We’re wrapping up our three-part State of the Market series with a look at Portfolio Opportunities.  Joining me to discuss this is Joe Massey, Strategic Partner and lender with Castle & Cooke Mortgage.  This topic is geared toward more advanced investors who have portfolios ranging from 1-15 properties .  We’re talking about not just optimizing your portfolio, but how to find the opportunities in it, too. 

To do this, we’re going over the four steps to identifying opportunities, four common types of properties we see in Colorado portfolios, and the number one mistake we see landlords make.

Four Steps for Identifying Opportunities in Your Real Estate Portfolio

Joe and I both sit down with clients and help them find inefficiencies and ways to improve their portfolios.  We love talking about general ideas and strategies.  And sometimes, the best move is to do nothing.  About 20% of Joe’s clients have a portfolio that’s already in great shape and doesn’t need to improve. 

To know if you need to make changes or stay the course, follow these four steps:

Step 1: Organize Your Portfolio

This isn’t sexy, but it’s very important.  Gather and double check your spreadsheets, loan balances, and what you’re getting in rent vs the current market rent.  We all like to think we’re on top of things, but life gets in the way.  When Joe was prepping for this episode, even he realized that his data was outdated by 18 months.  Even if you feel like you’re doing well, you need the hard numbers.

This is also the time to reflect on your portfolio and get in tune with how you feel about each individual property.  Investing is a mix of art and science—the emotional ties and headaches are worth counting, too.  Plus, it’s a good way to help you decide where to look for new opportunities.

You can put this data anywhere, but we recommend using our Portfolio Llama software.  We’re making updates to this portfolio analysis tool to make it more robust and user-friendly.  When Joe started putting his data in for this episode, it took him seven minutes for the first property, which dropped to three as he got more comfortable with it.  Go here to sign up for your free account.

Step 2: Review Your Goals and Strategy

Every time I tell Joe about a move I want to make, he always asks me what my plan is for the next five years.  Knowing why you want to make a move and what you want to accomplish with it are crucial components to portfolio optimization.

Take a step back and figure out your ultimate goal—retirement, funding your children’s college, etc.  That way, you can see if an individual property or your portfolio are lining up with that long term plan.

The point of real estate investing is to get you toward your goals; we can’t give you advice if you don’t know where you’re going.

Our 2022 Guide to Colorado Real Estate Investing Strategies is coming out soon.  Our clients, including Joe, wrote down their goals and strategies.  Be on the lookout to learn more about how other people are approaching Colorado investing.

Step 3: Identify Your Opportunities

This is the meat of the process.  In this step, you’re looking at your current performance and seeing what your options are.  Joe and I like to measure performance using cap rate, return on equity, loan to value (LTV), current cash flow, and gross rent multiplier (GRM).  You can use whatever metrics you prefer, just make sure they’re consistent and objective.

To see how performance can change, run different scenarios.  The common scenarios we use are selling a property for cash to reinvest in another property, investing in stocks, or paying off a debt.  We also look at refinancing and taking cash out that can be invested elsewhere.  A lot of people have equity, and refinancing into an Adjustable-Rate Mortgage (ARM) or a new 30-year fixed loan can allow you to take out cash up to 75%.  You may have a higher interest rate, but if you reinvest that cash, your spread can mean you’re earning more money overall.

It’s important to remember that prices and interest rates are going up, which compresses cash flow and returns, but that also means equity and appreciation are also increasing.  Figuring out how to leverage that equity is vital. 

Step 4: Write Out Your Action Plan

There’s a big difference between thinking or talking about something and actually writing it down.  This is the reason we write our Investing Guide every year—it holds our clients and us responsible for executing our strategies. 

Your action plan can be in any format you choose.  Just make sure it’s clear and succinct.  The best action plan is one that can be read and understood without having a conversation to explain it.

We created a one-page action plan for our Portfolio Analysis Mastermind you can use to get started.  To get a copy, email [email protected]. 

What’s the Number One Mistake Landlords Make?

After analyzing a lot of portfolios, the number one mistake we see landlords make is not keeping their properties at current market rents.  It’s difficult to keep up with massive increases, and landlords aren’t always thinking about it when their tenants renew.  Joe admits that he’s guilty of this, too. 

When we analyze properties, we look at market rates to evaluate performance.  A lot of properties would perform significantly better simply by renting at the current rate.  Even if you decide not to do this, it’s important to understand where the market is and how your property is performing.

Analyzing Four Common Properties

Shifting gears, we’re going to look at the four most common property types we analyze with investors: a primary residence, an investment condo, an investment multifamily property, and an investment single family home. 

Remember: every investor and portfolio are different, which means there will always be a slightly different solution to every problem.  And since we can’t solve every problem in one episode, we’re going to look at growth-focused investors who want more cash flow and net worth.  Keep in mind that growth-focused investing isn’t age-based.  Investors can aim to grow at any age, so think through where you are in your investing career and what you want to accomplish.

Property 1: Primary Residence

A lot of homeowners are wondering if they’re sitting on a pile of equity.  If they live in Denver, they probably are!  To illustrate this, we’re going to look at my primary residence.

I bought this house four years ago for $640K, and a recent appraisal puts the current value at $1MM.  To figure out what I should do, we walked through all of my options.

Option 1: Sell the house, net $350K, and buy something else.  This isn’t a realistic option for me because I have no desire to relocate my family, nor would it be easy to find a replacement property that mirrors our mother-in-law suite setup.

Option 2: Cash out refinance, up to 70%-80%, pay off existing loan balance, and pull out cash.  This would result in a higher interest rate.  The plus side would be that a fixed interest rate is protected against inflation.  However, my current interest rate is 2.5%, and I don’t want to change that.

Option 3: Get a second mortgage.  This would be fixed over a period of anywhere from 5, 10, 20, or even 30 years.  The tradeoff is that it’s in the second position, so the interest rate would be even higher, likely between 6%-8%.  While I would be able to take out $250K cash, the blending of interest rates between my first and second mortgage would probably put me in the 4.5% range.

Option 4: Get a Home Equity Line of Credit (HELOC).  HELOCs are a popular option for homeowners wanting to tap into equity.  Essentially, it’s like a credit card for your house.  That means that the interest rate is adjustable and can go up.  In fact, HELOCs are scheduled to go up another three times this year, at a rate of about 1.5% per year. 

A great aspect of HELOCs is that if you don’t use the cash, you don’t have to make payments.  If you do, though, the payments are likely to increase and the rate is not inflation-projected.  If you plan on using a HELOC, make sure you thoroughly understand them and have a plan in place.

Option 4: Do nothing.  It’s always valid to look at all of the options and decide you’re happy with where you are. 

I went with the HELOC and am scheduled to close in a couple weeks.  I’m fine with the interest rate because everything else I have is low and fixed.  I like that I can write checks to invest in other properties or businesses. 

Joe is now able to do HELOCs and can help you find very competitive terms. 

Property 2: Investment Condo

This is a three bedroom/two bathroom condo in Aurora.  It’s a very common type of investment property for our clients.  It was purchased in 2017 for $150K with 25% down.  The investor refinanced into a 3.5% interest rate when rates were low. 

The cash flow is strong at $700 a month.  The return on equity is below 10%; the LTV is 32%, and the cap rate is 4.8%.  All in all, the LTV is low; it has a decent cap rate; and the cash flow is good.  Currently, the investor has $200K in equity. 

Option 1: Do nothing.  The returns here aren’t bad, and if cash flow is important, then doing nothing makes sense.

Option 2: Sell and do a 1031 exchange.  To determine if you should sell and trade up, look at the cap rate.  At 4.8%, the cap rate is pretty decent for the current market.  Based on that, I would shy away from doing a 1031 exchange because the time crunch of finding a replacement property makes you less picky and you may not find a property between a high-4% to mid-5% cap rate.  The jump between a 3%-4% cap rate is much bigger than between 5%-6%.  The GRM is 146, which is very positive in this market.  It would be difficult to find a replacement property with that good a GRM.

Option 3: Refinance and pull out cash, or get a second mortgage.  The investor could refinance and pull out up to 75% LTV, but it would result in a brand-new, higher interest rate.  They could look at second mortgages, but the interest rate could be as high as 12%.  Blending the rates together, would that be worth the potentially $170K in cash?  $170k is a lot of money to reinvest, so it depends on their overall strategy.

Option 4: Get a HELOC.  Most banks don’t do a HELOC on investment properties.  They are classified as a Business Line of Credit because the property isn’t technically the investor’s home.  Business lines of credit require a renewal every year.  Joe doesn’t offer this option, but some banks may. 

Property 3: Multifamily Fourplex

This is a standard, 1960s brick multifamily property.  It was purchased in 2017 for $650K with 25% down.  Five years later, it’s valued at $1-1.1MM; monthly rent is $6200; and there’s $660K worth of equity between loan paydown and market appreciation.  The investor is seeing over $1K a month in cash flow; the cash-on-cash return is 8.2%; and the cap rate is 4.2%. 

Joe’s initial reaction is to look at the GRM, which is 177.  It’s not great, but it’s also not horrible, and the rents are below market.  He wonders if the property peaked in its GRM. 

Option 1: Do nothing.  Maybe this investor is happy with the decent amount of cash flow.  The rents are a little below market and could be pushed as leases turn. 

Option 2: Sell and trade up.  If the property’s value is outrunning the rents, then the returns will be lower in the future.  That means it could be a good time to sell, since the investor is sitting on $660K.  Joe recommends the investor look at buying three condos at $350K each and see if additional cash flow is possible. Chris would leverage up and buy a bigger multifamily or asset. 

Property 4: Single Family Home Investment Property

This is where the majority of landlords have the most opportunities and options.  This property is a three bedroom/two bathroom standard 1960s house in Littleton.  It cost $420K in 2016 and is now worth close to $750K.  It has huge appreciation, but it isn’t getting the best rents because more people are looking for bigger, 4-5 bedroom homes.  The annual cash flow is $2500; the LTV is low at 43%; and the cap rate is in the low-3% range. 

Joe points out that if I were to deposit $421K in his bank and he gave me back $2500 a year, I wouldn’t think that was a good return.  Every day the investor owns this property, they’re making that tradeoff. 

Option 1: Sell and buy a property in cash.  Rents will never catch up to the value of this home, so Joe thinks it’s a great time to sell.  If you buy a replacement property in cash, you can’t use a 1031 exchange, so you’d need to pay taxes.  It would be feasible to get $3K a month in cash flow in another property. 

Option 2: Sell and use a 1031 exchange.  My inclination is to use a 1031 exchange so the investor can avoid paying capital gains taxes.  They would still walk away with $350K to buy a multifamily property or a couple of other properties. 

Looking back to Episode 1 in this series, we highlighted a 5 bedroom/2 bathroom house in Lakewood.  At $150K all in, the investor could buy two of these types of properties. 

Remember, if you want to boost cash flow in any of these types of properties, you can always put more down.

So, What’s My Next Move?

Well, it depends (sensing a theme here?).  As you can see, Joe and I agreed and disagreed on various topics today.  There’s no right or wrong decision, just what works best for you and your portfolio.  Having these conversations and walking through different scenarios is the value-add we offer our clients. 

To have a one-on-one conversation, reach out to Joe or reach out to me.  We’ll be happy to sit down, go through the numbers, and help you figure out the next best move. 

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We want to hear from you!  Send us your questions, comments, strategies, and even why you disagree with any of our advice. Find us on LinkedIn and Instagram.

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