Owner Occupied Episode 2

Well, Peter, welcome back from Puerto Rico. How was it?

Thanks, it's great to be back. Uh, had a great time there. Weather was beautiful. It was 83 and sunny, breezy every day.

And what's it, what's it like in Ohio today?

Well, we got back late last night and it was about 17 degrees. It had snowed 4 inches, so I had to dig out the car from the airport parking lot. And yeah, it's about 23 degrees today and it's been snowing on and off all day.

Well, as we look forward to the conversation this week, I thought it would be good to explore a little bit how you made the transition from sort of just running your properties to thinking you needed more intensive management or managing more than just your properties, what went into that? And then you mentioned last week about a product you've acquired in the past, and you're in the middle of transactions today. So I thought people might be interested to know how you approach that process. And I'm in the middle of a transaction myself, buying both a building and a business and using the SBA process. So we could just talk about that. But why don't we start with, you've given us a little background about your history of working a W-2 job, investing in property with a partner. How did you go from running a property and doing that to a more expanded portfolio?

Yeah, definitely. So let's see. Well, The properties I bought with my partner, these are single families for the most part. I think there was a couple two-family properties in there. And those are pretty straightforward to self-manage, especially if you just have a small handful. When you're working a W-2 job, especially if you don't have a family, you've got plenty of time outside of work to run around and show the units to prospective tenants and collect rent and deal with things like that. So My partner and I put together some systems and processes to start self-managing these properties. And we did what everyone does, you try and read books and you try and look on the internet to see what's out there about how to do this. And as we started to acquire a few more and our jobs started to become a little bit more intense, it did start to become a little burdensome. And so we looked around for a property manager at that time. And this was around 2010, 2011, 2012.

How many properties did you have when you started looking for a possible property manager?

I think we had 4.

Okay.

4 or 5.

Okay.

And, you know, a lot of people have this idea that a property manager really only wants to work with folks who have a lot of units, and that's just not the case. Many, many, many property managers, I would say most property managers are happy to work with someone that has even just one unit. Now, there's a big difference between a property management company that's managing 100+ unit apartment buildings all over the city. That property manager's not going to answer your call, sure. But those are by far the minority. Most property management companies are dealing with mom-and-pop investors just like you who may only have one single-family rental or duplex or something like that. So don't be afraid to reach out to property managers even if you only have one. Don't, don't think that they're not going to return your call or anything.

Okay.

So you may not return your call, but it probably won't be for that reason.

It's not because you've got one, you've only got one property. So you've got 4 or 5 now. You start reaching out to property companies. What did you find when you did that?

Well, we didn't like what we found. In talking with other rental property owners and real estate investors around Columbus, Ohio here, no one really liked their property manager. You know, my business partner went to OSU. He'd had a really bad experience with a couple property managers, OSU area campus landlords. And so we, we were kind of like, you know what, there could be an opportunity here because In the process of self-managing, we sort of figured out how to do it to a certain extent. And because we're engineers, we put together some systems and processes on how to self-manage. Um, and we decided sort of concurrently that we were getting sick of working for other people. We really wanted to go out on our own, start our own company. And what we thought was, this is great, What we'll do is we'll start a property management company kind of on the side here, and then that will sort of supplement our income while we go out and we look for more deals. Because what we really wanted to do was to syndicate real estate investments and continue doing that and growing and growing our portfolio. So we put a plan together and the first thing we had to do was go out and get our real estate licenses. Most states require you to have a real estate license to manage property that you don't own. So it's no problem to manage your own property, of course, but if you want to manage property for a fee for another person that, that, that you don't own the property, you usually need a real estate license. So we took the classes, took the test, got our real estate licenses, and we partnered up with a broker. And then I quit my job, my engineering job in 2013 to start the property management company. Again, with the intention to, you know, build it up to some nominal size, such that we can go out and continue buying deals. Problem was, well, two problems. One, property management turns out to be a lot more intense and really consumes all of your resources if you want to do it correctly and really leaves no time left over for anything else. And the other problem was that by this time prices had started to climb quite rapidly. So 2013, 2014, 2015, our first couple years in business, well, we thought prices were really high and we were going to wait for the downturn to buy property. Well, we all know how that story turned out. Prices have done nothing but go up ever since with no end in sight. So we ended up really focusing our attention then on the property management business. And so that's, that's what we've been doing ever since is you know, full-time, full focus on management.

I'm curious. So you, once you make that, you've got some contacts in the, in the industry, because you've been talking to people, even in looking for your own, pursuing a property manager. Just what it was a little bit, what was your, how did you, how did you find properties to manage? What was your process for doing that?

Yeah, so it's a It's a broad approach and it includes a lot of networking. So go out, of course, to every real estate meetup, investment group, realtor meetings, professional groups, referral groups, anything where you're out and about bumping up against other folks who either own rental properties or help people who do. So I'll take a little tangent here. In real estate, Every time a property sells, there's a whole army of little helpers, I call them. Yeah. Who, who provide some value to the transaction and they take a fee. Okay. So of course you have the real estate brokers and the realtors and then you also have the lawyers, you have the title company and the folks who work there.

Wait a minute. You count the title company as the title insurance is a value add to the transaction?

Well, 99.9% 100, it's not, but the one time you need it, I guess.

That one out of 100 may come in real value.

All right. The bankers, CPAs. So all these folks, although they may not own rental properties directly, they are in a great position to refer you business. And so it would behoove you, and it did me, to stay in front of them, sort of remind and refresh them that, hey, I'm in the business of property management. I'm a thought leader in the space. We do right by our clients and kind of, you know, hope that they're going to remember you next time their client buys a property. So I did a lot of that. We also threw together a website. I remember vividly, I was at a conference for my day job and I was coding this property management website for our new company we were going to launch. I did it on Squarespace years and years ago, and that website served us well for quite a while. And we did some Google AdWords advertising. So that if someone searches for Columbus property manager, ideally, you're going to rank highly in the organic search results for that. And but that takes time. And in the meantime, you can of course buy ads so that you show up in the sponsored results for the keywords that you care about. And that works well, we got a lot of business through that way. The referrals. What else did we do? I think that was about it back then. It was, you know, of course I went on the internet forums like BiggerPockets. I spent a lot of time on BiggerPockets. We've definitely gotten some business through there. You can get into Facebook groups. There's a lot of Facebook groups, you know, talking about real estate investing. So it's, there's no like, there's no like panacea for generating leads. You really have to have your hands in a lot of different areas. And then ideally folks see your name a couple of times and then they'll reach out.

You know, it's interesting as you talk about it, you, you had the W-2 job and that was in engineering, right? You were, you were an engineer. You had one particular model that you were pursuing, the syndicating real estate deals and just kind of doing property management on the side. You networked and then you completely pivoted to property management, or not completely, but a big chunk. That kind of, when I hear that, I hear it commonly. One, I think of it as engineers who speak English, but you've got a system mindset, but you're able to communicate well and apply it to completely different things. You didn't learn, Property management and engineering school. You didn't pivot your business. You were able to do that because of a particular skillset. So it speaks to a more business mindset than— is the engineering related to that or?

Yeah. You know, you raise a great point and I've thought a lot about this. When I was an engineer, 'cause a lot of people say, why did you leave engineering? Like, did you not like it or? I liked engineering, but it got boring for me. And maybe it was just the line of work that I was in, but it was basically just, here's your next project and you're turning the crank, right? You're just, you're applying the same exact thing that you've already done to the next project. And it takes a couple months and eventually you're done and you go out and you commission that project and then you get another one. And that was fun for a while. I was an engineer for 5 years, but I was craving more. I was getting bored at work and that was reflecting in my performance. And so I don't necessarily have this burning passion for property management specifically, but what I really like doing is really two things. One, I really like helping people be successful. And I think that there's something that really appeals to me about real estate investing as a way that sort of the common person can really increase their net worth. In a way that's— it's hard to look at other paths that have the same bang for your buck. You know, you can go out and buy a duplex, live in one side, get owner-occupied financing, an FHA loan. You can put very little money down. And if you just do a good job managing it, you could even move out, rent the side that you lived in. 5, 10 years down the road, you're going to have the better part of $1 million net worth as long as you bought in a decent area of town and you paid down the mortgage that whole time. That is hard to get by any other way. And so if I can help people be successful with that, there's a little part of me that's like, I get frustrated when you read about the laws around investing in— there's this concept called an accredited investor. And in order to invest in VC deals and other kind of speculative ventures, you need to be what the IRS calls an accredited investor, which means you have a million-dollar net worth excluding your primary residence, or you meet some very high income threshold. I think it's like a quarter million dollars, 2 years in a row or something like that. And if you don't meet those qualifications, you literally are not allowed to invest in these other areas. You have to stick to the stock market or real estate. But real estate really is kind of like the backdoor into the alternative investment world. So I love the idea of being able to help people be successful there. But what I also really like doing is the challenge and excitement of growing and building a business. Now that happens to be property management right now. And I really feel that we're good at that here at the company. But for me, the challenge of organizing the team and creating the systems and the processes that allows our clients to be successful and our team members to be fulfilled in their job, I love that. And whether I was running a coffee shop or a widget manufacturing company or a property management company, there's commonalities there in how you structure and organize a bunch of different people such that their output exceeds their input. The value created is more than the cost input, and that value is shared by you as the business owner and the client who's paying you. So in— as an engineer, I learned, I learned about first principles, right? And I think there's a lot of commonality, actually, I think, between lawyers of all people and engineers in that they're both taught how to think rationally and how to sort of structure and organize their thinking in a way that can be foundational or from first principles, and in a way that you can take something and you relate it. You can learn one thing and then you can take that, what you've learned, and relate it to something else that may not be exactly the same. And so that was very powerful, and I'm glad I have my engineering degree, and I'm thankful that my parents pushed me into doing that even though I didn't really want to, because it forms a mindset that you can take anywhere, right? And that served me well. I'm really thankful for that. And, you know, I think I had an innate talent for it and it was sort of cultivated by my time in engineering school. And I feel blessed in that way.

That's awesome. It's a process when I look at employees and I started a company with bare walls and you grow and you're generating value for your clients. But there's a next level when you start— I was willing to take risk for myself, but then you're generating income for other people, you add employees, and you've got this thing going. It's a, it's a completely different process, that growth, that approach to growth and systematizing that. So you grew, and then you decided to to acquire and still, I believe, are you in the middle of a transaction now?

Can you— [Speaker:ROBERT_LEONARD] Yeah. So I'll talk a little bit about our pre— I guess our previous acquisitions. So within the first few years in business, we came across another property management company owner that was sort of divesting the property manage— the third-party property management portion of their business. This was a larger company that focused primarily on real estate syndications that they would own and then directly manage. But when they started, they took on third-party management as well, meaning management of properties that they didn't own or have any ownership interest in, and they wanted to get away from that. So it was perfect timing. We struck a deal with them where we bought their book of business for their management contracts and took that over. It was small, you know, it was only, I think it was like 30 or 40 units that we took over, but that worked out well for, for us. A number of those clients are still with us. We're still managing their properties. And then we did a very similar thing on a larger scale in 2020. So about a year ago now, we purchased a book of business from another local property management company owner, very similar. He owns a large and successful real estate brokerage that took on property management. Just to sort of keep the relationship with their clients such that when they would be ready to buy or sell again, you know, they would already have that relationship. But what they realized, just like we did, is that property management is really intense and it can be a big distraction if it's not your core focus. And so they decided to divest that part of their business. They're happy selling to us because we don't do brokerage. So if a client wants to buy or sell, we'll refer right back to them. It's great synergy there. And so that was about 130 units that we bought from them. And obviously, we still manage most of those. It's only been a year.

Did you finance that? Did you negotiate that? How did that— a little bit about the transaction?

Sure. So the first one, the small one, was small enough that we just paid cash. That was no problem. The one we did last year, So we structured, there's kind of two sides to this. The first is that we structured the deal with the seller such that we would be paying half upfront and then half a year later, and it would be prorated based on the number of clients that were still with us. So in other words, if a client left two months after we bought the contract because they were selling, we're not going to pay for that. So that's called a callback. It's pretty common in property management. Transactions, and it's very much recommended as the buyer. So he was fine with that. Now, to actually make the payments to him, we had some cash on hand that we used primarily, and we also drew down a line of credit that we had previously set up with our bank. We leaned on that a little bit, pretty quickly paid that back, but we were thankful that we had it. It does make things a little easier when you can finance. Now, you can finance purchases like this in more traditional ways. You can go out and get a loan. You can actually get an SBA loan for something like this, which is what we'll probably do. As you kind of referred to, we're in talks with another property management company locally. This would be the biggest one yet. They're about the same size as us. And if we do end up coming to agreement with those folks, we will have— we'll probably get an SBA loan for that one.

So I, uh, it's a— it's an exhaustive process. And I'm in a—

yeah, how's it going?

I'm in a small transaction, but the— it's been good. Bankers ask, uh, different questions and, and far more detail, uh, and they're so interested in my existing business, which doesn't necessarily, um— it's it parallels, but it's not part of the financing for the new business. But they, they want to know a lot about all of those transactions and, and a lot of the detail, and I don't need the loan at all. Like, I, I'm doing it to establish a network of relationships and kind of— I know this acquisition path is something I want to do more frequently. So I needed to fill in some gaps in bookkeeping and accounting and, and things that I just needed to tighten up anyway. And, and formalized. So I'm doing all that. And I'm learning. I met some great people on Twitter who have— some have volunteered their services, some have— some I've paid for advice and going through this process, but it is a mountain of paperwork. It made, it made buying a house look easy.

I have had the same experience because we're, we're in discussions Well, we're buying another unrelated business that has nothing to do with property management or real estate. And I hope to be able to talk more about that as we get closer. But we are— we're pursuing SBA financing and we're right, I think, on the same timeline as you, because in the past couple of weeks, like the paperwork requests have gotten absolutely mind-boggling. I mean, you're right, buying a house was way easier. You're getting a mortgage. You know, because I always kind of pride myself on having all my, all my records, you know, in order and digitized. And I can, you know, bankers are asking for past 3 years' taxes, and I'll reply back in 5 minutes with the PDFs attached and stuff like that. So I thought I was ready. Right. But I was not ready. I was not ready.

Right. Right. I mean, there's, there's certain things. There was one, I'm, I'm preparing a cash flow analysis, and it's been great. One, in my business, I don't have I don't have a lot of overhead and the payments are lumpy and for a variety of different reasons. So my existing business is not really cash flow dependent. I don't have a bunch of issues there. The business I'm buying, they wanted to see all of that and doing the projections. So in that process, I brought in some help to, I don't know how to do one. And so just to say, I don't know how to do that. And I've learned all about the margins of all the products. Looked at every transaction for the last year that the business had and coded them. And so now I can see the margins for each product and why I might want to pursue business in this line and that line versus another.

That's really valuable.

It's been great. It's really taught me by asking the questions, it's taught me the business and writing a business plan and a marketing plan for something that's related to my existing business, but not directly, it's been fascinating. It's been definitely good.

Have you ever looked into like a fractional CFO type person?

You know, I had an interaction. I've got one sitting in my inbox and I didn't understand the value of it. I didn't understand the value of it. I've got a guy that I use to do my books, and I know that it's more bookkeeping than CFO, but I didn't really understand the value proposition for a fractional CFO, but I didn't dismiss it. But I did understand that I needed to add this more professional skill set. And so I'm sitting through it, I'm learning, I go through the through the phase where my eyes glaze over. I've sat through the LinkedIn accounting course, you know, the basics of accounting. I've done all that. And then, and now I'm sitting through 8 weeks of how to build a 13-week cash flow analysis. And then I think I will be a better consumer of that fractional CFO work product. And so I totally intend to circle back on the fractional CFO. But why don't you tell me a little bit on what the difference of a fractional CFO versus a bookkeeper— what is the— what am I getting out of that fractional CFO that I might be unaware of?

Sure. So the first thing I'll recommend for everyone, I'm just looking up something here, is that there's a book called— you know, you mentioned taking the LinkedIn course on accounting. I'm not familiar with that. I'm sure it's good. The book that I read 8 or 9 years ago, right around the same time I started my company, was just, you know, those For Dummies books, the yellow ones. I think it was just called Accounting for Dummies. And it was, I think it changed my life because it gave me like a basic level understanding of business accounting and it helped helped make it real for me, the difference between debits and credits and assets and liabilities and the 3 primary financial statements, which is the cash flow, the balance sheet, and the income statement, and how those tie together. And just exactly, you nailed it. Having a basic level understanding of that stuff helps you be an informed consumer and lets you get way more value out of your time talking to an accountant or even a tax preparer, or certainly a, you know, a CFO type So that's the first book I recommend. The other one I really enjoyed is by a guy named Greg Crabtree, a book called Simple Numbers, Straight Talk, Big Profits. And he kind of building on that Accounting for Dummies, it takes it one step further and puts it into the perspective of a small business owner with very practical advice, not just like, here's how to read a statement, but like, here's some ideas about how to run your business to make it more profitable. Here's some red flags. Here's some guidelines. You know, if you're running a service business, you should be spending no more than 50% of your revenue on labor and stuff like that.

Right.

So highly recommended. Fractional CFO, we, we do not have a fractional CFO and I've not had one before. What I have done is consulted with companies that specialize in helping property management companies be profitable. And so what they're able to do, it's kind of like getting a fractional CFO just in like a more of like a snapshot type consulting engagement rather than an ongoing engagement. So what they're able to do is take a look at your books, look at the past year or two of your numbers and tell you like, okay, relative to other property management companies, it looks like you're spending more on labor, less on rent, you know, and really give you some ideas about Areas that you can work on, kind of similar to what you're saying about, hey, this line of product is profitable, this one's a money loser, this one's a loss leader, but these people tend to buy more of the other product, and really detailed analysis that will help you run your business more profitably and make intelligent decisions about like— like when I think about the value of a fractional CFO, you know, they're going to be able to help you with strategic moves, right? I mean, they're not going to tell you how to grow a Fortune 500 company, but they are going to be able to do something like help you understand whether it would be profitable to open a second location or whether you should focus on expanding a current line of products or maybe getting into a new line of product and offering those to your current customers and what might the profit margins be on that, or helping you analyze things like whether you should hire another employee in preparation for growth and what that might look like, kind of like, you know, specific to your business strategy, you know, much more than just bookkeeping. But of course, we both have businesses too small to have a full-time CFO, but neither are we experts in accounting and finance. So it's kind of this weird in-between place. I've talked with other folks who have hired fractional CFOs a little bit bigger than me, and they swear by it. I mean, they all say it changed the game permanently for them and really helped, you know, help them grow.

I feel like I'm— as I digest the business that I'm buying, I'm also buying a piece of real estate that the primary tenant is going to be the business that I'm buying. So I'm thinking through that process and how to structure those things. But I, I've already, I know that as I digest that, the point of doing that is to set the stage for the next, the next purchase. And I expect to bring in, to talk to someone and get some of that advice. I've already gotten some great advice in building sort of the accounting platform base that I've built. But yeah, that, that kind of detailed analysis, I appreciate the spur in that direction. Hopefully other people will get some use out of that.

Yeah.

All right. Well, is there anything else you wanted to bring up this week or what's on your mind for the show in the days and weeks ahead? What are you— what kinds of things do you want to talk about and why are you doing it?

Yeah. So I'd love to talk some more about property management, what it's like running a small business. Property management is a recurring revenue services business. And there are other businesses like property management, some of which are service but non-recurring revenue and some which are recurring revenue but not service. And so I think there's a lot that we've learned and that I've learned in running a property management business for 7, 8 years now that I'd love to sort of speak broadly about in a way that's relevant for certainly folks who are in real estate and property management, but also other small business owners as well. You know, I definitely share a lot on my Twitter account. I kind of use that as a way to gauge interest in different topics and, and sort of flesh out some of my thinking. So I'll probably be— if you follow me on Twitter, what I'll probably do is see what posts are getting engagement. And folks are asking questions about, and maybe I'll pull those in as topic ideas for the show. We can kind of go deep on that and really, you know, put some flavor to some of those, some of those discussion points. I'd love to, you know, really provide as much value as I can for, for the listeners here.

All right. Well, I'm, I'm interested in the, in the syndication idea. I suspect you're going to get back to that at some point eventually. But I started— I was intending to buy and thinking about investing in real estate. And I bumped into, I'm not sure how, but I bumped into Moses Kagan on Twitter. And then I read some books that he recommended from his website. And I thought, there's so much detail there. And the kind of the mindset of the person who manages the property and increases the ROI. That level of detail is not a strength of mine. And it's just not what I'm good at. And why would I want to compete against people who are doing that and are intimately aware of the rental market in Franklin County, Ohio? If it wasn't interesting to you, what does it mean that it's interesting to me? Or if I wanted to buy something in LA, What does it mean if I'm buying it? If all the people who specialize in LA don't want to buy it, how did I get it? I'd much rather just be with them and piggyback on their expertise. And in doing that, what I realized is the money I've got and the money I've been able to generate through my business is I need to just focus and do that better execute in my field, better build a better capital stack that I can then deploy, spend this year studying, learning, and growing, and then finding the right partners to, to participate in better deals.

Yeah, real estate is a great place to store and slowly grow wealth. But it's not a great place to start. Like if you're starting from zero net worth, real estate's a hard place to get to that first million. You're probably better off with, you know, a high-paid consulting or W-2 income. And then you take the profits from that and you invest in real estate, right? And you kind of let the money work for you over, you know, in the properties while you continue, you know, bringing in more cash. Real estate can be, you know, it's very illiquid and it doesn't throw off a lot of cash, especially in the first few decades. You know, later on when things are paid off and you can, you know, cash out refi if you want, stuff like that. But yeah, you really can't beat it as like a leveraged way to grow wealth in a very tax-advantaged way.

Well, I will use our time together on this show to plumb your brain on that as we, as we have continued conversations. I look forward to Next week, and absolutely we'll do it again.

All right, thanks.