5 Real Estate Rules That Keep Investors Winning

We've put together a list of rules that we follow on how to win in real estate.

If you do these rules and you have a long-term mindset, you will win.

Think about it like a game of chess. There are rules to the game.

Debt is like fire. You can burn your house down with it, or you can cook a really good steak.

Between 2022 and 2024, some of the smartest real estate investors in the world lost everything. Not because the market turned on them, but because they broke the 5 rules of real estate investing that have worked for decades. Today I sit down with Ben Frazier to go over exactly what those 5 rules are. Where the market went wrong, and how he's using them today to find the best opportunities. Let's dive in. So, Ben, I'm really looking forward to having this conversation with you today because traditionally real estate has been seen as an asset class to have in your portfolio for long-term stable wealth, right? Like, it is the cornerstone of the billionaire portfolio to be able to have something that you can rely on. However, if you just started investing in, let's say, multifamily real estate in 2021, your experience, or maybe your idea of having real estate in your portfolio is very flawed as we've seen truly. I mean, and you can give us some numbers here, but billions of equity wiped completely gone. And so before we talk about how to play the game, which is what we're going to discuss today, and you're going to give us the real 5 rules to playing the real estate game. I want to back up first and talk and really ask you the question, what the heck happened over the last couple of years, uh, that made this a really, you know, a really, I would say, unreliable asset class? Or did it?

Yeah, no, it's such a great point. You know, I think I've heard it before that 80% of all millionaires, you know, got rich through real estate, right? And we all know the book Rich Dad Poor Dad, right? This is the path to wealth. And a lot of people started investing in what I call the syndication boom and/or bubble, which we'll get into that, over the past few years. And so, it does beg the question like, "Wait, what happened? What changed? Because I thought this was the path. Now, I'm seeing capital calls. I'm seeing headlines of distress. I'm losing money." All these things are happening. If we rewind the clock a few years ago, there's a lot of things that led up to what I would say this syndication bubble bursting. We're going to break down what happened and then rewrite the story. But first off, it's really important to remember everything goes in cycles. As humans, we naturally like to look to the last cycle to try to avoid that same thing from happening again. And usually we're successful at that. We didn't have another banking and mortgage crisis like we had back in 2008, 2009, but the same issues cropped up in a different asset class. So the cycle that happens isn't always in the same asset class or the same area, but the kind of things that happen are pretty repeatable. And so really what happened, I think, first off, was we had very low interest rates for a long period of time, right? I remember having a conversation with a lot of really smart people in the real estate world, you know, back in 2019, you know, 2020. Is it possible the interest rates could go negative? I mean, we're seeing like negative interest rates just start to happen in Europe, right? And this was like part of the conversation. It was inconceivable that interest rates would go back up because they've been so low for so long and we were in this slow growth economy. And so it just seemed off the table. What that did though was drive a lot of aggressive lenders, predominantly debt funds. So these are non-bank lenders that raise capital from different sources and then lend that capital to real estate investors? Well, they got really hungry for deals. They're raising a lot of capital. There's a lot of capital looking for yield. You think about it, from an investor standpoint, all these big institutional investors were getting nothing in the public markets as far as yield goes. They had no interest on their money. So, they had to go into slightly more aggressive investments to get yield. And so, they invested in these debt funds. These debt funds started doing things that looking back, they shouldn't have done, they wish they wouldn't have done, which was very high leverage points, 80%, 85%, some even higher than that. These were short-term loans. These were 3-year maturities. So you had 3 years to execute the business plan. And they were generally what I would call fix and flip commercial real estate loans. These are very aggressive debt. It's much more expensive than the bank. And it's a short-term deal. So, you have 3 years to go execute this business plan. And generally, what they're expecting is a big value-add business plan. You're going to renovating all the units in a Class C property, and you're hoping you get a really big increase in rents at the end of the day. And then you can refinance the bank out or sell the property once you hit that business plan. So, that had been working for several years. And A lot of people made money doing that and they timed the market well, especially if they sold in 2021 or in 2022. And what happened is in 2022, I believe it was in the summer of '22, the multifamily values peaked. That was the highest point of value. And from there, the whole thing started to unravel because we started seeing these rapid interest rate increases. I mean, it's the fastest interest rate hike in history in the US. The speed and the size of interest rate hikes were unprecedented.

And can I just interrupt you real quick too, is to give some context to this. I was just looking online in June 22nd, 2021, so about a year before all the, you know, the Fed starts to rapidly raise interest rates, Jerome Powell Powell did come out and say the Fed will not raise rates on inflation fears alone. So like, not to say that he didn't say we're never going to raise rates, but there was a sentiment in which, again, if you see that and you're buying, it's like, you know, it's not like you can just get out of these deals immediately, right? So you see this news and you're buying real estate in 2021, or even in the beginning of 2022, the signal is interest rates are not just going to all of a sudden explode like they did, right? And so, you know, I just, I think that's helpful to put people back in that context. Also, if you're my age, you know, you're mid-30s or 40s, or heck, even, even in your 50s, we had never seen anything like this from an interest rate increase since the '80s. So like, I wasn't even born yet. And so you almost had no context of what could actually happen to multifamily values at that time. I mean, truly, unless you were just like you read that or knew that, that there was, there was really no context of that happening.

Yeah, 100%. And if you, you know, look at what led up to the interest rates, you know, going up, it was inflation. But what caused the inflation? It was, you know, COVID, which then caused this housing crisis, which then we saw this massive rent growth happening. Right. We were seeing double-digit year-over-year rent growth. In a lot of primary markets. And so it was just like a heyday for real estate. Everyone's like, it's just, you know, if you're having double-digit rent growth, you put that into a model and compound that for a couple years, it's crazy what the numbers look like, right? So there's just this expectation and this frothiness in the market, and then the song and dance ended, and that's when all these things started to unravel.

So what I really want to talk about today is not just— I think we've— and we've hit a lot on what has gone wrong in the last cycle. I really want to focus on how to win in real estate, you know, because the last cycle in '21, '22, '23 has really shown us, you know, what happens when you don't follow the rules of real estate investing. And we've put together a list of rules that we follow on how to win in real estate. You know, I think about it like a game of chess, right? There are rules to the game, right? And in, in many games, if you know the rules, it gives you an advantage. And if you don't know the rules, you know, you can get burned. And so I want to talk about each of these rules and I'll, I'll just read them and then maybe you give us some context and we can have a conversation on what they mean. So you ready to jump in here? All right. So the first one is make inflation your friend. So we just talked about how inflation was, you know, the Fed is trying to prevent inflation, but here, this is a rule we have that we actually want to make inflation our friend. What do you mean by that?

Yeah, no, it's interesting because in some ways people would've thought when they invested in '21, '22, I am making inflation my friend. So what do you mean? How does that work? Because the idea of inflation, this is something that we've gotten very accustomed to in the US and we normally have 2% to 3% inflation, sometimes lower than that in a slow growth economy. And so it's just part of the financial system. And basically, it just means that a dollar is worth more today than it is tomorrow. And what we've done in a lot of our historical research in looking at asset classes correlation to inflation, real estate, and specifically housing real estate like multifamily, has the highest correlation of any asset class that we could find to inflation, which basically means that if we see a CPI of 3% in the economy, you can expect maybe over the exact same time period, but over time that inflation rate will also match rent growth. And it makes sense because this is something that can be directly passed through to the end consumer. It is expected in real estate where most tenants expect a rate increase on their rent every year, every couple years. And so it's just built into the system. And when you're the owner of that, you directly benefit, right? So when you have higher rent growth, that generally translates to higher income, and higher income translates to higher values in commercial real estate because it's priced on value or income. And so when you have inflation in a system, and then you use a little bit of leverage, right? So now we're leveraging these assets from 60% up to 80%, somewhere in there, that impact on value, if it goes up, has a multiplicative impact on equity because you're leveraged. And so it doesn't happen always in a straight line. I think this is the hard part for people to understand is we're still very bullish on inflation. We actually think inflation is going to remain for the long haul. It creates a tailwind, but you can't always match the timing. What happens sometimes in real estate is with a lot of investing is it's not incremental straight line increase every year. It's almost like these ebbs and flows. We haven't had much rental inflation for the past few years in the system, partly because of all the supply pressures that have been happening in most major markets. But as the supply pressure is waning off, I expect we're going to see some very strong rent growth numbers in a lot of markets starting this year, going into next year, and it's going to be higher than average. It's almost kind of pent-up rental demand. And so, if you smooth out that growth and put it on a curve, you will see this kind of straight-line increase, but it's not always as simple as that in real estate. I think that's the hard part, and it will tie into what one of our other points here in a minute on playing the long game. But if you are an owner, inflation is your friend and you want to make sure that you're on the side of benefiting from inflation.

Yeah. Bubba always says, right, play the tides, not the waves. And that like rents are going to go up, right? Like if you believe rents are going to go up over time because of inflation, you know, you want to get that, you want to get that wind in your sail. I get that behind you as a tailwind. I was telling someone the other day when I moved to San Diego, California, Now, don't get me wrong, I was living in a house with 5 guys at the time, but I was paying $500 a month. All right, like, that's how you live as a college missionary in San Diego, California, making $500 a month. When I left, they were— the reason we left is my next rent increase was going to push me to $4,000 a month to live in a townhome in San Diego, California, right? Like, that, you know, is a lot of things, but a lot of that is inflation over the 10 years that I lived in San Diego.

Yeah, 100%. We've said in other places, but inflation is not neutral. You're either benefiting from it or you're losing from it. If you're a saver, if you're just sitting on cash and putting it in a checking account, you're losing the battle against inflation. It's not a neutral thing, and it's important that you are on the right side of it, that you can benefit from it. And it's, it's a key component of real estate. It's why real estate is such a great, great thing because we have inflation in the system. It's going to keep happening. But you have to also do it in conjunction with these other rules for it to actually work for you, which we'll get into.

Okay. Rule number 2, debt is like fire. Respect it or get burned.

Yeah. This one is where the last cycle really hurt a lot of people. When the money was cheap, when interest rates were low, and these debt funds and banks were willing to do crazy high leverage points, it attracted a lot of people into the market saying, "Hey, I don't have to put 10% down on a $20 million building and I can make all this money." That's a recipe that will always end in disaster if you're doing 10% low money down with aggressive debt funds. The reality is debt is actually very neutral in real estate because of the durability of the demand for rental housing real estate, the expectation of increasing rents over time. The need for housing is a long-term thing. Banks are willing to give you a lot of debt on it. And that's actually a very strong indicator that it's a good asset class. You can't go and get the same type of debt on say, a tech business. It's just the durability of that cash flow and demand is not there in the same way, but there's this sweet spot. If you go too highly levered, if there is upside, it's a really, really big impact to your equity, but if the values come down like they did in the last correction, it means a complete loss of equity. So there's this sweet spot. We think it's somewhere around 65% to 70% loan-to-value, where the leverage is actually multiplying the equity growth. So, it's a benefit to the equity, but it's not putting you at a significant disadvantage from a valuation standpoint. And so, Bob says it all this way. I love how he says it is, "Debt is like fire. You can burn your house down with it, or you can cook a really good steak." Right? And so it's how you use it and being thoughtful about the debt is very, very important. And before, there just wasn't a lot of thought. It was like, I'll just take as much debt as I can get, doesn't matter, because I can earn my way out of it through rent growth. And that, that ended up not happening.

The thing to, you know, to realize, or a good example of this, is there's a beautiful Class A apartment building next door to me that I'm sitting in our office right now. And the reality is that is not going anywhere. And so the asset doesn't leave. It's just that, you know, it passes through people's hands because of the debt, right? In the sense that, like, in 2020, 2023, the multifamily real estate didn't go anywhere, right? Just when some— when someone says I lost the asset, it doesn't mean like it disappeared, right? It just means that they lost it because the financing went wrong. And in most cases, even a conservative 65-70% That's 70% of the capital stack, meaning it's a major part of the deal. And so it's exactly right, like understanding rule number 2, debt is like fire. It can either cook you a steak or it can burn your house down. It's so key to know. I just thought an important metric maybe for folks to, to know is there's a term called DSCR, debt service coverage ratio, and the large agency lenders typically look for a 1.25 DSCR, right? Ben, explain what that means and why that is a healthy metric when someone is looking, you know, at, at debt on an asset, or why the agency lenders look at DSCR when they're underwriting an asset.

Yeah, it's a very, very simple metric, right? It's the, the income of the property, um, divided by the annual debt service, uh, usually on an amortizing basis, meaning that you're paying principal and interest. So even if you have an interest-only period on a loan, it's, it's estimating what the principal payment is going to be, and you want to be at a 1.25. The reason that lenders do that is, one, they want to make sure you can make the loan payments every month. And two, it's kind of a proxy for valuation, right? Because that's where most lenders are going to land at. You want to be able to hit that number or be able to hit that number over a period of time to be able to refinance into kind of agency loans. So here's kind of the path that a lot of real estate goes through. Most real estate is not purchased with agency loans. Now, that's changing a little bit. It's a little bit of an aside. What happened in the last cycle was most of the deals that were purchased did not cash flow day one. In fact, most of them were pretty negative cash flow. And they thought, hey, if we can put this money into the property, we can improve the condition of it, improve the unit's desirability, we can get rents up. Those higher rents will drive higher income after expenses that will then get us to a point that we are cash flowing the property. And then we can go into a permanent loan. A permanent loan is generally considered an agency loan that is going to be cheaper interest, they're gonna be a little more conservative. But you have cash flow at that point, but you got to have cash flow, there's no way you can go into without cash flow. And so, when you're looking at a deal, if it has negative cash flow day 1, or below 1.0 debt service coverage ratio, you know, you want to have a pretty clear path to get to that. Or you realize you're taking a lot more risk, right? And then you got to understand, is that risk something I'm comfortable with in this particular deal?

Which leads us to rule number 3, cash flow is king. Explain that, because to your point, there's opportunities to buy deals without cash flow. So what do we mean by cash flow is king?

Cash flow is the lifeblood of any property, right? Cash flow is what is used to pay the expenses of the property, like your property management, like your taxes, like your insurance, like your repairs. Cash flow is also what you use to pay your mortgage. And then if there's anything left over, you can make distributions. So it's a simple way to say it. But if you don't have cash flow, you still have to pay all these other things. So then you have the next question is, well, how are you going to do that? Well, if you're in a deal with, I would say, heavy value-add where they're going to do a significant amount of renovation, and hope to get the cash flow up through this renovation program, then you need to understand how long of a runway do I have before things get serious, right? If I don't hit cash flow breakeven, because every month the mortgage statement's still going to get sent to me and I still got to pay that. Every year I still got to pay my property taxes or the county might file a lien on my property, right? These are things that you have to manage. And so, at the end of the day, cash flow is king. And while there can be cycles of valuations. So there's this compounded impact right now in the market where not only have we not had rent growth for the past few years, we've had higher expenses that have hurt cash flow. We've also seen cap rates, which is the valuation of that cash flow, go up, or in the valuation scenario, the values have gone down. And so we've had this All these things are putting pressure on all these deals. And I would say we're at the bottom of the multifamily market, right? We have a lot of other research to support that. But if you're forced to sell right now, where a lot of deals are going to be forced to sell this year, and let's just be real, we had a conversation with Doug and Kelly that we just released in the podcast, $1 trillion of loans are maturing this year alone, 2026. And most of those deals are underwater. The problem is, if you don't have cash flow, you can't make it through the downtroths, right? You can't make it through the challenging times, because at this point, if you can make it through the bottom, you can actually have some hope to pick up the next uptick, the next bull market, if you have cash flow. And so again, cash flow is a— one, it's a great just reduction of risk because if you have cash flow, you can pay all those bills. If you don't get the upside that you're hoping for, you're at least not draining cash, bleeding cash, having to put more money in and putting good money after bad. And two, it helps give you some stability through the market cycles. And that's the real, real important part is real estate is cyclical, right? It's not always straight up to the right every single year, like a lot of people think it is when you're reading these books. You have to manage the cycles. The cash flow is the best way to do it.

Yeah, it, it, it is your insurance policy, right? In the sense that it allows you to weather the downturns, which there are. And even though maybe you don't realize, because you only realize the loss in real estate when you sell, right? Just like holding a stock. And so cash flow allows you to, uh, get through that. Okay, let's go to number 4, one of your favorites. Explain what you mean by this: prioritize basis, not pro forma dreams.

Yeah, gotta, gotta love a good basis, you know. That's what I always say. Basis is basically the price that you buy at, right? You've probably heard it said, you make your money on the buy, not, not on the sale. And I, I totally agree with that. This is a kind of flipping of what a lot of the excitement, enthusiasm, and honestly, an experience that came into the market over the past few years in real estate was, I don't care about my basis. I don't care what I'm buying at. I know rent growth is going to be there. I'm going to sell it for X down the road. The problem is that that's not going to happen now with the way that the market's gone. And if you got undisciplined in how you're buying, everything else is compounded. And what happened in a lot of these these deals is that you're not looking at the basis, you're not looking at this purchase price, and you're getting sucked into, "Well, if I have rent growth of 5% per year and my cap rate is sub-5% and my insurance costs aren't going to go up and blah, blah, blah, blah, blah." You can go down this line. You can make any deal look really, really good on a 5-year timeline if you just change a few inputs. And so, there's all this excitement. I remember just sucked into it, right? It's just everyone thought that it was never going to go down. There's just no way that real estate's going to go down. So, you want to be part of it because this is a chance you might miss and everything is up and to the right. Well, you make your money on the buy. And so, really being disciplined on that front end. Yeah.

It's such a good point, man, because even think about, we've talked about this, trying to get this idea of trying to get deals through committee. If you change the rent growth, your assumption to a, let's just say a conservative quote unquote 5% rent growth year over year, and you get no rent growth year over year for 5 years. I mean, those numbers are significantly different in terms of where you end up at. And then you add in, okay, let's say cap rates expand instead of compress over that same 5-year term, you know what I'm saying? So like, I think that is a really good point to make, is that's why we, you know, talk about basis is the priority, not pro forma, because you can make any deal worth, you know, worth the case, worth the, you know, worth the investment from a pro forma standpoint. And I think that is exactly what we saw in the last cycle, is huge assumptions, or maybe at that, you know, at looking back, unrealistic assumptions or expectations that were put into a pro forma that ultimately caused people to buy at a much higher basis than they should have.

100%. And this is what's interesting too, if you kind of, you know, talk about what's happening now, you know, because of our preferred equity platform where we're investing in a lot of different deals as preferred equity, we have an enormous amount of deal flow across all the major markets in the US. And what's really interesting is we're really seeing this resetting of the basis. And a lot of the exuberance has been weeded out or being weeded out. And the deals that are trading now are coming in on all these kind of— on the new frontier, right? On the new side of the transaction. And in most cases, the values from the prior purchase of, say, 3, 4, 5 years ago, it's about 25% to 30% lower. But when you get that kind of a reduction in basis, all of a sudden, everything else looks really good, right? You can actually qualify for agency financing day one. That's pretty crazy. You can, you know, have cash flow day one in a lot of cases. And you can also go into markets that you can look at the future supply curve and realize, hey, I'm putting myself in a good tailwind for future rent growth down the road. And so, basis is so important and being patient and waiting for the market to reward those who are patient and who aren't running the wrong direction when everyone has some bruises and some pain from the last cycle. It's actually the time to lean in, it's actually the time to Dollar cost average back into your losses because now is the time to go transact back into real estate with the values where they're at now.

Okay, last but not least here, rule number 5: it's a marathon, not a sprint.

Yeah, this is where, you know, the market got, got away from people. In addition to the aggressive debt, this was the other big, big challenge that people ran into was very aggressive growth assumptions on a very short timeframe. The reality is you can't control what the market does, right? No one expected the interest rate increases that we saw, but no one also expected the expenses to increase the way they have across the board. Some people probably thought, "Hey, we're going to have some rent growth suppression because of all the supply coming on market." But if everything in your business plan is relying on achieving a perfect outcome in a 2 to 3 year timeframe, you shouldn't do that deal regardless, because you don't know what you don't know. You don't know what the future holds, and there's always something unexpected that happens. But what can happen is if you can have a longer timeframe, and I'm not talking about just 3 to 5 years, I'm talking 5, 7, 10 year timeframe of investing in real estate, This is how you really win because we all know, like we said, all these rules are rules and they happen over the long, uh, the long haul, but it's not every single year and in every single part of the cycle, right? So you got to be coming in. I think right now is a great time to come into the beginning of a new cycle, but we also don't know what we don't know. We don't know when the cap rates are going to compress again. We don't know when we're going to see that rent growth exactly, although I have a Pretty good hunch it's going to be in the next 24 months because of supply, but I don't know for sure. There's a lot of factors I don't know, but I do know that I want to be positioned with those tailwinds behind me so that when the market does all recognize it, that's what happened in 2022. It was like the inflation was crazy. Capital markets were still very, very aggressive. Interest rates were still very, very low. And it was this perfect storm of all these things happened where values were just crazy high. That's going to happen again. I don't know when, maybe that won't get that exuberant, but all these things are going to line up and I want to be positioned because if you see it, it's too late if you're going to be a buyer. You want to be on the one selling at that time. To me, it's the right mindset. It's a good reframe for a lot of investors that got burned in the last cycle in this short-term mindset. You gotta, you gotta have a longer, uh, time frame to achieve the results.

Well, yeah, I also think too, it's just, it is the understanding what the asset is and what the asset class isn't, in the sense that I look at back at that cycle and a lot of people are relying on real estate, particularly multifamily, to almost be the, the growth engine for their portfolio, right? As, as if it was a, a private equity deal, as if it was a, a software startup deal. Honestly, like, this is— I mean, then I— me too, I mean Again, like, I was investing in multifamily during this time too. I remember. So I'll tell a story real quick, but I think that's also what we mean by this is that the reason historically that billionaires have allocated to real estate is not because they can double their money in 5 years. 100% of the tax benefits. Yeah, it's because of the tax benefits, the depreciation they can use to write off other income. Right. It's to shelter from taxes. That is a totally different mindset than I'm going to get in this deal and double or triple my money in the next 2 or 3 years. And so to even just put real estate where it needs to be in your portfolio is what we mean by marathon, not sprint. And I'll end with this story because looking back, you know, this is what I should have known is, you know, I was part of a lot of these real estate groups and was seeing deals trade. I remember, because I just— this guy was here in our office last week. He was a fund manager and they were buying deals in Phoenix. And this was— I remember him telling me, I said, when was it? He said June 2022 is when they sold the deal. So you said September was the high peak of the market. This was June 2022. So I should have listened to my gut. And he sold a deal in Phoenix that they had bought 18 months prior for like 180% return. I mean, it was unbelievable. I remember him posting it and I was— I remember sitting in my kitchen in San Diego and reading this email thinking, we're there. Like, we are, we are at the top. This is un— this is impossible, ridiculous level of returns that this guy just achieved in a short amount of time through real estate. Now, you know, unfortunately, I still put money into multifamily post that, but that was a sign for me, and I will never forget. It's like almost ingrained in my brain now to like just pay attention. Like, you know, let the signs speak for themselves. When we go against these rules and the market is starting to throw off these red alerts that, hey, people aren't treating real estate like they should be. It's a sprint, not a marathon. People are, you know, treating debt and being careless with it, right? Like all these things, cash flow doesn't matter anymore. The reason we give— like, we want to do this episode today is because if you follow these rules and you begin to see, to your point, Ben, when people are going against them, it becomes very obvious, like, we're, we're probably going to get in trouble. And the point here is to, you know, to, to, is, is to build and grow wealth over time. And I think looking back is like all these rules were breaking, and it is so obvious in hindsight. And hopefully we've learned enough to really avoid that and avoid that for our investors in the future.

100%. I just think one other quick encouragement for listeners is just because someone else is doing something stupid doesn't mean you got to do it either, right? We still see this in the deals that we evaluate in the pref equity that are a recapitalization or someone that still is using yesterday's kind of model where like, this is— we don't need to participate in their stupidity because they think these crazy things are going to happen. And so just like you said, benchmark everything against these 5 rules. And if, if there a couple of them get out of whack, probably sit on the sidelines on it, right? And, and kind of wait to see how things play out. And, um, if you do these rules and you have a long-term mindset, you will win. Absolutely.

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