Episode #63: Gary Beasley and Gregor Watson, “We’re Trying to Really Change the Way People Invest in Real Estate”
Guest: Gary Beasley and Gregor Watson. Gary and Gregor are the CEO & Co-Founder and Chariman & Co-Founder, respectively, of Roofstock. Gary has spent most of his career building businesses in the real estate, hospitality, and tech sectors. Immediately before Roofstock, Gary was co-CEO of Starwood Waypoint Residential Trust (NYSE: SWAY), one of the leading Single-Family Rental companies in the US. Gregor is a serial entrepreneur who most recently founded two companies in the Single-Family Rental space, 643 Capital and Dwell Finance. Gregor is considered one of the early pioneers of the Single-Family Rental space, raising some of the first institutional capital in the sector.
Date Recorded: 7/18/17
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Summary: In Episode 63, we welcome Gary Beasley and Gregor Watson, co-founders of Roofstock. If you’re one of our listeners who has written in requesting an episode on rental real estate, be sure not to miss this one.
We start with some quick background on the guys, how they came to found Roofstock, and the way in which their company is aiming to make rental real estate investing far easier. In essence, they want to simplify things by separating the “investing” side of rental real estate from the “operational” side of owning a rental home.
After the background, Meb starts with a broad, contextual question: So how would a new rental real estate investor start?
In the old way, you would identify a market in which you’re interested, look at tons of homes, make some offers, perform due diligence on the ones where the offers have some traction, renegotiation the price and finally buy, then find a property manager to handle operations for you.
But the guys then tell us how Roofstock is making this traditional process far simpler. Basically, the home and rents, tenant, and local property manager have already been vetted and approved. You see the various yields ahead of time. This enables investors to buy without all the traditional brain-damage. The guys tell us “Our goal is to make it incredibly easy to get exposure to the asset class (rental real estate).”
What follows is a wonderful discussion about some of the traditional challenges with rental real estate, and how Gary and Gregor are helping investors overcome those challenges. The discussion touches on how to compare rental homes across different markets… Evaluating rental homes via gross yield, net yield, IRR, and on an after-tax return basis… How Gary and Gregor arrive at rental home valuations… Financing versus all-cash buying…
There are also great tidbits of rental real estate investing wisdom dropped in. For instance, did you know that the total cost to a home-seller to vacate, spiff up, and sell is about 10-12% of the sale price? Did you know that the average cost of a property manager is about 7-8% of collected rents plus a separate leasing fee? Guess what percentage of rental real estate owners live within about an hour of the homes they own? You’ll find out…
Later in the episode, Meb asks about the range of yields on the various rental homes featured on Roofstock; specifically, why wouldn’t he invest in a handful of homes yielding, say, 25% versus those yielding just 5%? Is there a parallel here to high-grade bonds and junk bonds?
The guys tell us, yes, lower yielders tend to be the safer investments, whereas the higher-yielding homes are a bit riskier. But both potentially have a place in a rental portfolio, depending on the needs/goals of that investor.
There’s much more in this episode: the difference between buying single-family homes directly versus investing in a REIT… How to think about starting and building a rental real estate portfolio… How much time an investor would need to commit to being a landlord when not using a property manager… What happens if there’s another 2007… And Gary and Gregor’s single best piece of advice to listeners interested in starting with rental real estate investing.
What is it? Find out in Episode 63.
Links from the Episode:
Transcript of Episode 63:
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Meb: Welcome podcast listeners, today we have two special guests with us, Gary Beasley and Gregor Watson. Gary and Gregor co-founded Roofstock which connects real estate investors with lease rental properties. Before starting their company Gary was Co-CEO of Starwood Residential Trust, and Gregor founded two companies in the single-family-rental real-estate space. So if you’re one of the listeners who’s been writing in requesting a show on real estate, this one is for you. Gary and Gregor, welcome to the show.
Gary: Thanks, Meb great to be here.
Gregor: Thanks for having us.
Meb: I’m gonna apologize ahead of time if I’m a little sniffly, I have a little cold, I don’t know who gets a cold in July. But I managed to get one so much that Jeff is sitting outside of the recording studio because he’s afraid of getting sick. So if I’m a little sniffly I apologize.
But before we start one of the reasons I wanted to have you guys on the show is I don’t know anyone who’s ever had an investment conference at Squaw Valley before, but not only at Squaw Valley, I see you guys managed to hold an investment conference in an Irish pub. Did I have that right?
Gary: The Auld Dubliner. Absolutely. We actually not only did we have a conference in an Irish pub but we had one of the world’s top extreme skiers and athletes there, JT Holmes, who skied with some of our attendees the next day, and it was pretty incredible. So it was a good excuse to get a bunch of wealth managers to a pretty cool part of the world and talk to them about what we’re doing on the investment side, so kill two birds with one stone.
Gregor: I always feel like some of best decisions are made over a pint or two.
Meb: Very cool I hope this becomes an annual event, I have a lot of stitches and sutures and broken bones from Squaw. So one of my favorite places on the planet.
Before we dive in and start talking about real estate why don’t you guys just tell us real quickly about yourselves? I’d like to hear the origin story of how y’all two met, how you ended up starting Roofstock together, and just kind of a real quick overview of the company, before we, kind of, dive into real estate in general.
Gregor: Sure, so this is Gregor I’ll give you kind of my quick background how we got into the single-family space. So I’ve always been an entrepreneur, started in land and home building and managing money for some family offices [SP], and then saw the opportunity during the downturn to start buying master-planned communities from home builders.
So started doing that, then saw the opportunity to start buying single-family homes way below replacement cost. Thought it would be a good idea if we could rent these out, you know, we could send our investors some dividend checks, but it’d never really been done in scale.
So 2009, started buying houses, developing some technology to manage effectively, efficiently manage homes, kind of, throughout the Bay area. Ended up building that business into one of the top 10 owners of single-family homes in the country. It’s a national platform.
During that time built the debt business in the space but then also, which we sold to Blackstone. But had 1500 homes in Dallas and I wanted to sell 500 of them and they were rented. We had renovated them, they were rented. And I started calling brokers and the first woman I talked to she said that she didn’t have 500 signs. And I just started laughing, so your biggest issue is you don’t have 500 signs. I’ve got $50 million worth of the real estate I wanna sell.
So I called the next broker, and the next broker asked me when I was gonna move the people out, so that they can put a sign in the front yard and sell it to a homeowner down the street. And that’s kinda the genesis of where Roofstock was born.
We knew that we had done the hard work on these houses, we had renovated ’em, we’d put good tenants in there they were producing real cash flow, and the best buyer for those homes wasn’t necessarily in that neighborhood in Dallas, it could be in Hong Kong, or San Francisco, or New York. So we wanted to create a marketplace.
And so started thinking through that idea. Met Gary. Gary was, you know, running a big public company at the time in this space, and we started talking about the idea of exposing this asset class to the world.
And then, taking it a step further and really creating a transaction platform that eliminates the cost and friction associated with buying and selling homes.
So our goal… you know, we have a couple key things that we look at, at Roofstock, but one of them is how do we make this a more efficient transparent market? Make it better for the seller, better for the buyer? And then the other one is, for the buyer, how do we separate investing from operations. So that’s where we started and we’re two years into it now.
Meb: So I thought for today’s chat one of the ways we could structure it, and… you’re talking to someone who’s never owned a house. We talk a lot about on the podcast is four real big ways to make big money in investing. One being owning a business. Second being, being the bank. Third is, kind of, following the trends and that’s more of a trading system side, and then fourth is really holding the keys. So having income-generating real-estate property, and we don’t talk that much about it.
So for the listeners who probably aren’t as familiar, although ironically most people listening probably are more familiar with owning a home, than a lot of the other esoteric topics we talk about. Maybe we’ll talk about how, in general, how to evaluate properties, and moving on to tenants and leasing, and the pain points and the hassles which have always made me wanna shy away, and then how y’all saw those opportunities.
So first, with that framework in mind, I’m on blabbing on, but where should our listeners start? When you start to think about people looking to add rental real estate to their portfolios, you know, kinda before you guys, what are the options? How do people go about it? If I wanted to buy a property, how do people do this, for the past 50 years?
Gary: So this is Gary. So the old the way really to identify a market you might wanna be interested in, let’s say you live in Seattle and you wanna own property in Florida. You would fly to Florida, look at a bunch of homes, make a bunch of offers, hopefully get one or two of them accepted, and then you would do diligence and probably end up re-trading the price based on what you find. Maybe you end up with one. Then you have to find a property-management company to manage it for you. And it’s quite expensive and inefficient to do that.
As a consequence, about 70% of all rental homes today are owned within an hour’s drive of where the owner lives. Which is not a great diversification strategy from an investment standpoint, because you tend to be totally tied to where you live from an economic cycle standpoint.
So if you look at the way it’s done at Roofstock and you’d like to invest in a market that might be counter [SP] cyclical to where you live, we do all that in a very transparent way. So you could look at properties in markets all over the country, you can evaluate their diligence materials.
They’re already leased so you don’t have to worry about what they would rent for. So the home itself has been vetted, the tenants have been vetted, the local property managers have been vetted.
So at the end what you end up with is a much easier process, we charge sellers a lot less than conventional channels, so they can pass some of that savings along to the investor. And you can monitor your performance on those investments, through the app that we’ve developed. And we monitor that as well and provide some ongoing support, if you buy through our site.
So our goal is to make it incredibly easy to get exposure to the asset class, we’ve got people you can talk to about, you know, specific homes or markets or just investing in the asset class in general, or you could be very much a self-serve person if you know what you want, and know where you wanna do it, and you could do it yourself just through our website, and kind of [inaudible 00:09:36] in between.
Meb: So maybe we’ll walk through an example. You know, I spend some time on the site it seems like… and feel free to correct me because I have 1,000 questions. You know, it seems like there’s over, like, 400 properties on there, and, you know, they seem to range from maybe one hundred grand, up to $1.2 million or maybe… Sorry, excuse me. Forty grand up to $1.2 million. And so a lot of, kinda, what you guys built is the technology to make this whole process simpler.
So now that you’ve removed, sorta, the neighborhood kind of hassle of someone trying to go and buy rental properties because that’s how most people do it. You know, they’re in their town and they have a little value add. So now you’ve removed that, so you can invest anywhere. How do people start? If I’m looking for a house to buy where do I go? Like, what’s the criteria? What should I be thinking about?
Gregor: So I think you look at the goals of owning a rental property is you’re looking for cash flow you’re looking for long-term value appreciation, in a very tax efficient way. So that’s why people like… and you can lever your positions. That’s why people like owning rental properties. And everyone’s got their own way of viewing the world.
The way I typically like to look at it, is I start a very macro view. Okay where do I wanna invest globally? What do jobs look like? What does the population growth look like? And what are some of the hotter markets where I’ve read about, I’m interested in? Whether it’s Florida, Atlanta, Dallas and then start looking at… and what we’ve done at Roofstock is, you can now compare homes in Atlanta in a three star, or four star neighborhood, against homes in Dallas that are three star and four-star neighborhood and look at yield. And yield is really just a way to define cash flow.
So if, am I making 5%, 6%, 7% on my invested dollars? And so what kind of cash flow is that gonna give me on a monthly basis? And then outside of that we provide… all the inspections are done, so you can look at the home you say, “Okay I like this house, I like the return it’s providing, I like the macro story of Atlanta,” for example.
Now you can look at the photos, the 3D tour, and pick it, and put it in your basket. So I think it’s just like buying anything else. You wanna start a very high level. We put a lot of research on the site, and then you drill down and you start looking and comparing, you know, a home in Dallas against a home in Atlanta, and figuring out which one do you like more.
Meb: And so you guys currently are domestic only, right? Just in the U.S.?
Gregor: Yeah, we’ve got a lot of interest from foreign investors and people that want us to build out this market in, you know, the U.K. for example. But, you know, we’re currently in 14 markets in the U.S. and growing into a few others, the back half of this year.
Meb: I assume that’s part of the recently raised $20 million round? By the way, congrats guys…
Gregor: Thank you.
Meb: …for that expansion. One of the things I noticed on your site, so you go on there, maybe you identify the markets you’re interested in. By the way, we have Jeff’s high school town on there, Winston Salem, Jeff and I both, as well as recently moved into LA. So let’s say I narrow it down to a couple places. It looks to me like you guys have valuations set. Is that sort of like a CarMax model? How do you come to the valuations for the properties on the site?
Gary: Yeah, so we use a number of different third-party tools to evaluate value, and we put those on our website. So in the Diligence Vault there. So people we know will look at Zillow, we use a group called HouseCanary, we’ve used a few others.
The goal is to be transparent, and remember an appraiser’s value or an estimate of value is it’s just an estimate. It ultimately comes down to what it’s worth between a willing buyer and seller. But we do provide that sort of transparency because it is important for a lot of buyers who do wanna use financing, for the property to appraise. So our goal is to put as much of that information out there as we can.
We’ve developed some technology, internally, which we haven’t made live yet on the site, which estimates the probability of sale at different prices for example, and we’re perfecting that algorithm and that’s gonna continue to get better.
But we think we’re probably as good as anybody in the country at valuing rental properties because, we can look at for sale and existing comps that have sold, and we know where things are trading also, on an income basis. We know what investors are looking for on our site and how much homes should be worth on the marketplace today. So we should be getting better and better at predicting value, and allowing sellers to choose a price that meets their liquidity preference.
So some people may say, I wanna choose a price that will allow me to sell the home in a day and get liquidity faster. And others may say, I’m fine in waiting 30 or 60 days and ask for a little bit more and try to get it. And sorta, everything in between.
Gregor: The point of what we’re trying to do here is, in creating a marketplace, is provide the data and the transparency. So we don’t own these houses. We just provide all of that context for a buyer and seller to make a good decision.
We wanna make sure that the seller, you know, gets a price that makes sense for them, and that the buyer gets the value that they think makes sense for their side of the equation. What we’ve done in creating Roofstock is, we’ve created a very efficient way through that transaction to happen and reduce the cost.
So what that means is that the buyers can actually sell for a little bit less but net more proceeds, and therefore the… sorry the seller can sell for a little bit less and net more proceeds, and the buyer gets a better value going in. You don’t have the 6% brokerage commission. You don’t have that downtime of moving the renter out and putting it on the market, you know, which, you’re losing cash flow.
Gary: Yeah, so we’ve done the math. The total cost to a seller vacating a home to sell it on the MLS, spiffing it up a little bit to sell it, and paying a brokerage fee, is about 10% to 12% of the value of the home. So even if they sell it for full, fair market value they’re netting about 88 cents on the dollar.
Through Roofstock, the tenant stays in the home there’s no need for any of that Cap Ex or downtime, we charge a fraction of that fee. So it’s a couple points 2% to 2.5% is typically our fees.
Meb: And I assume that comes out of… kind of is it on both sides the seller and…?
Gary: [inaudible 00:16:10] seller. Yeah, it’s made by the seller, and we do charge a half a point marketplace fee, on the buy side, to use our platform and get all the diligence materials.
Gregor: Which ends up being about $500 to $600 dollars to the buyer. But what’s included in that is pretty interesting. Our background, Gary and I bought about $4 billion worth of houses over the last few years, across the country. And so we are bringing to the platform a lot of that institutional knowledge, but also that institutional pricing.
So, if you’re a retail investor and you go out and you try and get a home inspection you’re gonna pay anywhere from, you know, $700 to $1,500 just for the home inspection. Title work is gonna be much more, insurance is gonna be much more.
What we include on the buy side, is only once you decided to buy the home, you get the valuations that are done, you get the inspection that’s done, the pre-work on that title, 3D imaging and underwriting of the tenant. So all of that’s included once you’ve elected to buy.
Meb: I have so many questions. All right. So one, okay, so the cool thing about this in general, if you’re an investor, is that the properties already have tenants, and so there’s already kind of a defined income range you’re gonna get. So if you go to the site and you’re searching properties it says, “Here’s a house in Winston Salem, it’s a million bucks and, you know, you have a gross yield of 10% because this person is in there.
How do you guys kind of… is there any way to screen the tenants? And do most of the buyers then… And I don’t know if you have analytics on this… then just run it themselves or do they use a property-management company? What’s the process? Like, okay they decide to buy it. How do most people then manage the property?
Gary: First of all, the front end of your question we look at tenant ledgers and validate payment history. We make sure there’s a proper security deposit. It’s all part of our tenant certification. Look at the screening that was in place when that tenant was put in place, make sure they’re current on their rent etc. So we put them through that screen. So the homes that are fully certified on our site have the tenant-certification box checked. Right? So that’s first and foremost.
Then, when most people buy the homes they tend to pick one of our recommended property managers in that market. So we typically have two or three property managers that we have vetted, in those markets. And during your checkout process, you could select which one you want to take over the management of the home, if it’s not gonna be the incumbent property manager. Sometimes it is, but the majority of time the seller is not gonna retain management. That all gets transferred over during the closing process.
And by the time you close and take title to it, you are the owner, the property manager’s in place, and they handle all the leasing, repair and maintenance, any collection issues, things like that. It’s all handled by that local property manager.
Some people do choose to self-manage. It’s a small percentage of the people buying through the site today, but some people do choose to do that. You pretty much have to live in the market to be able to do that efficiently. And right now over 93% of our retail buyers are buying in markets where they don’t live. So in those cases, they’re pretty much all using third-party managers.
Gregor: The big thing that you get, that we find is, when we go into these markets, so you go into a Houston or Dallas. We have a team that goes and interviews all the bigger property managers in that space, we find the very best two or three. We negotiate on the behalf of our clients, a discounted rate. We work through the contract to make sure there’s no issues there and we certify that property manager. So it’s a full diligence dive on those property managers. Kind of a Good Housekeeping seal of approval on those guys. They now become part of our platform. We don’t get paid from them, we just wanna make sure there’s a good experience.
And then on a go-forward basis what Roofstock does is, we provide a digital layer of asset management that is between you, as the investor, and the property manager. So if you don’t wanna get the phone calls, you don’t wanna deal with the day to day, we can handle all of that through our app. We also provide reporting, accounting, all of the things that you would need in running a property, or a portfolio of properties, through the Roofsavvy app that we’ve just launched.
Meb: So if you’re deciding to go the property management route, that’s interesting that it’s 90% plus, but it makes sense given that most people are coming to you for the convenience of, kind of, collateralizing these asset class. What’s the cost or what’s the take for a property management company? I mean, I have no idea. Do they do it as a percentage of the total-rent budget?
Meb: Is it a per-month fee? What’s typical?
Gary: It is usually about 7% to 8% of collected rents, and then there oftentimes tends to be a leasing fee that’s charged in connection with the lease. But it’s all transparent on our site, you can see what the property managers charge. And all those expenses are built into the pro forma on the site.
So when you look at these net yields on our site, if it’s 5.5%, 6%, 6.5%, that’s after the estimated property-management costs, as well as an estimate on vacancy and turn costs, and all that. That’s already built into the [inaudible 00:21:34].
Gregor: Yeah, it’s net, net, net. It’s basically your cash flow after all expenses.
Meb: And why don’t you guys explain that, real quick, just for newbie investors. Because there’s a couple different sort of yields and numbers on there for people who don’t understand. So you have gross yield, you have net yield, you have levered IRR. Maybe just a quick tutorial on what you mean by all those numbers.
Gary: Sure, the gross yield, very simply, is your annualized rent over your purchase price. So if it’s $10,000 a year in rent collection, and it’s $100,000 you buy it for, that’s a 10% gross yield. That’s the very simplest metric.
Gregor: And I think, this is very basic, but you really need to separate that gross from that net. So we’ll see a lot of brokers out there that will advertise the gross yield. And the gross yield really, it’s interesting, but it’s not what puts money in your pocket.
Gary: Exactly, that’s a great point. The net yield is, on our site if you look at net yield. So after all your expenses which includes, you can see repair and maintenance, property taxes, insurance. Really, any cost that you have, and property management, after operating that. This is before debt. This is assuming it was just a cash purchase. And let’s say in this example, if it was a 10% gross yield. Let’s say it’s $5,000 of cash flow after all those expenses. That would be a 5% net yield, on that same $100,000 home.
And then the third metric that we have on there is called Internal Rate of Return or IRR, and that’s your annualized return on your equity investment, assuming debt financing is put in place. So that’s after debt service, it assumes a five year hold period and an appreciation assumption, which is highlighted in the upper right corner there, of our listing sheet.
You can adjust that to be a 1-year projection, a 5-year historical a 20-year historical average or you can play with it and plug in your own number.
So now IRR is a measure of what your annualized total return would be on that investment, if you bought it today and generated the cash flows that are projected in the model, and you sell it at the end of five years, assuming the appreciation that’s outlined there.
Gregor: Need to [SP] add a little bit on some of the different terms and how we get there, but I think the most important piece of this thing is that… It is twofold. One is the unlevered cash flow. So really what you’re looking for is, what kind of free-cash flow am I getting at the end of each month from owning this house? And the other thing is that, you can lever at 50%, up to 80%.
So I look at my own portfolio. I look at, okay I can buy using a Fannie Mae loan, I can buy up to 10 houses and lever it at, you know, up to 80%, 30-year fixed financing at 4%, and I’m buying something that’s got a 5.5% or 6% unlevered yield. I’ve got a very good spread between what I’m paying my debt, and what my net cash flow is. So I’m positive there, and I’m using that leverage to get a nice portfolio. So your current levered cash flow is, you know, kind of 8%, 9%.
The thing that’s really interesting about owning real estate as opposed to owning debt is, it’s very tax efficient. So that you can shield a lot of that current cash flow by depreciation of the asset.
So a lot of people will compare their pre-tax earnings, so they’ll say, “Okay I’m getting 9% buying these loans, I’m getting 9% buying these homes.” But really, what you need to look at as an individual investor is, what is your after-tax return? So when you can depreciate that asset shield, you know, 30%, 40% of that income, it looks, you know, much more attractive than what you see in some of the other asset classes that are out there.
Meb: Two quick questions. Do most people you find, that are investors, are they financing the homes?
Gregor: Yeah. The majority of our retail investors are financing the home. It really just depends on risk appetite, kind of, where you are. Some people finance at 60%, they just never really wanna, you know, worry about coverage. And then other people that are, you know, a little bit more aggressive are taking full financing from Fannie Mae up to 80%.
Gary: What we’re finding is a number of people are coming to our site not really knowing that there’s investor financing available, that’s attractive. And let’s say they have $100,000 that they’re looking to invest, and they’re thinking they’re gonna buy a single property. They’ll get on our site and they’ll start engaging with our advisors and learn that they can actually borrow 80%.
So for that 100,000 they could buy, you know, potentially four or five homes, maybe in some different markets, and build a diversified portfolio, where the cash flows really efficiently, with that financing.
So some people just wanna own a single asset or two without debt, and others want to maximize the number of assets that they can own, and take advantage of that financing. They’re both good options.
Meb: I think, here’s a question a lot of listeners would probably have, is you are looking at all these 400-plus options in the marketplace, same as an investor, maybe, would be looking at MLS or all these other stats and statistics. And you have kind of projected yields ranging, again, from low single digits all the way up to almost 30%.
Are the yields seen as in, kind of, the traditional risk-return spectrum where, you know, in many asset classes a lower yield in most cases tends to be a safer investment, and a 30% yielder [SP] is a Greek bond, is that the case here? Or are there some other dynamics at play? Like, why wouldn’t I just go buy a bunch of 25%-yielding houses and go from there?
Gary: You’re exactly right. I would think about it very much in bond parlance, a lower yielding, kinda, 4.5% to 5%, you know, yield on our site, would be more like a AAA bond. The lower-yielding assets are like more like AAA investment. Great bond, much lower risk, lower volatility, perhaps a lower total return, but it’s more safety and security. And we have a neighborhood score, which we just rolled out last week on our site, which I would encourage people to go look at.
We’ve rated all 72,000 census tracks in the United States, and you can see the five-star neighborhoods and the four star are less risky than say one and two star. When you go into the one- and two-star neighborhoods you’re thinking more junk-bond type returns, in that you can get higher coupon, higher yield, but you’re gonna have probably more variability, and some risk of loss, when you’re seeking the higher return.
Meb: What are the main inputs there for that score?
Gary: We’ve got a number of different inputs. It’s things like median home price, percentage owner-occupied versus rental, quality of school districts, employment growth, a number of factors like that. That all can go into an overall score, that measures, kind of, the overall quality or risk of that neighborhood.
When you talk about risk and return, that’s the exact reason that we introduced this neighborhood score. So what a lot of people end up doing is, figuring out what’s their risk appetite, and then start looking at properties that are similar, across the country.
We have some people who just wanna look at four-star neighborhoods and above, and just want safety and security. They’re willing to accept the lower return. Other people say, “You know what? I’m young, I wanna see a little bit higher return, I don’t mind variability. I’m gonna finance maybe a little bit more conservatively. And I’m gonna try to get higher returns on my equity. And I’m gonna go into more of some two-star neighborhoods,” for example and, kind of, everything in between.
Meb: Maybe thinking about not just individuals diversifying, but institutions as well. Is this something where… Have you guys ever thought about any sort of advisor-facing options or funds? Like, there’s no way for someone to come in and be like, “You know what I just wanna buy a part of 10 or 100 houses. I don’t necessarily wanna do all the due diligence.” Do you guys have any sort of… I’m sure you have five different things in the works, but anything in that sort of vein?
Gary: Yeah it’s funny that you say that because, we’re working on that strategy right now. We’ve had a lot of people contacting us and say, “Hey, I’d really love to just put money into a fund. Do you guys have sort of a real estate ETF, or something like that we can invest in by market?”
So we’re talking to a couple different fund sponsors who will be looking at aggregating homes in different markets, with different strategies, so people could come in and get exposure to a… think about it as a fractional interest in a pool of homes.
So very much as you’re talking about. Very efficient, you still get the direct exposure, very low fees. But you could develop your own kind of strategy of, “Maybe I wanna put some money in a Midwestern high-yield strategy and some in a California or a coastal strategy.” All of these things could be set up as the, sort of, focused ETFs and it would be a lot of [inaudible 00:31:14].
Gregor: One of the big things we’re trying to do is, we’re going to really change the way people invest in real estate, from a load [SP] perspective or a fee perspective. A lot of the private funds are very high cost, and a lot of the public companies have very high costs. There are some good things about public companies, they are very liquid, but they’re also correlated to the stock market, and the dividends are very low.
So we think we can create a better mousetrap for people, private investors, that wanna invest in real estate and provide a lower cost way to get exposure to an asset class by using technology to do a lot of the oversight accounting reporting, and then let people, you know, experts pick them up.
Meb: You may have just touched on my next question, which was devil’s advocate, why wouldn’t someone just go buy a REIT, like Silver Bay. Is that what you meant when you said public company?
Gregor: Yeah, public company, that’s exactly right. I mean, Gary’s probably a better person to talk with since he ran one. But I’ve heard the spiel of, when he was a public-company CEO why it’s so great to invest in a REIT, and then now I hear the other side. You know, I think, the thing that I think about when I’m investing in real estate is, across the board, asset levels are at an all time high. Right? So equities are really elevated, a lot of commercial real estate’s really elevated. And so if you’re gonna try and do something that’s uncorrelated to that stock market, binary is not the way to do it.
So, you know, you’ve got things that are an elevated level, you wanna get something that’s uncorrelated and so you want direct exposure. So you don’t wanna be tied. So when the stock market moves the REIT stocks move with it.
The second piece of this is, running a public company is very expensive, so there’s huge overhead, really expensive people that you’re hiring to manage it. That eats into your dividend. There are reasons to own REITs, but I think if you’re looking for direct exposure and a higher yield you wanna figure out the most efficient way to own real estate directly.
Gary: I think Gregor, you summed it up quite eloquently. Having run a REIT I’m pretty familiar with the pros and the cons. And the pros really are, it’s very easy. You’ve got perfect liquidity and really broad diversification. But it does tend to act more like a stock. And so if you feel like stocks are… I view my REIT holdings as one of my equity holdings, it happens to be a real-estate company. These are very much stocks. I view the homes that I own as my real-estate holdings.
So the only other thing I would point out is… that Gregor didn’t mention. You can pick your markets more. So if you wanted exposure, if you say, “I’m a real believer in Texas,” or, “I’m a real believer in North Carolina,” you could buy homes in those markets, but if you’re buying a REIT, you’re buying something that’s pretty broadly diversified.
You can also use leverage more efficiently at an asset level. If you’re doing it for yourself you could borrow 80%. The REITs tend to be, kinda, 40% leverage or less generally, because that’s the way REIT institutional investors like them to capitalized.
That’s just another advantage which means your distributable cash, your return on your equity, that you can get with a properly constructed and properly-managed individual portfolio, could be higher because of those factors.
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Meb: So if someone’s thinking about this there’s two obvious questions in my head. One is, how do you start to think about building a portfolio? Because, you know, just the same as buying one stock or buying an investment, one tends to be pretty risky. So is there a minimum amount of homes that you would consider to be kind of a diversified portfolio? And if so, I assume they would need to be in different geographies, or different star ratings. How do you think about, kind of, putting it all together?
Gregor: So look, I think part of what we’ve set up here, is your portfolios are always good. Kind of, the more the better, the more diversification the less variability you have on cash flow. You know, but I wouldn’t shy away from buying just one house. Buying one home if you’ve got the transparency that we provide, you’re looking at it, and that you have some reserves that you’ve set aside. So that, you know, if the tenant moves out and you have two months of downtime, you can cover the couple hundred dollars you might have in debt service.
You never wanna stretch to where your last dollar is into anything. Right? So as long as you’ve got the right risk tolerance, and that you’ve got some cash reserves, one home is a great way to start.
A lot of people that we work with have a goal of, kinda, buying one home every year and building up a portfolio for their retirement. Where their renter is paying down their debt they’re gonna have equity at the end of the day, they’re also gonna have cash flow. And that’s a very great way to build a pretty nice piggy bank of cash-flowing assets. It doesn’t need to be all at once to build a portfolio it needs to be, kinda, over time. If you can get the 3 to 5 to 20 houses that just depends on, kinda, your personal situation.
Gary: Yeah I think a lot of people are looking at diversification a couple of layers. The first level of diversification might be just getting some money out of the equity market into something like housing. So you’re diversifying just by getting on the stock market, which oftentimes moves, kind of, in unison. And then being able to buy in a market that is not where you live, gives you that much more diversification even if you’re buying a single house. And then over time, I think, people are looking to add properties, as Gregor says, over time which gives you an ability to have even properties themselves that are moving into [SP] different cycles.
Meb: I think that’s actually really good advice because, almost applying almost like a private equity, sort of, lends to investing in these homes because, I talk to so many friends that are getting into new things like angel investing. And I said, “Look, you need to commit to maybe, I don’t know, five-, seven-year timeframe where you’re gonna commit X amount each year because, you don’t know where you are in this cycle, and in that sort of equity world it feels pretty late.” But, to be able to commit in good times as bad, to be able to balance it out, and I think that’s some thoughtful advice for this too.
I meant to ask this earlier. Let’s say you have a portfolio of, I don’t know, less than five homes. One to five homes, what would you estimate if you’re using the property management services? How much time are you really spending on that per year, if you own a couple of homes across the country? Is it a consistent effort, or is it, kinda, just like, I deal with it at year end and that’s it? What’s the, kinda, time requirement? And then also what’s the time requirement if you’re doing it on your own?
Gregor: I’ll address the doing it on your own later. But I think one of the things that, you know, is a game changer with what we’ve built here, is the ability to own multiple homes in different markets, and not have to interact with each property manager.
You know, what we’ve created with our app is we actually pull in all the data from, let’s say, you have [SP] three homes in three different markets, with three different property managers. The old way would have been you would have gotten three separate statements, three different people you’d have to talk to and manage, and give feedback on certain pieces of the, you know, repair and maintenance, or a, you know, a new lease.
What we’ve done is we actually pull in all the data. So we consolidate all the information from each of those property managers, we provide you, in our app, one consolidated financial statement. We tell you exactly what happened last month, how much cash came in. Were there any expenses? And then we also, we do a lot of the math for you. Here’s your yield, here’s your, you know, a total return for the last quarter, for the last year. And then if there’s issues we actually will look at the data and if your water heater goes out in Tampa, and they charge you $1,000. Our data says, no it should be $600 in Tampa based on all the information we see. We’ll flag that for you. So we really try and separate investing from operations. If you’re using our certified property managers, you can kind of ease in [SP] [inaudible 00:40:29] as active as you wanna be.
But most of the people that we deal with, the whole reason they wanna invest with Roofstock is because they don’t wanna deal with this stuff. They want an allocation to private real estate but they don’t wanna, you know, be the manager.
Meb: So maybe like 10 hours a year or something? Twenty, 10 to 20 or something like that, is that reasonable?
Gregor: Yeah, I mean, I own quite a few homes and I just choose not to deal with it. The property managers deal with it, Roofstock deals with it. You know, there are other people that are really interested in wanting to know every $50 expense item and wanna talk about it, so, and that’s fine too…
Gary: Yeah, and on a typical monthly basis there’s really nothing to talk about. There’s the month… The rent comes in most of the time, on time, on schedule, and there may be some repair and maintenance items you get notified about, but it’s really, unless you’re self-managing and people are calling you because their, you know, their toilet’s clogged or things like that, that’s why people choose to use third-party managers.
So I think when you self-manage it could be tens of hours. When you use third-party managers through Roofstock it’s a very light [inaudible 00:41:39] of your time.
Gregor: You know, if you wanna get involved, and you know, if there’s a water heater goes out you wanna understand, okay, that’s maybe once every couple years, you’re gonna spend an hour on it.
If the tenant moves and you gotta release the home you may wanna understand what’s going on in the market. Can you push your rents? Spend a little time on it. Outside of that you’re not really dealing with it.
Now if you self-manage and you’re trying to save that 8% of collected rent, which really just isn’t, in my mind, isn’t that much, you’re very heavy on when you’re trying to find a new tenant. It’s very hard to do, when you’re out of market, so that’s why people tend to do it in their backyard.
Meb: It’s really interesting because we just published an article talking about investors that spend an amount of time… The amount of time they spend trying to beat the market and the analysis was, “Look, if you’re spending two, four, six, eight hours a week, you know, trying to beat the market, and, you know, you value your time anywhere, $20 to $500 an hour, it goes to show that, like, all this time spent… I mean that’s fine if it’s a hobby and you’re learning, and you’re considering it, that growth, that’s fine. But actually, like, the effort to think you’re adding value add it doesn’t even make sense until like the value of the portfolio gets above something like $20 million or $50 million.
This is interesting, kind of, exercise in this thought [SP], where it’s like, why would you do the house, or just use a property-management company. It seems pretty obvious.
Gregor: Yeah, I think, I mean, look the whole thing here is you’re just like betting into stocks or whatever, you’re putting an allocation into real estate. You made your assumptions on the market you wanted to invest in. And then you really… your whole thing here is, you just wanna get picked off. Right? And that’s where Roofstock provides that kind of, that oversight, where the property manager, or the tenant, or someone is not gonna do something that’s out of market, and we provide benchmarking.
How are you doing compared to the market? Should you make a change with the property manager? Or, is your insurance higher than it should be? That knowledge that we’re able to provide the retail investor, is huge value add, and it doesn’t require any time [inaudible 00:44:00].
Meb: So I got about three more questions and we only have about 10 minutes so these are gonna be kind of rapid fire. But all of a sudden, another 2008/2009 comes along… 2007/2009 real estate topped a little earlier. What would you, kinda, recommend to investors when they’re thinking about this?
I think it would be tempting for a lot of people to start levering up pretty large, would be what kind of cushion and buffer? You mentioned REITs earlier, which declined…. public REITs declined 70% in the financial crisis. Like, how should people think about, kinda, worst-case scenarios and, what, sort of, reasonable rules of thumb? Think about properties and the income as well.
Gary: Well I think that people I think have learned a bit of a lessons through the last cycle. Also I think what’s different now is you have institutional investors who will step in to buy these rental properties, when the prices drop because the yield get attractive.
So when you think back when Gregor and I first started buying homes in our last platforms during the downturn in ’09, 2010, there was really no institutional bid on those homes, and there was, really, very little owner-occupied bid. So we were able to buy those homes at a very low price. They’d dropped, in many cases, 50% from the peaks.
Today those same homes that have been purchased, renovated and have appreciated meaningfully again. There is, in my view, some downside protection for these homes that could be rented at a decent yield, by institutional investors who would view this as a buying opportunity.
So I don’t see the prices upping [SP] as precipitously as they did in the first downturn, when there was no institutional ownership for rental property. So that’s one thing to think about.
But I also think about, you know, when you own a rental property the maximum leverage you could put on it is 80%. A lot of our people are doing 70, that’s probably the average level that people are levering. When you buy a home to live in, oftentimes people’ll borrow 97%, 95%, 97%, so there’s very little equity cushion. You could be under water in your primary residence pretty easily.
So you’ve got a 20% or 30% equity cushion when you buy these investment properties, and most of our people are getting fixed-rate financing as well as opposed to floating rate, that could have a balloon. That’s what got a lot of people in trouble [inaudible 00:46:09] downturn.
Gregor: Yeah, I think, you know, when I look at this there’s, okay, think about what did people do in the past? They were focused on appreciation. Right? So they were willing to actually go negative-cash flow on a monthly basis because, home prices never went down. Oh, guess what? They can go down.
But what was interesting is, when we went back, we looked over multiple decades of data and we looked at what happened, especially in 2008, to rents. What happened was when the financial crisis happened and home prices went down dramatically, home building stopped. So there’s no new supply coming on the market. Those people continued to create families, we had population growth, so actually a demand for rental property.
So what you saw in the downturn was, you actually saw, as long as you weren’t on a, you know, balloon loan or that you were negative from a cash-flow situation, you saw your rents or your yields, increase over your costs basis. So, when I look at this from a downside perspective, I always like to limit the amount of leverage. But more importantly I look at, what is my monthly cost for that debt and what is my rent? And, how much cushion do I have till I get to where it’s breakeven?
If I have a couple hundred dollars in there and in a downturn rents actually increase, you know, I feel pretty comfortable that I’m gonna be able to ride out the storm. You know, there’s not many asset classes where you can look at your downside being just holding a little bit longer, but still actually getting as good or increased cash flow.
Meb: I have like three more pages of questions but we’re bumping into the final couple minutes. What’s the, kind of, biggest challen… Like, I imagine when we talk to the PeerStreet [SP] guys, which I know y’all are friendly with. One, you know, I assume they’re kind of a complimentary offering rather than, necessarily, a direct competitor, but they’ve mentioned the biggest challenge is, kind of, the supply versus the demand. How do you balance the amount of properties on your website for people looking to sell versus people looking to buy? Is that a big challenge? How do you, kinda, work with that?
Gary: Yeah really with any marketplace, balancing supply and demand is typically the biggest challenge, and depending on what week it is Gregor and I will be more concerned about one side or the other. Which is, I think, the sign of a healthy marketplace.
But right now we probably have over 10,000 homes at the top of our funnel that we’re evaluating to put through. We don’t wanna certify and put those homes on the site tomorrow because that would too much inventory. So we’re constantly trying to filter that through, and match that with the demand that we’re getting, as we continue to build our brand and get more and more consumer traffic.
But the good news is, there’s 16 million rental homes in America, that’s our target, is about $3 trillion of assets, and we’ve got as you mentioned about 400 homes, perhaps, on our site today, out of that 16 million.
Again, I hesitate to say, a limitless supply but effectively there is, of product here. We’re kind of the filter through which people hopefully, can see, and find, and shop for homes that have been put through onto our marketplace and just greatly simplify that shopping process. Let us do some of that heavy lifting for them. And then over time, we’ll spend more and more dollars attracting people to our website, and growing our brand and growing that demand side as well.
Meb: I loved one of y’all’s tweets talking about talking to an investor on the airplane who, by the time the plane landed, had invested in one of the properties. So podcast listener, if you bought a house by the end of the podcast certainly let me know. Particularly if it’s in Winston Salem, I’ll tell you where it is.
Last question because we don’t really have any time. What one piece of advice would you guys give to our listeners regarding making their first rental-real-estate investment what would it be?
Gregor: I think that the most important thing to do is to get in early. I mean, I wish I would have started buying, you know, houses as soon as I could afford the down payment, to start building a portfolio. You know, sometimes you sacrifice a vacation here or there to start building that portfolio so, you know, that’s important. And second thing is just make sure that you’ve got enough cash there’s always things that come up, it may not be in the first year or the second year, but at some point, the home will need a little TLC. So make sure you got, you know, a reserve there.
Gary: Yeah, I would say in addition to that don’t freak out if property prices drop a little bit. That’s the whole reason you invest for the long term, in this asset class. So if property prices go down, as long as you’ve financed it properly, it doesn’t mean it’s a bad investment just because it may have some variability in what it’s worth on paper. It’s only a loss if you choose to sell it or have to sell it during that time. So view it as part of a longer-term strategy. I like Gregor’s idea of, you know, just trying to buy, kind of, a kind of a home a year, so that, you know, you can do that, and then it’s almost dollar-cost averaging. You, kind of, buy through cycles, and at the end of the day you look back in 5 or 10 years and you’ve got a portfolio, that you’ve constructed over time and taken advantage of, wherever you are in the cycle
Meb: That reminds me of the old Charlie Mongrel, when he says the two biggest things that muck up investor portfolios is credit and chemicals. And so I think that’s great advice. Start early, start slow and don’t over lever yourself. Gary and Gregor, thanks so much for taking the time out today.
Gregor: Yeah, thanks very much Meb.
Gary: Yeah, really enjoyed it.
Meb: So where can people follow you? Twitter, website, where, if they wanna learn more, where do they go?
Gary: Yeah, @roofstock is our Twitter handle and they could go to our website, which is just roofstock.com and get more info.
Meb: It’s been a blast. Listeners, thanks for taking the time to listen in today. We always welcome more feedback and questions to the mailbag at [email protected]
As a reminder, you can always find the show notes and other episodes at mebfabershow.com/podcasts. You can subscribe to the show on iTunes and if you’re enjoying the podcast please leave a review. Thanks for listening friends, and good investing.
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