By Harman Nagi and Anish Patel

Jove Kuang | Software Skillsets to Hard Asset Investments

Jove leveraged his software industry W2 background to accelerate his growth within real estate, ultimately founding FK Capital Partners. For his first deals, he leveraged his coding background to scrape Redfin and Zillow and identify properties that met his pre-defined investment criteria. Now, he's leveraging his skillsets in enterprise sales to develop tight relationships with commercial tenants for his medical office and industrial spaces.

It Won’t Be a Recession—It Will Just Feel Like One: The Wall Street Journal struck a balanced tone, summarizing the perspectives of 71 economists.

→ Implications: At initial glance, top line expected job gains may not be sufficient to flush out top line expected gains in supply; however, if we assess at a more granular level gains in supply are largely occurring in higher end segments whereas job gains are largely in lower income segments. Any interest rate declines will boost the housing market, but affordability will still be a challenge.

Sticky inflation: The monthly US data release on price movement suggests the last mile of interest rate reduction - to get to the Fed’s target of 2% - may prove tougher than many are assuming.

→ Implications: Investors should refrain from assuming significant interest rate cuts when underwriting deals. Doesn’t mean to avoid investing altogether, just need to account for a “higher for longer” scenario.

Oops

The future is difficult to predict, so forecasts should always be taken with a grain of salt. It’s of course a tricky science, but it’s helpful to see how these intertwined metrics performed relative to what the experts assumed in April of last year.

$16,000 of lessons you don’t have to pay for

By Anish Patel

Remember this chart?

Today, we’re going to focus on that part that says you might lose a little in the beginning. Near-sightedness waning after a long week of [insert whatever you do at work]?

Here’s the part we’re talking about:

Still can’t see? Here’s an even closer look:

Yes, it can be like that. After finally mustering the courage to move forward with the first property, things will happen that were so totally not predicted by your crystal ball - I mean underwriting spreadsheet. 

This is somewhat of a right of passage - you grow through what you go through - but it doesn’t have to be calamitous. You can benefit from the lessons paid for by others. After all, this was Charlie Munger’s approach:

"I want to learn as much as I can vicariously. It's too painful to do it by personal hardship. Of course. I collect big calamities in my head and big stupidities. I do that so I can avoid them.”

That approach worked pretty well for him, so today, just for you, we’re going to walk through the first 9 quarters of my first duplex purchased out of state. Why 9 quarters? Because while the investment started off nicely, it then went through a tough period (an understatement as you’ll see), and it wasn’t until the 8th and 9th quarters that we were back to being profitable. In this deep-dive I’ve done my best to outline what my partners and I believed at each step of the journey based on the information available to us and our limited experience at the time. 

If nothing else, in these next 12 minutes I will show you that owning an out of state rental and working with a property manager is NOT passive investing. Don’t let anyone tell you otherwise. But I aspire to do better than teaching you just that, and if I’m successful, you’ll also learn:

• The importance of establishing criteria and sticking to the criteria

• The impact a property manager can have to the well-being of your property, your financials, and your mental health

• “Hidden” costs to factor into underwriting

• Major wealth gains come through equity growth not through cash flow

• And much more…

Oh and stay tuned to the end for another hopefully helpful visual.

Let’s dive in. 

Pre-purchase

Market selection: We identified Columbus, OH as our market of choice because it checked a lot of boxes such as having a growing population, diversified industries, growing investment from large corporations, strong education ecosystem, favorable landlord / tenant laws, and favorable price to rent ratios.

Agent selection: We identified an investor friendly agent that seemed to be all over BiggerPockets with good reviews. 

Property manager selection: We sourced multiple PMs through BiggerPockets, interviewed them based on guidance from David Greene’s Long-Distance Real Estate Investing: How to Buy, Rehab, and Manage Out-of-State Rental Properties, and ended up moving forward with one that seemed to fit our needs.

We evaluated dozens of MLS properties from our agent. Once we got the hang of it, our process would take around 5 - 10 min and looked something like the below. Keep in mind this was our first foray into out of state rental property investing. We didn’t know what we didn’t know. Many of the assumptions were based on our perusing through Bigger Pockets, Reddit forums, and discussions with other investors:

1. Go to rentometer.com, Zillow, Craigslist to evaluate rent potential

2. Apply the following standard assumptions: 

   1. 20% down, 4% interest, 30-year mortgage

   2. 5% closing costs

   3. 10% vacancy rate

   4. 1% and .75% of property value to maintenance and capex costs, respectively

   5. 6% of collected rent toward 3rd party management costs

   6. Property tax based on tax records and Ohio tax rate

   7. 0.5% of property value for insurance

   8. 2% annual growth rate for rent

   9. 3% annual growth rate for expenses

3. Check that expense ratio is ~50% to gut-check assumptions

4. Confirm property is not in a flood zone or high crime neighborhood

5. Submit offer for price point that would yield 5% or higher annual cash on cash return (we really wanted 10% but we figured that our underwriting was overly conservative, so established a lower bar (spoiler alert: we were not conservative enough))

6. If offer accepted, get under contract

7. Ask the property manager about their thoughts on the location, rent assumptions, etc.

8. Conduct inspection 

9. Get out of contract if PM or inspection feedback suggests to look elsewhere

Obviously, our first duplex made it through these steps right? Well… sort of. In dusting off the cobwebs on old spreadsheets and emails it’s clear that at some point our emotions got involved with wanting to get our first out of state rental. We fell into the classic beginner trap of wanting to get a deal done and making the numbers work vs. being objective and sticking to our rules.

Nowhere was that more apparent than in our rent assumptions. Only one side was occupied at $950. Feedback from the property manager suggested rents should be in the $1,200 to $1,300 range. Even with that rent range, we needed to ask for much less than what the seller was asking for. The seller was not willing to budge much and long story short, given online data sources (e.g., Zillow, Rentometer) suggested much higher rental rates, we convinced ourselves that the property manager was likely sandbagging. We decided to underwrite for $1,400 a side ($2,800 total).

We ultimately settled at a $314,000 purchase price, which was a mere $6K off the asking price. In fairness, we did feel that this was a very competitive price-point relative to similar properties in the neighborhood at the time, which didn’t even account for the fact that the property came with an EXTRA parcel (see below). Also, the location was great - blocks away from Nationwide Children’s Hospital, one of the top employers in Columbus, OH. This also left open the door for renting to travel nurses in the future.

 Here were the projected numbers at the time of purchase. These numbers reflect performance upon stabilization - not from day 1. We planned to operate as a standard 12-month lease rental.

As you can see below, 879 - 881 are the unit addresses of the property and next to it there is a plot of land on which we could theoretically build an entire duplex!

Mindset at the time: OMG we’re doing the thing!!

The early days

We knew that given the in-place tenant was well below market and that the second unit was vacant we were going to lose cash in the initial months.

Once the unit was rent-ready, the unit was on the market for a few weeks and ended up renting for $1,200, well below the $1,400 rate we assumed. Can’t say we weren’t warned…

Here’s how Q1 compared to our projections (above projections multiplied by 3 to be quarterly):

Mindset at the time: Yep - we predicted it would be this way in the initial months. Totally expected. Nothing to be alarmed about.

Even a broken clock…

We had a few “lucky” cash flow drivers in these quarters:

• The new tenants would always pay a week late, and that was adding about $50 in extra cash flow a month in late fees, which we weren’t complaining about.

• The other tenant’s lease was going to expire as well, but upon learning that the rents would be raised, they chose to move to a month-to-month lease that was $100 higher than what they were currently paying, so that helped for short term cash flow.

• We found that expenses were turning out to be much lower than we had projected, despite the new unit not listing as high as we had hoped, we actually were profitable in these two quarters! 

Oh yeah, one more thing. Somewhere in Q2 I started getting a bit annoyed at my property manager. We were cash flowing, so why on Earth was I annoyed? Because there were too many points of contact. I didn’t like how I had to keep track of the different emails for the person responsible for leasing, the person responsible for repairs, and the person responsible for administrative stuff and reporting. 

Around Q3, my partners and I started looking at another property. An investor that we had built a relationship with and had seen great success in Columbus was in talks with us to sell one of her properties and advised us to work with her property manager. After we closed on this second property, we decided to switch over the property manager to this new one, so we could have one property manager across both properties. 

While trusting recommendations from other, successful investors is a strong best practice, having too many points of contact is absolutely NOT a good reason to switch out a property manager, especially if things are going well.

Mindset at the time: IT’S HAPPENING. We’re living the dream! We’re making money while we sleep! I can fire my property manager for dumb reasons and it will probably still cash flow!

Sh** hits the fan

We came into these quarters on a high. We were profitable for 2 straight quarters and we just purchased our second property. Oh how the tables can turn.

The first thing that was very notable was a sharp increase in expenses. We asked our new property manager why there was a sudden increase. They explained that there wasn’t anything unusual and that all bills can be reviewed in their 1990s era online dashboard, which was an absolute pain to use. This is an example of you don’t know how good something is until you lose it - the prior property manager used Buildium (something to ask for).

The next thing we started to notice was a sharp decline in income. We learned that the month-to-month tenant stopped paying. Also, the other unit started becoming even more delayed in paying rent. The property manager told us that they were particularly busy but assured us they were “doing everything they could” and “on top of it”. 

Meanwhile, expenses continued to increase. This new property manager didn’t seem to have great internal coordination as NO ONE seemed to understand what was happening at the property. They began to give us the runaround (i.e., “Oh I don’t have that information, you should talk to [X].” We talk to [X], who would suggest we talk to the original person we reached out to. We’d reach back out to that person, and we would struggle to get a hold of them again). 

After 4 months of this poor communication and negative cash flow, we decided we needed to change the property manager (tip: do NOT take this long to realize this). We spent about 2 more months looking for a new property manager because we wanted to get it right this time and didn’t want to have to switch again. 

As we were making this transition the month-to-month tenant was evicted. Somewhere between the eviction and our newest property manager getting the keys, a couple squatters moved in. The property manager we ultimately fired was at this time still responsible for securing the property, and they failed to catch this. They also became all but impossible to reach at this point, which made the transition to the newest property manager more challenging.

A quick aside: Why was this property manager so bad? Didn’t they come through a referral from another investor that we trusted? Yes and it was still true that this property manager had performed well for this other investor. Unfortunately for us, this property manager had grown very rapidly in recent years and had grown past their capacity and competency. We caught them just as they were starting to decline in quality. After having many conversations with other property managers and investors since, we’ve learned that 700 units is a critical milestone at which point the property manager should have strong systems in place to continue to scale and manage their business. 

Our 3rd property manager officially got the keys in the middle of Q5, got the squatters out of the vacant unit, and began the process of listing the unit. The prior tenant and or the squatters were not kind to the unit. And by not kind, I mean abusive. To put things into perspective, the toilet was RIPPED off the floor. How does one do that??????? 

This unit not only went through an extended rehab process but also an extended leasing process given it was in the dead of Columbus, OH winter. (tip: avoid at all costs listing in the winter. Time lease expirations to be in the Spring).

To make things worse, the other tenant went month-to-month and ended up moving out at the end of Q6. The turn scope for this unit ended up being higher than what our original projections could account for. We realized at this time that we underestimated the costs of turning units by assuming it would be accounted for by ongoing repair and maintenance assumptions. Don’t make this mistake. 

Here was the damage:

Mindset at the time:

Is it over? How can we be sure?

Despite this also being a negative quarter overall, things started to look up again (last month of Q7 was positive). The second unit ended up leasing faster (less than 20 days) given we were in late winter, early spring. Communication with the new property manager and overall professionalism was remarkably better than our prior two property managers. We did see higher costs because of a HVAC and washing machine repair, but our income was higher than ever before with the new tenants and better property manager (i.e., better collections). In fact, our income was approaching our original projections!

Mindset at the time: Honestly probably numb from prior period but best summarized as “cautiously optimistic.” 

Stabilization

Ahhh - stabilization. There is really nothing at all to report from this period as the property was, finally, stabilized. It was a boring period. And boring is good. As you can see below, performance was solid and cash flow started to exceed original expectations.

Mindset at the time: Probably some combination of smug (i.e., “Pshht called it. Always knew this would happen”) and surprised (i.e., no way, we’re actually profitable?!)

Summary

Did you do the math? This first property lost >$16,000 in its first two years. But it wasn’t in vain. It won’t happen again. 

I (and now you) learned the following lessons:

1. The importance of establishing criteria and sticking to the criteria

   • Do NOT waver from your criteria to "make a deal work"

   • Ensure there is plenty of buffer for the unexpected

   • BE PATIENT. 

2. The impact a property manager can have to your well-being of your property, your financials, and your well-being

   • Trust your property manager's opinion over that of online data sources (e.g., Zillow, Rentometer)

   • Hire SLOWLY. Spend a considerable amount of time evaluating property managers. As part of your evaluation, get a sense of your property managers’ growth plans and systems they have in place to handle their next phase of growth

   • …and fire FAST. Fire your property manager quickly if they are not meeting your standards

   • DO NOT fire your property manager for dumb reasons

   • Hire a property manager that will periodically check on units to ensure 1) Unit conditions are good; 2) There are no squatters

   • Tenants not appropriately vetted can destroy units; ensure your property manager has a robust application process. It may mean longer lease-up times, but it will save you money in the long run.

3. “Hidden” costs to factor into underwriting

   • Account for unit turn costs as a separate line item ABOVE ongoing repairs and maintenance and capex assumptions. Ask your property manager what average turn scopes are amounting to while doing your underwriting.

   • You are very unlikely to have cash flow from day 1. It takes time to stabilize a property. Account for this in your underwriting.

4. You will make your major wealth gains through equity growth not through cash flow

   • In this 9 quarter period, sales of comparable properties in this area suggest this duplex appreciated anywhere from $85,000 to $125,000. And that’s not factoring in the value of the extra plot of land. So even though we took some losses on a monthly level, we still came out ahead on paper. 

   • This is NOT to say you ignore monthly profitability. Strictly relying on appreciation is speculative and largely not in your control. Over the long run, you should benefit from appreciation, and ideally, you are covering predicted and unpredictable losses with the income generated.

5. And, much more...

   • Avoid leasing units during the winter; structure leases such that they expire in late winter / spring to minimize time to lease and maximize rental rates

   • Clearly you can learn A LOT from your first property. Further, all of these learnings are applicable to any property size. So if you have aspirations to invest in large multifamily complexes, it’s not a bad idea to start with something small to get the rookie learnings out of the way that you can then apply to larger scale or more complex deals. 

   • I did this deal with 2 other partners that were also new to out of state rental property investing. While this means that we split the losses three ways, we still each received 100% of the learnings. If there are people in your network that you trust, it is not a bad idea to take advantage of this educational arbitrage.

As promised, a hopefully helpful visual

The VAST majority of wealth growth from this property during its first 9 quarters came through appreciation. That is not an outlier result - that is typical. It will take A LOT of small midwestern duplexes to displace your day job income through cash flow. But that’s okay. Think of the cash flow as a way to cover expenses while your property appreciates over time and provides you with true wealth growth. Along the way, you’ll learn a lot as well.

Surprise! I’m actually giving you two visuals - the first demonstrates wealth growth from my first duplex:

And another you can show your tattoo artist:

You can also respond to this email and tell us what you thought! Was it too long, too short, or missing something? Anything you would like us to cover in future newsletters? We’d love to hear from you!

The views and opinions expressed in this newsletter are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action. Please contact your legal, tax, and financial professionals before considering any investment.