Are you someone who is asking “How can I buy my first investment property?” Do you want to learn about getting started in real estate investing to build passive income through multifamily real estate? During this podcast, we discuss and refute the three main objections to investing in the California real estate market and explain why none of them should deter an investor.
The top objections to California real estate that we counter are:
- High barriers to entry
- Low cap rates
- Properties are too expensive
Today we’re going to talk about California real estate, specifically SoCal real estate. Let’s start by giving a synopsis and your opinion on how the California real estate market is currently performing.
It was interesting, this year values were supposed to go up by four and a half percent, and then COVID hits, right? We’re thinking, “Geez, this is the worst.
We’re in a recession, so values are going to drop, right?” That’s not correct, big financial institutions such as Goldman Sachs, Wells Fargo, and JP Morgan are projecting that it’s actually going to increase by three percent. Even when you hit us with the worst possible situation of high unemployment and the recession, the real estate market is still going up. A lot of our clients are calling me saying, “Hey Juan, we’re looking for the best deals.
Clearly sellers are desperate.” To which I reply, why would they be desperate? They have tenants in place who are paying rent. Yes, they’ve changed the laws, and it’s getting a little tougher, but there are no desperate sellers because loans aren’t coming due. People are just hanging tight, and what we’re seeing is less sales because sellers are thinking, “With all this going on, I don’t want to have to sell at a discount.” To which I reply, it doesn’t mean you have to sell at a discount, in fact, we’ve been able to successfully list and sell properties at market value.
What’s happening now above the four-unit market is that underwriting has gotten really strict. Now as a buyer, you have to come in with even more down making it a bit more difficult. The current benefit though is that interest rates are still good. As we get further and further and further along, we’re not seeing a discount on the price of the property, so buyers start thinking, “Okay, let’s just go buy the best thing that’s out there.”
Yeah, I think the discount is in the interest rates right now. They’re down 100-120 basis points to where they were three or four months ago. Sure, you’re not buying on a higher cap rate, but you’re still getting a discount through that interest rate which is still a great buy-in if you’re a long-term holder.
I love what you just said. Yes, the discount is in the interest rate, and a lot of times I tell our clients, “Don’t focus on the purchase price, as that’s not what we’re signing up for. We’re signing up for the payment.” That’s it, I don’t need further analysis. Believe me, we could go deep into numbers, but we don’t have to do that.
Absolutely. So I brought you on today to debunk the myth of California real estate. I think you either love California as a real estate market or you don’t. I want people to understand that there’s potential to make a lot of money in any real estate market, and California is certainly one of those.
Because of the low cap rates, you can make millions of millions of dollars here quickly, so I want to start by asking, what are the biggest challenges of California real estate investing?
When I was looking through these questions I thought, “What really is the biggest challenge?” Honestly, I don’t see any challenges for buying in California. I’m an immigrant and I’ve owned over 30 properties and sold many doors, as a matter of fact, my first property I bought at the age of 23. If I could do it, how can it be a challenge to anybody?
There were three questions that I came up with. They are questions that I get often, “Juan, do I buy in-state, do I buy out-of-state? The barrier to entry is so expensive here.” First is the barrier to entry. What’s that even mean? If you wanted to go get a loan right now for a fourplex could you go get one?
Okay, so is there a barrier to entry for you to buy something? No. I see blue collar, young, and old people, and really anyone who wants to buy and qualifies for a loan buying something. I get people fresh out of college, hungry to buy. They’ve read the books, they’ve listened to a podcast like yours, and they’re thinking, “Hey, I want to get started.” FHA loan? Let’s do it. Live in one of the units for two years and rent out the others and then move on to the next property, refinance, etc. During COVID, we helped a vet buy a fourplex property at $1,355,000.
Through a VA loan, a lot of veterans are given a great opportunity to buy an investment property. That’s a tremendous opportunity for vets. Zero down with really, really low interest rates. The barrier to entry to me is made up because no one’s stopping anybody from buying anything that we don’t want to buy, that’s the first one.
The second is that cap rates are too low. When we look at the cap rate, we are looking at a snapshot of one-year ownership. Do you intend to own your investment for one year? No. You’re going to own it for 10, 15, 20 years, right? Why would you make a decision off of a one year snapshot? That doesn’t make any sense. Are you not going to raise the income, make improvements, and manage it better? Are you going to raise the net operating income and lower your expenses? Of course you are, so we can’t look at the cap rates. If you are looking or making a decision based on the cap rate as the only measure, you’re doing it all wrong. There are five or six other measures you should be looking at. If you know what you’re doing, and if you have the right team you could change that cap rate, so why does the first year matter so much?
The third is, the market is too expensive. What does that even mean it’s too expensive? Do you think it was not too expensive for my clients who purchased property 20 years ago? It was probably too expensive back then too, but they got started and knew that this was a long-term hold. In California, I look at things as a long-term hold. One thing that I was taught by my mentor early on was, it’s not get rich quick. It’s get rich, guaranteed. So long as you give it enough time, and that, to this day, is still absolutely true.
So those are the three. Okay, barrier to entry. Not true. Cap rates are too low. So what? It’s expensive. And I’ll say, “What’s that even mean?” If the income supports the debt, you’re perfectly fine, in my opinion.
So what about, the one thing I don’t like about California is the landlord friendliness of the state, which is not a landlord-friendly state. How can people reduce their risk when it comes to investing in a landlord-friendly state? Because it’s not a complete disqualifier. You just have to understand how to tackle that challenge.
Last year the state of California got hit with rent control. We thought, “Okay, what’s this mean? Are people going to want to get out?” One, even with rent control in place, have values dropped?
Even if the statement “California is anti-landlord” is true, did it decrease my value? No. Did it decrease my rents? No. Are sellers getting out of California because, “Oh my gosh, it’s the worst?” No. Not to mention during COVID, they hit us with the eviction moratorium in the city of Long Beach which means that you literally cannot get a bad tenant out. Even with those things in place I’m not seeing a mass exit of people saying, “Oh my gosh, sell my property at a discount, get me out of this. I can’t believe I made these millions and now they’re going to limit how much more I can make.” It just isn’t happening.
How do you prepare yourself? As an investor coming in you must be knowledgeable of what’s going on and navigate the waters. Here at our firm, we specialize in really knowing the rent control law. At one point we had two laws, the state-level law and the city-level law which competed against each other. With different rules, it made it really difficult for people to buy and sell apartment buildings, but all these changes are just rules and we have to learn to play within the rules.
I’ve never thought, “I won’t be able to buy right now,” but rather, “Okay, I just have to do things differently.”
Yep. It just sounds like it’s all about education and understanding the game you’re playing. As long as you understand the rules and how to utilize them to your advantage, then you can get around them.
Okay. So, let’s flip the switch here. What are some other things that you love about SoCal real estate investing right now?
So, there are some opportunities. With the larger units, units above five, they seem to be sitting on the market a little longer right now and the reason being because a lot of buyers who were buying all of a sudden have to come in with a bigger down payment which skews your investment figures. Buyers start thinking, “Do I really want to invest that much?”
Currently, I see a little bit of a stall in the larger investment properties and what is happening is that sellers start asking, “Why is my building not selling?”
Two months ago, I was saying, anyone who bought in the last three years was a first-time investor. If their rent stops coming in, some of these newer investors are going to panic. They’ve never had a building where the rents don’t come in, and all of a sudden they freak out and start thinking, “Okay, I’m done. I’m done.” We thought that there were going to be a lot of these people coming out saying, “Okay, get me out of the investment game,” but that hasn’t happened yet.
It could be that towards the end of the year we see more properties coming on the market because we know that a lot of investors held their properties. For that reason, I expect some good deals to pop up towards the end of the year.
What I love about the California Market is that if you decide to go the apartment route, the investment route, I’m buying something that I know that there’s demand for. There are people waiting to move in and pay a little more for a renovated building which is a very neat thing. Tenants are waiting to move in, and I don’t know that every state has that. As much as we hear that, “Hey, California is losing part of its population,”
The LA Times came out with a great article which says, “You are losing some of the population, but really, what’s coming in are skilled professionals. People with big degrees coming in who want to live in Southern California because of the location. You can imagine that if we have skilled labor coming into Southern California, they will want to live here and buy here which directly leads to continual rising of property values.
If you’re an owner you’re in a great position, and if you’re an owner of an apartment building, being a housing provider and providing good housing is more important now than ever before.
Yep. Can you still get cash flow in California markets? Or are they mainly an appreciation play?
That’s a really good question. There are parts of Long Beach that might not be the best areas for cashflow, but we could go out to Riverside County to Victorville and find ideal properties. There are areas where you could certainly go cash flow, as not all of Southern California is near a beach, right?
When it comes to cash flow, it all depends. We help clients come out of a property and they’re putting 50% down who can cash flow. Certainly, if you’re buying in with 5, 10, 15% down, my advice is to get you to a break-even point from day one. Moving forward from there, what changes can we make to the property? Where can we add parking? Where can we add laundry? All the things that we know a tenant is going to appreciate and pay more for. I’ll never say to just raise the rent for the fact of raising the rent, because what have you done to justify that? What lifestyle benefit or amenities are you giving the tenant to be able to justify that rent? So when people ask, “Hey, can we cash flow?” Of course! It all depends on the location and on your down payment.
Appreciation to me is king. In fact, I thought and have researched, who are our sellers and buyers? Our sellers are between 60 to 80 years old and have owned lots and lots of units for over 30 years. They’ve self-managed their units, and I joke around and say, they all have accents. This means they weren’t born here, and they weren’t given an apartment building at birth. They started from the bottom, purchased a fourplex, duplex, condo, or whatever they bought, and it went up. Now what I see is, they’ve made their appreciation.
Where do you see California real estate in the next three to five years? We’re obviously in a recession. Do you think it’s going to bounce back quickly? Where do you see it in three to five years?
In a recession, I know this is going to sound shocking, real estate actually goes up. Even though we’re in a recession, it doesn’t mean we’re in a real estate bubble and that real estate values are going to drop. Real estate performs differently in a recession.
During our last downturn in 2008 the values of real estate did drop, but it did so because we caused the recession. In our current case, this recession was not caused by real estate. As a matter of fact, real estate had strong fundamentals to begin with.
Where’s it headed? We all know that if you raise the income on a property, you’re raising the value significantly, and not dollar for dollar. If you get a thousand dollars more out of a building, you’re not raising it a thousand dollars in value, but rather we’re going to multiply that by 15, 18, 20% off that thousand dollars which is a significant increase in value.
Because of rent control, where we are now, we’re now restricted on what the increase could be per year that we could do. A lot of the landlords and a lot of our clients, even us, will go years, five to ten years without raising the rent. I know what you’re going to say, “Geez, that’s the complete reverse of what I’ve read. These books say every year you’re going to raise the rent.” I know it says that, but when you’re self-managing your units you’re not raising the rent every year because you build a relationship with your tenants and you want to help them out because someone has helped you out.
Here was the response from one of my mentors, “Now, because of rent control, I have no choice but to raise their rent. Somewhere around 8% every single year. Now I have no choice. If every investor says, “If I don’t raise my rent this year, I’m going to be behind,” now, rent control didn’t really help the tenants. It actually hurt the tenants a lot because every owner out there is going to be raising the rent by 8% every single year. So Kyle, Lalita, if I raise the rent every year by 8%, what happens to my value?
Yeah, it goes up. And 8% is a lot.
It goes up.
I don’t know any other market, or any market, where you’re underwriting for 8% rent growth year-over-year.
And here’s one other thing. In the past, you felt bad raising the rent. When you’re in the middle of this, there is no choice. Where we previously felt less need to raise rent and felt bad for doing so, now, it’s almost like, “Hey, due to rent control, we have to raise your rent.” The tenant is also accepting of it saying, “Yeah, I guess you’re right. Yeah. Thanks, rent control.”
So anyhow, where do I see it? I don’t believe that the recession is going to hurt us. Rents are going to continue to rise, and subsequently if rents go up values, go up.
Perfect. All right. Lalita is going to take us into our final four questions. Are you ready?
Let’s do it.
What is the one tool you use in real estate investing that you cannot do without?
A big question that I get is, “Juan, when did you decide to buy something?” Our goal is to acquire a new property every year, if not more than one, but there’s opportunities in everything. We’ve purchased condos, commercial, and multi-family.
CCIM is really, really good. In fact, I recommend anyone to look into that because that’s what gave me the confidence to advise my clients and myself on what I should buy. That analysis is really in depth and I realized that in the smaller scale of stuff, you don’t need that. So we created the stage 5-2-1 formula. What that is, it’s five evaluation metrics. Two investment strategies and an exit plan. So, I take any of my properties and any of my client’s properties through this 5-2-1 formula, and we get a real clear picture of if we should buy it? Under what metrics does it kick butt on? Where does it fail? What can we change after year-one?
And so, my 5-2-1 formula is something that I use to screen all properties and I definitely won’t buy any property unless I run it through that. That’s my formula, I didn’t pay for an app, it’s what I’ve created because I know that this has worked for me and my clients in the past.
Fantastic. Can you tell us a story about your biggest mistake in real estate investing? And what’s the main takeaway for our listeners?
I told you that I got started investing as a 23-year-old in college, and by the summer, after graduating, I had my first condo, bought a triplex, and then started buying more properties. This was in 2003. Then I had five years of this massive equity growth and I thought, “Oh my gosh, this is so easy. I’m so smart.” That was not the case, because there were a lot of mistakes that I made.
So, my two biggest mistakes. One, getting into short-term financing whether it is 12 months, 18 months, or 24 months. I no longer sign up for short-term financing. It scares me because here’s what happened. Short-term financing means that the financing is going to come due, and if the market dips quickly, you will get stuck and unable to cover that debt.
We were in negative positions on several properties and the loans come due, then you have to sell. Now you’re a desperate seller. That’s why I’m a very, very big advocate on four-unit buildings. When you buy a four-unit building you get 30-year financing, so you know that your biggest expense is going to be capped for 30 years which is a beautiful thing.
My biggest expense is capped, the one thing that is not capped is my rent which will keep going up. If your analysis stops there, you’re going to win. So, short-term financing… that was a big lesson.
The second thing is choosing the right partners. I’ve bought stuff with people and found really good deals. Because I’m a real estate broker, I get to see the deals first and get to decide whether I want to buy them or take them to my database? I saw one of your videos called, “Hey, this is not an individual event. You need a team behind you,” so a lot of buildings that we own we call our database. “Hey, do you want to buy this with us? Who’s going to qualify for the loan? How much money do we need?” Not having every partner in agreement on how long to hold the property is a problem because properties appreciate. New investors see some level of money and growth and they want to sell sometimes too quickly as to not maximize the investment.
Let me recap, my first one was short-term financing, I don’t like it. My second is making sure that you have that strategy in place and in writing before you partner up with anybody, because I will promise you that you’re going to have partner issues.
Thanks. What is it that you need to do now to grow your life to the next level?
There’s two things in my role that I need to be doing to grow, and the first thing is learn. I have to learn every single day. Learn from you guys, learn from people that are investing out-of-state, learn from folks that are buying industrial buildings, and people that are doing new things; that’s my first thing.
The second is, I have to be getting leads. In my case, I have two types of leads, leads on new clients and leads on new buyers. I need to be learning and I need to be focusing on leads; those two things will allow me to continue our growth.
Great. Well, thanks for sharing your knowledge and experience with us all today. We really appreciate you being on the show.
Kyle, Lalita, thank you guys so much. You guys are doing a great job. Impressed, like I told you earlier, you’re doing everything right.
Hey everyone, thanks again for tuning in. We really appreciate your support. If you’re interested in learning more about APT Capital Group and speaking to someone on our team, click on the link and schedule a call with us. We’re here to help, and we’d be excited to speak with you and get to know more about you and your goals. Talk to you soon.