Instant Cash Flow or Huge Headache? (Rookie Reply)

Ashley:Let’s be honest. Figuring out how to partner with a contractor, navigating tenant leases or scaling a short-term rental portfolio isn’t something you learn from a textbook.

Tony:I mean, these are real life curve balls that rookie investors are facing right now. And today we’re answering three questions straight from the BiggerPockets form to help you avoid these common pitfalls.

Ashley:This is the Real Estate Rookie podcast. I am Ashley Kehr.

Tony:And I’m Tony j Robinson. And with that, let’s get into today’s first question. Alright, so question one comes from Steve in the BiggerPockets forms and Steve says, I found a partner that I like to start flipping houses with. He’s very well qualified and he actually reached out to me to partner up. Our goal is the same started flipping business. He used to own his own contracting business for six years and is now the onsite manager of a construction company that built apartments and subdivisions. I’m bringing the capital, he’s doing some of the labor himself and charging me nothing for labor, anything he can’t do, he will charge me book cost for a specialist labor and cost for materials. He offered me a 70 30 partnership. I figured instead of a private loan, 70% sounded pretty appealing. I’ll also get to help out and learn some trades with him.My main concern is he doesn’t have enough cash now to have any skin in the game or cover any upfront fees. I asked if he’d give me a personal guarantee on a private asset around 10 K. He said he doesn’t own anything outright that’s worth 10 k. Does anyone have protection recommendation? So I can sleep a little easier. I’m getting cold feet since I’ll have the skin in the game Financially, if something goes south on the flip and he doesn’t have enough to pay me back or we lose the money, how will he pay me? Alright, this is a great question. I think first Ashton might be beneficial just to discuss the different types of partnerships. So there’s a debt partnership and then there’s an equity partnership. Steve, for you, it sounds like what you guys are pursuing is an equity partnership. If you really want to make sure that you are protecting yourself, then maybe a better scenario here is for you just to be this person’s private money lender where you give them a loan and with that loan now you get a lien against the property.You get a promissory note that outlines how much he’s supposed to pay you back, and if for whatever reason he doesn’t repay you, well now you’ve got a means to go after the property and try and recoup some of what was invested. That is the way that a debt partnership works. The equity partnership on the other hand is like you guys going into this deal together. So there really isn’t, I mean, and again, you can set up the partnership in a way that you want, but typically in an equity partnership, you guys are sharing in both the upside potential of that deal and the downside potential of that deal. So if things do go sideways, there is no, he’s paying me back, Hey, I brought in the capital, he’s bringing in his time and this is kind of the risks that we’re taking is that, hey, maybe he doesn’t finish, or maybe this does go wrong. So I think in an equity partnership you get more of the upside, but part of what you’re accepting is that downside risk as well.

Ashley:I think one of the things that I noticed at the end of the question as to he’s asking if he can have a lien on some personal property that the contractor has or how will he make sure that he’s paid back if the flip goes south? And that’s one really important thing about being an equity partner is they have no obligation to pay you back just because they’re the other partner in the deal. You are partners on this. If it goes south, you guys eat the loss. Your partner has no liability to have to pay you back for what went south on the deal. So I agree with Tony, maybe being a debt partner is actually better for you or you could do both. My very first deal, I had a partner who was an equity partner and the debt partner, so he actually got monthly payments every month, five and a half percent he was making on his money and he was also 50% owner of the property.Now this was a very good deal for him. I probably wouldn’t recommend doing that for your first deal. It’s like giving up that much equity, but also you’re on the side that my partner was where you’re getting all of these benefits. So maybe instead of 70 30, you actually do the 50 and then you are making five and a half percent interest and you get monthly payments to yourself or you wait until the end of the deal and actually pay yourself interest or pay yourself off at the end of the deal. So when you sell the flip, your balance is repaid to you, the capital is repaid to you, then maybe you’re even if it’s a small amount of 3% interest or something like that. So I think be very confident in the difference between the responsibility of being a debt partner compared to being an equity partner.But I think in this scenario that you have the opportunity to be both. So you could put the lien on the property as the debt partner so that when the property goes to sell, you are getting paid first before you and your partner get a capital distribution from any profit that is paid out. So I would try this way out for your first deal together and then maybe if it goes well and down the line you can just say, you know what? I don’t need to do the debt partnership part. Let’s just do full on equity.

Tony:Yeah, I think, yeah, you bring up a really good point Ash, and again, it goes back to what we say often is that there’s no right or wrong way to structure a partnership. It’s really more about what the two of you feel most comfortable with. But I think that maybe one of the questions that you guys should answer amongst yourselves is, well, what happens if your contracting partner doesn’t fulfill his duties? What happens if he misses a lot of, or maybe just isn’t showing up to the job site or the work that he promised to do isn’t being done? What then can you do as a money partner to kind of course correct this deal? And maybe it’s like, hey, if you miss deadline by X number of weeks or certain milestones aren’t met within a certain timeframe, then maybe you as the person who brought the capital, has the ability to swap him out with someone else, or maybe he loses his 30% equity in that deal and now there’s something else.So it feels like maybe there’s some solutions here, but honestly, I feel like the best solution if you’ve already asked some question marks, is just to be a straight up debt partner That’ll simplify this in a way that I think allows you to sleep a little bit easier at night. You get more of a guaranteed return because there’s that note there and you don’t necessarily have to worry about like, Hey, what happens if the deal doesn’t go according to plan? Because if it doesn’t, you’re still obligated to get that return. Now, will you actually get it is a different story, but at least you have that obligation there that he’s supposed to pay you back.

Ashley:We’re going to take a short break, but when we’re going to come back, we’re going to go over a scenario where someone’s purchasing a duplex that has a tenant in place, but they also want to live in the property. We’ll be right back. Okay, welcome back. Our next question is from Isaiah in the BiggerPockets forums, I’m planning to make an offer on a duplex listed around 455,000 here in Raleigh. I’m planning to live in one unit and rent out the other. So owner occupancy is a must for my FHA loan. One side is vacant. The only wrinkle is that the tenant on the other side has a lease that runs until July, 2026, about eight months from now. My goal is to have vacant possession at closing or as soon as reasonably possible after without putting pressure on the tenant or making the seller’s life difficult for those who’ve been in similar situations.What’s the best way to structure this in the offer? So it’s fair for everyone, seller, tenant and myself. Should I ask for the seller to provide notice to the tenant right after due diligence ends request delayed possession until lease end and possibly negotiate a rent credit, reduced purchase price to offset holding costs include a vacant possession clause contingent upon lease termination before closing. Any examples of how you worded this in your own offers or leases would really help? My goal is to keep this deal smooth and respectful, but still align with the FHA owner occupancy rules. From what I’ve learned on the BP podcast, inheriting tenants can sometimes be more trouble than it’s worth because they’re used to the previous owner’s way of doing things. I want to make this transition as smooth as possible and avoid stepping in as the bad guy trying to change rules or expectations. So one thing I want to clarify here, Tony, and tell me if you understood it the same way. Is he thinking that he needs to have the whole property vacant upon possession or he just wants to have it?

Tony:Yeah, my understanding is that he just wants to have a clean slate when he steps in because one side is already vacant for him to move into. But yeah, it sounds at the bottom down there, right? From what I’ve learned, inheriting tenants can sometimes be more trouble than what it’s worth. I want to make this transition as smooth as possible and avoid stepping in as a bad guy. So it sounds like he’s just got maybe some fear and hesitation around inheriting tenants and just wants a clean break.

Ashley:Yeah, he said my goal is to keep this deal smooth and respectful, but still align with the FHA owner occupancy rules. So just to be clear, if anyone did think that you can have one unit rented out, you just need to have at least one unit for you to live in. So this property as is does comply with FHA rules. You don’t need to have the whole thing vacant for you to move into when you close on the property. So inheriting tenants, I’ve had the good and I’ve had the bad. I’ve had one lady that I inherited and when I inherited her, she lived there for 30 years and it’s been eight years and she’s still living there. Wonderful, wonderful tenant. Also had people where we’ve evicted them within the first six months of taking over the property. So definitely is difficult because you aren’t the one that screened the person.So you don’t have the background, you don’t know what their credit score was, you don’t know their background check, and you didn’t get to decide who’s moving in or you into the property. So I can understand where this person is coming from is wanting a clean slate. So when you are negotiating with the sellers on this, understand that, I don’t know North Carolina laws, but in there anything like New York, that’s very, very hard to get a tenant out for just because you want them to move out with no significant reason. So usually that’s nonpayment of rent or if the lease is up for renewal. But if they do have a lease in place, it’s very, very hard to get someone out. The thing that I could offer you to suggest is to do a cash for keys situation where you ask the sellers, you could ask them first if they would be willing to have the property vacant.Maybe the sellers already know a way to make that happen by offering cash for keys or they know some way to get the tenant out of the property. You could put that in. If they say no, they’re not going to do that, then see if they would be willing to have you offer cash to the tenant to vacate before they move out of the property. So the only problem is with this is if I was the seller of the property, I would be very cautious of getting the property completely vacant because what if we don’t close on the property and now I’m stuck with a vacant building with no tenant in place and we didn’t close on the property. Now I have to start the whole sales process all over again. And who knows how long that could take? And now I’m sitting vacant. So also think about the seller side of things, but another thing you could do is just wait until you have ownership of the property and you could serve notice that you are going to terminate their lease at the end of their lease and it’s not up for renewal.And again, this is dependent on state laws. I’m pretty sure California can’t even do that. You have to offer renewal unless it’s something crazy like you’re demoing the property or you’re moving a family member in something like that. So make sure you know your state laws, but worst case scenario, you put something in place so the day you take ownership, you’re working towards making sure they know that their lease is terminated at the end of the eight months. So step one, just ask the sellers, ask if they would be willing to have it vacant. The next step is to offer a cash for keys, see if they would be okay with that, that you offer cash for keys to the tenant that’s in the property to move out by the time you close on the property. And then third is have a plan in place for when you take ownership for when that lease does expire, that they are vacating the property.

Tony:Ash, let me ask you a follow-up question. I think in my mind part of it comes down to how good of a deal this actually is. Because if you’re getting a really killer deal, even if this tenant doesn’t pay for eight months, if you plan to hold this thing for the next 5, 10, 15, 20, 30 years, eight months out of that timeframe is a relatively small percentage. So I guess the question that I want to ask you, Ash, is let’s say that maybe the current owner tells this new buyer, man, these tenants have been a real pain in the butt, actually hate being their landlord, but they complain about everything they pay on time, but they’re just hard to deal with. Would you, if it was a really killer deal, still buy that and knowing that it’s an eight month lease?

Ashley:Yeah, I would because I also look at it as like, okay, here’s one of the other things he said was what if I do delayed possession where we wait for closing and then they’re getting a credit for holding costs or whatever during that time. But you as the buyer of the property, if they know this property is sold, but you’re taking delayed possession of the property until that person is moved out, are they going to care about the property? Are they going to, I’m buying a house right now where I saw it in the spring, we just went under contract. So this is almost six months later, the gutters are falling off. I was looking at pictures from the spring compared to how it looks now and just from it’s sitting for six months of them just knowing they’re going to sell the property and not really, they didn’t put it on the MLS, anything like that. It’s like I cannot believe how dilapidated it looks just for the six months from nobody living there, nobody taking care of it. That’s what I would worry about too, is that delayed possession as in they’re not going to take care of the property. And just as a seller too, I would just want to offload the property. There’s a reason I’m selling it and I don’t want to wait eight more months for the buyer to take possession of it too.

Tony:Yeah, that’s true. My oldest son is a senior in high school right now, so we’re having a lot of talks about senioritis and it’s almost the same thing. It’s like when you can see the finish line is so close, you kind of take your foot off the gas. So yeah, I didn’t think about that from the seller’s perspective, but I mean, yeah, I think if it’s a good deal, Isaiah, I would say still move forward with it. Don’t let a good deal slip through your fingers because there’s a tenant there and you don’t even know how great of a tenant it is. And again, in a worst case scenario, maybe just underwrite, Hey, what happens if they didn’t pay for the next eight months or even the next 12 months? You’ve added some additional time to evict them if you need to, but if they didn’t pay for 12 months, what does this deal look like?If I had to float this by myself, since it’s a house hack, there’s a chance that maybe whatever you’re paying for your new mortgage is the same that you’ve been paying in rent anyway. So I think that there’s maybe some other elements to consider about whether or not you should or should move forward with this deal. Let me ask, right, you did say that you had one tenant, you inherited, lived there for however many years, others that you wanted to evict on day one. Were there any maybe red flags during the closing your due diligence period that you maybe overlooked where now you’re like, okay, I know I’m always going to look for this to see if I get another bats in it?

Ashley:Yeah, there actually was one, and it was actually a five unit before residential, and the first red flag was when we went to see the property, we couldn’t get into that unit the person was working. The next red flag was that while we were during the closing process and under contract, one person was already evicted from that property. Then the third red flag is in my final walkthrough inspection, the morning of closing, we still can’t get into that other unit. And my real estate agent said, yeah, you’re not getting into it. He’s not allowing access. The seller isn’t pushing it, you’re not getting into it. And it was that circumstance where it was a good enough deal that it didn’t matter. We had already baked into our numbers. We were rehabbing every single unit in there.One thing too was we were under the impression it was a one bedroom, but it’s actually a studio, but it gets crazy amount in rent, so it wouldn’t matter, I guess. But they paid for a while and then they stopped paying and then we had to go through the whole eviction process with them. But I think the fact that they were giving trouble to get into the unit and that was another red flag, and then just the owner didn’t even really know that that wasn’t a one bedroom. So it was just all of those little things and somebody else in that property was already, this was pretty run down when we bought it. So I guess there was the red flags of this isn’t the greatest building to live in, so why would a really good quality tenant want to live here? I guess. So I think as long as you are setting yourself up for the expectation that you may need to clear house and get other people in there, or if you are not knowing the condition of units, making sure that you’re baking it into your numbers, that this could be a full rehab of that apartment too, not knowing the condition of it.So there were those little red flags.

Tony:So I mean, at least Isaiah, you know what to look out for and hopefully it still works out for you. And then we’ll bring you on to the podcast as a guest and you can talk about how great this story was. Or maybe we’ll bring you on as a guest. You can talk about how horrible it was and the advice we gave you was not great advice. So either way, it’ll make for a good story. Alright guys, we’ve got one question left and we’ll hit that right after A quick word from today’s show sponsors. But while we’re gone, if you’re not yet following us on YouTube, there is a real estate Ricky YouTube piano. You can find us at realestate Ricky. You can see mine and Ashley’s smiling faces, but you guys can be a part of the community on YouTube as well. So we’ll be right back after we’re from today’s show sponsors.Alright guys, welcome back. We are here with our third and final question, another question from the BiggerPockets forums, and this one comes from Jacob. And Jacob says, is anyone successful in scaling a short-term rental portfolio? If yes, how many properties do you have? And are you still growing? Or is the current market too unfavorable? It seems that being so much more hands-on that they’re a little bit harder to scale. But I’m curious what people who actually built portfolios think. That’s a great question, Jacob. So 1000%, it is true that managing one single family short-term rental is going to take more time, effort, and energy than one single family long-term rental. With a long-term rental, you’re signing a lease for 12 months. To Ashley’s point on the last question, you might get someone who stays here for decades with a short-term rental, your average data ratio is probably between two to three to four days, depending on the size of the property in the market.And you could have multiple people coming through on a monthly basis typically. So just that sheer increased volume of foot traffic through the property, the different personalities you’re dealing with, the expectations that people have when they’re booking a place for their vacation, it just in and of itself is going to require more work. Now I think that, and I don’t know if you saw this actually, she asked yesterday, but there’s a short-term rental company called Sonder. Have you heard of them? So Sonder is, to my understanding, probably the biggest company that operates and manages short-term rentals. They’ve got, I believe it was like 9,000 listings. Their model was more of an arbitrage model where they were leasing out nice apartment complexes in a lot of places, but they had like 9,000 units, but they just yesterday basically filed for bankruptcy. And they’re immediately ceasing operations.And I think part of the reason that that happens is because it is a little bit more difficult to scale short-term rental operations than it is long-term rental. It’s part of the reason why companies like Evolve or Vac Casa have maybe seen their stock prices take a hit over the last couple of years because the quality of their listings decreases when you’ve got 30,000 listings that you’re managing. So when you talk about scale at that level, I think it is difficult now for most of the people listening to this podcast and we talk about scale, we’re not talking about 9,000 or 30,000 plus listings. We’re talking like five or 10, maybe 15 or 20, right? If you’re really, really crushing it. And I think that level of scale is very much doable, very much feasible if you set up the right tools, systems, and processes to support that. Is it more work? Yes. But is it possible? Absolutely. You just got to make sure you put the right pieces in place.

Ashley:I think one thing that I’m noticing is that having these unique experiences and things like that really make you stand out that it is the people that have the blah, the standard Airbnb. And I was one of those people, I had two Airbnb arbitrages that were just boring apartments. They had cute bedding, cute furniture, cute decor on the walls, but you can’t add an amenity to an apartment. So I think that was what was really limiting and just they’re become so many Airbnbs that the markets have just become so saturated that you’d need something unique to stand out. And also, I am wondering too, and I have no data to back this up, this is all just my personal preference and maybe other people are feeling the same way. And that’s why some of these Airbnbs aren’t being successful. I would rather stay in a hotel.I have decided I do not staying in an Airbnb. I like my room cleaned. I like in fresh sheets on my bed. I like to have a restaurant. I like the amenities. I like having a gym, all of these things that a hotel offers compared to an Airbnb. But if it’s something unique and we have our own sauna or have a big pond or it’s on a lake or things like that, then I’m all for it. Or maybe if you just have a huge family and you all want to stay together, but if it’s just me traveling or just me with my kids and it’s just like we’re already doing something, we just really need a place to sleep, 100%. I am picking the hotel or the Airbnb. I don’t want to have a checklist of things to do in the morning, take out the garbage. I don’t want ’em to bring my own toilet paper if they only supply one roll for two weeks. So maybe there is other people like me that this shift has happened also. But I just feel like also in a lot of markets, it’s not that big of a price difference. I felt like for a while Airbnbs were actually a better price than getting a hotel. But now when I compare and look going somewhere, it’s not really that big of a difference at all.

Tony:Ash. I do think that’s why Airbnb is really, I dunno if you’ve seen some of their, they’ve been spending a lot on marketing and advertising lately, but one of their commercials, it’s like a group of girls who are sharing one hotel room and there’s one bathroom, one mirror, and then they do the split screen where it’s the same girls, but they’re in a four bedroom house and everyone’s got their own bathroom and it’s like a bachelorette themed thing. And I think that’s maybe where Airbnb has a bit of a leg up. There was another commercial where it was like a couple who had went on vacation to get away from their kids and they’re hanging out at the pool at the hotel and there’s a bunch of kids running around and they’re like, we came here to get away from the kids. And then the split screen is them at their own private Airbnb with their private pool and enjoying it that way. So I do think that there are definitely a percentage of folks who just like the amenity to come along with the hotel and what that experience is. But there’s definitely still, I think a growing group of people who like the privacy, the experiences that you mentioned. And then also the ability if you’re going with the big group, grandma, grandpa, the cousins, the kids, just to have one big place that you guys can all stay

Ashley:All set and hang out. Yeah,

Tony:I think there’s always a market for that too. And I guess that kind of leads to the other points of Jacob’s question. Is the market too unfavorable? I mean, you could ask that for every single real estate investing strategy right now. Is it too unfavorable for flipping? Is it too unfavorable for single family long-term rentals? Are there challenges now in terms of interest rate, in terms of affordability? Absolutely. But does it mean that the strategies themselves are no longer working? No, it just means you have to tweak and adjust your strategy and how you’re executing to fit the reality of today’s environment. So people are always investing in real estate as a market’s done, whatever it’s done over the life of the United States, people have always invested in real estate. And it’s worked out because over time it still tends to be a good investment.

Ashley:And I think exactly what you said is what you have to consider to see if the strategy will work in your market. So if you are going into a market where there are a ton of Airbnbs and just having a plain Jane apartment doing Airbnb arbitrage or just getting a house that has no amenities, are there a million others? Just like that? And do you to have something unique and something to stand out to. So really look at the market that you want to go into and see what is going to make yourself stand out from all the other listings too, or what type of property is always booked? Is it one that has the bar with all of the different glam sets for the girls to do their makeup for the bachelorette parties? So really doing your market research on what people are actually looking for and want and why they would choose you over another Airbnb. Airbnb or over a hotel to come to that market. To

Tony:Episode 6 48, which released on December 3rd. We interviewed John Bianchi and Jamie Lane, two folks from the short-term rental industry who are experts in the data side of things. And if you want more insights on what to look for, how to do that market research, again, go check out episode 6 48.

Ashley:Well, thank you guys so much for joining us for this week’s rookie reply. I’m Ashley. He’s Tony. And we’ll see you guys next time.