy. I mean, there’s obviously a whole bunch of opportunities out there to buy. The ones that float to the top are the ones that have more incremental opportunities, such as below market rents. That’s one we especially look for. We also frequently we’ve had some good success recently with RUBs, ratio utility bill back. Those have been really good, especially in an environment like we have right now where there’s low vacancy and there’s a lot of competition among renters and things like that. You’ve got to make sure that your market can support it.
Julie Clark: Let’s just tell them, what he’s talking about when he says RUBs is a utility bill back program. It’s to bill back the water, sewer, garbage, and sometimes even, at least in Seattle, the trash to tenants. You don’t have to have your building sub metered separately for the units. There’s services that you can hire that will manage that process and invoice the tenants for you. It’s a very, very good, I mean, what is it? It could be 25 to 60 bucks a unit add on.
Scott Price: Absolutely.
Julie Clark: Boom. If you just buy a building, I mean, I wouldn’t think that’s enough to add enough value in your deal, but it is sure a quick first look thing to add on as a value add increase to your properties, right?
Scott Price: Oh, absolutely. In terms of cash flow, it becomes basically cash flow that does not require new carpeting and fix up and expenses, things like that. It’s kind of invented out of thin air kind of thing.
Julie Clark: It can apply to every unit not just the units that need an upgrade.
Scott Price: Exactly.
Julie Clark: Across the board.
Scott Price: Yeah. It’s a big benefit there. That plus the market rent options are both nice, because by themselves, they don’t require a capital outlay to improve the property. Now we always improve our properties in some way. We generally prefer, I would say, B and C, which is for those who aren’t familiar with it, you usually have A, B, C, D level of “quality” of properties. The value and the return now, and usually actually, but especially now, is usually tends to be more in the C and a little bit in the B, because people are just paying way too much for the A luxury properties. On the D, you can get a good return, but they can be very problematic, high turnovers, and lots of damage when there is turnover and things like that. So there’s kind of a sweet spot in there between the extremes.
Julie Clark: I always used to think, I hope this isn’t politically incorrect, but I’ll say it, the blue collar properties are the best. You know? I don’t know if that’s politically incorrect. I apologize if it is. I’m not trying to do that. But like you said, the Bs or taking a C to a B.
Scott Price: Right. Exactly. That also points to another thing. We did that recently with one of our properties where we were specifically looking not just at the property, but we were looking at the path of progress around it. We purchased a property that was sandwiched between two up and coming neighborhoods. It was in a so-so neighborhood right in between, but it was very clear that the up and coming neighborhoods on the side were expanding. They were expanding in. We did benefit from that. So we look for those kinds of macro level opportunities as well where the market itself will help us to increase it on the income side and not just on the expenses side.
Julie Clark: Oh my god. I could go on all day like this. This is probably one of the longer podcasts we’ve done, because I’m just geeking out. I feel like it’s just you, me, and Joe hanging out here, and I am geeking out personally here. Thanks, guys, for letting me have some fun today. So, Scott, just to start headed down the path of wrapping up here, because my sidekick, Buddy, is getting hungry, and I think needs to take a pee. Right, Buddy? Okay. That’s my Labradoodle Buddy. He’s our sidekick here. So are you interested in any out of state investing? Are you interested in joint venturing with anybody these days? I was going to talk to you about syndication, but I think we’ll save that for another time, because it’s a higher level topic, and we’re running out of time here today. So what I want to know is if people have deals that they are interested and need help on, how can they reach you? Are you interested in partnering? Are you interested in mentoring? What’s your spin on all that?
Scott Price: Sure. So actually to answer the first question about out of state, we have purchased out of state. We actually sold our out of state. We’re going to get back into out of state when the market turns. Right now what’s happening is the cap rates are going down nationally. The benefit of going to some of the traditional cash flow markets out of state are less than they used to be. There’s still an advantage, but there’s less of an advantage than there used to be.
Julie Clark: Which out of state markets would you say you had your eye on?
Scott Price: Well, let’s see. We purchased in Memphis. We had a 40 unit in Memphis that we just sold a couple months ago. Then Pittsburgh, Columbus, and Atlanta. Those were our top four that we were checking out.
Julie Clark: I always thought that Memphis would be oversaturated with all these guru types out of Memphis. I’m sure they do a great job. I don’t know. I haven’t checked them out. Seems like everybody’s going to Memphis, because that’s part of where they’re at.
Scott Price: Yeah. Well, it can have good cash flow, but you got to really know not just the market, but the sub market, and literally it can be down to which side of the street you’re on can make a difference. So you got to be really careful in Memphis.
Julie Clark: Right on.
Scott Price: At the same time, it was interesting. We made some good money there. We kind of got out, and we’re redeploying that money into-
Julie Clark: Got out while the getting was good.
Scott Price: Exactly. Yep. So to jump to your other question, we certainly are open to partnering with other people and very interested in that. We’re actually very, very active and interested buyers. It’s a hard market to buy in right now. If people have strong deals, we’re certainly very interested to look at it. We’re ready to jump in at any time.
Julie Clark: Well, if people have deals they want to send you and run by you and maybe even partner with you, where can they reach you?
Scott Price: Sure. Two ways to reach me. One of them would be there’s various contact information on my website, which is bonvolo.com. That’s B-O-N-V-O-L-O.com. Or you can reach me directly at my personal email address, which is Scott, S-C-O-T-T, @bonvolo.com.
Julie Clark: Awesome. You know, I’ve lacked on one thing today. I like to crack jokes and goof around. I’ve been so interested in what you’re saying, I forgot to bring the funny today. I got to tell you what, this has been awesome for me. Thank you just personally from me. This has been super awesome.
Scott Price: Likewise.
Julie Clark: Great information. I hope you guys all realized how ninja and great information you got today, especially about all that financing stuff, which is so key to the multifamily and commercial investing. So we got your back here at Seattle Investors Club, guys. Any questions that you have, throw them down below on the podcast. You can always reach me at [email protected] That’s [email protected] Or my partner Joe, that’s [email protected] We want to help you guys build your wealth and have massive success, so we all get the freedom that we’re all after. So, Joe, anything else that we need to add here today before Buddy tries to bite me on the leg?
Joe Bauer: I just want to say thanks Scott and Julie as well. I’ve just been sitting back here taking notes myself, because you guys are just fun to listen to. So thank you for that. For all of those out there listening as well, the show notes are at SeattleInvestorsClub.com/27. I know there’s just a ton of info in there. We’re going to have links and all that fun stuff at that SeattleInvestorsClub.com/27. If you enjoyed this podcast or any of our podcasts, we always appreciate a review on iTunes, which you can do by going to SeattleInvestorsClub.com/iTunes. We would love it. Again, Scott, thank you so much for being on the show. We really appreciate it.
Scott Price: Thank you for having me.
Joe Bauer: Yeah.
Julie Clark: Awesome. Love it.
Joe Bauer: All right, guys. We will see you on another podcast.
Julie Clark: Over and out.
Joe Bauer: Bye.
Speaker 1: Thanks for listening to the Seattle Investors Club podcast. If you have questions that you’d like to have answered on the show, shoot us an email at [email protected] Now, go out, take that action, and build that real estate business. Thanks for listening.