Are you curious about the untapped potential of the commercial real estate market? Discover the power of holding property and the critical lessons learned by J Scott in his journey of flipping 450 houses. Join us as we delve into the fascinating insights he shares about affordability, government intervention, and cash management in this engaging episode.
Key Takeaways:
- Market Dynamics and Affordability: J Scott discusses the evolving dynamics of the real estate market, emphasizing the impact of shifting demographics on affordability. He highlights the importance of understanding the distinctions in the rental market and how different income brackets are affected.
- Cash Management and Inflation: J Scott emphasizes the significance of cash management and the role it plays in real estate investing, especially during periods of inflation. He provides valuable insights into the relationship between inflation and treasury yields, offering a balanced perspective on the impact of inflation on investment strategies.
- Government Intervention and Long-Term Solutions: J Scott explores the role of government intervention in addressing affordability challenges in real estate. He advocates for incentivizing investors to create market-based solutions, rather than relying solely on legislative measures, and discusses the potential long-term implications for the real estate landscape.
J Scott | Real Estate Background
- Partner at Bar Down Investments and Host of the Drunk Real Estate Podcast
- Portfolio:
- About 1,000 units of SFR and multifamily
- 5,000 units as an LP
- Based in: Sarasota, FL
- Say hi to him at:
- Best Ever Book: Thinking, Fast and Slow by Daniel Kahneman
- Greatest Lesson: The value in holding property for the long-term. That's where real wealth building happens.
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Transcript
Narrator:
Quick disclaimer, the views and opinions expressed in this podcast 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. For more information, go to bestevershow.com.
J Scott:
The way the Fed has tried to tackle is by raising interest rates. When we raise interest rates, two things happen. One, we get more money when we save. So we can now put money in a savings account at 4% or CDs at 5% or treasuries at 6%. So consumers are encouraged not to spend as much, they're encouraged to save more. And likewise, when interest rates go up, the cost of everything goes up.
Narrator:
Welcome to the best ever show, the world's longest running daily commercial real estate podcast. Our hosts interview commercial real estate experts every day to get you the best advice ever with none of the fluffy stuff.
Joe Cornwell:
All right, best ever listeners. Welcome to the best real estate investing advice ever show. I am your host, Joe Cornwell. Today I am joined by the world famous J Scott. He's a partner in Borrowed Down Investments. He's a multifamily syndicator. He is controlling over a thousand units and he is a limited partner in several other deals. And he is a host of the Drunk Real Estate Podcast. Jay, welcome and thank you so much for joining us.
J Scott:
Hey, thanks for having me, Joe, thrilled to be back.
Joe Cornwell:
Anything I missed there? I know you've written a ton of books as well. I think there's five now. Anything new on that front?
J Scott:
No, everything's pretty much status quo. I'm not that busy these days.
Joe Cornwell:
Awesome. No new books in the works?
J Scott:
No, actually writing books is tough and it's not something I particularly enjoy doing and I do it if I'm really inspired, if I find some topic that there's either no other books out there that I feel are really good on a topic or there are no other books on a topic period. And there are no topics I'm really excited to write about right now that I can't find other great books out there.
Joe Cornwell:
Awesome. Well, I, I appreciate it. I think I found you probably eight years ago through one of the first books you wrote maybe 2015, 2016 and your flipping book. I think that was one of your first. So yeah, I've been following you a long time. I know our audience is probably aware of you. If not, hopefully they will find you and follow you from this call today.
So the first topic I had in mind is what is your current business? What are you focused on today? I know that's changed a lot over the years, but what are you spending most of your time on?
J Scott:
So it actually hasn't changed that much over the years. I did spend about 10 years in single family residential flipping rentals. 2018, 2019-ish moved into multifamily syndication. So for the last four or five years, I've been focused on syndicating large multifamily apartment complexes, basically buying, repositioning and reselling.
Joe Cornwell:
Gotcha. So you are still actively doing acquisitions for new multifamily deals. What does that look like? What markets are you looking in and how are you structuring this?
J Scott:
Yeah, in theory, we are still acquiring. In reality, it's tough to find good deals these days. We're pretty conservative group. So we don't do a lot of deals, but we have taken this last year and a half where things have slowed down considerably as an opportunity to reach out to brokers and other markets to really start getting familiar with other markets.
Historically, we've been focused on Houston, Texas. So most of our units are there. We do have some units in Kansas city, Dayton, Ohio, and we're almost under contract in Atlanta. So we are branching out. We like the Carolinas. We like a couple of cities in the Midwest. Basically all of those traditionally good multifamily areas, landlord friendly, relatively stable prices, that sort of thing.
Joe Cornwell:
Awesome. I didn't know you were in Dayton. That's just a stone's throw away from me here in Cincinnati. So, that's cool to hear that.
So given the last 18 months, you just mentioned, how have you shifted your business and with your partners? What has been the biggest shift for you guys on operations and finding deals?
J Scott:
From an operations side, Houston has had some challenges the last year or so. First has been evictions. So they have about an 80,000 tenant backlog on eviction. So what used to take two to three weeks to get a tenant out once the eviction process started, now takes three to four months. So that can really hit the balance sheet in the P&L pretty hard because all of that debt that's piling up that the tenants aren't paying while they're in the units, the day they get evicted that all hits the profit and loss statement. So from an accounting standpoint it makes our monthly numbers look a lot worse. We're not necessarily making less money because obviously we knew those people weren't paying, but because all of that bad debt hits at one time it hurts what numbers look like to the outside world. So for any deals that we're looking to sell or we might want to market, it makes it more difficult to do that.
Number two, just because those evictions are taking longer, that means tenants are staying in units that they're not paying for longer. They're doing more damage. So once we get those units back, typically our turns are more expensive, taking a little bit longer. Those units we have to upgrade anyway aren't a big deal, but the units that were previously upgraded and now need to be re-renovated and turned to a larger degree is more expensive and takes more time. So that hits us as well.
And then there's been expense issues. So the biggest in Texas, and this is the same in a couple other states, but it's been insurance. So our insurance on some of our properties has gone up 50%, 100%. On one of our deals, our insurance has gone up two and a half times. And that's caused a tremendous hit on our P&L. When expenses go up like that, it cuts into your cash flow, it cuts into your distributions. So we and our investors have to take that hit, and we need to figure out workarounds.
So yeah, there have definitely been some challenges that on the side of things that everybody is dealing with. For anybody that has floating rate debt out there, we have these things called rate caps. So rate caps are basically an insurance product that ensures that we don't have to pay too much above the interest rate that we locked in when we first bought the property. These insurance policies have gone through the roof in price, so typically they last one, two, three years in duration.
Anybody that bought a property in 2020, 2021, 2022, may be facing these insurance policies needing to renew. And just to give an example on the one deal that we've had to renew our rate cap, when we bought the policy back in 2020, we were paying $30,000 a year to renew $480,000. So literally an extra $450,000 a year, which as anybody listening can imagine, that's gonna have a significant impact on cashflow and profits.
Joe Cornwell:
Let me ask you real quick on that. So what is the difference in your actual cost on a deal this size, obviously you didn't give us specific numbers and that's fine, but I assume when it comes down to the simple math of it, at a certain point it makes sense to pay for these insurance policies versus just paying the higher interest payments. What is the apex in that decision making? What do you have to look at for that?
J Scott:
To a large degree, most larger banks, definitely the agency lenders, Fannie Mae, Freddie Mac, if you get a CNBS loan, what you're going to find is you don't really have a choice. You have to get those rate cap policies to avoid that situation that we saw last year, the last year and a half, where rates have literally gone up five, five and a half points, mortgage rates have gone up five, five and a half, six points. So lenders know that DSCRs, or debt service coverage ratio, can't support payments that high.
So basically what they want to see is that you have an insurance policy in place so that you're at some point maxed out on how much you have to pay to the lender, which means you're not going to get a DSCR that's below whatever the lenders decided is reasonable. Now the problem is I don't think lenders ever considered the fact, or maybe they considered it, but they didn't really put any safeguards in place. The fact that, yeah, they can ensure that monthly payments don't go above a certain amount with these rate caps, but they couldn't ensure that the price of these rate caps didn't skyrocket and we pay those costs on a monthly basis as well. So that basically just adds a big monthly expense to the P&L. So that's hurting investors as much, if not more, than interest rates themselves going up.
Joe Cornwell:
Okay, so yeah, that's something I was unfamiliar with. So it's not simply the math of, let's say it's $200,000 in excess interest you'd pay on the adjustment. It's the fact that you're required to have these by the lender, so you don't have a choice.
J Scott:
Absolutely. Yeah, the lender tells us when we get that floating rate loan that we need to protect ourselves and them by getting this insurance policy. Nobody's ever really thought about it because the thing that drives these policy prices tends to be volatility. When nobody knows where interest rates are headed, when there's a risk interest rates could jump another one, two, three points over the next couple of years, insurers have to protect themselves against that volatility. And so that's what causes these high insurance prices. It's not necessarily just that rates are high.
If rates are high, rates are low, the insurance policies are basically the same because the lenders are insuring at whatever the interest rate is on the day you buy the policy. But for them, the big risk is that volatility. Could they go up a bunch? And we haven't seen a lot of volatility in rates over the last 10, 15 years. Basically in 2008, they went down. They went up a little bit, and then in 2020, they went down. But we haven't seen a time in the last 15 years where rates have really gone up quickly.
So I guess these insurance carriers haven't really been thinking about those scenarios. Volatility on the upside has been low. And so prices have stayed low. And so nobody's really thought about these rate caps. You just pay your $30,000 or $40,000 a year. But now suddenly we're half million dollars. I've seen rate caps at a million dollars and even multi-million dollars.
Joe Cornwell:
So as we all know, anyone who's paid attention in multifamily has seen Houston as one of the hottest markets the last seven, eight years at least, probably longer. What can other operator syndicators do? I know a lot of operators that have properties there. It sounds like this is probably affecting almost anybody that had purchased in the last three years, let's say. So what's the option? I mean, what can people do?
J Scott:
Well, the best option is just to be conservative. The nice thing is that all three things that I mentioned, evictions, insurance, and rate caps are all, I hate to use the term likely, but most likely to resolve themselves over the next year or two. So on the eviction side, as we get through that eviction backlog, things should, in theory, go back to normal a few weeks to get to an eviction.
Insurance, I'm hopeful that the state and local governments will put in place some legislation that will hopefully bring down the insurance costs. I know we're talking about that here in Florida. It may take a little bit longer in Texas, but hopefully it'll happen in Texas as well.
And then on the rate cap side, again, as the volatility slows down and we know where the economy's headed, there's a good reason to believe that rate caps are going to come down as well. So all three of those things are temporary issues. And so if you're underwriting a deal today and you underwrite with all three of those issues in mind and you're conservative with respect to all three of those issues, then in theory you can get a decent deal today that in a year or two or three becomes a fantastic deal when evictions are no longer a problem, when insurance is no longer a problem, when rate caps are no longer a problem. This decent deal that you got today is now a home.
Joe Cornwell:
Yeah. And that makes complete sense, especially for people actually trying to do acquisitions. But for somebody like yourself, who's been purchasing properties the last few years in this size, and it sounds like in this market, is there anything you can do now to stabilize or just try to weather the storm and get through the next year or two? On an operations standpoint, what are you guys trying to do to stop any potential income loss?
J Scott:
For us, the biggest thing is be conservative, number one. So while we never like to slow down distributions to our investors, for most of our deals we have. We've slowed down distributions. We've started bulking up reserves. And basically the message we send to our investors, the message we intend to send is we are going to be proactive. We're going to be conservative. Even if it means taking a little bit of money out of your distributions today, the goal is that we can weather any storm so that we can still hit all our projections, exceed all our projections down the road.
So number one is we've been bulking up our reserves. We've had our asset managers and our property managers basically beating down vendors to get our expenses as low as possible. So on that side of the P&L, just knocking down our expenses as much as possible.
On the other side, on the revenue side, trying to bulk up our other income as much as possible. And then for the good paying tenants, we're doing what we need to keep tenants in place. So one of the things that we're finding is that turned units or upgraded units are no longer getting the premium they were getting a couple years ago or even a year ago.
So there's not a lot of benefit in doing a bunch of upgrades or doing renovations when you do a turn. So for us, keeping the tenants that are in place in place, because we can't raise the rent anyway, is going to be of utmost benefit because turning the unit, losing that tenant for a couple of weeks, finding a new tenant all costs money. So if that means basically not raising rent, if that means giving concessions, whatever it is, we're going to be more profitable if we keep a tenant versus getting rid of a tenant and finding a new tenant.
So basically all three of those, being conservative with our investors and distributions, focusing on expenses, focusing on revenue.
Joe Cornwell:
Yeah. And it's interesting you say that. I feel like all of the operators I've talked to, let's say the last three years, it was heavy value add. Almost every multifamily investor I knew was looking for value add deals. And it seems like it started to shift a little bit where it's making more sense to really optimize operations. And that's where they're actually getting more value than, like you said, trying to go in gut units, do massive renovations, and try to really push rents up because we're just not seeing that in a lot of the major markets.
J Scott:
This industry, we've gone from a growth phase in the industry where values are going up and units are getting renovated and new supply is coming online to really a preservation phase. We've gotten to the point where we aren't thinking about how do we grow the value of our properties.
How do we continue to raise rents? How do we continue to do upgrades? Instead, we're thinking about how do we ensure that this property is positioned to weather any storm that comes along in the next year or two so that we can get over the hump of what we're dealing with economically, get into the next phase of the economic cycle, and then take advantage of values going up down the road. So right now is live to fight another day.
Joe Cornwell:
That's a good way to summarize it. So one of the reasons I follow you and a lot of your content is I love your opinions on the economic status, economy.
I'd love to spend a little bit of time on that. And I saw you guys had a new episode come out again, the drunk real estate podcast for anyone who hasn't checked it out, I highly recommend it. I listen every week. And I know you guys cover that a lot on your show, but if you could give us a brief summary of where we are today, just kind of high level, and then I'll have a few follow-up questions on where we're headed.
J Scott:
Yeah. And keep in mind if this episode isn't coming out within five minutes of us recording it, everything can change. In fact, it's interesting. So we're recording this beginning of November and this is a huge economic week so the Fed in about 40 minutes from now is announcing if they're going to do another rate hike suspect not but it's possible there's jobs numbers coming out tomorrow there's 1,500 businesses that reporting quarterly earnings we have manufacturing numbers coming out this week so it really is one of those things that week to week it's changing which is crazy but at the end of the day what we're seeing economically is that the data is very strong.
So if you just look at the data, you don't ask people, you don't actually observe what's going on. If you just look at the data, things are very strong. GDP is strong, jobs numbers are strong, stock market's holding up. Basically everything you look at, inflation's coming down, everything you look at looks good. That said, if you actually go out and talk to people, what you're seeing is two separate stories. Top five or 10% of people out there, those that have enough money that they're buying hard assets, that they have investments, that they're generating cash flow, they would tell you the economy is going great because all this money that's been printed over the last five years, this $8 trillion, for the most part, flows up to the top five or 10% of the socioeconomic classes.
Then you go look at the other 85% of Americans who are working a W-2 job, who may be living paycheck to paycheck, who don't have a lot in savings, whose earnings are being eaten away by inflation. Their wages aren't going up very fast, and they're dealing with all of this stuff that the 5 or 10 percent aren't seeing, you ask them and they'll probably tell you that it feels like we're in a recession, and they're struggling.
So we're basically living in two separate Americas, and depending on what assets you own, depending on what your income is, depending on your socioeconomic level, your view of what's going on economically might be completely different than much of the rest of the country.
So it's really hard to say. I know if you ask somebody, are we in a recession? Are we not in a recession? It's a hard question to answer because it depends on perspective. But from a pure data standpoint, we are not in a recession.
That said, we're starting to see the jobs number softening. If you dig into jobs a little bit, what you'll find is that the jobs outlook isn't as rosy as that top line 3.8% unemployment number might indicate. You have to dig in a little bit, but you'll see things aren't that rosy.
If you dig into the business picture, and I like to look at businesses because historically, if you look at how consumers are reacting or being impacted by the economy, that's a lagging indicator. Basically whatever we're experiencing as consumers is a result of things that happened three, six, nine months ago. The leading indicator for the economy tends to be businesses and what businesses are feeling and what businesses are doing.
So if you look at if businesses are flush with cash, are businesses spending money? Are businesses able to get cheap debt? That's the thing that's gonna tell you where the economy's headed. And if you look at that right now, it's actually pretty scary. A lot of businesses work off of short-term debt. In the tech world, which accounts for about 20% of businesses out there, the venture capital backed tech world, businesses that are getting investments from angel investors, venture capitalists, basically they get investments for two-year periods.
They raise enough money that they can survive for two years, at which point they have to raise more money. If they can't raise more money after two years, and if the larger businesses that are taking out short-term debt at two, three, five years can't raise additional money when their debt expires, then they're in trouble, because tech businesses and a lot of big businesses, even outside of technology, rely on debt to fund their operations. So what we're seeing is, we're coming up against this cliff where about 20% of the businesses out there, these venture-backed tech businesses, are getting ready to run out of money because they haven't been able to raise for about two years.
A lot of the larger businesses think the Targets and the Walmarts and those types of businesses, they rely on issuing bonds to raise money. Well, they were issuing bonds at three and 4%. Now they're issuing them at six, seven, eight percent. So they're paying a lot more interest on that money. And then the mom and pop businesses out there, they rely on things like SBA loans and bank loans. Those loans a couple years ago they were getting them for three, four, five percent they're now paying six, seven, eight percent and a lot of these businesses don't have the financials to support these additional interest payments.
So at the end of the day what we're seeing is a whole lot of businesses that are going to start defaulting on their debt we're going to see a whole lot of bankruptcies we're going to see a whole lot of innovation based businesses tech businesses that start to go out of business.
And when that happens, not only is it going to hit the economy because those businesses are no longer spending money, but all of those employees are now going to be unemployed, they're not going to have income, they're going to be struggling, they're not going to be able to make their mortgage payments, they're not going to be able to buy food, they're not going to be able to pay their credit card or their car payments, they're not going to be able to find another job because all these businesses are closing. And that's when that avalanche, that snowball takes over and everything goes to hell.
Joe Cornwell:
Let's talk about that because that was my next question. And I do have one other thing I want to go back to here in a minute.
I agree with everything you're saying and you know it much better than I do. And that's why I listened to what you had to say with all of that said, where do you think this is heading and when? And I know that's obviously very open ended question. And I think a lot of people opinions from a year ago are probably changed over time to today. But when do you think these things start happening?
J Scott:
You mentioned the drunk real estate podcast. I'll give a little plug, but I also want to give some background. It's a podcast that three friends of mine and I host every week. And the friends are one of my business partners, Kyle Wilson, Mauricio Raul, who is a well-known securities attorney in the space, and AJ Osborne, who owns about a half billion dollars in self-storage. So all well-experienced investors. And we talk about this a lot, when's it coming? And we don't agree completely, but we're all within about six months.
And at this point, we all think it's going to be the first half of 2024. Just based on the trajectory of jobs, based on the trajectory of business issues, where inflation is still going. We kind of get this impression that the first half of 2024 is when things are gonna start to deteriorate.
So then the question is how quickly and how extreme does the Fed respond? So we saw interest rates come up 5% over the course of a little over a year. Will they drop rates 5%? Certainly if they did that, that would spur the economy again, but then you run the risk of a couple of years down the road, we have this inflation problem again. And so that's the big unknown.
Even if we do have this recession, how is the Fed going to respond? Are they going to be willing to pull the trigger and drop rates and risk breaking the inflation thing again, or are they going to be more conservative and say, okay, we just have to let things break? And so that's the big question.
Joe Cornwell:
Yeah. In my opinion, what I've seen, it seems like the Fed is indicating they are okay with things breaking, I guess to summarize it would be they want to control it as much as they can, which I don't know how much control they really have ever once it starts happening.
J Scott:
The Fed is a lot like my golden retriever. If you listen to her bark, she sounds tough, but you walk up to her and she's a pussy cat, she's not going to hurt you. That's kind of the fed. They talk tough, but at the end of the day, they don't act tough.
Joe Cornwell:
Yeah. So it would seem then if things do start to break, that's going to be where the alarm bells go off and they're going to do what they can to scramble to try to minimize the damage. And so I guess on that line of thought, what is the thing that they want to see? Is it unemployment they want that to increase? Is it reduced consumer spending? What do you think that they're looking for? And what should we as investors be following as far as the data?
J Scott:
The single biggest concern that they have right now is inflation. Because inflation is that compounding tax on consumers that just eats away at our income. If inflation is at 4% or 5% and wages aren't growing at 4% or 5% and wages don't grow 4% or 5% long term, then every year Americans are losing spending power.
And that is what the Fed is concerned about. Additionally, inflation can hurt businesses. A little bit of inflation is great. It means they can raise their prices a little bit. There's more demand. Everybody's making more money. But high inflation makes it hard because businesses now have to pay higher salary. The minimum wage goes up. And so even for businesses, high inflation is bad.
So that is the key number. The Fed wants inflation at about 2% a year. Historically, that's about where it's been. It peaked last March at about 9%. It's down to about 3.7%. So we've made great strides, but 3.7% is still a good bit away from 2%, especially when you think about the compounding effects. It's not just 3% a year, it's 3% compounded, 3% on top of three, on top of three every year. So the difference between 3.7 and two is pretty big, and the Fed knows that.
Joe Cornwell:
So it sounds like we're tackling that problem by going from nine to 3.7, but we're still a good ways off. So how do we get that number down?
At the end of the day, it's really consumer demand. It's getting people to spend less money. And how do you get people to spend less money? Well, if they lose their jobs, they're gonna spend less money. So unemployment going up is one way to tackle inflation. If people run out of money, that's another way that inflation is gonna go down, because they're not gonna have the money to spend.
The way the Fed has tried to tackle it is by raising interest rates. When we raise interest rates, two things happen. One, we get more money when we save.
So we can now put money in a savings account at 4% or CDs at 5% or treasuries at 6%. So consumers are encouraged not to spend as much. They're encouraged to save more. And likewise, when interest rates go up, the cost of everything goes up. Mortgages go up, car loans go up, credit card interest goes up. So we're discouraged from spending. So that's the reason the Fed raises rates. They want to encourage people to save. They want to discourage people from spending.
But so far, raising rates has not discouraged people from spending. People are still spending like crazy. And that's why we have inflation.
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Joe Cornwell:
Yeah. So it would almost seem that until something changes from the current path we're on, all the things the Fed have done have not had the intended impact yet. But that's what you're saying. Maybe first quarter, second quarter of next year, we're going to see the compounding effects of all the things the Fed's tried to do by increasing interest rates and reducing the money supply in the market.
J Scott:
Holiday and Christmas season will be interesting this year. I think people have been on a spending frenzy. In Q3, we saw GDP, which is this barometer of how much activity is going on in the economy at 4.9%, which is the highest number we've seen in a long time. I don't know exactly when, but it's been at least a decade. It's just a crazy high number. So the question is, do people have enough money left to go out this holiday season and just continue to be buying like crazy?
So come Black Friday, Cyber Monday, generally within a week of those, we get some preliminary numbers on how much people are spending for the holiday season. So that'll be interesting to see. I think if we find that people are spending like crazy or continuing to spend like crazy after Thanksgiving, then yeah, it could be Q2 of next year or closer to the middle of next year before anything breaks. But if we get to Thanksgiving and we see people are slowing down their spending over the holidays because their credit card debt has gone through the roof, and they just don't have the money and can't afford it, well, then that could snowball things a lot sooner.
Joe Cornwell:
That's a very interesting point. And I think that it sounds like you're saying that'll give us a very good indication of timing to seeing where the spending comes in. So back to a point you made when you were talking about the market in general. And I agree with this, something I've talked about with other guests recently. The lower half of the economy, the lower half of income earners, of the people even employed and working, are feeling the squeeze of the current economy more than anybody. And my question is, what do you see happening with the affordability, and we can even relate it back to real estate, obviously it affects every aspect of life in the economy, but even in the context of real estate, your tenant base, especially on base in the Midwest, we have a lot of lower rents when compared to the country as a whole. So where do you see the lower income tenants and from like, let's say, median income all the way down, what is their options for affordability in the next two to five years?
J Scott:
It's a great question. And the first thing I wanna point out is you talk about the lower 50%, but lower 50% would make sense if we still had a big middle class. And if salaries and income were a bell curve, where the top of the curve, like the average, the median fell at the 50% mark, but the reality is we've lost the middle class.
So it isn't that half the people have been pushed up and half the people have been pushed down. Like I was saying before, 80, 85 percent of people have been pushed down and 10 or 15 percent of people have been pushed up. So unfortunately, it's not just 50 percent we're talking about, it's more than 50 percent. So there are a couple of things at play. One with the cost of homeownership so high, there are a lot more people that are going to be forced into renting. So that's going to drive demand.
So my partner Ashley has been saying for a while now, and it looks like she's right, that we're moving towards being a renter nation. Historically, about two thirds, about 66% of people own their own homes, but that number is starting to drop. So we're gonna see more people renting. In theory, that's good for us as landlords. But in reality, as landlords, we have some safeguards in place to ensure that our tenants can't pay more than they can afford. So we might say, we're only gonna let them pay an amount that is one third of their monthly income. So, we can't just arbitrarily raise rents because there's more demand, because at some point we're gonna say, well, salaries aren't high enough, they're not hitting that threshold, so we don't have enough qualified tenants. And we're actually seeing that in Houston, where if we stick to that three times income, we're finding it difficult to find qualified tenants. We're sticking to it, but we see a lot of operators around us that are going to 2.75 times, 2.5 times to get more tenants in. But when you do that, you're going to get less qualified tenants, tenants who are paying more of their disposable income towards rent, and you're going to see evictions go up, bad debt's going to go up, you're going to see your economic loss is going to increase, and that's going to be bad for landlords. So I think on both sides of the equation, things are going to be tough moving forward.
Joe Cornwell:
Let me start with this. What's your average rent in your Houston portfolio if you had to ballpark it as an average number?
J Scott:
We have A minus properties and we have C plus properties, but I would say on average 1,300, 1,400.
Joe Cornwell:
And that's for one, two beds. What are you looking at? Two beds, okay. Obviously a little bit higher than Midwest, not drastically higher depending on the neighborhood, but what I would say is that as your rents go up and that three times rule that most of us as operators use, it becomes more affordable in the sense of, if you're making, let's say, $10,000 a month in gross income, and you're only paying $30,000 or $3,500 in rent, while that's still extremely high, you still have $6,000 or whatever in excess money for the other expenses. So as that number goes up, the rest of your life becomes more affordable, right? And it's a similar way when you look at mortgages. If you make $20,000 in take-home pay and your mortgage is $10,000, that's still a ton, but you now have $10,000 for all your other expenses, which is typically manageable in most markets. So what are your thoughts on that? Is that something that you're paying attention to market by market or you think in general, everybody's in a little bit of trouble?
J Scott:
That's a benefit of owning A-class properties. Your tenants tend to be in a better position because even if they're not seeing a pay raise this year, even if they are a consultant, lose a contract or something, typically, like you said, their cushion is going to be a good bit higher than somebody that's earning $45,000 a year and a third of their income is going away, that they really don't have much of a margin. So it's really going to depend on the class of property. But I think it's going to be an issue on both sides. I think renters are going to be squeezed just because there's going to be so much more demand and that's going to put pressure on rents to go up over the next couple years. And landlords are going to be squeezed because they're going to see all this demand, but the demand isn't necessarily going to be coming from qualified renters.
Joe Cornwell:
You know the specific metro markets better than I do. In your opinion, what areas are the most at risk right now with compressing rents? Is there specific markets you're following that you think are in big trouble?
J Scott:
I think it's going to be the markets that are seeing stagnating population growth or loss of population growth. That was the big thing that we saw with COVID. It's no secret that during COVID people moved and there are places where people obviously moved from their places where people obviously moved to. So that migration to some extent, not like it was in 2021, but to some extent it's still taking place. People are still moving to the South and Southeast. Why? Because a lot of people can work from home now that couldn't before. A lot of people have retired that weren't going to retire, but COVID came and they were 60 years old, they were five years away from retirement and they decided, I might as well just retire. And so they can live anywhere they want.
So where do people want to live? They want to live where the weather's nice. They want to live where the taxes are low. A lot of people want to live where there's less government interference when things like COVID take place. So they choose to move these days to the South and the Southeast. So I think that's why a lot of operators, a lot of multifamily syndicators are moving to the South and Southeast. Where are they moving away from? They're moving away from the big cities in the North, they're moving away from and going back to the regulation piece. I like to say there are places I want to live and there are places I want to own property and they're not necessarily the same. I want to own property in places that are very landlord friendly. I don't want to have to worry about lockdown restrictions. I don't want to have to worry about legislation that forces me to keep renters in that aren't paying. I don't want to have to worry about rent control, things like that.
So typically it's the red states that tend to be more blue states tend to be more tenant friendly. So landlords tend to be flocking and a lot of people as well tend to be flocking towards the red states from the blue states. And again, this isn't political. I'm not trying to get political here. I've lived in mostly blue states my life and I've loved them. So again, it's not where you want to live but it's what makes sense as an operator. So I would say as an operator these days, South and Southeast, a little bit of Midwest, like you said, because prices are a lot more stabilized.
They didn't see the huge run-up that we saw a couple years ago. Where we saw that huge run-up, those are the places that are taking the biggest hit right now. You look at Las Vegas, you look at Boise, Idaho, you look at Phoenix, Arizona, places where the market was up 60, 70, 80% during COVID, just unsustainable. And now it's a falling back to earth. And so those markets that are where people are moving and where prices have been stable, those are the best markets in my opinion.
Joe Cornwell:
With that line of thought in your business, with your partners, are you guys more apt to go after markets that are likely to appreciate or the assumption is they will appreciate or are you looking for more stabilized cash flowing markets what are you looking for today?
J Scott:
It's a combination so we want the appreciation but we don't expect the natural appreciation we don't expect the market to go up just as the market goes up we want the forced appreciation we want to drive the value of our properties up by increasing the revenue, lowering expenses, overall increasing the net operating income. That's how we make our money. If the market happens to go up in value, great, but our business plan will work out if values basically in the market, if cap rates in the market stay flat.
Whenever we do a deal, we forecast that cap rates are going to go up, which means values are going to come down to some degree. So pretty much for any deal we do, if the market stays absolutely flat in terms of cap rates, we're going to win because we projected the other direction. We tend to be very conservative there. A lot of operators are conservative there. So as far as I'm concerned, we don't build appreciation into our model other than that rent growth one or two or 3% a year. We don't seek out markets where we expect that to happen because we know best laid plans, maybe it will, maybe it won't. Always like to get lucky, but we don't rely. So you're looking for deals where you're going in under market value.
You know that there's a reliable metric there for raising rents and whatever the business plan surrounding that. Not necessarily any sort of projection after that, meaning once you're at the current market rents, it should be a good deal if you're gonna execute it, or slow growth appreciation, not anything like we've seen the last three years where markets were having 10, 20% year over year growth.
Joe Cornwell:
That makes sense. All right, let's shift gears a little bit. Tell me about biggest mistake or lesson learned and let's say the last year, because I'm sure you've answered that question in the past, in the last year.
J Scott:
That's a hard one. I'm trying to think what lessons we've learned in the last year. We haven't done very many deals in the last year. One thing I would have done a little bit differently, so I guess this is the big one, and I learned this lesson in 2008 and I kind of remembered it, but I didn't remember it enough, is how important cash is. You tend to forget after 15 years of easy money in this business, you kind of forget that you can have a year where you don't make anything. So having cash just to pay expenses, just your everyday living stuff, but also more importantly, or not more importantly, but as importantly, having cash to jump on opportunities. Because there may not be any great deals today, but anytime you have a market like we have today, at some point soon, good deals are gonna be coming down the pipeline. And having cash on hand gives you a big advantage over those that are relying on partners or relying on debt or whatever it is. So we certainly kept more cash on hand this time than we did in 2008.
But in retrospect, I probably didn't learn that lesson well enough. And if I had to do it over again a year ago, I would have stocked away a lot more cash.
Joe Cornwell:
Yeah, it's interesting you say that. I believe it was you, and I could be wrong. So if I'm wrong, I apologize. But I believe it was you, and this might have been two or three years ago. And I don't know, maybe it was bigger pockets. I'm not sure what show you were on, but I heard you talking about same idea. We think the market's at the top, stockpile cash, have access to cash. Now's the time to get on low interest debt. This was the time in which you were talking about this. Obviously none of us really saw what was going to happen after that.
J Scott:
This was literally 2018. And it was the reason I got into multifamily because I said, what asset class do I want to be involved in if we're heading into a recession? Yes. It was multifamily. I was off by about three years.
Joe Cornwell:
Yeah, that sounds right. And what's funny, though, is that while that was obviously great advice, it's always great advice to have you heavy on cash, then we hit the COVID massive inflation, right? So that kind of came out of nowhere black swan event because I was in a similar vein following people like you listening to good advice and saying okay I want to stockpile as much cash as I can. Well then all of a sudden it's like wait a minute if we have nine ten percent inflation and we got cash in the bank well now that money's getting chewed up. So all of a sudden then it became oh okay well I actually need to deploy this. It's interesting how quickly that dynamic changes. So I'm sure a couple years ago your viewpoint on that would probably be different than it was a year ago and obviously different than it is today.
A little bit because there is a lagging effect, but keep in mind, 9% inflation led to 6% treasury yields, and we're no longer at 9% inflation. So 9% inflation last March led to under 4% inflation today, but 6% treasury yields. So there was about a 6 to 12 month period where your cash was losing a tremendous amount of money, but if you wrote out that year with your cash and just stuck it in treasuries right now, you're now beating inflation in treasuries and you still have that cash sitting. So again, there was certainly six to 12 months where you were negative, but that has a way of working itself out in the market.
Joe Cornwell:
Yeah, that's a good point. A couple of last questions. We'll do the lightning round. So back to the affordability piece, and I wanted to get your opinion on this. And you may have been one of the people I've heard say this, but when you look at America and I don't want to get into the politics of it, but I would have assumed as an American citizen that the last administration the current administration came in they would have been looking to increase affordability for lower income I think that would probably safe assumption for many of the voters obviously that hasn't worked out of the same in the way they wanted it to where do you see that going is there a government intervention of some sort does America look more like Europe in the next ten twenty years we were your thoughts on that long-term where we're at?
J Scott:
It's a really important question, but it's a really difficult question. I'm a big proponent of the government stepping in and helping people when people need help. I'm also a big proponent of the government not doing that more than necessary. I'd like to think I'm pretty centrist on the issue. So unfortunately we have this two party system that's pretty polarized right now where one side tends to be more pull yourself up by your bootstraps. The other side tends to be more. Let's take care of everybody, whether they need it or not. And I think both sides are operating from extremes right now.
So I do think to a large degree, whichever party is in power over the next few years is going to determine whether we start to see government regulation around housing and affordability. I think if the Democrats stay in power, I think we're going to see a lot more than that. I think if the Republicans get back into power, we're probably going to see less of that than we should see.
I think either way it's going to be too much of an extreme. But I think long term the market will figure it out. I actually would prefer the government for the most part to stay out of it, other than perhaps incentivizing people like you and me, incentivizing investors to help the market fix the problem directly. And what I mean by that is we already have incentives for developers to build affordable housing. So we have tax credits and we have other things that federal governments, state governments, county governments, local governments are providing to incentivize us to do that.
The problem is when things get so out of whack when it comes to costs, cost to build and rents and labor material costs, when things get so far out of whack, the incentives that the government's offering right now just aren't enough to make it worthwhile. We can make more money going out and buying market rate properties than going out and building affordable housing solutions. So I think the solution if I were in government is I would bulk up those incentives so that at the end of the day, yeah, the government is stepping in, the government is spending money to fix the problem, but they're handing it down to the investors to create market based solutions, not legislative based solutions.
Joe Cornwell:
Yeah, I can't agree more with that. One of my goals for next year is to get into new development, single and multifamily building, new construction and construction is my background in business.
So it's extremely difficult. Even here in the Cincinnati area where you can get land relatively cheap, if you go out from the city a little bit, it's almost impossible to make the numbers work and as much as I would love to build affordable housing, it's almost impossible even when you find some of those local jurisdictions that give some of the CRAs and tax incentives and things like that, it's just not enough to offset the rapidly increased cost of construction. Also, I love that perspective. All right. Let's transition to the best ever lightning round. You ready?
J Scott:
Let's do it.
Joe Cornwell:
All right, best ever book you've read recently?
J Scott:
Book I read once a year because I love it so much. It's called Thinking Fast and Slow by Daniel Kahneman.
Joe Cornwell:
Never heard of it. Tell me just a quick synopsis of it.
J Scott:
Best book I've ever read. Daniel Kahneman is a research psychologist, I believe, and it's all about how the brain works. And so it helps make sense of how people think and how they ration rationale and what drives us in our motivations and things like that. And it's a little bit of science, it's a lot of great data and studies, and as an entrepreneur, you're going to get a ton out of it.
Joe Cornwell:
I will check that one out. Best way you like to give back.
J Scott:
What I want to be doing isn't necessarily what I am doing, so we've been talking for a couple years about starting a foundation and hoping to do that soon. But these days I'm very involved with a local organization, a food bank in my area. So I volunteer a few times a month and I help raise money and things like that. So these days it's directly involved, but I would love to be raising money as well through a foundation.
Joe Cornwell:
I already asked you for a recent lesson learned. Give me one. If you had to pick out one in the last 15, 20 years you've been investing.
J Scott:
So I like to say that I have flipped 450 houses or so in my career and I've made about 450 Snow. The biggest lesson I've learned is the value in holding property. The lure of those big buckets of profits is really nice, but holding property is where the long-term wealth building comes in. So I've ignored the cashflow. I've ignored the tax benefits, ignored the loan amortization benefits to my detriment over 10 of those 15 years. And I wish I had those 450 properties back. I would have held everyone.
Joe Cornwell:
That's awesome. That's great advice. And I couldn't agree more. Where can people learn more about you or get in touch with you?
J Scott:
Jscott.com. letter Jscott.com and that'll link you out to everyone.
Joe Cornwell:
Awesome, J I appreciate it so much for joining us today. I'm sure everyone learned as much as I did. Listeners, if you learned something today, please leave us a five star review. Follow us on all our social media platforms. Follow J Scott if not already. Like I said, I've been a big fan for the last seven, eight years that I've followed you. I've learned a ton from you. I really appreciate it. I hope you'll come back and join us again. Hope everyone has a best every day. Thanks everybody.
Narrator:
Hi, Best Ever listeners, Joe Fairless here again. And one last thing before you go, would you like to receive a short weekly email with proven tips from experienced investors, free tools and resources, and a roundup of the week's most relevant news and Best Ever content? Well, if so, join the community of nearly 15,000 commercial real estate passive and active investors who receive the Best Ever newsletter. Just go to bestevercre.com forward slash access and you'll get the very next one. I hope you enjoyed this episode, and as always, thank you for listening, and have a best ever day.
