Last Follow Along Friday, Theo mentioned that he has decided to sell his 12 unit portfolio. Joe was taken by surprise and wanted to really dive into the story with Theo on another episode of Follow Along Friday, rather than quickly mentioning it in last week’s episode. We’ll hear the mistakes Theo made, which is part of the reason why he’s selling now. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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“Anytime I had a few months of cash flow, I’d have to spend that cash flow to fix something else” – Theo
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TRANSCRIPTION
Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast, where we only talk about the best advice ever, we don’t get into any of that fluffy stuff. With us today we have Theo Hicks, as he is usually with us on Follow Along Fridays. Theo, how are you doing, my friend?
Theo Hicks: I’m doing great, Joe. How are you doing?
Joe Fairless: I am doing well, and looking forward to diving in today… Best Ever listeners, as a refresher, the purpose of Follow Along Friday is to talk about things that we are discovering and learning along our entrepreneurial journey, so that we can share those observations with you to help you along your real estate entrepreneurial journey.
Today we’re gonna be focused on Theo’s portfolio, that he has chosen to sell. Last Follow Along Friday he mentioned it, and it surprised me… And I was like “Well, we need to discuss this. I’d just love to learn more about the thought process”, and we didn’t have enough time last week, so we decided to dedicate today’s conversation to that.
Take it away, my friend.
Theo Hicks: I’ll just give my general thought process and then you can ask any follow-up questions that you would like. As most people know, when I first bought these properties we talked about them a lot on the podcast, and the issues that I faced and how I overcame them… But to take a step back, when I bought these properties my initial plan was to–
Joe Fairless: And taking a step back even further real quick – what is the property? How many units? Give us the lay of the land.
Theo Hicks: They’re three fourplexes, so a total of 12 units. All three fourplexes are in the same street. Two are right next to each other, and then there’s two houses in-between and then another fourplex. When I bought them, the seller was actually selling five fourplexes on that same street, that were essentially all in a row. I think there was maybe one property in-between. And I bought three of them about a little bit under what they were listed for – good thing, because I think they appraised for the list price, so I kind of had built-in equity right away with the properties.
But when I initially looked at them, based on my understanding of that area, I knew that the rents were low, even based on the condition of the units; the rents were just too low. So my plan was to go in, buy the properties obviously, and not do any value-add renovations right away, because all the leases were month-to-month leases… So I was gonna go in there and just raise the rents to market rates, and then eventually once I started to see other properties start to upgrade their units with new appliances, new floors, things like that, then I was gonna do that using the cashflow that I made during the year or two years that I was holding on to the properties after increasing the rents.
Everyone knows that’s not what happened. I thought that the properties did not have a high level of deferred maintenance because of the inspection that I received…
Joe Fairless: The boiler got you. I remember that.
Theo Hicks: And there was the boiler issue, and then there was plumbing issues… I had to replace multiple stacks, so obviously that involves breaking into the walls and replacing those cast iron stacks.
Joe Fairless: What’s a stack, for anyone who’s not familiar?
Theo Hicks: The main sewage pipe in the house. Like when you flush the toilet, when the tub drains and the sinks drain – it all pours down there. These older cast iron pipes were not only themselves corroded, but there’s all these twists and turns, and whenever there’s a turn, all of the crap literally will pile up in there, so the hole will get smaller and smaller until it gets clogged enough that it can’t go through it. So I had to replace multiple ones of those…
Essentially, every time that I would make cashflow for a few months in a row, I’d have to end up spending all that cashflow to fix something up.
So when I finally got to the point where the majority of the deferred maintenance was fixed up, I kind of had the decision of “Okay, I can either now go back and renovate these units and increase the rents by $100”, or since I have been able to raise the rents, I can liquidate, pull out the equity that I initially put in, as well as the extra equity that I have, and the money that I have saved up, to buy one property, a 20-unit, a 25-unit, or whatever.
My thought process behind that was 1) I wanna buy a property regardless, so it’s either I’m going to have these 12 units that I’m gonna have to take some of my personal money to fix up, which means that I have less money to buy another property that I will probably also wanna fix up… And it might not necessarily be right next to these properties, so I’m gonna have four or five or six fourplexes scattered across Cincinnati, as opposed to just having a 20-unit or a 25-unit in one spot, and using all that money to fix up that property. That’s my thought process behind it right now.
Joe Fairless: In terms of the numbers, can you give some concrete numbers for what option A is in terms of if you kept it and you put more money in, how much money all-in would you be? And any other relevant information there. And then option B is the option you’re choosing to do; what are the properties’ worth, what do you have into it, how much are you gonna come out with, projected?
Theo Hicks: Yeah. I bought each property for 220k, and I put 25% down. Everything that I’ve done to the property so far has just been using the cashflow from the property, so I haven’t had to dip into my personal bank account yet to actually fund any of these deferred maintenance issues.
Luckily, I had like 15k saved up, just in case something happened, and something did happen instantaneously for the boiler, so once I paid for all of that, I was able to just use cashflow to fix everything up… So from my perspective, I still consider myself in at 220k total, because I didn’t have to come out anything extra; it was just from the cashflow. Maybe I should be considering it differently, but that’s just kind of how I’m looking at it.
Joe Fairless: 220k per place?
Theo Hicks: Yeah, per property.
Joe Fairless: Alright, so 660k total.
Theo Hicks: Yeah. And then right now they’re listed at 275k, and assuming it goes around there, I would come out with between 45k, down to maybe 30k per property. Then once you take away the commissions, let’s just say 25k-30k per property so somewhere around 75k to 90k in profits.
Joe Fairless: That’s right.
Theo Hicks: But the biggest issue is that I could technically refinance and then use that capital to fix these things up, or I could use my own personal capital, invest it into this property to fix them up. Something else we wanna talk about too is the conversation we had yesterday about you selling your properties – what potential cash-on-cash return you would get with that capital by investing in something else, as opposed to investing it into your property. I haven’t done that exact analysis yet. I’m assuming it’s gonna come out to pretty much the same.
I kind of just wanna have all my units in one property and have that be my strategy moving forward. So every time I buy a property, I can fix it up, raise the rents, increase the value in some form or fashion, and then liquidate and then upgrade to a bigger property. So with this next property I wanna do the exact same thing.
Something that I definitely wanna talk about is some of the things that I’m gonna do differently on the buy side, but assuming that I put those into place, buy this 25-unit property, increase the rents… For this 25-unit property, the value of the property will actually be dependent on the rents, which is not the case for these, because they’re residential…
Joe Fairless: Right.
Theo Hicks: Force the value there for 2-4 years, and then sell again, and buy a 50-unit property, in combination with money I’ve saved up and the money I made from the property. So it’s less of — okay, this deal that I have right now, if I invest money into it, would it be a good idea? Obviously, it is, and anyone who buys it will be able to do that… It’s more of wanting to continue to get larger and larger properties, and just have one property in one location.
Joe Fairless: Okay. A couple questions. One, with your 12 units, the three fourplexes, are you currently packaging them as one opportunity, and then pricing it based on a cap rate? Because I’ve seen people do that with a portfolio of single-family homes.
Theo Hicks: That’s essentially how I got to my list price. I figured out what the total package would be worth, and then just divided it by 3 and have that be each of the individual property listings.
Joe Fairless: You figured out what the total package would be worth, but was that based on how residential is underwritten, or using…?
Theo Hicks: Using the net operating income and the cap rate.
Joe Fairless: Oh, okay. What cap rate did you use, do you remember?
Theo Hicks: I think it was 6% or 6.5%. I can’t remember exactly what it was, but 6% or 6.5%.
Joe Fairless: It sounds like a good cap rate, for you… [laughs]
Theo Hicks: Yeah. And I based it on a few other properties that were very close, that recently sold… Based on their rent, assuming that their expenses are close enough to mine… And those ones actually sold. One sold for a little bit over 300k, and that one was a stronger NOI than mine, and one sold for (I think) 240k, and the NOI was a little bit weaker than mine. But the cap rate would be the same, because they’re all in the exact same little neighborhood in Pleasant Ridge.
And regarding the last question about the packaging – on each of the individual property listings it mentions that this is one of three properties that are sold, and you can buy all of them or individually.
Joe Fairless: Okay. Are you asking them to pay a premium for one, or can they buy one at the same price as if they bought two or three?
Theo Hicks: The same price. It’s funny, because when I was initially buying these properties I was kind of thinking the same thing – “Oh, if I’m buying all three properties, maybe I can get them at a discount.”
Joe Fairless: I was thinking the opposite. It wouldn’t be a discount if you buy all three, but there would be a premium if you just bought one or two.
Theo Hicks: No, I don’t have that.
Joe Fairless: Okay. Just as a relevant note, you should post this in our Cincinnati meetup group, the three deals.
My next question – taking a step back, your focus is on apartment syndication, yes?
Theo Hicks: Mm-hm.
Joe Fairless: Okay. Why buy a 20-unit versus keeping this cash and then using it to put into the next deal that you do when you syndicate a larger apartment community.
Theo Hicks: I will. I’m not gonna use all the money that I have to buy… Because technically I could probably buy a 30 or 40-unit. I still wanna have — and obviously, personal reasons, like six months of personal expenses saved up, just in case something were to happen… And then we’re gonna keep at least our minimum investment amount for our syndication in our bank account, so that when we find a deal, I can invest in that deal as well.
Joe Fairless: Okay.
Theo Hicks: I wouldn’t necessarily say it’s for diversification reasons (maybe it actually is), but I do want to have my own properties on the side, for — not necessarily retirement, but just kind of continuing to build that up on the side. From my experience with these 12 units, it doesn’t take as much time, as long as I’m not managing them myself. It just takes speaking with your management company every single week for half an hour to an hour, to make sure that everything is operating smoothly… Of course, this is after you actually buy the property, and since I’m only buying properties every 1-3 years, that time investment is fine. It won’t really take away from my spending time on apartment syndication… I kind of just want that to be my 401K, in a sense.
Joe Fairless: Okay. And then the third thing is what you and I talked about yesterday when I called you up and I said “Theo, I’d love to get your opinion on how to think about this.” The scenario is the three single-family homes that I own, and one of the homes is coming up for a lease renewal, and the property management company did an inspection of it and it needs some help. They’ve got a dog, and he chewed up all the outdoor wood frame area, because apparently he wanted inside, but they weren’t letting him inside… And there’s a couple other things that need some lovin’. So whatever – invest in it, fix it up, fine with me; I’m looking at it from the long-term standpoint. But is it the best approach to continue to rent those homes out when there’s trapped equity in each of those three homes? And I’ve mentioned the numbers before on this show; I’ll just quickly mention them again.
The home are about 175k each, so in total 525k, and I have 157k in debt on them, so that’s about 368k. Let’s just say fixing them up, broker fees etc, I could probably net $300,000. So I’m removing 68k off the top, so about $300,000 trapped equity in total, from those three homes. So I came to you yesterday and I was like “Hey, how would you think about this?” And you went through an interesting thought process… Can you just talk about that a little bit, what we discussed?
Theo Hicks: Yeah, so how I thought about it was you’ve got a certain amount of equity trapped in the property that you could technically pull out and invest in something else, and get some sort of return… Something to think about when you’re looking at the situation is “Okay, so I’ve got this equity… What return am I currently making on that equity right now?”, based on whatever cashflow you’re getting per month. We came to the conclusion – this would be the selling scenario, based on how much equity you’d be able to take out if you sold, and then also based on how much cashflow you’re making per month, it would be about a 3% cash-on-cash return.
Joe Fairless: Yeah, because right now the three homes, year-to-date — or actually through March, so the first quarter of the year, they made $2,300. $9,200 for the year that they’re on pace to make. So you divide that by three homes, and you divide that by 12 – they’re making $255/month, each of the homes, on average.
So you said “Okay, $9,200 a year divided by the trapped equity that you have in it, which is 300k, that’s a 3.07% return on that trapped equity. Not so good. Can you do better than that?” I was like, “Well, yes.” We can do better than that when I take that 300k and invest it into our apartment syndications that I’m doing. Then it made it crystal clear to me that “Okay, I need to make a move on these homes.”
The other option is to refinance. And when I refinance these three homes, talking to the lender, I could probably get about 100k out from the homes. But then I’ve got a bunch of paperwork, I’d have three different loans, I’d have to go through the process, and my financials are not easily understood by banks, so there’s a long process that is just a headache. And if I can just rip the band-aid off… I don’t wanna be melodramatic; this is a quality problem to have, so I guess I shouldn’t say that way… But if I want to resolve what I’m trying to resolve, then I think just sell each of the three and then take that money…
So then the question is do I 1031 into something that you’re discussing, a smaller deal? Maybe a 600k-800k property. Or do I just bite the bullet, pay the capital gains and invest the difference in one of our deals?
I’m on the opposite side of the fence from you. I never want to have a 20-unit, or a 30-unit, or a 40-unit on my own, ever, ever, ever. I want to just pump that money into our deals, because I don’t wanna be on those calls every week, discussing a 30-unit. I have no desire for that at all. So I won’t be doing a 1031 at all, I’m just gonna bite the bullet, pay the long-term capital gains, and then pump it into our own deals.
Theo Hicks: Yeah, so I did the same exercise for my properties, and the ROI that I’m making on that trapped equity is around 4% to 5%. And again, [unintelligible [00:16:50].02] “Okay, what if I put in more money and I’m able to increase the rents? Now what’s gonna be the cash-on-cash return based on the new trapped equity and the new income?” It might be a little bit higher, but it’s gonna take time, and I’m gonna be in the exact situation with those properties that I would be with just buying a brand new property.
Something else I’ve mentioned was something on the buy side that I definitely need to do, and I know I’ve talked about this before, but just to reiterate – I really need to be a lot more detailed on my due diligence on the physical condition of the property. I need to not just look on the outside, very surface-level, like “Oh, this looks fine.” Certain things that I know need to be looked at in greater detail, and I can’t just pass those up. I can’t just assume the inspector knows what he’s doing. When I’m with the inspector during the inspection, I need to be like “Alright, can you please take a deeper look at the boilers? Can you please take a deeper look at the plumbing in the basement? And let me know based on what you see in the basement how would you interpret the rest of the property’s plumbing.” Things like that I definitely need to do upfront.
It’s so funny, because I don’t think I was as involved with underwriting for apartment deals when I bought these properties. I don’t think I was, because I definitely did not have our cashflow calculator at that time. I did not use that cashflow calculator to underwrite, so my underwriting was not as detailed either. It wasn’t the 50% rule and that was it, but it was definitely not detailed enough. I was not thinking about it properly.
Now I’ve gained so much knowledge in the past 2,5 years that I’ve owned these properties in regards to the underwriting process, so I’m very confident in my ability to find a much better deal in the sense of buying a much better deal on the front end, after I actually do proper underwriting and then proper due diligence.
Joe Fairless: I think there are a lot of lessons, and I’m grateful that you brought this up and we talked about it.
Theo Hicks: Yeah. Once I actually sell the property, I’d definitely like to go into more granular detail on it. Once I sell the property, I can talk about the numbers specifically, and then talk about more lessons that I learned, and then how do I plan for moving forward.
Alright, trivia question time. I always enjoy finding these trivia questions… It’s a fun exercise.
Joe Fairless: Yeah, and I enjoy getting the answers wrong, every time except for once.
Theo Hicks: [laughs] Last week’s question was more of like a fill-in-the-blank. It was “One out of three Fortune 500 companies are headquartered in this many markets, this many MSAs specifically (metropolitan statistical areas).” I think you said three. The answer is actually six. I think it was 180 out of the 500 are in six MSAs. This is from the least to most Fortune 500 companies – San Francisco was sixth, Minneapolis was fifth, Houston was fourth, Dallas was third, Chicago was second, New York City was first.
Joe Fairless: Minneapolis… Sneaky, sneaky.
Theo Hicks: That was surprising.
Joe Fairless: I wouldn’t have put them on that list. I was just there to see Texas Tech almost beat Virginia about a month or so ago, and I had no idea they had so many Fortune 500 companies. Huh.
Theo Hicks: Keep in mind that it’s not just the city Minneapolis, it’s the MSA; that includes Saint Paul. San Francisco includes all the places surrounding it… So that was the answer to last week’s question.
This week’s question is in 2018 the total number of jobs nationwide increased by about 1.8%. The question is how many markets (MSAs again) experienced a job growth 3% or greater? With the national average being 1.79% exactly, how many MSAs experienced job growth of 3% or greater?
Joe Fairless: How many total MSAs are there in the U.S.?
Theo Hicks: That’s a good question, I do not know the answer to that.
Joe Fairless: Approximately… Like 300? Well, you don’t know, so…
Theo Hicks: I can’t even give you that guess…
Joe Fairless: [unintelligible [00:20:38].06] same question, but you’re still gonna have the same answer, right? Alright, I’m gonna say four. I don’t know even where to begin with that one.
Theo Hicks: Alright. As always, submit your answer to the question either in the comments of this YouTube video, or you can e-mail info@joefairless.com, and the first person to get it correctly will receive the signed copy of our first book.
Lastly, we’re going to do the review of the week. If you purchase the Best Ever Apartment Syndication Book on Amazon and you leave a review and send us a screenshot of that review, not only will you receive a link to download the free apartment syndication documents and resources that we have available, but you will also have the opportunity to have your review read aloud on the podcast.
This week’s review is actually submitted via Facebook. It was from Cory B, who actually took a selfie with the book, and he said: “This is a phenomenal book. Joe Fairless.” And he posted that on Facebook.
Joe Fairless: Yeah, thanks so much for posting on Facebook and tagging me in all the comments from all your friends, and the interaction. I really enjoyed it. It reminded me that I haven’t interviewed you in a while. I saw Cory at the Best Ever Conference in Denver… So I’m looking forward to that interview that we’re gonna be doing.
And then on a separate note, but related to what we were saying, there are 383 MSAs in the United States… Guess how many there are in Puerto Rico? Real quick.
Theo Hicks: Zero.
Joe Fairless: Seven. [laughs]
Theo Hicks: Seven?!
Joe Fairless: Seven MSAs in Puerto Rico, yeah. It happened to be in the same Google search, so that’s why I mentioned it. Well, Best Ever listeners, I enjoyed hanging out. I hope you got a lot of value from today’s conversation. Have a best ever day, and we’ll talk to you again tomorrow.