[RWS #731] Rental Income: Building a Real Estate Empire

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Rental Income: Building a Real Estate Empire, Real Wealth Show Podcast Episode #731

Call it dumb luck or brilliant market timing. Our guest today bailed out of the stock market right before the Great Recession, and gravitated toward real estate in 2009 with a pile of cash. Since then, he’s invested in single-family, multi-family, and vacation rentals. He has also invested in fix-and-flips, and more than 25 syndicated deals. He is currently part of the Investor Relations Team at Ashcroft Capital and has made it his mission to share what he’s learned with others. One of his favorite topics is how to create more time in your life or what he calls “time freedom.” I am delighted to welcome Travis Watts to the Real Wealth Show.

Podcast Transcript

Kathy Fettke: Travis, welcome to The Real Wealth Show. It’s great to have you here.

Travis Watts: Thanks so much for having me, Kathy.

Journey Into Real Estate

Kathy: You have gone from being an active investor to being passive. Let’s take a look at your journey into real estate. How did you get started?

Travis: Funny story. About 2006, somewhere in that time frame, my dad randomly found a Rich Dad’s Prophecy book. A lot of people get started or intrigued to follow real estate after Rich Dad, Poor Dad. I’ve never heard of that book, but I did read Rich Dad’s Prophecy. At the time, being 2006 right before that meltdown, I had 100% of my portfolio in the stock market. What little I did have.

After reading that book, if you haven’t read it, the gist of it is that we’re going to have this huge market collapse and don’t be in the stock market. There was no exact takeaway from it other than things are going to be doom and gloom. Considering that was my setup, all I knew how to do was hit the sell button, so I did that and I sat literally in cash in a brokerage account throughout the recession. That was partially coincidence.

I don’t claim to be any kind of guru or a prediction individual, [laughs] but coincidentally I kept reading and I kept networking. I eventually did read more on real estate and decided that’s really what I wanted to do. In 2009 is when I actually got started with single-family homes in the real estate market.

Getting Started in 2009

Kathy: Wait, are you telling me you got started in 2009 with money and good credit? Because that’s pretty awesome.

Travis: It was pretty impeccable timing. That was the case. Yes.

Kathy: [laughs] Man, okay. I am going to consider you a prediction expert, but anyways.

Travis: [laughs]

Kathy: What did you do next? Because who didn’t want a bunch of money and good credit in 2009? Lots of us were the opposite; we lost it all, I’m one of them, and lost our credit as well, so good on you.

Travis: Well, I had just actually come out of college. I wasn’t really in a place in the previous couple of years to be investing or to get into real estate. It really was more or less the fluke. On the downside, I didn’t have many job opportunities, things like that. On the flip side, I got a great deal on my first real estate project. It was actually an owner-occupied home. That’s how I got started.

At that time in 2009, the government was giving up the $8,000 tax credit for first-time home buyers. I took advantage of that, I bought a distressed property and I started actually with house hacking. I was renting out a spare bedroom to a tenant and then I realized that if I had it fully-furnished, I could get a little more rent. I eventually ended up renting to two tenants a couple of years down the road– individually because it was next to a college campus.

That sparked my interest, that’s what really got me rolling in the direction of real estate. I really got involved because my dad had gotten involved with single-family real estate in his 50s. I got to see first hand the benefits of cash flow and passive income, and what a major impact that was having for him right before retirement.

Kathy: He didn’t get hit by the downturn?

Travis: He did, actually. He decided after getting hit in the downturn mainly being in stocks, bonds, mutual funds, things like that, he shifted his portfolio over to real estate about the same time, a little bit before me. His whole thing has been single-family. That was the only context that I had, that’s the only thing I really knew. When someone said, “Invest in real estate,” I just thought of the single-family home.

The Active Side of Single-Family Rentals

As much as I wanted to be passive and as much as I wanted the residual passive income, I got more into the active side of single-family. I started doing fix-and-flips, vacation rentals, things that were just taking a ton of my time, in addition to working a W2 job full-time, and not just full-time but in the oil industry, so 100-hour work weeks. I got in over my head. It was the bottom line.

I couldn’t manage my portfolio. I was trying to bring in friends, family, my girlfriend at the time, which is now my wife, “Hey, can you go collect that check? Can you go back in those car bids?” [laughs] trying to leverage people because I had no time to do it. Then, I got some property managers and that ended up being even more workload that I didn’t anticipate.

Long story short, around 2015 is when I had this big breakthrough of– I didn’t know what I was going to do. I had everything on my mind from, “Quit real estate. Get out of it. You can’t handle it, you can’t scale it. It’s not cut out for you,” everything from thoughts like that to, “People are out there somehow doing this passively and I don’t know how,” because I couldn’t see how it’s going to take my handful of properties and scale up to 50 or 100 homes.

I took a big step back, did a lot more research, went back to real estate, networking and podcasts, reading books and going to seminars. I kept hearing syndication, people talking about, “Have you heard of syndication? Have you tried syndication?” I had no idea what that meant.

Passive Investing with Syndications

Kathy: It’s a pretty common word today, right? But back then nobody knew what it was.

Travis: Especially because I hadn’t taken, in my opinion, enough of a proactive educational approach. I was so focused on single-family thinking that’s the only way to be a real estate investor. Long story short, that’s when I made a big transition into truly becoming a passive investor. Today my wife and I only invest in passive opportunities, most of which distribute monthly, and a lot in the value-add multifamily sector with a number of groups.

Kathy: Let’s talk about that, because there’s a lot of people saying that owning a single-family rental portfolio is passive. We have had that on our website as well. We’ve recently changed it, because it’s not. We try to help people make it less active but when you own a single-family rental portfolio, even if you have property managers you’re still involved, versus investing in the syndication where somebody else is managing the whole thing. Do you consider owning a rental portfolio passive?

Travis: I don’t, as far as single-family goes. One, that’s from personal experience, and two, now seeing– My dad actually now is fully retired. He’s got, I don’t know the exact number, seven or eight rental homes, single-family, and that has become his job. Honestly, I couldn’t see him having any more than that without literally going back to work per se. It’s just the little things. It’s not always the big things but it’s adjusting a sprinkler head or it’s dealing with the late rent collection and stressing out about that.

Kathy: He’s property managing himself?

Travis: He is, yes.

Should You Hire a Property Manager?

Kathy: No wonder, that’s a full-time job for sure. Would he ever consider just getting a property manager?

Travis: He might. What happened when I did that, it was bad timing on my part because all of my tenants knew me and then I tried putting a property management company on top. What was happening is sometimes they were going through the property manager, other times they were circumventing, coming back to me anyway because they knew me. [chuckles] It became this double-leverage thing where I’m having to manage the property manager.

Then, any issues that were arising were still coming back to me anyway. It was just having kind of a middle man there in between. I don’t know if he would or he wouldn’t, but one thing I love about scaling up larger into multifamily is that economy of scale, being able to have a full-time management team, boots on the ground, maintenance individuals, there on site and for a lesser fee. Maybe you’re going to pay 4% property management fee instead of a 10% property management fee on a single-family home.

There’s pros and cons and everyone’s different. Some individuals like being hands on or there are people, persons, they like dealing with accommodating individuals into their homes. I just found out that wasn’t the type of career or job that I wanted. That was not my skill set or my strength. I really just wanted to be hands off and passive.

Kathy: How did you do that?

Travis: Well, it started pretty simply. After educating myself, I just did one syndication and I did it with a local group. I was in Denver at the time, Denver, Colorado. I was a little skeptical, to be honest. It just seemed too good to be true. I was looking at proformas, thinking, these returns or what I’m getting doing my own active real estate, I don’t see how I can do that without being hands off.

I just sold the properties. I was willing to put some capital into this one project, the minimum investment. It was like 50K or something like that. I watched the monthly distributions come in completely passively, and I watched the monthly reporting come in. The team made themselves available where I could call them anytime and ask any questions I had. Then I just got to realize if I can’t do it myself as good as them or better, then why not just leverage their expertise and truly have a passive model? Whether I had one investment or a thousand, it wasn’t going to require any additional time on my behalf and that’s really what I was seeking.

Analyzing the Syndicated Deal

Kathy: There’s a lot of people syndicating today and there’s a lot of people who don’t know what they’re doing, and yet they’re taking investor money. What would you say are the most important things to look for when investing in somebody else’s deal, in somebody else’s syndication?

Travis: That is a great point and something that I always say was my biggest mistake when I got started. I put far too much emphasis on the proforma and the projected returns and the deal itself without putting near enough emphasis on the team behind the scenes. What is their track record and what is their experience? Have they done this before? What were the outcomes to that? That’s really where my focus should have been first is on the team, and then second on the market and the deal itself.

I totally agree with you and I see it, I attended a lot of networking events and seminars, and you’re absolutely right. It’s become the buzzword and like you said, everybody’s going through boot camps training and starting their first deals. I look far more at the team than I do the deal these days.

Make Sure You Have a Good Team

Kathy: Okay. What do you look for in that team besides the obvious, the experience, or is that mainly what you look for?

Travis: Mainly it’s experience and track record. I do believe in giving people a chance as well, everyone has to start somewhere. It really depends on what connections they have. Are they in the markets that I believe in personally? What is the business plan? How heavy is it? If it’s as simple as repainting some units and putting new appliances then I think a lot of teams can pull that off fairly easily. If they’re going to go in and gut all the units and start over from scratch and there’s 300 of them and they’re a brand new team they may be in for a little more than they anticipated taking on, so– I may not do a deal like that.

Kathy: What I like to do is a lot of times you’ll find somebody young and dynamic and they’re good at their research, but they just don’t have the experience. I like to see somebody on the team who has that experience, but also somebody young and dynamic and energetic, to have both is ideal in my opinion.

Travis: Yes, 100%, I agree.

Identifying Good Markets

Kathy: Yes, okay. When you say market, a market you like, what do you like? What are you looking for?

Travis: Yes. That’s a great question. Again, everyone’s different, everyone looks for different metrics, different things. What I look for is diversification within the job market. So I don’t want a market where everybody’s job employment may be in one sector, maybe like a Detroit and car manufacturing, things like that in the downturn. Something where you’ve got some healthcare, some financial, some industrial, you’ve got a good mix there.

For example, at Dallas Fort Worth, I read somewhere that there’s no one in particular industry there that makes up more than 20% of the entire sector. So you’ve got– If one goes down, you’ve got a lot of others to lift it up. The other thing I look at personally pretty closely is migration trends. Where are people moving from and where are people moving to. We have this recent tax change that just happened, and a lot of people are leaving the high tax states like California or New York and they’re going to Florida and they’re going to Texas, tax-free States. I do keep tabs on things like that as well, obviously that’s important for having a diversified tenant base and enough people demanding to rent.

Investing with a Self-Directed IRA

Kathy: Yes. What do you think about using a self-directed IRA to invest in a syndication?

Travis: That’s a great question. I did have several different types of IRAs, I did have a self-directed. What I did personally, I used it for some alternative investing. Like I had some note lending funds that I invested in. I did that because that particular type of investment doesn’t hold any tax advantages in itself. You’re basically getting more or less like interest income and so there’s no depreciation or anything. I put that inside of my pre-tax, a self-directed IRA.

A lot of people will invest with self-directed in syndications. I don’t see anything wrong with it, I think what it comes down to is your personal preference. Do you have the cash available? Do you not? What are your alternatives for your IRA? Are you happy with what you currently have? If you’re holding through a big brokerage house with your stocks, bonds and mutual funds.

Do you have enough downside protection in there? It really just comes down to the numbers and your philosophy and if you think syndication’s a better, safer investment for you, it’s something definitely worth looking into. I wish a lot more people knew they could do a self-directed IRA and what advantages those have.

Kathy: Absolutely, yes. If you don’t know that, go check it out at our website, there’s a dropdown for resources and there are a lot of companies out there that can help you self-direct your IRA. If you talk to your broker, they’ll say they can self-direct it, but what they mean is they’ll let you pick the stocks and bonds that you want to be in. It’s not that kind of self-directing, it’s different, it’s a different company that does it for you.

What I found, Travis, is that always people should talk to their CPAs before using their IRA to invest in syndications because there could be tax consequences in the IRA. We do a lot of syndications where we buy land and build homes and sell those homes. That becomes an active business that your IRA is investing in because it’s the business of building and selling homes. There could be UBIT taxes to your IRA, unrelated business income taxes. Always talk with your CPA before investing in any syndication, that’s just so important.

Travis: Absolutely. I totally agree with that, and big lesson I learned on that related note was I used the same CPA for years and years and years when I was a W2 employee back in the day. As I evolved and became more of a so-called real estate professional, I quickly realized how valuable it is to have a good CPA team on your side and you should always, like you said, consult before you’re making any type of investment to see what the tax consequences are going to be.

Kathy: Yes. Speaking of that, can you reduce your taxes by investing in syndications?

Travis: You absolutely can. There’s a lot to this, and again it’s always safe to say, you know, I’m not a CPA, I’m not a tax accountant or an expert. Do seek your own advice on this but you can be what’s deemed a real estate professional in the eyes of the IRS. Which essentially means that the depreciation that you’re receiving and any cost segregation that’s done and bonus appreciation, all of these things are paper losses.

As you’re receiving your tax forms in a syndication, for example, you may have received $10,000 in distributions for the year, but you may be looking at a tax form that says on paper that you lost $20,000 in that current year. The benefit of being the real estate professional is that it is possible if you qualify for certain things and metrics that you have to hit, where you can take those–

Not only the 10,000 and distributions you received as a tax-free income for the year, you can take that additional 10, you can even offset active income from a W2 job possibly or 1099 income that you have through other sources. This is how some of the true professionals out in the industry are paying no taxes legally, both at a federal and a state level by being deemed a real estate professional. Definitely something to look into and research more. It’s really not that hard to qualify, but you do need to seek professional advice to see if you qualify in your situation.

Proforma Reality Check

Kathy: Very good, okay. To sum it up, should you believe everything you read in the private placement memorandum that is being offered to you in a syndication? In other words, yes, someone gives you a PPM and should you believe everything you see in there?

Travis: Right, great question. First of all, try to have your legal team, whoever is on your team look those things over. There’s so much in there, some of those can be two, 300 pages long. If you yourself aren’t the expert it’s probably not a good idea just to skim it and say, “Yes, that’s good enough,” and then sign the paperwork. Number two, when you talk about PPM’s and proformas and projections, you always have to keep in mind that all it is, is a projection.

All it is, is somebody’s best educated guess on what they think is going to happen on the project. What I look for is someone being conservative. If I look at a proforma and they say, “The rents are going to increase 10% a year for the next 10 years.” That’s way out of this world aggressive, I don’t think that that’s going to happen. I look for very conservative underwriting approaches, very reasonable expectations on what they’re doing.

I try to shy away from these super heavy lifts where you’re taking something with no occupancy and trying to lease up 300 units. That’s just so aggressive, so hard to pull off. You need a really great team to be able to do it. It’s definitely possible, and it gets done all the time, but you need to find the right groups for that. No, I look for primarily cash flow because that is the majority of my income, I’m very cash flow focused.

If the equity is there, that’s awesome, five, seven years down the road, whatever it may be according to the business plan. I don’t focus too much on those types of projections because you just never know. Are we going into a recession? Are we not? Unforeseen events, I look mainly at the cash flow historicals on maybe a 1980s or 1990s property where you have those historics.

In a lot of cases to look back and say, “Man, well this property due in 2008, 2009 how did that hold up?” and then you have a little more so-called safety net or some resources to go by to make a more educated decision.

Know Your Investor Rights

Kathy: Oh my goodness. What you said is so very important. Have somebody who understands how to read a PPM, look it over for you, because you’ve got to know what your rights are. That’s what’s in the operating agreement. Does your investor group have any voting rights? Do you have any control at all? Can the operator make unilateral decisions? Are they getting paid a big fee along the way, or they get their profit at the end?

It’s so important to read it and to have somebody else read it who understands it. Because even if you read it you might not understand what it really means. Very, very, very important. I also love what you said about avoiding those deals that have a lot of heavy lifting with a team who’s maybe not done that before. One of the early apartment deals that we did, it was a heavy lift and it was difficult and it ended up being more costly than we expected, and the city came in and made more and more requirements because the more we had to do the more they required, because you’re really digging in and having to bring the inspectors over to get the permits. Sometimes they like to find new things. What I would like to definitely recommend is that if you look at an apartment deal, make sure there is a lot set aside for reserves and for surprises like that. That’s where people get in trouble. A second thing I recommend is make sure it’s not over leveraged.

These are the two apartments that I was involved in that were very, very difficult, did not turn out as expected and did not have the profits we expected was number one. The first one was a heavy lift like you said and the second one had too much leverage. It was just too high a debt. Because it took longer to get done what we wanted to get done, the debt really killed the profit. I’m concerned that a lot of people are trying to make deals work today because they’re harder and harder to find, so they’re taking on more debt and that could end up biting them in the end.

Travis: Totally agree. 100%.

Kathy: Okay. Travis, thank you so much for joining me here today on The Real Wealth Show and sharing your wisdom.

Travis: Hey, you’re very welcome. Thank you, Kathy.

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