Why are interest rates a big deal in the real estate industry? One of the accurate answers would be leverage. Using interest rates as an advantage is great when the economy is doing well, but it is terrible when the market is falling apart. Jason talks about the significant changes coming to real estate investors as he goes in-depth in what happened in Europe, Asia, and the USA, where interest rates are declining to date. As he dives into the two biggest risks in the real estate industry, Kaylee McMahon, a top producer at Lux Locators and Founder of Tahoewego LLC, comes aboard to reveal the top five mistakes real estate investors make as they get into this business.
Listen to the podcast here:
Interest Rates: What’s Next For SF And MF? with Kaylee McMahon
A buddy of mine, Jeff Emmerson put on a fantastic event over there at AMI. He did it at a great little place in West U. There were 25 to 30 of us. It was a fantastic event. I got to meet a ton of people I had not met before that were really interesting. There were a lot of industry people. There are two reasons why I want to go out to networking events. There are two things I am looking for. I am looking for information to make my business better. What is it that you are doing? What do you see in the marketplace? I like that marketplace data. There are really two things I am looking for. “Can you help me with my business? Can I help you with yours? What is it that I can learn from you about our market place here in Texas?” I met some people from all over Texas. It was a lot of fun. Thanks so much for Jeff and the sponsors for putting that event on.
I want to talk about what happened. Everybody is freaking out. The European Central Bank, ECB, came out and said, “We are not going to raise rates. We are going to keep interest rates where they are.” What does that mean? The fascinating thing is the President of ECB, Mario Draghi, came out and said, “Not only we are not going to raise rates, but we are going to do as much as we can to ensure the stability of the euro.” That is weird. What does that exactly mean? What it means is, at least in my mind, that Europe is going to do everything it can to ensure that the money that they borrowed over there is inexpensive to spur on businesses. This is weird because all we heard for the last few years is, “Rates are going up, everybody get ready. Rates are going up, houses are going to crash. Real estate market is going to crash because rates are going up.”
This is what changed my mind about multifamily. Third quarter of 2018, Donald Trump comes out and calls out the Federal Reserve, “You are not going to raise rates? Rates are too high. The money is too expensive.” They said, “I don’t know. We will consider that. Maybe, maybe not.” The Fed comes out and said, “We are not going to raise rates. We might raise rates once in 2019.” If you look at the FOMC minutes from the end of March, I don’t think we are going to see any rate increases. In fact, from where I am in, rumor on the street is we might see a decrease in rates in 2020. What does that mean for real estate investors? It means to buy all the real estate you can get your hands on.
It is going to be a bit of a problem for single-family. Let me explain why. I say this, people freak out. People who have been in real estate for 30 years will argue with me. I will say, “You need to start doing a little bit of Google searching.” Here is what they argue with me about. In the single-family real estate industry, when rates rise, investors are willing to take more risk on those borrowers. Meaning there is more appetite for that paper, that mortgage. 5%, 6%, 7% mortgage is very attractive to Wall Street. Insurance companies, big banks, they like that paper. However, if it is 3.5%, Wall Street didn’t have an appetite for that. They like that Grade A single-family paper when it is 6% or 7%. They are willing to maybe let some people borrow money that is a little bit riskier because there is a higher rate of return.Debt is a tool, but it is not something you are meant to carry forever. Click To Tweet
When people come out and say, “You hear this from economist as well, rates are rising and when rates rise, houses get less affordable and nobody is going to buy houses.” That is not what happens in real time. What really happens is as rates rise, more borrowers such as buyers enter the marketplace. What you see are rents begin to fall. As more people can afford houses, they move out of apartments and out of rental single-family houses. That is exactly what happens. We have seen it time and time again.
A few years ago, I was on our radio show and we were having a very similar conversation. We were sitting around the table basically saying, “Rates are going up. There are going to be a whole lot of people that will get into this marketplace. This is going to be the last push until the next business cycle, until the next slowdown. We will have another three or four years of this then real estate will start all over again.” What happens? Donald J. Trump gets a hold of Twitter at 3:00 in the morning and says, “Rates are too high. It is destroying the economy.” What do they do? They stop raising rates. That is insane. The guy literally reset the world with a tweet, “Don’t do it anymore.” Whether you like it or not, that is exactly what has happened.
The European Central Bank, ECB, comes out and says, “We are not raising rates either. In fact, we may add a little more liquidity to the marketplace to prop up the euro.” It is like, “Is this ‘07, ‘08 all over again? What is going on here?” The market freaked out a little bit. I can’t remember his exact quote. It was very similar to what Paulson said, “We are willing to use all of our tools in the toolbox,” which funny because all the Fed could really do is play with interest rates. They can’t do much else especially when they are already tapped out. Rates are on the decline. We will be in this weird area especially in commercial real estate where cap rates will be steady. They have risen just a little bit. Rates have substantially decreased where you are going to be able to get some pretty good deals by the arbitrage between cap rates and interest rates.
I firmly believe in the next two years you are going to see cap rates decrease. I realized nobody is saying that. “Jason, that sounds crazy,” but just watch. I was looking at some interesting data out of the Texas A&M Real Estate Center. It’s one of the best real estate websites. There was a report in there by market by asset class. There is something really interesting in Houston happening in the office space. For those of you who have been paying attention to the office environment, you know that offices have a crazy vacancy right now due to the decline in the price of oil. Historical occupancy is 8%, 9% or 10%. We are 20%. I have always thought, “It would be nice to own my own building.” Maybe it is not right, then I started looking for vacancies. With interest rates coming down I thought, “I might be able to pick a deal here if you get your eyes open.” You might be able to pick up a nice little deal in Houston, Texas. There are a lot of empty buildings.
In fact, there is one right across the street from the studio here. They have been trying to lease that for about a year. It is huge. The whole place is empty. Bought it at an auction. I would keep my eye on interest rates. The whole story that people are not going to be buying houses. We may be in a situation in Europe very similar to Japan 25 years ago. We may be witnessing a cyclical decline in Europe as we have in Japan. What does that mean for the real estate investor? I will give you one big tip. If you can’t make money in Europe anymore, where does that money go? A lot of European countries are declining in population. There is not a lot of construction going on in most of Europe. It drives a lot of our business here in Texas. There are not a lot of new businesses getting formed in Europe. Europe is a disaster from a “let’s start a business” standpoint. Not the entire continent but a good portion of it. It is not a business-friendly environment.
If interest rates continue to decrease and investors pull out “safe assets,” where does their money going to end up? It is going to end up right here in the United States. The last step I read somewhere, I wish I can remember the actual stat but it is something a fact of 20% of all the foreign money that comes in the United States comes to Texas. It is in the form of lending and direct asset purchases. If we are seeing a long-term decline in Europe, we are going to see cashflow into these marketplaces. We have seen it before and it is going to happen again.
Why are interest rates such a big deal in real estate? It’s simple because you can use leverage. Let us not talk about leverage as a way of juicing a return. There is a great quote out there that says, “Don’t mistake leverage for genius.” That is great because debt is a tool but I also don’t think it is something you are meant to carry forever. I know you have a ton of choices of people to listen to with regards to real estate but here is what I will tell you. I have had the good fortune to meet a litany of really successful investors. A lot of them own property free and clear. That is hard to do in your first couple of years in real estate. Leverage is great when the economy is doing well. Leverage is awful when the market is falling apart. When you look at what destroys portfolios, a lot of times it is too much leverage. Be careful with the debt. I am not saying don’t get it. I am saying be careful with it.
There was an apartment investor, two business partners I met a million years ago. They had 1,100 units up in DFW. It was two separate properties. They bought them dirt cheap. They fixed them up, turned them around. They were crushing it, a great cashflow, incredible returns. When you sat down and look at it, maybe they were 50% leverage. The problem is their note came due and it came due right in the middle of the credit crisis. Here was the problem, regardless of how well they operated that asset, they could not raise enough money to pay their balloon payment off. Nobody was lending. It was a blood bath back then. When you use leverage, you’ve got to be smart. The gold standard for leverage is a 30-year fixed rate loan with a 30-year end. You’ve got a 30-year loan on a piece of property for 30 years at a fixed interest rate.Facts are facts, and that's what should control your decision-making. Click To Tweet
With the rates as low as they are now, it is absolutely incredible. Thirty years, 4.5%, 5%. Anything under 7% when you get down to it is free money. You sit down and do the calculation, putting in a little inflation, cost of money, cost of goods going up, all that kind of stuff. Under 7% is pretty much free money. I haven’t pulled up interest rates in a couple of weeks. The last time I looked, we were are at a minimum of twelve-month lows. It is crazy how cheap money is. Here is what is incredible and let us talk about a single-family. For those of you who are single-family real estate investors, the amount of loan products out there that are available to you if you want to build a portfolio is immense. There are so many different loans.
Back in the day when I started many years ago, you can get ten Fannie Mae loans in your name. If you are financially fit, you can get ten in your spouse’s name. You’ve got twenty little rental properties with 30-year fix rate mortgages at 5%, 6%. Here’s the problem. If you buy twenty, you want to buy 40. If you buy 40, you want to buy 100. The only way to raise that capital is through private investors or you have to go to local banks. The problem with local banks is they do this interest-only. Sometimes they’re a 20 or 25-year AMP. They want 25% down and it has got a five-year balloon. You have to pray that the economy wants to renew that loan or there is somebody out there who wants to renew money in five years. That means in five years, someone is writing a check if the bank doesn’t want to renew that note.
That is how the game was essentially played a few years ago. Now, Wall Street has stepped into this space and they offer 30-year products. One of the dirty little secrets in the real estate industry that a lot of people don’t talk about, you don’t hear it from the stage and a lot of these apartments gurus. That is there are two big risks. One is interest rate risk and the other is refinance risk. A few years ago, I was telling all these apartment guys, “You all be careful because rates are supposed to go up. If you are refinancing this property and you bought it at a seven cap, interest rates are seven and your rates really haven’t gone up that much, you might have a problem with negative cashflow if you don’t have enough equity.” That is a big problem. The scarier problem is refinance risk. That is exactly what happened to those guys in Dallas. Beautiful asset, a crazy amount of equity making piles and piles of money, but they had one little problem. There wasn’t a single bank that had the appetite for commercial multifamily loans. The bank took the property back and they lost everything.
Refinance risk is something I have never heard any real estate guru talk about. It is one of the scariest things in multifamily investing. If you are in a syndication deal, you are participating as an equity partner in a multifamily deal, I highly recommend you get the longest-term financing you can. There is some 30-year money out there for multifamily. It is a little challenging to find it. I don’t know if I would do any loans under ten years. That is just me. Ten years is enough time that if there is a crash in the middle of something, you can get it sorted out. Somewhere around year six or seven, you can start the process of refinancing the property. Pull equity out if you want or leave it in. I am a leave it in kind of guy. You have to be very careful out there. With the decrease in interest rates, that makes things very interesting for us as real estate investors. Our money is very inexpensive. Inexpensive for a long time, 30 years, 4.5%. I don’t think rates are going to raise any more.
We were talking about borrowing money, the cost of moolah. It is getting cheap to borrow money again. I personally believe we are going to see a rate decrease. Unlike 10% to 20%, we will see a rate decrease in Q4 2019. There is a 10% to 20% chance that this is going to happen. We will have at least two in 2020. If you go to the FRED database, which is the St. Louis Federal Reserve, they’ve got a lot of good data. You can put up all kinds of cool real estate metrics. If you look at the cost of real estate or the performance of real estate, you can pick any metric. They’ve got so many different metrics. It is great. There are so many ways you can cut the data if you will. I love looking at the charts there. It is a line graph that goes from left to right usually going up in a linear fashion like a part of an X going across the page. That little line there represents an increasing value.
Real estate is increasing in value over time. We all know that. That is not a shock to anyone. What is fascinating is to look at what happens to real estate when it is in those little gray bars. The little gray bars are the recessions. What is amazing is with exception to 2008, 2009, you have to go back over twenty years to find the last real estate slow down. You can parse this data by state. I love looking at the Texas stuff because Texas is an absolute animal. It is a machine. Remember ‘08, ‘09, the whole world is on fire and Texas was like, “We are going to start creating more jobs than the entire country combined.” That is what happened. Things got a little rough here but it wasn’t like Southern California, Arizona or Florida. Texas does its thing. It’s keeps on trucking in part because we have a friendly business environment.
When I hear, “They are bringing rates down because there is a recession coming,” “Really? You did that a few years ago and it didn’t seem to faze anybody.” If you go back to 2007, 2008 there were very few people that were predicting a crash. In fact, so few there are a couple of good books and a good movie about shorting the housing market. That is how rare the thought of a crash was. Virtually no one thought the market was going to crash. Now, everybody is running around. Everybody is going, “There’s a crash.” I have heard there is a crash coming for ten years. “Jason, there is so much debt in the system. The whole system is going to collapse. It is going to be pure bedlam. We are going to start prepping. It’s going to be chaos on the streets. Everybody, get your AR15.” It’s not going to happen.
They call it a Black Swan Event for a reason. It is statistically incredibly rare. That is what happened in ‘08 and ‘09. The best book to read is Aaron Clarey’s book, Behind the Housing Crash: Confessions from an Insider. We’ve got to have Aaron on the radio show at some point. He would totally do it if we reached out to him. It’s the best book on the housing crash. When you read that book, you realize that so many things had to align in order for the world to end. If you go back and look at these other recessions, they don’t faze real estate in Texas. It slows down a little bit for the retail market. $400,000, $500,000, $600,000 houses or $1 million houses. It slows down a little bit there. By and large, Texas is a machine that keeps on trucking.Don't let things scare you and stop you from getting involved in investing. Click To Tweet
Our market doesn’t seem to slow down in a recession. I never get all worked up about, “When is the next crash?” I am going to sit on the sidelines waiting for the next crash. Do you realize the next crash might be another ten or fifteen years away? “Jason, what happens if I buy real estate now and then the market crashes ten years from now?” You are probably going to have 50% equity in your assets. Ask a couple of your buddies. Go to that next network event. I will be at the Redneck Country Club event. Grab a couple of investors that have portfolios with assets in them that are over ten years old. What that will tell you is, “I’ve got about 50% to 60% equity in this thing. There could be a real estate crash now. I will lose 20% current market value, but I will still have 30% to 40% equity.” That is how the game works. You get into a really good loan on a really good piece of property that produces cash that has got some equity and you tie that thing up with a 30-year mortgage.
I will say it this way for you finance guys. A 30-year mortgage is like a 30-year call option. That is 80% leverage on a piece of real estate. I realize that doesn’t make sense to a lot of people out there but that is the best way I can explain it. That 30-year mortgage is so important. It is the gold standard in lending and borrowing. It is a great product because it allows you to refi or sell anytime you want in the future. With rates going down, this is going to be the perfect storm for real estate investors. There are a lot of really great loan products out there. Rates are coming down. There is plenty of room in this market for rent increases. Not huge ones but a little bit of room for rent increases. I highly recommend if you are interested in doing real estate, now is the time. Now is the time to get into this business. I don’t think rates are going to be this low forever. It can’t be. I’ve got a special guest.
Kaylee McMahon here of RE by Kaylee. I am down here from Dallas.
You sent me a note that said, “I am going to be in Houston to meet with an investor.” I said, “Why don’t you come on to Houston? Why don’t you come on to the radio show?” You said, “Okay. What do I do?” I said, “Just show up, we will figure it out.” First, I want to ask, how is the house we have in the Heights? Is it nice? I haven’t been there for a while.
It is really nice.
You are a real estate investor. You and I do a show together on Propelio TV. I am supposed to emcee that event this May 2019. That is going to be the hardest thing is not going through the name. We do a weekly show for them. If you go to Propelio.tv you will see us there. They have a YouTube Channel. There is a bunch of people there and it’s a lot of fun. You and I do a multifamily there and a show for brand new real estate investors. You and I were chatting, we were at a networking event and you said, “What should we talk about?” I was like, “Let’s talk about the biggest mistakes new investors make when they get in.” You were like, “I’ve got this whole laundry list of these things.” You have been a real estate investor for how long now?
I would say a full year.
You are a real estate agent, broker and all that other stuff. You have been around the industry for a million years. What are the top mistakes you see real estate investors make as they get into this business?It is either fear that is controlling your motivation to get started or it is self-doubt. Click To Tweet
The number one thing, and I would say it is funny because it is pretty obvious, but people always come back and say this after they have done it for a while. They always say, “I waited too long to start.” That is something whether it is fear that is controlling your motivation to get started or whether it is self-doubt or whatever it is. They always say fear of, “What if I can’t resell it after I buy it? What if I can’t do the repairs or what if my guy who is doing the repairs backs out on me? Someone gets hurt and they sue me?” For example, one of my fears was what if a contractor puts a lien on your property? All these are stuff that you are going to deal with, but there are answers to all of these questions. There is a way around how to deal with every single one of them.
I ran into a lot of folks out there and are like, “I wish I started five years ago. I wish I started ten years ago.” I was doing a presentation at a big real estate event in front of a thousand people. I said, “Could everyone raise their hand that wished they bought more real estate five years?” The whole room raises their hand. “I would like to see a show of hands of those who wished they bought less real estate.” Of course, it is zero. One of my biggest fear is regret. You don’t want to leave anything on the field if you will. I totally agree with that. That is the biggest one. Start now. Do not wait. I have never understood the waiting game. There are answers to all of those questions, “Could you get sued? Could this happen? Could that happen?” Yes. North Korea could launch nukes tomorrow and it all ends. Who knows what is going to happen tomorrow? I have no idea. What do you think the second or third big mistakes that new real estate investors make when they get started?
I want to go back to not starting. There is a lot of fear mongering. If you spend so much time watching Fox News, CNN or whatever channel or TV in general, there’s a lot of, “There is a recession coming. There is this and that. Pending down cycle of the economy and the real estate economy.” I went to an Old Capital Speaker Series with Dr. Mark Dotzour from Texas A&M Real Estate Center. He spoke about that inverted yield curve that everyone is freaking about. Basically, 30,000-foot view on his speech was there is more positivity that you realize is out there if you look at the facts.
It is like looking at a Bible verse and looking at one of it versus a whole page or whole several different verses that are all intertwined together. You have to look at the bigger picture. You need to look at historical averages for the last 30 years or the last 35 years. Not just the last five years or since we had that recession. Consumer confidence is up. Everything looks good in a 30,000-foot view. Honestly, in the next three years, I would say after the next three years I would be a little cautious about another down cycle. Until then we needed to continue buying so that we don’t force ourselves into a recession. Buy cautiously. Make sure the numbers work.
You hit the nail in the head. If there is one thing you can do now to improve your life is to stop watching the news. Just turn the garbage off. I sit there and watch for fifteen to twenty minutes and I say, “I can’t do this.” I used to love watching Meet the Press. I can’t even watch Meet the Press anymore. It is so awful. I am not a big Chuck Todd fan anyway but this is so ridiculous. You start to realize the whole idea here is to get you all worked up so you tune into the next episode of who did what and what’s going on. It’s absurd. The financial news media is probably the worst because they’re dealing with a very complicated subject in sound bites to get you to keep tuning in. There’s no ratings in good positive news. That would be a goal for you. Turn all the major news networks off.
I am just staying updated with the Wall Street Journal as far as numbers on there go. Facts are facts and that’s what should control your decision-making and don’t let things like that scare you and stop you from getting involved in investing.
I can’t tell you how many folks that I’ve talked to say, “Jason, I’m waiting for the next crash.” Five years later, “Jason, I’m waiting for the next crash.” The other thing I find fascinating when someone says, “I’m waiting for a downturn in the market.” I always like to ask them, “Are you prepared to take advantage of that?” “Yeah, I’ve got some cash sitting on the sidelines.” “How many assets do you own now? What have you bought in the last ten years?” “I’m learning a lot.” What you don’t understand is that investing is a skill. You’ve got to start investing in that skill set now. If you think you’re just going to turn around and go, “I’m going to go buy 300 houses in six months when the market’s in a complete tailspin,” that’s not very realistic. Who are going to be buying all these houses are people who are already in the game, who are already in the business that are the ones that are actually going to be successful in the downturn. What else have you got there, Kaylee? I see your work and I see your notes. What other big mistakes do you see real estate investors make?
The top five is what we are going to focus on. Number two would be not having a plan. You get over your fears and you’re like, “I’m going to do this face first,” then you’re like, “Now what? I don’t have a plan.” Knowing exactly what your goals are as far as like, “Do I want to do single-family rentals? Do I want to flip and get out of the projects quickly? Do I want to earn X, Y, Z amount of returns?” Knowing all those things up front and saying, “Here’s my end goal,” then working backward is having a plan. That’s something that I think people just don’t do. That’s the quickest way to lose a lot of money.
Whenever someone says, “I want to get into real estate investing,” “Let’s talk about what we’re trying to accomplish. The second thing, let’s talk about the resources you have. What kind of time and money are you able to have?” This is it not freeing. This is investing and it’s going to require some time and it’s going to require some money. If you don’t have time or money, there’s not much I can do for you. Unless you’re trying to sell him a class on wholesaling for $9.97. We talked about some mistakes that real estate investors do when they first get started. Let’s talk about Kaylee. Let’s talk about some mistakes you may have made in your first year. Let’s start with the first one. What have got here?
I have brought in some new material, some of them I am going over and said, “That, that and that.” A lot of it has to do with not having a plan. The next thing we are going to talk about was not requiring written repair bids every time. Everything that I ask for now needs to be turnkey. I don’t know if you have a different experience. I said, “That sounds great. It is cheaper.” No, it is not. Cost plus contract what they do is, “Here is my base bid on all these items that you want but we are not going to account for extra labor. We are not going to account for change orders.” Sometimes change orders are warranted. I get that and I will sign off on it. Trying to have your contractor upfront and say, “Here is everything line item by line item, labor and parts all included.” Not just have them sign off on that contract but also utilizing the ability.
As a real estate agent, I can make up a contract. There are so many TREC forms, Texas Real Estate Commission forms that you can use to write up some binding contract where if that contractor is late on delivery. I always give a grace period but you have to have your draw schedule in accordance with each item to know exactly what you are going to be releasing from the bank every week on those projects. You need to know basically everything up front. I always give a grace period. If there is rain, seven days or whatever. Also letting them know that, “If you are late you are not going to be sitting there tapping your toes. I need to charge you for being late. $100 every day that you go over.” I realize in this last situation, my girlfriend said, “You need to sit down with your contractor and tell them your daily whole cost. Everything that you pay, principal, interest, insurance, utilities, the dumpster. Everything that you are paying for broken out by day, but he didn’t care. He said, “You didn’t have me signing anything, so why do I care?”
It is funny, most contractors are judgment-proof anyway. Sometimes you can have all the stuff you want. What was the last lesson you learned in the last couple of months?
Paying for construction cost before completion. With that draw schedule I have guys who are like, “I need 50%.” The best guys that I have ever used was Sergio. He’s the best framer. He actually requires zero payment upfront. They’re busy so you’ve got to get him when you can. It is a good sign that they are busy. They provide materials. That is a good sign that they are not starving for jobs and they need you to pay for materials up front. They will provide anything. They will get it done. Obviously, you’ll have an agreement with delivery time and then on delivery, you pay him after you inspect it. He is totally professional.
Kaylee, thanks so much for being here. We’ll see you again soon.
- European Central Bank
- Texas A&M Real Estate Center
- St. Louis Federal Reserve
- Behind the Housing Crash: Confessions from an Insider
- RE by Kaylee
About Kaylee McMahon
With her trademark Hair, rapidly growing sales, and outfits as classy as her personality, Kaylee McMahon is quickly becoming a staple of the Dallas real estate scene. As a top producer at Lux Locators and Founder of Tahoewego LLC, Kaylee has secured over 2 million dollars in real estate in her first 2 months moving into residential home sales.
Kaylee has emerged as one of Dallas’ top Apartment locators having placed clients in luxury apartments, high rises, and condos. She Wanted more in the luxury Real estate world. So she began education to be well-versed in residential home sales.
Originally from Portland Oregon, Kaylee is a speaker on Propelio TV, an investor funded Free information Network. It is for those who want to get started in creating financial freedom.
Kaylee is currently flipping a home in Denison Texas because she feels that to be truly confident in giving advice to clients about buying/selling/flipping/investing in Real Estate one should NEVER take advice from someone who has never gone through these things themselves.
Kaylee has completed continuing education this year in home comparables, appraisals, real estate investor representation, investment and wealth creation, and GRI Marketing for sellers. GRI is the graduate institute for realtors and is a distinction that shows Kaylee is committed to the success of selling your home and getting you top dollar on your investments.