CW 959 - Client Case Study, Scott & Kelly from DC - Shopping Centers to SFRs on 1031 Exchange, Part 1

Welcome to the Creating wealth show with Jason Hartman. You're about to learn a new slant on investing some exciting techniques and fresh new approaches to the world's most historically proven asset class that will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine self made multimillionaire who's actually been there and done it. He, he's a successful investor, lender, developer and entrepreneur who's owned properties in 11 states, had hundreds of tenants and been involved in thousands of real estate transactions. This program will help you follow in Jason's footsteps on the road to your financial Independence Day. You really can do it. And now, here's your host, Jason Hartman with the complete solution for real estate investors. Welcome listeners from 165 countries worldwide. This is your host, Jason Hartman with episode number 959. 959. Thank you so much for joining me today as we have yet another client case study. A lot of you met Scott and maybe Kelly at several of our events. Scott was at Meet the Masters. I don't believe Kelly came with him, but they are a young couple that is doing great things with their real estate portfolio. You're going to hear about today. They have moved from shopping centers to single family homes. And I know what some of you might be thinking, why would you do that? Don't you want to own a bunch of shopping centers and be a big wig? Maybe not. You know, housing is where it's at, folks. Housing is where it's at. That is where you should be. I've told you all the reasons over the years. Over the last 14 years I've been saying, you know, they can always outsource all the office jobs offshore, they can outsource the manufacturing offshore, they can outsource the retail to the Internet. And all of this has a huge impact. But everybody still needs a place to live. It's a fundamental human need. What are the three fundamental human needs? Food, clothing and love. Happy Valentine's Day. By the way, everybody, it is Valentine's Day. No, it's actually food, clothing and shelter. And food, clothing and shelter. But I will tell you, I was kind of hoping V day here today would fall on a 10th episode show because I have a special Valentine's Day episode for you. And I guess we will run that as episode number 960 coming up. Remember, every tenth episode, every show that ends in a zero, we run something of general interest. And hey, love you is of general interest. Right. To all of humanity. Well, almost. We will run our Valentine's day show a little late, but hey, it's better Nate than lever. I mean, late than never. We're gonna get to our case study today. That's what we're gonna do. That's what we're gonna do. But first I wanna tell you a few things. The good old national association of Realtors, you know them? That largest trade group in the world with like 1.4 million members. Yeah, they're big, big. We've had their chief economist on the show before. We'll have them back again to talk about stuff. But they're out with some new research as they are all the time. Today they just published that nearly 2/3 of U.S. housing markets see home prices hit an all time high while housing inventory hits an all time low. And I know what some of you are thinking, Is it a bubble, Jason? Is it a bubble, Pop? No, it's not a bubble yet, but it will be eventually. So sit tight, stay tuned. I'll let you know when I think it's a bubble. But hey, what do I know? I don't even know. Nobody knows, you know. Nobody knows. The head of the Federal Reserve doesn't know. The President of the United States doesn't know. NAR certainly doesn't know. John Burns doesn't know. Jeff Myers doesn't know. Jason Hartman doesn't know. But you know, we can get some clues here and there, can't we? The question is not what is the price of the home. The question is compared to what? Is it an all time high compared to the monthly mortgage payment on the home? Or is it an all time high compared to the price of the home? See, therein lies the problem, as you know, because you are a sophisticated smart investor. Because you listen to my show. You'd have to be smart and sophisticated to listen to my show. Otherwise you wouldn't be able to keep up with the superior information we are, we are sharing here. Okay, so I don't know. I get kind of goofy sometimes, don't I? So people buy a house on a payment, not a price. In fact, they don't care what the price is. If the payment is low enough, that's what they're buying. They're buying a payment. So it is not at a all time high based on the payment. And then you have to ask geographically, where are you talking about? Two thirds, two thirds of US housing markets? Well, is that of the case Shiller 20? Or is it all 400ish housing markets nationwide? And that is the question we need to ask, right? We need to Know this stuff because the Case Shiller is heavily loaded. In fact, 3/4 of the case Shiller 20 are cyclical, bubble oriented crazy markets that I wouldn't touch with a ten foot pole. In fact, where do you think that saying came from? Do a lot of people carry around, like in the old days when someone came up with a 10 foot pole saying, did people carry around 10 foot poles and decide not to touch things? I don't know, it's goofy. Funny saying, right? Okay, so consumer satisfaction research. Yeah, that's boring. Who cares about that? You know these groups are always doing surveys to say how great they are, right? I'm not going to share anything with that with you. But this one's interesting. Also from nar. Housing affordability declined from a year ago in December, moving the index down 2.3%, moving it down 2.3% from a year ago. And this is December to December. Obviously it's not December anymore as we know, because hey, there's a clue. It's Valentine's Day. We know that's not in December, don't we? So yeah, housing affordability declining, but still in the linear markets, it's not far off. Housing affordability is still pretty good and that's why inventory is so low and the market is booming. In the cyclical markets though, man, there's going to be a bloodbath. Some people are gonna get hurt. They're gonna get hurt. I'm telling you, watch out. You know, we've got this event coming up in Silicon Valley, March 3, San Jose. Hope you're going to be there. And join us for Jason Hartman University. Go to jasonartman university.com and one of our clients, Greg, who was at Meet the Masters, of course, and many of our other events, he sent me a voxer message this morning and he said, Jason, I will be there on March 3rd in Silicon Valley and I am trying to get some of my California friends to come and hear what you have to say. And I just can't peel them away from thinking. Now he didn't exactly say this. I am, I'm using some poetic license. So let me run with it because this was the gist of it. I can't peel them away from the fact that they think they are all brilliant geniuses because they speculated on a house in a cyclical market and the price went up. And you know the old saying, you've heard me say it. I don't know if this is actually an old saying like that 10 foot pole thing, but at least I say this everybody's a genius in a bull market, aren't they? Everybody's a genius in a bull market. A rising tide floats all ships. You've heard that one, right? I didn't make that one up. That everybody's a genius in a bull market. That could be me. I don't know. I'm not sure. I'm not going to take credit because I'm not sure I deserve credit. But anyway, you know, if I was Bill Clinton, I would take credit for everything even though I didn't do it. If I was Obama, I would too. So I picked on the Democrats. Check. What else can I do today? Okay. Yeah, we're gonna have our client case study. We talked about some NAR stats. Those are interesting. Of course. I look forward to seeing you in Silicon Valley. San Jose March 3rd Jason hartman.com or Jason hartmanuniversity.com and this is a great event. We'll only have it once this year. I think you will learn the math of real estate. You'll learn how to do the math. In fact, that's thing that Greg said to me said, you know these California people, they just don't know how to do math. Now he didn't mean that broadly, but if they knew how to analyze a real estate deal, they would never invest in these total fluff, crazy nutty markets. What goes up must come down. Hey, that's an old saying too, like that ten foot pole thing. So yeah, just remember that the higher they fly, the harder they fall. All of these markets will eventually fall. How much longer can they go? Nobody knows for sure. But believe me, they're not going to go forever. So that's what you got to know about that. So linear markets where the conservative, prudent, real investors invest, that's where you want to be. Let's go to part one and let's talk to Scott about how he went on his real estate investing journey that started just 10 years ago. That's it. In 10 short years just did an exchange exchanging one of his commercial properties for 30 I think 37. Oh no, no, not on the exchange. He bought some others from us before the exchange and then a bunch more during the 1031 exchange. So it's good stuff. The most tax favored asset class in America, the most historically proven asset class in the world. And guess what? You can find those, those great things@jason hartman.com properties jason hartman.com properties all right Jason, stop talking. Get to the guest. Part one Client case study. Scott and Kelly, you're gonna love this. Here we go, Hey, I want to bring to you another case study. Study. We have a couple of wonderful clients that volunteered to be on the show. They've got a big story and just a great outlook and attitude on real estate investing and a long background in, in the income property investing world from commercial to residential. So we'll talk about that transition. Now it is Scott and Kelly. They live in Washington, D.C. and Scott, welcome. How are you?

Hey, Jason. I'm excellent. How are you today?

Yeah, good, good. It's good to have you on the show. Thank you for coming on and sharing your story. Give us a little bit of your background, you and your wife and, you know, just kind of tell us about that and then we'll dive into your story.

Yeah, sure. Kelly and I are kind of your typical hard working, well educated people. We went to graduate school and we got jobs in the corporate world. And then when the real estate market crash came along, we came across an opportunity to buy a portfolio of shopping centers. And so in 2009, we acquired five shopping centers and tried to shepherd them through the real estate crash. And we were able to do that. And recently we've been selling off the shopping centers and converting to a more residential model.

Cool. So, Scott, first of all, everybody's going to, you know, the begging, the question that everyone's begging to ask probably is, how did you get the money to acquire all those shopping centers? Because that's a pretty good head start, isn't it? Or, or no. You know, sometimes these kind of stories can surprise you a bit.

We got lucky. This is a person that I had worked for doing their bookkeeping when I was in college. And I kept in contact with them over the years. And when the real estate crash came, this individual was really looking forward to retiring and selling all the property and suddenly they weren't able to. And so they were looking at holding a portfolio of shopping centers through another business cycle. And the way it was looking is going to be quite a long one. And so I was just having a conversation with this person and said, you know, if you really want to sell those things and retire, why don't you sell them to me? And so he did, and he sold Kelly and I the entire portfolio. No money down.

Wow. Oh, my gosh. That's fantastic. What, what an amazing story. So when you say you worked for him, was he in the business of being a landlord or was there another business? What do you mean by that?

Yeah, he was fully in the business of investment real estate.

Okay.

And I was just doing his bookkeeping and collecting rents from tenants while I was going to undergrad.

Yeah, fantastic. What an amazing story. So here is the secret then, folks. The thing you can take from this is go to work for some big time real estate investor, do the bookkeeping so you know the numbers and then when the next recession hits, you know, see if you can buy it. It's great story. That is totally awesome. So these were, you know, retail shopping centers. So interesting, you know, during the Great Recession, were you worried about the retail apocalypse, as they call it now? Did you see it coming? I was just kind of wondering what, what was your outlook? What was Kelly's outlook on that at the time?

Yeah, we were definitely concerned. We had, you know, careers that were based on, you know, graduate degrees and all this that we'd been working on for decades or about a decade and a half. And we had to make the decision to give up on both of those careers and go full time into managing shopping centers. So, yes, we were very concerned about all the risks associated with that, but in the end we found that we didn't have that much difficulty. I mean, retail is definitely changing, but all neighborhoods need a barber and a beautician and a nail salon and a liquor store and those kinds of things. And the kind of neighborhood strip centers that we have, they've survived. Okay?

Right, right. Because they don't have the big box and the other stuff that's affected by the online. Online takeover of retail. And you know, I gotta tell you, it concerns me. The typical thing that happens in every business is you get. Whenever you get some big player, they'll come in and essentially buy the market by undercutting it. Auto companies do this. Know Uber has done this. Yeah, I mean, you know, it's a common practice in business. Right. Buy the market, even if you have to run at a loss or, you know, just very low profits. Buy the market, kill your competitors and then raise the prices and abuse your customers. You know, that's sort of the typical story. So that concerns me very much about, you know, big centralized power like Amazon. Any thoughts on that? Just as a tangent?

Yeah, absolutely. These tech companies are able to run at a loss for years and years in a row and somehow their stock price just goes up and they're able to generate more funds from investors. And so it really would concern me if I was a grocery store and Amazon was coming in to the grocery market. I would be very concerned because, you know, a local grocery store chain just isn't able to raise money in that way.

Yeah, right. They don't have the scale. That's what's sort of perverse about the marketplace and the way the venture capital system works and. And so forth, isn't it?

Oh, absolutely. You know, it's scary being a small business person when you're going up against corporations who, you know, have tax advantages that maybe small business just doesn't have, or the ability to borrow funds at rates that are much lower than small business has.

Right.

It's always been scary, but you kind of hope that being nimble and taking your own talent and really putting it into something full time that you'll be able to find a way, find a niche in a market. And we were able to do that.

Yeah. Yeah, Good stuff. Okay, good. That's obviously a tangent, but it does concern me for, I mean, for the customers, from a customer perspective, mostly. You know, why. And when did you get the idea that you should sell the shopping centers or at least some of them, and then buy residential properties, buy single family homes and tell us about that evolution?

Sure. Well, it was never our goal to be full time owners of shopping centers. It's just an opportunity that was too good to say no to, that we decided to take on. Really what we want to do is just have a nice life and not work too hard. And these particular shopping centers took a lot of effort to run. Part of the reason for that is they were in parts of town where it's hard to hire professionals to come and do the management for us. And so we had to do our own property management. And so part of the reason that we're selling the shopping centers and exchanging them for single family homes is that we'll be able to get property management with these portfolios of homes so that we don't have to do so much work ourselves.

Right. Right. Okay. Okay, good. What did you do and when did you do it? Well, I guess maybe the first question is when did you discover. I guess you discovered my podcast. You and Kelly came to a couple of events. Tell us about that.

One thing that happens when you don't have a real estate background, that you instantly buy a, you know, very expensive portfolio of real estate, realized you don't know anything about this field and you have to learn. So I didn't really have friends in the real estate field, so I was looking for resources and podcasts was really something that I could do on my own schedule and get information about the real estate market without having to know any individuals or pay for classwork or anything like that. Just really convenient. As soon as we bought this portfolio. I started listening to your podcast in 2009, and we were sold on the idea. We really liked the idea of turnkey single family, especially as a way to grow our portfolio as time went on. And so in 2012, we bought our first property in Memphis through your group. Now, Kelly was not as excited as I was at the time about it, so I had to convince her, so I had to invest with my own money. So I actually used my Iraq and purchased a single family home in my ira, and it's worked out great.

So, okay, this is interesting. So your wife wasn't excited about it. So she says, hey, use your own money in your retirement account that you had before we were married if you want to do it. Honey, put your money where your mouth is. Don't put my money there.

There's not a lot of money. That's just mine. You know, it's a whole hour. Yeah, but. And this is. You know, I think a lot of marriages probably work this way, but my. My retirement fund is something that I squirreled away on my own, and I really thought it was going to work out. And to prove the point, you know, I went and I bought a house. Yeah. And it worked.

Yeah. Yeah. Good stuff. You came to our Memphis, one of our Memphis property tours. Right. And you bought one property. That's. That's it? Just one?

Initially, I just bought one.

Okay.

And then the next year, I think we bought one more, and then the year after that, we bought two more. And then the year after that, we bought another two more.

Okay, Were those all Memphis, by the way? Were you staying in that same market? Okay. Okay. So you just kept doubling down in Memphis for a while. And what happened the year after that? You were about to say the year.

After that was last year. And so last year we bought 12 in Memphis, we bought 15 in Jackson, and we bought four in Oklahoma City.

Okay, cool. So you've got. Through our group now, Scott, what do you have, about 36 properties or something like that?

37.

37. Okay, good. And what happened last year, that was the big change of acquiring all these additional properties.

It really happened. On the commercial side, we saw that interest rates look like they were starting to go up. And commercial real estate is valued primarily by the cap rate or the return rate that people can expect when they purchase it. And so when the interest rate goes up, that will deteriorate the value of the shopping center as far as your ability to sell it. And so we saw interest rates coming up. They're still low at the time Last year. So we decided to sell the shopping center and switch over into residential, primarily because residential prices are still a bit low. I think there's a lot of opportunity to pick up value there. And also, it looks like homes are going up in value kind of quickly, whereas shopping centers are going down in value as the interest rate rises. So it's just a good time to take advantage of the difference between the two markets.

I couldn't agree with you more, by the way. I think that's very insightful that the residential market just has a much better future than retail properties do. We talked about the retail apocalypse. Obviously, you know, most people understand what's going on there, but at the end of the day, you know, Scott, like I always say, everybody needs a place to live, and that is just not going to change.

Right, Absolutely. And, you know, the markets we're buying in are robust markets. The population is stable and growing, and the values are stable and growing. It's not like we're just buying residential anywhere. Mm. We're buying in good markets.

Right.

You know, one of the other benefits, Jason, is with our shopping centers. They're all located in one geographic area, but with this residential, we were able to diversify across three different markets.

Right. So you've got. You've reduced your risk by diversifying like that. That's one of the other good reasons. It's. It's good to not have, you know, like, one lump of an expensive property or. Or anything like that, because you can definitely diversify geographically. All real estate is local, as I like to say. Certainly not my saying, that's an old saying, but. But yeah, it does. It does allow you to do that. But, you know, Scott, I mean, you and Kelly, as you were thinking of doing a 1031 exchange on, you know, shopping centers, and you were also, you know, just buying real estate before you did the first exchange. You could have done anything. I mean, you could have adopted numerous different strategies. You Live in Washington, D.C. that's obviously an expensive cyclical market. Why not just invest right around the corner from where you live?

Well, you know, we try to invest where the investment makes sense. And so in the case of the properties that we acquired from you guys, we were able to make sure that we get a nice return, that they're in good, solid markets where we know we'll get that return over a long period of time. And we have property management in place. We don't actually have to do the work ourselves to run the property.

Right. So let's talk a little bit about Property management with the shopping centers. You did your own management, by the way, what do you still own in terms of retail properties? And what did you sell? Did you only sell one of the centers or two of them?

We sold three of them last year. We sold one in years gone by. So we're just down to one last shopping center.

Okay, got it, got it, got it. And by the way, isn't the 1031 tax deferred exchange just a beautiful thing?

It is so great. It's going to do so much good for us having done this exchange last year. I'm just thrilled.

Yeah, good, good stuff.

You don't even realize some of these benefits until you do it yourself. The benefits for our depreciation are just amazing. And I did it last year. If I were to do it in 2018, it would be even better.

And you mean because you got to restart the clock on your depreciation. And plus the residential property properties have a shorter depreciation schedule. It's about 25% shorter, which means you get more tax benefit more quickly.

Right, right. And the life of my investment is probably not going to be 40 years long. So in the case of a commercial depreciation schedule, I'd almost certainly never get to the end of it. But with the residential, I'll be able to get a lot more, capture a lot more depreciation.

Right, right. If there's a couple of newbies listening to the real estate game, depreciation makes income property the most tax favored asset class in America. It is the most wonderful benefit and it's such an oxymoron that you can have appreciation and make money on that and you can have depreciation and save a ton of money on that at the same time. It's such a great, great asset class. It really is. You did that exchange. You've shortened your depreciation schedule. Before we talk about property management, before we started this, this recording for the show, Scott, you were telling me about how your exchange went and, you know, just sharing a couple stories about working with our network. I thought that was pretty interesting. Did you want to share that with the listeners?

Well, luckily, when you're selling commercial real estate, the timeline for selling a property is quite long. So we were under contract and still had 90 days to go before we got to the actual closing of the commercial property. And so I had a few extra days to do some property tours. So I got in contact with Sarah, my investment coordinator over there, and we went and visited, or I went and visited a few markets and got to know property managers, got to see their product. And I was pretty sure I knew which markets I was going into on the closing day. On the closing day, I had 45 days to identify my properties. And within a week I'd identified the properties in Oklahoma City and in Jackson, Mississippi. But I still had quite a bit of capital left over that I need to allocate. And I was planning on allocating that to a certain market. And the vendor, the provider of the homes actually went through bankruptcy. And the bankruptcy was announced in the newspaper just before I signed my sales documents to purchase that portfolio. And, and so I spoke to my attorney and they said, well, being a 1031 exchange, you can't be guaranteed that you're going to be able to buy these in case there's some kind of action in the foreclosure court. And so I actually had to back off of a rather large investment. Just a couple of weeks into my selection process.

Right.

I found a new market and I was all set to reinvest with this other company, another provider, this time in Memphis.

Right. Another one of our local market specialists. Yeah.

I had lined up another rather large portfolio and I was getting ready to sign to purchase these. And I showed it to the bank I was borrowing money from, and they said that they didn't want to finance any new home purchases. So they never said that to me back when they were giving me the commitment, the loan commitment. But when it came time to identify houses for these portfolios, the financing company I was working with actually didn't want to do the deal if they're brand new homes, brand new construction. And so once again, I had taken the time to identify these homes, and then the last minute I had to abandon my plans. Wow.

Yeah. So were you, were you, were you worried?

I can't really describe how worried I was. I was very worried. I'd like to say that I aged about two years in that 45 days.

Okay, so let me just explain this to the listeners. So this is because, you know, you have these tight deadlines to complete 1031 tax deferred exchanges. And if you don't, you know, for example, like you could lose some of the properties you were buying and not be able to acquire them or identify them. And you would just have to pay tax on the, the amount of money you didn't reinvest. Okay. So it's not like the whole thing was off, but anything outside of the exchange is going to be taxable. So you wanted to not have any tax liability and transfer all of the gain from the sale of the shopping center into the new single family homes you were buying. And this is the problem you're describing. Go ahead.

Yeah, so I, you know, especially when you're dealing with large sums of money and the tax rate comes out to something like 23.8%, it can be really scary. So I was looking at about 10 more days left in my identification period. And I was calling Sarah and I was freaking out. And she did some good digging for me, put me in touch with a provider in Memphis, and I was able to allocate the final 800,000 in our purchase with just about seven days left in our selection period. And so that worked out great. That provider basically saved me. They gave me all their inventory for the next two months and just let me buy it all at once. Lo and behold, three months later, we closed on all that property all in one day.

Right, right. Yeah, yeah. You're reminding me of a story. Not this part specifically, but we had some clients a few years back and we talked about their story on the show. They sold a. Another single family home that they'd inherited. It was in California, it was about two and a half million dollars. And then they purchased, I think 36 or 38 homes through us on the exchange. You know, income properties, obviously, I don't shouldn't call them homes, they're investment properties, but single family homes. They were pretty amazed that we were able to help them pull that off, you know, that's all. There's a lot of properties to acquire in one swoop like that really quickly. Especially in a market where, you know, the market is obviously tight. Right. And things are selling like hotcakes. I mean, there's very little inventory, so that can make it really worrisome. I've done a few exchanges over the past few years and personally, even though I'm in the business of doing this, I had the same problem. You know, I was really worried that I couldn't complete the exchange. And I don't want to get stuck paying the tax on the capital gains from the. The relinquished properties. Yeah, yeah. Good stuff.

It can be serious. Yeah. But, you know, I don't think this opportunity really existed before companies like Platinum Properties were around.

Right.

If I were to try to go out and use the MLS to purchase 31 single family homes, it's a nightmare. And try to negotiate on all 31 and try to get them all inspected and close, it would never happen. It's completely impossible.

Yeah.

And especially with the financing I used, I had to be able to close on at least half a million dollars at once at the same closing on the same day in order for them to do the financing.

Right.

Try to do that with, you know, 31 different single family home.

Oh God.

Sellers.

It would have never happened. Yeah, that's, that's really amazing how you share that story. This will be continued on the next episode. Thank you for listening and happy investing. Hey, I hope you'll join me in San Jose on March 3rd as we host our Jason Hartman University event. Now this event is for the real, practical, hands on interactive education on income property investing where you will learn how to actually do the math, how to evaluate the deals. We will go in depth into this subject of how to analyze a real estate deal. And once we do that, we'll talk about how to build a portfolio, how to properly structure a portfolio, how to diversify it, how to sequence your mortgage financing. And it is a fun event. We do some gamification. You'll meet a lot of people because you'll be working with the people in the class and it's a one day event. You can check it out at jason jason hartman university.com jasonhartmanuniversity.com We've been doing this event for about three or four years and people absolutely love it. We've done it in San Diego, in Salt Lake City, now we're doing it in San Jose. We've done it other places as well. I just can't remember where offhand. But it's a great event and we try to do it about once a year. Last year we did it in Oklahoma City. This time we will be in San Jose Silicon Valley on March 3. Jason Hartmanuniversity.com Jason Hartmanuniversity.com get your tickets today and we'll look forward to seeing you in Silicon Valley on March 3. Thank you so much for listening. Please be sure to subscribe so that you don't miss any episodes. Be sure to check out the shows specific website and our general website, hartmanmedia.com for appropriate disclaimers and terms of service. Remember that guest opinions are their own and if you require specific legal or tax advice or advice in any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to itunes or Stitcher Radio or whatever platform you're using and write a review for the show. We would very much appreciate that and be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.