Intro: Royal Standley of Oregon Pacific Financial Advisors, offering securities through United Planner Financial Services, member of FINRA/SIPC, shares his planning approach to help people toward a place where they may be at peace regarding their financial goals. In this dynamic podcast, Royal will share his insights on how to design a retirement plan to help you plan for your future. Now, onto the show
Aric Johnson: Hello and welcome to Life by Design with Royal Standley from Oregon Pacific Financial Advisors. Today we're going to be talking about diversifying into real estate. And this is something that I have never spoken to Royal about before so I'm pretty excited to hear what he has to say. Good morning, Royal! How are you?
Royal Standley: I'm doing great. How are you doing Aric?
Aric: Doing great. I'm excited to be well into 2019. We've got a great start. And from everything I'm seeing the real estate market is still pretty good. So, this is a great topic.
Royal: I think so and it's one that's really pretty timeless. I think you look back over, you know, the years of people building wealth, real estate really is one of the best ways of building wealth for Americans.
Aric: Mm-hmm.
Royal: Home-ownership is such a giant indicator of having a net worth above a million dollars. It's such a way of not only with your own personal residence having that stability there but diversifying into other forms of real estate really allowing people to grow their net worth. Grow their assets and it's one of the most exciting topics I talk about with my clients. The fun part is being able to sit down as a financial planner and help them walk through whether or not they should invest in real estate.
Aric: Mm-hmm.
Royal: What are the best strategies for doing that and giving them hopefully a little bit of guidance to go talk to a mortgage broker or a real estate agent to begin that process of diversifying into rentals.
Aric: So when you actually ask them that question you kind of discuss that with them, what is your feeling as far as their response? Are they nervous about the topic, are they saying we don't know, I've heard really bad things. I've heard great things and they're excited to go do it. What's the reaction generally?
Royal: All over the map.
Aric: Ahh.
Royal: I talk to people who and I just ask the questions: have you ever thought about owning rentals? And some people are gung-ho and say absolutely. It's part of the plan I want to have for my family for generations to come. And other people say I've tried that once or my parents tried it and it didn't work out.
Aric: Mm-hmm.
Royal: And I have no desire for that. I don't want to be tied to something. So, kind of regardless of where someone's at I want to meet them there and just give them guidance. If somebody says I don't want to do to rentals. It sounds like a nightmare. We just take that right off the table. I don't think there's a need for people to go down that route because there's definitely some downsides when you get into owning rentals that a lot of people don't even consider.
Aric: Yeah. Royal, I have a rental property. I have one. I had planned to have between seven and ten. Long term goal was to be able to, you know, get everything paid off and use some of the property possibly to fund my children's college. And all these things, all these ideas. And after the one, we had great renters at front and then we had some really bad ones that my wife was so stressed out because of what they had done to the house and what they had done to us that she was done. She's like uh-uh. no more. So I have one and that was about it.
Royal: Yes I think a lot of people who are interested in rentals have very grand plans. But oftentimes I think most people hit, hit, hit a wall there. Sometimes that wall is after the first one. Sometimes It's after five. Only occasionally do I see people with more than seven or eight rentals.
Aric: Yeah.
Royal: Because there is a certain point where it becomes a whole lot of work.
Aric: Yup, absolutely.
Royal: So let me tell you a little about my family and my history with real estate.
Aric: All right.
Royal: I really grew up in this. So my dad served in World War Two and spent basically 22 years in the Navy. When he got out in about 1968, he moved to San Diego and settled there and just started buying real estate in downtown San Diego. Over the course of the next 12, 13 years he ended up buying about 100 different rentals and he really became someone who would buy distressed properties. Go in, fix them up and get them rented. His objective was to have this real estate, to get renters in there, collect those rents and then eventually down the road he began to sell those properties. But really, that was his passion. He'd work all day for the city of San Diego in the maintenance department and then in the evenings him and his best friend Cal would get together at whatever new property they were working on. And you know get to work doing those renovations.
Aric: Hmm.
Royal: So it was a whole family family affair, really.
Aric: Yeah.
Royal: The interesting thing was as I remember asking my dad years Years later and I was like why, why were you and Cal friends? And he looks at me he goes oh well that's because Cal did great electrical work.
Aric: [Laughter] Yes that's a good friend to have.
Royal: And I was I was amazed by his answer.
Aric: That's funny. That's great.
Royal: Yeah. So I grew up and you know understanding the value of real estate both from the standpoint of having it as a rental but also what you can do if it gets to the point of hey let's sell this property and then selling it on a note. Which is another great way I think of being able to monetize that real estate investment that you had.
Aric: Royal, you said selling it on a note. What does that mean?
Royal: So basically when you have a piece of property that's paid off, you as the owner can basically act as the bank. You might accept a, you know, 20 or 30% percent down payment but then you're actually carrying the paper,
Aric: Ohhh!
Royal: Just like a bank would when they give you a mortgage,
Aric: Gotcha.
Royal: For that new purchaser. So, my family actually still carries one of these notes that my dad sold years ago. He's actually refinanced it a few times. It's tied to property there in San Diego. And you know just like a bank you get to collect those principal payments as well as the interest payment on that. So, depending on the interest rate environment it can be a very nice long-term investment for you.
Aric: Yeah absolutely. So, I'm assuming it's similar to rent-to-own but not the same?
Royal: It's more like just a traditional real estate transaction except there's no bank involved. There's no,
Aric: Gotcha.
Royal: Bank that owns that mortgage. The owner of the the property basically gives a note to the seller of the property saying we're going to make payments over the next 30 years at this interest rate just like he would with a traditional mortgage.
Aric: Got it. Got it. Well that sounds great.
Royal: Yeah in a high-interest rate environment it's really attractive. The interest rate environment we've been in the last 10 years really not so, because you're not getting paid, I think, enough,
Aric: Mm-hmm.
Royal: To really make it worth your while.
Aric: Got it. Got it.
Royal: So that's kind of my background there with real estate. I've owned a number of rentals in my life. I definitely know the pros and cons there.
Aric: So Royal, I know the, the home that I own, my rental property. It's up right now, from what I owe, so if I sell it, I'm going to, I'm going to make some money on it. Which is good. But it's not a major asset necessarily for me because it's a much lower-priced home in the Omaha area. So as a asset class how do how does real estate work?
Royal: Basically as an asset class it's really a diversifier, I think, for the rest of your portfolio. It's not tied to the stock market.
Aric: Mm-hmm.
Royal: It's a physical asset and if you're buying individual real estate, often you're using some leverage there in the form of a mortgage,
Aric: Mm-hmm.
Royal: That leverage can help boost your rate of return on that asset class over the long term. So that's one thing I think people don't really think about there or if they do maybe don't compare directly to the stock market is when you buy a home and you have a mortgage on that home you're only investing let's say 20 percent down on that asset. So, let's say you take $25,000 and invest it in a down payment on a $150,000 home, well that $25,000 is controlling a $150,000 asset. So, when that asset appreciates the rate of return on your $25,000 investment is pretty great.
Aric: Mm-hmm.
Royal: It's one of the best ways of building wealth, especially over the long run there. So, we like it as a diversifier. We like it as a way of using leverage on a piece of your portfolio. Because you certainly in most cases wouldn't normally use any leverage on your 401(k) or other invested assets in the stock market, ‘cause to be perfectly frank, those markets are probably too volatile to really effectively use leverage over the long run.
Aric: Absolutely. Yeah absolutely.
Royal: We also have that conversation about real estate investment trusts versus rentals. Real estate investment trusts are a way of getting exposure to real estate as an asset class and getting away from real estate that's just focused on residential. Real estate investment trusts are basically companies whose main focus is just buying and managing real estate. So, you can buy REITs that just focus on, let's say, warehouses, on commercial office buildings, retail as well as apartment buildings and that sort of thing. The nice thing with investing in REITs is you never get calls from your tenants.
Aric: Yeah, that would be nice.
[Laughter]
Royal: So, there is no cost of ownership there, as far as time and doing maintenance there,
Aric: Mm-hmm.
Royal: Which is which is a nice differentiator there. With rentals, you're going to have to be involved in a much more active hands-on way.
Aric: Yep.
Royal: Some people love that. Other people despise it.
Aric: Yeah absolutely. I know there's management companies out there, as well, that can help you to do that. But there's a cost involved. And they don't handle everything. So it just depends on your individual situation. For me I've got one home. There's no way I would use a management company because that would be a complete waste but if I owned 20 homes that would probably be a really good idea because that would just be too much work.
Royal: Absolutely absolutely.
Aric: So, when we talk about investing in real estate obviously there are many different types of buildings. Like you said there's a warehouse there’s, you could buy into business-type buildings or, or residential properties. What is your best tip to make that purchase or begin that process?
Royal: Yeah absolutely. So I think the way most people initially get started with rentals is really they buy their first starter home. They live in it for you know 5, 10 years. They build up some equity there and they're ready for that next home.
Aric: Mm-hmm.
Royal: So at that point, you know, they have a decision to make there. They can sell their starter home and use all of that equity in their next upgraded home. Or they can keep that starter home and convert it into a rental. You can pull some of the equity out of that rental to use for a down payment for the upgraded home. But I think that's probably one of the easiest ways of beginning that process of getting started with a rental. So, you buy your first home. Stay in it a few years and then after 5, 10 years, you basically make that move to a bigger, nicer home, but keep that original starter as, as your first rental. I see that quite often with people who just keep that starter home and begin the landlord process right there.
Aric: Gotcha. That sounds like a pretty good plan.
Royal: The other way, and often I talked to this about young people who are looking at buying a home, is I really recommend, take a look at buying, making your first home a duplex.
Aric: Oh yeah, That's a great idea.
Royal: Or looking for something with a mother-in-law unit,
Aric: Mm-hmm.
Royal: Or an apartment or maybe two houses on one lot. I think that's a fantastic way of getting into a property and becoming a landlord really right away. And that's really one of the best ways I see people beginning the process, of kind of diversifying into real estate. The real question is is are you ok living next to your tenants.
Aric: Mm-hmm, mm-hmm.
Royal: There's definitely some pros and cons there. The con is is you're here. You're the one that's going to get their door knocked on at 3:00 in the morning when something breaks. The pro there is you can keep an eye on things and make sure that you can kind of spread your pride of ownership to that property.
Aric: Yeah absolutely.
Royal: So, if you own your home, you don't want to get into a duplex where you live, you don't want to do the, kind of, that starter-home-transition-into-a-rental. What you'll need to just purchase a rental outright is, usually the number the banks are looking for is 20% to 25% for a down payment. And that's really where we work with clients is how do we come up with that to make that first purchase? We really want to get away from you know tapping the 401(k) and pulling out that money as a loan. It's a possibility to do, but in the long run I think it puts a lot of stress on your retirement plans, as well as you because you've got to pay that loan back within five years to the 401(k) plan. So we really want to work with people of getting that, that account setup either a savings account or an investment account that's after tax that we can start putting money into and building up that nest egg for that that first down payment for a rental. The other thing you can look at doing is maybe doing a refinance on your existing home to take that 20% out and put down the rental. We want to be really careful when we're adding that kind of leverage because what can happen there is if you don't have that 20% down payment and you just pull it out of your home you've basically bought that rental with 100% debt.
Aric: Mm-hmm.
Royal: So we want to be very careful looking at those leverage ratios to make sure that people don't get kind of over the end of their skis there. That's what we saw a lot in 2008 where people were just levering up and levering up. We like the idea of using real estate. We like the idea of using a mortgage but we want to be very, very careful that we're not taking on too much risk when we do it.
Aric: Yeah, that, I mean, that can be, I mean we saw it then how many people were foreclosed upon because of those types of situations.
Royal: Absolutely. Absolutely. The other thing I would say is if you own a business there's definitely some opportunities there of looking at buying either the office building or the facility that you need for the business. There's always great incentives there as a business owner to do that and to purchase that property and not pay rent to someone else. It's another great way of building long term net worth.
Aric: Yeah and if the building’s large enough, you'll maybe you have extra space for other offices.
Royal: Absolutely. Absolutely. Definitely. Just a few ways for people to look at getting into real estate as an investment outside of their own personal residence.
Aric: Royal, like I said earlier my grandiose plans for my rental kingdom was about 10 properties didn't come to fruition and honestly this home I bought it back in 2001 or 2002. It has not been a huge source of income for me. We've... for many different reasons, but repairs and other things and getting renters in there and having damage and all those other things. It hasn't been a great source of income. What are your thoughts on income from rental properties in general?
Royal: This is a great topic. Income for rentals, I think, is wonderful but it takes a while to get to that income.
Aric: Mm-hmm.
Royal: Especially as you start with the purchase of a piece of, a piece of property of a rental, is if you're going to have a mortgage on it, unless you're buying it outright and have you know large bags of cash sitting around you to be able to do that,
Aric: Mm-hmm.
Royal: Most people are going to buy it on a mortgage. And so, what we see quite often is between taxes, insurance, improvements, mortgage payments, that most of the income that comes from a rental is just going to go right back into that piece of property. Sometimes we'll see some numbers where you can put some money there but ultimately when you look at the passive income that's produced by real estate. It has to be a long-term plan for most people. Now if you buy a piece of property and get the perfect deal and do a lot of work yourself sometimes you can really up those numbers. But for most people they're seeing a small bit of income from their rental property to begin with. Now over time as rents are able to be increased and your mortgage payments stay steady over that 15- or 30-year mortgage you can start to see more income coming out of those properties. But for the most part I'm going to say your income is going to be relatively minor,
Aric: Mm-hmm.
Royal: For probably the first 10 years that you own the rental. Now in the long run it will really begin to pay off just as the property appreciates you can increase the rents that you're charging. But initially there most rentals are going to be a break-even proposition for most people getting into them and that's okay. You know investing is about doing it over the long term. We can talk maybe at a later date about the whole idea of flipping houses and all the risks that come with that.
Aric: Yeah. Yep.
Royal: You know that's a much different type of investing than owning rentals.
Aric: Got it.
Royal: Yeah, I've met with a few millennial clients looking to retire before the age of 40 or 45 or 50. And you know good for them. That's an awesome goal to have, but you have to be realistic about the amounts of money you have to save as well as the size of your lifestyle can be when you retire that young.
Aric: Yeah absolutely. I mean that's a great goal. I would love that. But the reality of it is, is that possible with, like you said, if you're trying to do rental properties as part of it, that's a big down payment. That's a big payment up front that's not going to bring you a whole lot of income like you said, what for the first decade or so? Those are things you really have to be able to look at and how are you going to make sure everything is done correctly during that decade in your savings and your 401(k)s and your other investments along with these rentals to make a complete package. That's that's a long shot in my opinion for retiring at 45. But not going to pooh-pooh the idea. I would love that.
Royal: It's definitely possible for the right people. And you know I love working with those people but sometimes I have to just kind of provide a little bit of a dose of reality there.
Aric: Yeah. Yeah
Royal: Of how long it takes for these to become really cash-flow positive.
Aric: Yep
Royal: And it does take a little while.
Aric: Got it. Royal I love the story you told earlier about your dad and his buddy, is it Cal?
Royal: That's right that's right.
Aric: Cal. The electrician. I've got a buddy of mine, Stu, who is a great electrician and he helps me. Because I've, I've got an issue with my house right now. I'm redoing the kitchen and I've had to redo some other rooms because of some damage that happened. And when we pulled the carpet up that was really heavily damaged, the original hardwood floors are there. And this house was built in 1903.
Royal: Hmm.
Aric: I love woodwork. I am so excited to do this. It's a ton of work. But what I'm not excited to do is that electrical. So Stu is going to help me with that. Update some of those things in the kitchen. And I know that you've had rental properties. It's blood, sweat, and tears a lot of times and I'm spending unfortunately a lot of my weekends right now going over to the other house that's like you said live in a duplex right next door which is great but I don't so I have to go down to the other house and I spend quite a bit of time there doing these repairs and putting this kitchen back together and these other rooms together. What's your experience with the rental properties you've had?
Royal: So I have a much different experience because I do not have that, that handyman gene that my father had.
Aric: Gotcha. Okay.
Royal: So I really have to call people whenever there's an issue with, with, with a rental or a piece of property that I own. It makes it very tough. And what's interesting is a lot of the property that I've owned I have not lived in that same time zone or area code for those pieces of property.
Aric: Mmm.
Royal: So, often times we had do a lot of things by phone. It's an additional cost and it's definitely something to consider and be realistic, I think, when you buy a rental and in saying how much time energy and expertise do I have to put into this rental property. It's okay to hire people and get the job done right and quickly. But you have to kind of factor all of those in when you look at rentals and whether or not they're right, kind of, the right investment for you. And it will also help kind of determine what types of properties you'll look at when you're looking at buying rental. So if you're someone who doesn't have that handyman gene you probably don't want to look at a place that's a giant fixer-upper without factoring in what those costs are going to be to bring in professionals to do that fixing up.
Aric: Well the other thing is honestly this home has now been vacant since November 1st basically.
Royal: Mm-hmm.
Aric: And with the holidays, with everything that keeps us busy, I haven't gotten there every weekend and so now I'm redoing these floors. I'm really excited about it. But you know we're into 2019 so I have not collected any rent for that entire time. You know nobody living there. So that's another thing to determine. Would it cost me more to do it myself and it's going to take me six-to-eight months to redo everything or do I pay four or five thousand dollars for somebody to come in and redo it in a week or two weeks.
Royal: Mm-hmm.
Aric: So that's that's a big difference there. So how do people determine whether or not they're suited for rental properties or that it's a good idea for them?
Royal: So, I think people have to determine that for themselves. Do they have the right attitude to deal with tenants? Do they have the right attitude to own a piece of property that they have pride of pride of ownership in and have the possibility that someone else will trash it,
Aric: Mm-hmm.
Royal: Or not treat it like they would? You have to have that thick skin there, at least to a certain level to be able to own real estate.
Aric: Yeah.
Royal: Because tenants are not you. They’re- Nothing in the world is better than a good tenant and nothing is worse than a bad one.
Aric: Absolutely.
Royal: I've had both. When you have a great tenant, owning real estate is the easiest thing in the world.
Aric: Mm-hmm.
Royal: When you have a bad tenant, it can become a nightmare. So, you want to be really careful there and be very, very careful either with the tenant that you put in there or that the company that's doing the tenant screening really is doing their job right.
Aric: Exactly.
Royal: And making sure that the people in that property are taking care of it. Maybe not at the same level you would, but in that range at least.
Aric: Yeah, absolutely. The last piece is know your laws in your state for each state that you own property in because tenant versus landlord laws vary state to state and some states are way on the side of the tenant and some are on the way on the side of a landlord. It makes a huge difference because when you get a bad tenant usually they know what the laws are and they will play the system to a point where it gets pretty ugly and it costs a lot of time and money so it's not a good idea unless you're ready for that commitment.
Royal: Absolutely. We just saw the laws here in Oregon move dramatically towards the tenants rights.
Aric: Yeah.
Royal: So definitely something to consider. Talk to other people who own real estate and who've done this before. Is another great way just to determine if real estate is right for you.
Aric: Absolutely. And there's usually a landlord association in each state. Probably more even in a county or city.
Royal: Yep.
Aric: Look those up and they have a lot of good resources as well.
Royal: Absolutely right.
Aric: Any closing thoughts today, Royal?
Royal: No I think that's it.
Aric: Right on. Thank you so much for the time.
Royal: My pleasure. You have a good one.
Aric: All right thank you for listening to the Life by Design podcast with Royal Standley. If you have not subscribed to the podcast yet, please click the subscribe button below. This way when Royal comes out with a new podcast it'll show up directly on your listening device. This makes it much easier to share these podcasts with your friends and family. Thanks again for listening today and for everyone at Oregon Pacific Financial Advisors, this is Aric Johnson reminding you to live your best day, every day and we'll see you next time.
Outro: Thank you for listening to the Life By Design Podcast. Click the subscribe button below to be notified when new episodes become available. The views expressed are those of the presenter and may not reflect the views of United Planner Financial Services. Material discussed is meant to provide general information and is not to be construed as specific investment, tax ,or legal advice. Individual needs vary and require consideration of your unique objectives and financial situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.
Advisory services offered through Oregon Pacific Financial Advisors Inc., and securities offered through United Planner Financial Services of America, member FINRA and SIPC. Oregon Pacific Financial Advisors Inc. and United Planners Financial Services are independent companies.
