JF933: Your FORMULA to Buy 5 Rentals in 2 Years and Payoff in 7!

Complete Episode

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. We only talk about the best advice ever, we don’t get into any fluffy stuff.

We spoke to Barbara Corcoran from Shark Tank, Robert Kiyosaki, the author of Rich Dad, Poor Dad, Jay Papasan, the co-author of The ONE Thing with Gary Keller, and a whole bunch of other best-selling books.

With us today – Andrew Holmes. How are you doing, Andrew?

Andrew Holmes: Doing great, how about you?

Joe Fairless: I’m doing well, nice to have you on the show. A little bit about Andrew: he is a real estate invest and founder of ChicagoCashflow.com, which is Chicago’s number one flipping team. He’s the radio show host of Real Estate Live With Andrew Holmes. He has over 160 rental properties and based in Chicago, Illinois.

With that being said, Andrew, do you wanna give the Best Ever listeners a little bit more about your background and your focus?

Andrew Holmes: Sure, so my background was a real estate agent since I was 19 years old until about 33-34. In 2008 it was the first time I started with flips. For a couple of years I had done well as a real estate agent, but I kind of found myself on a treadmill, so I switched to flips, which worked out quite well in 2008, 2009, 2010, but what I found was I had traded it in for a bigger treadmill. It was kind of a rational sort of a business, and I didn’t want transactions, I wanted investing.

In 2011 is when the focus shifted to about 60%-70% of all properties that we touch today go into a rental portfolio. The key is that it needs to be paid off in 7 years or less. That’s basically what we focus on today.

Joe Fairless: Did I hear that right, you pay the properties off in seven years or less?

Andrew Holmes: That’s correct.

Joe Fairless: So you own your properties free and clear within seven years, that’s the goal…?

Andrew Holmes: That’s the goal. We use a formula we call 2-5-7 – that’s kind of where it started. In two years how do you accumulate a minimum of 5 properties and get them all paid off in 7? You can do that 2-10-7, 2-20-7… The formula doesn’t change, it’s just the number of properties, how much cash flow do you wanna create a month; you scale based on that.

Joe Fairless: And please educate us – how do you in two years get five properties and have them paid off in seven?

Andrew Holmes: Most people, whenever they own rental properties, they tend to buy rental properties in areas that are rather challenging. We have a different philosophy, which is we tend to buy in bread and butter areas, right next to what we would call premium areas. Basically, if premium areas are A, we tend to buy B- or C+ category areas.

The other requirement is whenever we’re buying a property, after rehab it must have a minimum of 25% equity. Also, it must have [unintelligible [00:05:04].03] We focus on buying small three-bedroom, one and one-and-a-half bath ranches. They must cash flow to the tune of 400-450 dollars/property after all expenses, including management.

The biggest challenge people have is that they try to invest in properties with residential loans, and the scale at which they can grow is hampered, because you need seasoning on those, you need all those types of issues. What we always do is we buy them with commercial loans. Basically, a five-year balloon with a 25-year amortization type of a loan; it’s a commercial loan at five, five and a half percent. The speed at which you can scale and grow is much faster, and the seasoning requirements [unintelligible [00:05:52].01] so you’re borrowing money to buy the property, you’re borrowing money to do the rehab, and then you’re going to a commercial lender, refinancing it and then putting the money back to do the second one, the third one, the fourth one and the fifth one.

Joe Fairless: There’s a couple keys here: one is finding the properties that meet the criteria that you just mentioned, the other is having the lender lined up that works with you on that. Let’s talk about the lender real quick; who do you use for the commercial loan?

Andrew Holmes: For commercial loans we typically tend to go to the small banks that are in town. Every town has like a small X, Y, X bank or trust type of a bank. Typically, they have anywhere from one to five, ten, fifteen, twenty ranches. That said, we’re not gonna go to Chase Bank and we’re not gonna go to the big lenders, because they don’t really offer these programs for small investors. So typically, we tend to go to them.

B2R – your listeners might have heard of them… That’s another place. Their rates are a bit high compared to local banks that we can find, but typically they’re local, small banks. Every community in America has those.

Joe Fairless: Let’s say we know a community bank or credit union in our area – we definitely do. When we walk in the door, who do we ask for and what questions do we ask.

Andrew Holmes: That’s a great question, because you always wanna go and directly talk to the VP. Typically, at these small banks the VP is pretty much the main guy there, and that’s the person you wanna approach. You do not wanna talk to a residential loan officer, because that’s where the teller or somebody at the front is going to try to push you to, because that’s really what they’re familiar with. But you really wanna go directly to the VP of the bank.

What you wanna tell them is that we’re looking for properties that are purchased, rehabbed and they already have a tenant in them. So they’re stabilized properties when we go to these types of lenders, and there’s cash flow that comes in. As you know, that covers a ratio of about 1.25, but our minimum standard is that every property that we take to them has a minimum debt coverage ratio of at least 1.5, 1.6, 1.7, so we’re well above their thresholds.

First they have a hard time believing that you can even do these numbers, but once they look at them and they see you have a nice equity position, they will tend to give you 70-75% (in some cases 80%) of appraised value.

If it’s okay, can I give out some numbers, so that listeners will get a little bit better idea?

Joe Fairless: Yeah, I love it.

Andrew Holmes: Okay, great. Basically, let’s say you’re buying a bread and butter property, three-bedroom, one bath ranch for $65.000. You’re gonna put $20.000-$25,000 into rehabbing the property. You have another carrying cost of another $5.000-$6.000, so you’re all in cost into the property is somewhere around $90.000. This is the most critical part, which to me is investing, versus what most people do, and that is the property needs to appraise on a conservative refinance appraisal for $120.000-$125.000-$130.000. That’s the key thing – that’s the only way you’re gonna be able to get all the capital that you put into the property out, so that you can efficiently recycle the same money over and over and over.

So the property appraises for about $125.000. The lender is gonna give you about 75% of appraised value. We can get more technical with it, but for starting out purposes, that’s the key thing. That’s the benchmark people have to look at. If the property appraises for $120.000-$125.000-$130.000-$135.000, now they’ll give the $90.000-$95.000 refinanced.
So you put that loan, you pay your first lender off – the lender you used to buy the property and to do the rehab – and then you just recycle the same funds. Or if it’s your own money, that’s fine also, but you just repeat that process over and over and over, goal being you need to get to a minimum of five. Obviously, 10 is better, 15 is even better, but five is the critical number.

Joe Fairless: With the questions… Going back to walking into the bank, and we are in front of the vice-president, and we are asking the questions about the minimum debt coverage ratio that they look for and what we’re anticipating… You went into some of the business plan, which is great, and it helped clear things up a little bit – or at least, not clear things up, but paint the picture… What specific questions would you ask of him or her as the vice-president so that you get the answers to what you’re looking for?

Andrew Holmes: What we’ve always done is when we walk in, we tend to describe them really briefly (in two minutes or less), kind of an elevator pitch as to what we do. What I typically say is “Hey, we’re buying foreclosure type of properties or investment properties that are rentals. When we come to you, they’re gonna be purchased, they’re gonna be already stabilized – they like that word – there’s already an existing tenant. We do two-year to three-year (minimum) leases only; we don’t do short-term leases” and we explain to them why and what the philosophy is and how we wanna aggressively pay down properties.

First, they’re kind of shocked, like “You actually do this?”, and then their head starts nodding as you start getting into more technical issues, which is “I know typically most banks look for 1.2/1.25 debt coverage ratios. Any property we bring to you is gonna have 1.5/1.6 debt coverage ratios”, and we’ll show them a couple of actual examples. If you’re brand new, just show them a property of two maybe that you have in the works, that you plan to do.

The key thing to understand is a lot of these small banks will have a footprint in an area. Let’s say in X, Y, Z community – they wanna lend in a community that is typically around that area. They’re not going to go in a big city like Chicago — if a bank in the Southern part of Chicago, typically they’re not familiar with the North Side. They might say, “Yeah, that’s a market, but that’s really in our footprint.” That is key to understand – where you ask them to lend is also a very critical piece whenever you talk to these lenders. A lot of times, they’ll be able to tell you yes, that is something that they would be willing to look at.

Now, some banks, when you go to them they’ll say, “Well, we won’t do the rental part of it, but we’ll do the purchase. We’ll help you on that end.” Or “We don’t really wanna do onesie-twosie loans, we want a minimum of 5-7 properties at a time.” So it just depends on what the appetite of that bank is.

Back in 2011, literally, I had to go to about 30 or 40 banks to find one. Today almost every bank that I walk into, they’re more than happy, they jump up and down, because the mood of the market has changed quite a bit, obviously, around the country.

Joe Fairless: One thing that you mentioned as far as the bank’s footprint – maybe it’s too far out, even if they’re within the same city… Would you recommend identifying your submarket and then looking at the community banks and credit unions within that submarket and going to them first?

Andrew Holmes: I think you hit the nail right on the head. There’s a site that people might be familiar with that they can go to, which is called Bauer Financial. Any state that they live in, they can go to that particular website and look up which are all the small banks in that area.
Whatever community you live in, I would just draw a 10-15-mile radius around it, and then start with the ones that are closest to wherever you’re going to buy properties. Especially if it’s in a B market, a C+ type of market, then the banks that are local in that area, they have depositors from that particular area and they need to make a certain amount of loans in that particular market. So that’s the first place you start.

As you start developing relations, as you start having credibility with a particular bank, they’ll scratch their arms a little bit for you, but in general, the place to start always is the community banks – they wanna have a relationship; it’s a relationship sort of a lending, and they really like that word. If you go in and say, “Hey, we wanna develop a relationship with you” and you tell them that you’re gonna put your rental deposits in their bank, they’re all over that, because that’s really what in the long run they’re looking for. It’s not a one-way street. Especially, we’ve had lenders that have developed relations with us for a long time now.

In 2010 or 2011 when we started accumulating these, they’ve literally in Chicago helped hundreds and hundreds of lenders. They don’t have a [00:14:38].10] stringent criteria. For people who may not have a W-2 income, they’ll work with 1099. If somebody doesn’t have a W-2 or 1099, but has retirement income, they’ll work with it. If somebody doesn’t even have that but has some assets, a good portfolio in the stock market or just cash – they’re much more forgiving and they’re not as sensitive, even in the department of credit scores.
They’re not gonna analyze everything to that debt, and they’re not gonna ask you where did the forefathers come from. We like a traditional, residential bank; every single thing you have to explain. They tend to be very willing to work with you.

Other advantages… As you work with these commercial banks, you can buy properties in your LLCs, you can buy properties in your S Corps, you can buy companies under a trust… Let’s say you bought a property with a partner – at the time of closing, you can [unintelligible [00:15:30].19] over to whatever company you want… There’s a ton of flexibility if you really understand how to work that niche.
That’s been a godsend to us when we found these commercial banks, and there’s tons of them. There’s always a pro and a con to it, and the only con to these is typically these institutions tend to have a limit. They’ll do 3-4 loans for you initially, then they’ll say “Okay, let’s stop. You need to bring in your tax returns and then after February we’ll again start doing more.” Next year they’ll do 7-8, and once you reach a threshold typically of about a million dollars or so (850-900), they’ll kind of put the brakes on, and a lot of times they have a lot of sister banks that they do business with, and if you develop good relations with them, they’ll be happy to refer to you, and your business becomes easier and easier to grow.

Joe Fairless: Outstanding information. Best Ever listeners, the Bauer Financial can be found at BauerFinancial.com. I had not heard of that. I went there, and it’s great. You can search for credit unions in your area. I’m sure you’ve heard me mention this before about what we’re talking about, which are portfolio lenders – community banks and credit unions. They keep the loan in their portfolio, therefore they can be more flexible with the terms, and they don’t sell it on the secondary market like the Bank of America, Wells Fargo, Chase do, typically. It is their own loan, and that’s why they can be more flexible.

You mentioned talking to them about providing a stabilized property, with a tenant. That assumes that you already have the money to buy the property in the first place. What about someone starting out, wanting to implement this strategy? How would you get finance initially? Or do you just need to save up the cash to do so?

Andrew Holmes: No, absolutely not. I’ve never – even today, even though we happen to have obviously a significant amount of accumulated cash, still it can be done three different ways. Number one, you can partner with somebody that has the capital and do a 50/50 joint venture. They buy the property, they put up the money for capital – that’s one way of doing it. Obviously, you’re the driving force, you’re doing all the work, but you’re giving up 50% if the returns. That’s where I started initially.

The second way to do it is the traditional route, which is you borrow money from a hard money lender, and put some of your own money. The third route, which we tend to use the most, and that is understanding — I’m sure on the podcast you’ve talked about private money. Probably that is the biggest bonanza for real estate investors, which is join your local REIOs, join the local groups; whichever town you’re in, there are tons of them. There are people that are willing to make loans out of their IRAs, they have personal money, and you end up paying anywhere from 8% to 12%, and that’s what we tend to do and that’s what we always try to get people to understand – there’s a lot of money out there where people are willing to loan for the front end of the transaction. So that’s a great, great way to start.

Either partner for it, go to a hard money lender… The rates can be rather high there, but my first choice always is private investors.

Joe Fairless: Best Ever listeners, if you are doing a flip, which is not what we’re talking about, or talking about improving it and then holding on to it for the long run – which I like much better than flipping it… But if you are doing a flip and you’re needing cash, then FundThatFlip is a sponsor of the show, and they have opportunities for you on that.

What is your best real estate investing advice ever, Andrew?

Andrew Holmes: I would say this… If you take care of real estate for the first five years, it will take care of you for the rest of your life. Most people screw that up because they don’t build it on the right foundation. Whenever you look at long-term building wealth, you have to learn how to take care of the foundation, which is the first five years. If you take care of that, the rest of your life you’re pretty much set, as long as the first foundation is made properly.

Joe Fairless: I love that philosophy. I love how you started out by talking about the transactional nature initially, and then more of a long-term approach. One other follow-up question about the business model… I mentioned it requires a great lending partner, but then also your ability to find these deals that qualify, so that you do have the ability to take your money back out and roll it into the next one because of that equity. How do you find those deals?

Andrew Holmes: We find the deals in three places. In Chicago about 15% of the market is still just sales. That’s down from about 40% if the market, so obviously it’s going in the right direction, stabilizing the market. The last transactions we find with auctions, the Sheriff Sales type of places… We’re still buying quite a bit on the online auctions. Obviously, the MLS, and still in today’s market when there’s multiple bids going on, there’s not as much competition for buy and hold type of properties.

Most people are in the rat race of trying to do a flip, which god bless them, but that’s just not a strategy that we — we do some of those still if there’s a wide margin and it doesn’t fit our rental criteria, we’ll still do a flip, but that’s basically just additional income. That’s not our main focus.

The last place, which is probably the most ignored one, which is probates, free foreclosures… Some sort of distress; a lot of villages have issued fines, out of town homeowners… We have started doing a lot of direct marketing directly to sellers, to find properties that way. We’re looking to do about 80-100 transactions a year, and we have another group of people in Chicago that buys another 200, kind of onesies or twosies, and we’re able to find about 200 deals no problem. Our market is so large, that still that exists as long as you know what your back end numbers are.

The key is to know the numbers, to know the neighborhoods like the back of your hand.

Joe Fairless: Are you ready for the Best Ever Lightning Round?

Andrew Holmes: Absolutely.

Joe Fairless: Alright, let’s do it.

Break: [00:22:00].19] to [00:22:55].08]

Joe Fairless: Best ever book you’ve read?

Andrew Holmes: Rich Dad, Poor Dad.

Joe Fairless: Best ever deal you’ve done?

Andrew Holmes: Bought it for $12,000, and we keep it, and it’s worth over $150,000.

Joe Fairless: Where did you get the lead?

Andrew Holmes: Actually I got while driving for DOMs.

Joe Fairless: You’re driving around and you see a distressed property, and then you look up the owner and you call the owner? Or how did it work?

Andrew Holmes: I was driving around, I saw a really bad driveway, windows were all messed up; it looked like a house that clearly was distressed, so I called the owner and he said, “Well, it’s going to auction, and I want nothing to do with the property.” We approached the owner and we paid him 2,000, paid off the $10,000 mortgage and that was the end of the story.

Joe Fairless: What would be the incentive for him to sell it for $2,000 out of pocket?

Andrew Holmes: He had already moved out of town. The village had put a whole bunch of [unintelligible [00:23:52].28] on the property, so they would not negotiate with them. When we went to them, they were like “As long as you can give us an affidavit and a $10,000 deposit, the property would be brought up to code as per our requirements. We will renegotiate all the liens, all the things that they had put on it. It was only a $900 ticket. In Chicago in some places the charge is $7,000/day for violations, because they don’t want boarded up properties.

So we negotiated with the village. He just thought that it was an impossible thing to solve. He should have hired an attorney and rework the whole thing, but he just didn’t know what he didn’t know, and he was out of town.

Joe Fairless: Best ever way you like to give back?

Andrew Holmes: I think the best ever way I like to give back is share what we know, because the more that I share, the more openly information is shared, the more we get to grow; a lot of times people hold this belief, “Why would you share so openly?” I’ve always laughed, that every time I share, I get back so many more folds, because people give back in ways they don’t even know. The best way of learning is to teach others to do it.

Joe Fairless: What’s the biggest mistake you’ve made on a deal?

Andrew Holmes: Getting greedy and not trusting your gut instinct when it says no. It doesn’t matter how good it sounds, pass.

Joe Fairless: And lastly, what’s the best place that Best Ever listeners can get in touch with you?

Andrew Holmes: They can reach us at info@ChicagoCashflow.com.

Joe Fairless: And Best Ever listeners, the .com URL is in the show notes page. You can just click through and go check out the website and get in touch with Andrew and his team.

Andrew, thanks for being on the show, talking about how you and your company are buying 200 properties a year in Chicago. The long-term approach — not transactional, the long-term buy and hold approach of finding a property that is distressed or undervalued, increasing the value by forcing appreciation through renovations or talking to the city, getting the liens dismissed or paying a nominal fee to get certain things taken care of, and then going to a portfolio lender, putting that loan under the portfolio, and then recycling that money into the next deal and then paying that off over the term with the cash out proceeds from these new deals.

One question I have – to pay off the deal on the five-year balloon, are you simply paying that off from money from a previous deal? Is that how you do it?

Andrew Holmes: No, so the deal is that you accumulate fives. On an average, if you accumulate five, with the numbers that we do, you’re gonna have about $3,000 cash flow a month. So you start attacking the mortgage number one. Let’s say it takes you a year to accumulate five properties; you wait for about three months, build a reserve, and then after the fourth month you take the cash flow income from all five properties, attack property number one. That’s gonna take about two, two-and-a-half years (with our numbers) to pay off. The second property is gonna take about 19 months, the third property is gonna take about 13 months, and so on and so forth, depending on how quick you pick them.

That’s the reason why the five number is critical. If you do a proper rehab, appropriate for the next 5-7 years, put tenants on a 2-3 year lease minimum. It won’t work if you sign one-year leases, because you want stability for the long term, you don’t want tenant turnover at all. It’s okay to get a little bit less rent, but what you’re really looking for is a high-quality tenant so that you don’t have any downtime as much as possible.

Then you’re using property cash flow from five properties to pay off number one, then it builds, then you pay number two, number three, so on and so forth.

Joe Fairless: That makes sense. Thank you so much for being on the show, Andrew. I hope you have a best ever day. We’ll talk to you soon.

Andrew Holmes: Joe, I love your podcast. Thank you so much for having me on.