The world of real estate is filled with the dynamic between risk and reward. As an investor, it is your job to manage the relationship between the two. Even more important in this day and age, Robert Orfino discusses the recession that is about to come and how you can get yourself prepared for it. He then talks about cap rates and provides some effective tips and wonderful strategies in making profits and being successful in the real estate business. Join Robert as he discusses more about risks and rewards and building relationships.
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Risk Versus Reward – Establishing A Relationship With Co-Host Robert Orfino
You are likely waking up to the news about a German bond auction at a negative 0.11%. It’s a German thing. Do you know what’s fun about real estate? This is one thing that confuses a lot of people. The global real estate market changes slowly. It’s getting run over in real estate. Unless you’re on the development side, it’s like being run over by a train. When you get hit, you’re going to take a big hit, but you can see the train coming. There’s no surprise when the real estate market turns over. Financial markets, it’s a whole different animal. Typically, you start having problems in the financial markets before you get any bad signs that the market is turning over. One of which was the inverted yield curve that we talked about.
The second bell-weather and the data is now coming in, is what happens at the discount retailer market? A good example of who a discount retailer is, Walmart and Target. When you begin to see good earnings coming out of Walmart and Target, the economist becomes concerned. Why do they become concerned? Our consumers are taking those dollars from other luxury goods, Apple products, the new car, and deploying their precious resources into buying household goods at Walmart. That data is starting to trickle in. We will know how real this “recession” is going to be. It’s going to happen. I don’t care how many decades of experience you have as a real estate broker. You would not believe the number of emails I’ve gotten when I sent out that recession email. It has traveled the globe and it has become a topic du jour of about every single real estate podcast and radio shows across the country.
Recession Is Coming
I’m telling you, the recession is coming. You can’t stop it. It’s a natural part of the business cycle. When is up for debate. If I’m flipping million-dollar houses in Houston, Texas, I’d like to get off that inventory as fast as humanly possible. Here’s the interesting thing about Houston. For the most part, Houston is countercyclical, meaning when the country is not doing well, Houston is doing pretty good. Part of it has to do with where Houston makes its money, healthcare and energy.Real estate is as volatile as anything else if you don’t know what you’re doing. Click To Tweet
You’re already seeing this. You would not believe the phone calls we’re already getting from people. We’re getting international investors that are saying, “We’re going to take a little bit of money off the table. We’re going to take a few $100 million off the table.” It sounds like a lot of money, but in the grand scheme of things of financial assets, it’s nothing. “We’re going to take a few $100 million and we’re going to go park it in a couple of apartment buildings. We’re going to go park it in some warehouses. We’re going to go park it in some REITs. We’re going to go park it in some other stuff because we’re not sure what’s going on. Let’s go ahead and take some profits now and park some capital over in a place that we know is relatively safe, compared to the capital markets.” There’s as much risk in real estate as there is in anything else. Let’s not play that little game.
“Real estate is risk-free and very little risk compared to stock.” It’s as volatile as anything else if you don’t know what you’re doing. We’re seeing international capital flows pulling out of certain positions, certain assets, mutual funds, and all that stuff and even private capital. That money is being deployed into real estate. It’s already happening. There’s a report that comes out monthly that shows international capital flows. You’ll see it come out of hedge funds. You’ll see it come out of mutual funds. You’ll see it coming out of these index funds. There are a handful of people across the country that track where those dollars end up. Where are they coming from and where do they go? Capital is like a person. They go where they’re treated best. Where they’re treated best is the place that gives them the least amount of risk with the highest amount of return. It’s that simple.
I got this from Casey Eberhart when he was in town, “Your job as an entrepreneur, an investor, the manager of your family business is to manage the relationship between risk and reward.” That is probably the most elegant way I’ve heard that put. We can take this fantastic solution into anything. Personal relationships, business relationships, your relationship with money, your investment portfolio, everything. Your entire job for the rest of your life is that. I was on Facebook and there was a guy who posted a video. It’s this man on a motorcycle. It could have been Colorado but it did look like Utah. He is on this bike and he is screaming, flying on this dirt bike. You could see it starts going up this small mountain. It goes straight up.
He jumps off this thing and he’s literally flying in the air. They’re like, “This guy is going to be left in pieces. The bike is going to be in a million pieces all over the place.” He throws out a parachute and glides out. A parachute comes out of the bike. The bike lands relatively safely. That is where we’re at. Since ‘09 we’ve had the Federal Reserve and the Treasury playing some little games. Some of it is quantitative easing. You’ll hear that called helicopter money. The other thing is playing with interest rates. The third is what we’ll call monetary policy. We’re spending money and creating money all over the place. It’s like taking that motorcycle and jamming that throttle down, your full throttle for ten years. The man is cranking it. You’re going up this hill.
I’ll tell you what that hill is. That hill is the S&P 500, The DAO, the Nasdaq. All this free money, you’re riding this free money motorcycle. You’ve got throttle to the redline for ten years. You get to the top of that ramp and you start flying. That’s where we’re at. We have left earth. We are off that big ramp, that mountain and we are flying in the air. We’re still ascending. It feels great. If any of you have jumped bikes before or skateboards, it is a blast. You’re still ascending, like your momentum is still upward but you are not connected to anything below you except for whatever took you up to that spot. We’re beginning to figure out who brought their parachute and who didn’t. There are a lot of people, and I don’t mean the real estate community, I mean in the money industry at large, that forgot to pack the parachute. We’re going to see over the next couple of months and inside of these years who brought their parachute and who didn’t.
Everyone’s going to return to earth at some point. Gravity will bring you back down. It’s a law of living here. The market will have to return to the mean. At some point, we will reduce ourselves to the mean. What does that mean? We’ll find out. While we’re riding this motorcycle, and we’ve left the earth here, we’re still ascending. People are going to look around and go, “It’s still pretty good. This is going to last forever.” I knew my email was right when I got so many people disagreeing with me, “There’s no recession. What are you talking about? It’s never going to happen.” I heard this exact same thing in ‘08 and ‘09, “What are you talking about? Housing is not overheated. There’s all this free money out there. Everybody can get a house. Everything’s great.” This story has played out so many times it’s not even funny. This time it’s going to happen in a different asset class.If you’re not having fun in real estate, you might as well quit. Click To Tweet
Here’s what’s going to happen. We’re going to figure out who’s got a parachute, who doesn’t. It is a debt issue. I shouldn’t do this the German, I figure if Rush Limbaugh does it, I can get away with it too. It’s worked out for him. He makes $50 million or $100 million a year talking on the radio. Most people don’t know he’s got a staff of almost 300 people that work for him to put that whole show on. I figure if it works out for Rush, it probably works out for me. 2019 has turned into the biggest, “I told you so,” moment for me starting in September, October of 2018. Here’s what I’ll tell you that’s been amazing is when I saw the tweets. When I read the tweets back in September, October of 2018, and Trump is going back and forth with the Fed, “You’re raising rates too high. Let’s stop the rate raising. This is not going to be good for the economy. It’s terrible. It’s going to crash the economy.”
Trump says some crazy stuff. You know how crazy it is for a sitting president to get on a public broadcast system and say, “If you do this, the economy will crash.” That’s a big deal. When I saw that I immediately knew rates are coming down. If you back up, “Everyone said there’s no way we’re going to have two more rate hikes in ‘18. We’re going to have seven in ‘19. In 2020, rates are going to go 900%.” It was all this ridiculous nonsense. I’m like, “It’s not going to happen. Here’s what’s going to happen next, rates are going to go down, cap rates are going to stay about the same.”
Making Money On Spreads And Cap Rates
Where we make money as real estate investors are in the spread. I kid you not, a friend of mine, Merrill Kaliser dropped the article. We’ve not seen the dispersion between cap rates and interest rates this wide in years. It’s only going to get worse. We refinance a little single-family home in my wife’s portfolio. Her refinance rate, this is a non-owner occupied. This is her fifth or sixth, I don’t know how many properties we have in her portfolio. We got a handful of properties in there. I put little single-families in there from time to time. She refinanced a non-owner occupant property at 4.125%. I was like, “Maybe we should have waited another three months.” Those spreads are widening.Everyone’s going to return to earth at some point. Gravity will bring you back down. Click To Tweet
We’re seeing a big gap in interest rates and cap rates. I know it’s going to happen. That Sharp commercial guys and gals out there are already looking and they’re like, “If I can get this money at 4.5% and I can go in at a 10% cap, I’m going to absolutely crush it.” That’s the discussion that’s going on amongst some big boardrooms or inside somebody’s Mercedes talking to their different friends in commercial real estate. The spreads are getting pretty wide. The articles I talk about are on the show I put in the Mr. Texas Real Estate Facebook group. If you’re interested in any of these articles, join that group. You’ll have to ask for approval and Rob or I will approve you in that group. That group has gone from 200 to about 800. The growth has been insane.
One of the articles that we’ve posted is we’re seeing the discussion about cap rates. If the economy has a little hiccup here or there, we’re not anticipating additional cap rate compression. I find that a hilarious statement. This is why cap rates are insanely low. I haven’t looked at the data. My guess is they’re near all-time lows. We have classy assets in Texas trading it at 7%, 6.5% cap. That’s an apartment complex that you go to look at and it’s stabilized and it’s still scary. That lower in class C-stuff. You look at those numbers and then you read this article. The article says, “We haven’t seen this aggressive cap rate compression as we have in the past.” Where are they supposed to go?
I flew out back and forth to LA all the time. Rob and I are going to be out there. We’re going to fly up to New Jersey. We look at all the commercial stuff up there. We have a zillion conversations with investors in those markets. In California, they get happy with a 3% cap on a class B-asset. They’re like, “We found a deal.” Where else are cap rates going to go? If interest rates continue to fall, that gap keeps widening. The cashflow is going to be phenomenal. Assuming you’ve bought that asset and positioned yourself in such a way in that submarket, to where you can ensure that if there is slow down in the economy, you’re not the one that gets hit with it. That requires a little bit of education, a little bit of finesse. It also depends on the market you’re in. Texas is going to be relatively insulated from a lot of stuff. That doesn’t mean it won’t be impacted.
For grins, I went and looked at what the lowest fifteen-year mortgage was. It was back in March ‘13 where a fifteen year got as low as 2.56%. That’s literally free money. The median sovereign debt is technically negative return. Alan Greenspan said, “We could get used to treasury below 0%.” I’m like, “What?” This is how you know the Overton window has moved because people are saying crazy stuff. Stuff that would have been crazy years ago. Everyone’s like, “It’s cool. We put our money and stuff and we’ll have negative interest rate mortgages. That’s normal.”
What It Takes To Be In Real Estate Investing
If you’re not having fun in real estate, you might as well quit. I see so many people walk around with these grumpy faces all the time, “There are no deals out there, life sucks.” I listen to some of these podcasts and radio programs, I’m like, “If you don’t do something right now, the world is going to end. Your 401(k) is going to be 201(k).” I’m like, “You forgot to divide the one.” They’re like, “It doesn’t matter, it’s going to get cut in half.” I’ve been hearing them say the same thing for several years. It gets so boring. Somebody made a post in one of the groups I’m in and they said, “Do you invest in the stock market?” All these people were like, “I don’t invest in the stock market. I don’t believe in college education.”
I’m sitting there reading this stuff and I’m like, “When did it become cool to be a moron? When did you become proud of the fact that you are just against the grain to be against the grain?” When you wake up every morning it’s there. It’s like you cannot believe that it’s right there in front of your face, “I don’t believe in it.” I’m like, “Here it is. We can pull up the ticker. This is it. It’s the stock market.” Investing in the stock market does work. I will tell you that. It absolutely works. You’ve got to know what you’re doing like anything else. There’s a lot more risk there, “I don’t believe in getting a college degree.” I’m like, “Are you ridiculous?”One of the things that make real estate so attractive is that it is location independent. You can do it from anywhere. Click To Tweet
There are tons of professions out there that don’t require a college degree. To think that’s a great plan, I don’t get it at all. I read some of these real estate groups and I am sure this is prevalent in other industries. My background is in risk management in healthcare and biomedical research. In that industry, you’ve got to have a lot of formal education, terminal degrees, those sorts of things. There are lots of people with Master’s. That’s the world I’m used to. I step over into this real estate side and I read the absolute, most insane stuff. What’s fascinating to watch is you get educated people. They will say things to me where I’m like, “We’re going to send out these yellow letters and we’re going to do this. That’s how we’re going to build our real estate portfolio.” I’ll say, “Bob, what do you do for a living?” He’s like, “I’m a petroleum engineer, or I’m a salesperson.” I’m like, “Let’s replace real estate with what you do for your job, would that plan work?” They look at you and they go, “You’re right, this is absolutely absurd.”
We get into real estate and we think this business is so much different than what we do at work. We think it requires a less level of sophistication. If I tell the seller our close quick with cash, I’ll buy $1 million in real estate and be no money out of pocket. We believe these lies about investing. The problem is that we have a real challenge with the root word, and that is investing. That requires two things, your money and your time. You’ve got to have both. That’s investing. When your career begins to take off, you can replace your money and your time with your expertise. That’s years out from now.
We don’t talk a lot about that on the show. We don’t teach it because it is at least five years before your expertise is such that it requires less of your money and less of your time. When you’re starting out, those first five years, it’s investing. It’s not freeing. Be careful when you read this crazy stuff online or you listen to these shows that they’ve got here, they got on the podcast. You hear this stuff and like, “Let me show you how to do free real estate.” You can but you’ve got to know a lot of stuff before you get there. The problem with the something for nothing crowd, which is, “You don’t need to go to college and you can make it. You don’t need to invest in yourself.” That’s what they’re saying. You don’t need to invest in yourself to become successful. That is not true.
Can you be successful without a college degree? Absolutely, but you’re going to have to invest somewhere. You’re going to have to develop a skillset that the marketplace will reward, regardless of your industry. If you are in real estate you have to develop skillsets that the real estate marketplace will reward. You’re investing somewhere. If you think you’re going to send out six yellow letters, make ten offers on MLS and become a millionaire, you and I both know that’s ridiculous. That works nowhere else in your life. It’s like, “I can have a kid and feed them for a couple of weeks. They’ll figure it out. They’ll grow up all on their own. I don’t do anything.” That doesn’t work there. It doesn’t work in interpersonal relationships. It doesn’t work in the business that you own. It doesn’t work at the place of employment that you have to go to every day. You’re going to have to invest every single day.
What’s unique about real estate is that if you decide that you want to take a month off to go on vacation, you just go. You can come back and restart that whole business when you come back from vacation. You can do real estate while you’re on vacation. You can still take in deals and put stuff under contract. One of the things that make real estate so attractive is that it is location independent. You can do it from anywhere. The tools are getting even better. You can also start and stop if you want to. Don’t believe that’s something for nothing.
I find it fascinating when I read through real estate. I don’t know if it’s a single-family thing or if it’s this prevalent commercial, probably not because it requires a little more education do commercial. When I read some of the stuff that people put out there, I’m like, “It’s the fake it until you make it. You can do it with no skillset.” Rob and I joke and one of our favorite jokes is, “To become an out of state Senator, we sell a class in which we can teach you how to be a Senator from another state while living in the state that you want to.” It’s this little tongue and cheek joke that we’ve got running around.
The reason we joke about it is because it’s absurd. The reason it’s so absurd is because that’s how these real estate classes are pitched. It’s like, “You don’t need a skillset. You don’t need to invest. You need to show up and you’ll be showered with millions.” I’m like, “That does not work at all.” Here’s the point I’m trying to make. The vast majority of you following the show, you’re doing okay. You’ve got a decent job. The family is taken care of. Your retirement is looking okay but you’re nervous. I can tell you because I was in that exact same spot. I’m like, “Everything’s doing pretty good but not so sure about the retirement side,” especially those of you all under 50. You should be a little more nervous than the people above 50.
You start looking at your retirement. You start doing some calculations. “How much am I going to need to retire?” If you’re around 40 or younger, you’re going to need at least $5 million. $5 million is going to get you into a decent retirement. You’re probably going to need closer to $10 million or you’re going to have to build a portfolio in such a way in real estate that produces as much cash as possible to give you that lifestyle. There are a handful of ways that you can calculate this stuff. The reality is that, while you’re working, put your money in your 401(k) up to your employer’s match. Unless you work for a small company that’s doing well, then you might want to put some more in there. If you got options, you can buy stocks and discounts and all that. I would recommend doing that. You could look at your portfolio and say, “At least they’ll give me the match.” Whatever you’re saving every month, “Let’s go buy two to four houses a year. Let’s go buy a duplex or a quadplex that produces some cash. Let’s go buy a couple of little things here and there.” I’ll go back to this little goofball deal that we did in Katy that we bought right after the flood. We’re all in $110,000. It’s worth $140,000 when we bought it. Now it’s worth about $170,000. We’ve got $60,000 in equity.
It’s one of those deals in closing costs on the purchase, it was $5,000 or $7,000 out of pocket. It doesn’t cashflow a whole lot. It brings in $200, $300 a month. That’s not crushing it on cashflow. I know if you listen to some other radio show and they’re like, “$300 a month. You make a 90% rate of return.” It doesn’t produce enough cash to make a whole lot of sense when you look at it long-term. According to the IRS, when you look at my schedule, those properties don’t make anything when you put in all the depreciation. Depreciation is not a gift that the IRS gives you. They know that what depreciation is. It’s future capital expenditures. In other words, the AC is slowly degrading. The roof is degrading. It’s going to need paint and carpet at some point. I don’t hear anybody on the radio talk about single-family cashflow as it relates to future capital expenditures.
You hear it all the time in commercials. You never hear it on the single-family side. If you’ve got a property that’s casual and you’re $300, $400 a month, it’s not making any money, let’s be honest. However, where you’re making money in single-family real estate is the appreciation. That’s where the real money is. Unless you go to Airbnb, that’s a whole different business model. The highest and best use for single-family real estate is Airbnb. However, we also mix into our portfolio the small apartments where you can buy a little duplex for $150,000, $200,000. That brings in $2,000 a month, $2,500 a month, $3,000 a month.
Rob is headed down Corpus Christi. We have gotten a complete piece of junk that we’re buying down there. We’re buying it for $97,000 because they wanted to sell it to us at $100,000. Rob is like, “No, we’ll do it for $97,000.” I was like, “It was a fine deal at $100,000.” He’s like, “I’ll see if we can get another $3,000.” I’m like, “Fine.” It’s got three single-family houses on it, a duplex and an old liquor store. Whatever picture you have in your mind of an old liquor store, that’s what it looks like. We’re going to convert the duplex into a triplex and the liquor store into two efficiencies. We bought it for $97,000 and we’re going to put $170,000 into it. We’ll be all in for $280,000 or $290,000.
That deal will bring in $6,000 a month in gross cash. That’s not a bad deal. They’re out there all over the place. You buy your little single-families, let them appreciate and then you pay off these commercial assets. You know what my worry is during the next real estate down term when I own my portfolio free and clear, how fast can I buy more property? That’s all I’m going to care about, not my current portfolio. It’s going to fuel my expansion. I know at this point that you’re going to have to get into real estate to pick up that interest rate spread, but to protect the rest of your portfolio from the downside if you’re heavily invested in stocks, bonds and all that other stuff. We’re going to see some challenges here in the marketplace. A great way to hedge that is by adding a handful of properties in your portfolio. I’m not saying cash out your 401(k) and all that other nonsense you’ll hear on a lot of these financial shows or whatever class they’re pitching. Buy a handful of properties. It’s no big deal. If you guys are interested in us selling you some properties or getting involved with us in one of our classes, send a text to Rob (281) 401-9008.