I’m going to do something a little bit different today. Recently, I was invited to be a guest on The Real Estate CPA show, which is hosted by Brandon Hall. If you recall, Brandon was a guest of mine on episode 90. That episode was titled Sheltering Your Rental Income from Taxes (and Other Tax Tips). Brandon is a sharp guy, a great investor, and CPA. He focuses on creative tax strategies but he’s really dialed into the whole tax scene and how to reduce your taxes as an investor. He invited me on his show and we had a great conversation about a lot of different things. Some of it is great review for investors and other questions that he had was great for virtually any investor listening in. I wanted to share that episode with you. I did get Brandon’s permission to re-air if you will that episode on my show. We talked about things like the biggest real estate investing myth, what drives different markets, and the market differences, how to choose a market. We talked about investing locally versus long distance, the macroeconomic factors in selecting a market and there are four of them. Those are good to know. The three kinds of markets at a spectrum, there are three categorizations for that. Different types of neighborhoods, what is an A, B, and C classification for a neighborhood. This is really what I tell people when I’m doing a live presentation. It’s some good material and a few other things. It’s a great interview and I wanted to share that with you. Without any further delay, I’m going to let that roll. Hopefully, you enjoy it and we will see you again next week.
If you missed our last episode, be sure to listen to Investing in Houston, Texas (and Hurricane Harvey).
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Exploring New Markets – My Interview on The Real Estate CPA Podcast
Today, we’re going to do something a little bit different. I’ve got a guest that’s going to be joining me on the show today. His name is Marco Santarelli. He is the owner of Norada Real Estate Investments. It’s a turnkey real estate investment provider. He’s got some really cool things to say. We’re going to be exploring how do you pick investment markets, what investment markets he is currently in, and how do you go about picking the actual neighborhood that you want to invest in. Before we touch on that, a couple quick things: One, pay attention to the newsletter especially as these tax plans start coming out in the house in the senate. We’re going to be keeping everybody up to date with our newsletter. We’re analyzing the tax changes and how they might be affecting real estate investors, so just pay attention to that. The second quick announcement is that we’ve got two webinars coming up in November, one for clients and one for non-clients. It’s just going to be a walkthrough of the tax plans that have been proposed by Congress and how they’re actually going to be affecting real estate investors as a whole. If you like the show, please leave us a rating on iTunes. We would love to hear from you. I’m super appreciative of everybody that has already left us ratings to date.
Today, our guest is Marco Santarelli. Marco is an investor, author and the founder of Norada Real Estate Investments and nationwide provider of turnkey cashflow rental properties. Since 2004, they’ve helped over 1,000 real estate investors create wealth in passive income through real estate. He’s also the host of the Passive Real Estate Investing podcast. Marco, how are you doing?
I’m doing good, Brandon. I’m glad to be here.
Thanks for joining us. Tell us a little bit about yourself.
I’m a full-time real estate investor, have been for over fourteen years, and love what I do. I love helping other people get to the point where they have passive income and are creating wealth just like what we’re doing here in my company. I don’t know how far back you want me to go in terms of my history but I actually jumped into real estate investing when I was eighteen years old. As soon as I could qualify for financing, I decided to purchase, renovate and manage my own property. I did that with a townhome unit in my hometown. What’s surprising maybe to some degree is everything was textbook. I was able to renovate and lease up, manage that property and hold it for a number of years. As far as I can tell, I did a really good job at it. My biggest regret though, and I learned this early on, is I ended up selling the property a number of years later and I made a good return, I made a good capital gain. The lesson to be learned is that for the most part, you never really want to sell income-producing real estate. You want to buy, hold and accumulate and maybe trade up as time goes on, but never sell it just for the sake of taking those gains and doing something else other than investing.
That’s basically where I started. If you fast forward to 2003, 2004, right before I started my current company, Norada Real Estate Investments where we’re helping other investors, I was involved in several other startups and business ventures. I cut my teeth and had my fair share of failures, all of which I pushed forward into building this business, which has become very successful and I’m very happy about because we’re helping other real estate investors achieve the things that we are doing ourselves.
That’s fascinating that you started when you were eighteen years old. There’s not a lot of people that can say that. What did that first deal look like?
I don’t remember the specific numbers but if I had to guess and this goes back a number of decades so it’s a long time ago, but it was an end-unit townhome. It was not a condo and it was not an HOA scenario. I believe I paid about $40,000 for that property. I don’t remember what the rent was but I’m sure it was probably in the neighborhood of $600 a month at that time. I say my biggest mistake was selling it. Today, that property is probably worth about $400,000. It’s worth a lot more and that’s all equity. The mistake and the lesson learned is I could have taken that equity and leveraged up and really magnified my success and my returns by taking it and putting it into more income-producing real estate.
Hindsight is always 20/20. You can always look back and say, “I wish I’ve done it differently,” but at the time, it was probably a really good decision.
Yeah. I don’t regret it. I learned a lot from it. It set the tone and the writing was on the wall. I took that and I leveraged it. I focused on getting my real estate license and looking for more real estate and really just trying to build my financial freedom through both real estate and building businesses.
You invested in real estate yourself and then you decided that you want to start your own business because you’ve been in the small business environment. You start Norada Real Estate Investments and you decided that you’re going to focus on turnkey investments. What made you decide to start a business centered on turnkey investments?
What had happened is in late 2003, I got involved with some boot camps or workshops, whatever you want to call it, along with literally thousands of other real estate investors that were buying into this $15,000, $25,000, and ultimately $35,000 boot camps that were being hosted around the country. In the process of investing myself, investors were coming to me and saying, “Marco, where are you finding these deals? How are you negotiating it? How are you analyzing the numbers? How are you putting it all together?” All that just led up to the question of, “Can you help me? Can you help me find some deals? Do you want a partner or this or that?” That was the light bulb moment. That’s when I decided to start offering other investors at that time, it was just through networking, through these workshops and boot camps, deals that I was coming across. I had enough deal flow being focused on this full-time that I was able to share.
In the very, very beginning, I was actually charging clients, in other words I didn’t even call them clients at the time but basically the other investors call them customers, I was charging them a finder’s fee that started at $2,500. Then, it ultimately worked up to I think about $5,000 or $7,000 depending on the size of the deal. I quickly flipped that around and turned the model into a freevalue-added service for these investors who are now what we call clients. Our compensation became and still is to this day coming from the seller side of the equation instead of the buyer side. Essentially, we are like a nationwide brokerage of these turnkey rental properties. We provide the value to the client and hold them by the hand and help them build their portfolio. The compensation comes from the other end of the equation, which is the seller.
The start of Norada was you identified a gap. There were a lot of people that couldn’t find the deals or couldn’t figure out what markets to invest in and you filled that gap and provided them value via these turnkey properties.
That hole or that gap or that need if you want to call it that, it still exists today and it’s probably more so today than it was back then. The reason is this and this is probably going to resonate with a lot of people listening. We talk to investors, just regular people every day from all walks of life. They’re professionals. They’re dentists. They’re small business owners. They’re regular W2 employees. They all have a common problem and that is lack of time. That’s the biggest thing. There’s also a lack of knowledge, a lack of resources, etc. but at the end of the day, most people have a full-time job or career. They have a family. They have got kids. I like to say they have Johnny’s soccer game on the weekends. They’re busy living their life and pursuing their career and spending time with their family. That doesn’t leave them the time that they require to find the right markets, find the right deals, do the due diligence and the work that’s necessary to build that real estate portfolio, at least not in an easy way. Even if they do have some of the time, there’s still a learning curve. They still have to gain the knowledge that they need in order to know where to look, what to look for, how to assemble that team, put together the resources and the contacts they’ll need for mortgage brokers, local providers, builders, inspectors, title companies, etc. That’s the common denominator that everybody had and still has today. If you can take care of 70% to 80% of that, what happens is you provide a very valuable service especially when there’s no cost involved to you. That’s what I refer to as “turnkey real estate investing.” It’s basically an easy way to create passive income and create wealth. It’s not an entirely-done-for-you model. It’s done with you because nobody at all can do everything for you. You have to be engaged and you have to be involved.
I can totally resonate with the fact that people just don’t have the time. That describes 90% plus of our clients at the CPA firm here. We’ve got clients that are in high net worth or high net income situations and they’ve got the cash to spend. They just simply don’t have the time to figure out how to build their own rental real estate portfolio. At that time, we see a lot of our clients move to turnkey properties and move to turnkey providers. I know that you’re in quite a few markets, but how do you actually go about picking the type of market that you want to invest in or that you want to move? Maybe we can talk about this as a business perspective. How do you pick the markets that you want to offer to your clients? How do you pick personally?
I think you have to start off by dispelling a myth and that is there is no such thing as a national real estate market. The reason I bring this up is because whenever you read the paper, read articles or listen to the media whether it’s radio or TV, they always talk about the real estate market. The real estate market is up, down. Sales are up, down, whatever the case is. The fact is there’s no such thing as a national real estate market. All real estate is local. Every local market has its own politics, its own local economy, its own local business environment. It has its own local supply and demand. Aside from global and national factors like interest rates and federal regulations, everything else happens at the local level. What happens in San Francisco is different than what happens in Detroit, Michigan, which is different than what happens in Tampa, Florida. Once you have that clearly established in your mind, then your focus changes from thinking about real estate as this blob at a 40,000-foot level to something that you can be hyperfocused on at the local and hyperlocal level. I’m not just talking about Metropolitan Statistical Areas or MSAs like Atlanta, Georgia or Kansas City, Missouri. You start focusing on places like Independence, Missouri, which is a submarket of Kansas City or Blue Springs or Lee’s Summit or Raytown. These are getting more specific. You can even be more granular than that. You can start looking at neighborhoods within these submarkets of these larger metropolitan areas. A prudent investor or smart investor will look at things that way. They start from the macro and they work their way down to become more and more specific as to where they’re looking and what they’re looking at.
When we’re talking about the macro trends here, how do you go about identifying? What identifiers are you looking for to say, “I want to explore that market further and then I want to drill down into the actual neighborhoods of that market?” Just on the macro level, how do you even go about picking that market? Not to just jump on here, a follow-up question would be, are you looking at primary markets like San Francisco, DC or you’re looking at secondary and tertiary markets that probably won’t have an appreciation play but they’re higher on the cashflow?
I guess at a high level what I would look for and look at are the things that are driving a market. The differences between markets are the drivers where they may be in their market cycle, the median price of that market, the median rent of that market. When you compare those two at a big picture level, you have what’s called a rent-to-value ratio or rent-to-price ratio. The affordability in one market like the Bay Area of California is going to be very low. You need at least 50% or more of your income to afford a median price home there versus another market let’s say Birmingham, Alabama where you can get $50,000 to $100,000 homes and you don’t need a high income to afford property there. Property taxes is another factor. These are the things that you want to consider. I know some people’s eyes maybe glazing over and they’re thinking, “Where in the heck do I even start with all these? Where do I find this information?” It’s out there. A lot of it, in fact if not most of it is available online for free at various websites, whether it’s the Bureau of Labor Statistics or Neighborhood data website, etc.
The short answer to your question is ultimately this: I’m looking for a market that has jobs and job growth because at the end of the day, that’s at the heart of it. People move to cities and stay in cities in markets because there are jobs. They have employment. If there’s job growth, even better because now you have upward pressure on the demand and pricing for that market. Jobs is key. Jobs is definitely at the heart of it. The other thing you want to also consider is the population growth. Do you have a market that is growing or do you have a market that is declining in terms of its population? If it’s minor, it’s not a big deal. You’re pretty much looking at a stable market. If it’s growing, that’s good because now you’ve got demand for housing and you’ve got demand for rentals. If population is declining and it has been for a long time, that’s a long time trend, that could be a concern. We’ve seen that in cities throughout the Rust Belt, the Northeast of the US. Detroit is usually a market that comes to mind because for decades, Detroit has been losing population going from a couple of million people down to about 800,000 in the heart of Detroit. I’m talking about the city, not the suburbs. I just use that as an example because it’s often used as the poster child.
Basically to answer your question, I look for jobs, population growth, affordability. To come back to that rent-to-value ratio, when you start looking at properties ultimately within that market, you have to be able to find deals that have a rent-to-value ratio of roughly 1%. In other words, if it’s $100,000 home you’re looking at, you want to see that the rents come in right around $1,000 per month. This will change by the neighborhood type, but generally speaking, you want to be close to that 1%. If it’s a little lower, that’s fine. If it’s a little higher, even better. That’s a rule thumb.
I’ve written about this before. Every locality should have something called a Cumulative Annual Financial Report. It’s a CAFR. If you were to Google Wilmington NC CAFR, you’ll be able to pull up their cumulative annual financial report. It’ll have a bunch of demographic information like the top ten employers, what the trends are with employment and all that in that report. That could be something to check out. Here’s a question for you, Marco. We have a lot of clients that like to invest out-of-state. Assuming that you haven’t invested out-of-state before, where do you start? Do you just pick a place on the map and you say, “I’m going to explore that area?” Is there some macro-level data that you can sift through that maybe helps you direct your search?
Everything I’m talking about and more is stuff that we here in our company look at. We go through the same process that anybody else would do or should do. When it comes to selecting a market, there are four key things that we look for. These are what I will refer to as macroeconomic factors and it’s really basic stuff or at least I think it’s basic stuff. The first thing you want to look at is whether you’re in a stable or volatile market. We refer to this technically speaking as a linear market or a cyclical market. If you look at a price trend of this market overall and again this could change as you look at submarkets and neighborhoods within that same market, but overall if you look at a price trend for the last ten to twenty years, is it relatively smooth and does it flow in a smooth, natural, more organic up and down motion so it’s relatively flat? Or is it more cyclical like a rollercoaster? That will play in heavily because we find those volatile or cyclical markets are typically all along the Coast, East and West Coast of the United States. You also got Washington, DC. You’ve got sometimes places like Phoenix, Denver, Colorado, Portland, Oregon. These can be more volatile than anything else.
We prefer to be in stable, linear markets because they provide stability and consistency. You could hit it out of the park in a volatile market if you know how to time a market. You get in near its bottom or early on in its uptrend but we’re not speculators. We’re investors. We’re looking for cashflow first and foremost, so we don’t want volatile markets. Number two is we want a market that has a diverse economy. We want a diverse job market. We want a stable economy because it’s not a one-trick pony market like oil and gas driven. We want to see a lot of different industry from healthcare to finance to professional services. That’s a key thing. You want diversity in that metropolitan market. Third, we’ve already talked about. Generally speaking, we want to see a market that has a favorable rent-to-value ratios. Ideally, anywhere from 0.8% to 1%. If you can get more, great but don’t compromise neighborhood quality for that.
Fourth is ideally you want to be in landlord-friendly markets where the laws favor landlords, probably with places like California for example. Are the tenant landlord laws heavily favor the tenants? If you get a bad tenant, which hopefully you don’t especially if you’re in a good neighborhood you won’t see that, but you could get stuck with a tenant we’ve referred to as professional tenants. They know how to gain the system. They can stop paying and they can sit without being kicked out or evicted in your property for six months or more. That’s a situation where you have little control to get them out and you have no income so you’re now running at a loss. Landlord-friendly states are places where the eviction laws are stacked favorably in your favor if and when you ever have to do an eviction. That doesn’t happen very often but you just want to be prepared for it.
Those are what we look at the macroeconomic level. We take that high level approach. Ultimately, we’re going to take those markets and categorize them as cashflow markets, growth markets or hybrid markets. That really plays into you as an investor. What are your investment goals? Are you heavily focused on the left side of that spectrum for cashflow or are you really trying to see greater appreciation potential? You want growth along with cashflow but lesser amounts of cashflow? Or are you looking for a hybrid market where you have a balance between the two? A lot of our investors focus on those hybrid markets. At the end of the day, it’s just who you are, what your risk tolerance is, and what you’re trying to achieve.
I really love that one of your indicators is a landlord-friendly market. I don’t think that that’s really talked about enough. We have investors that invest in anti-landlord states. I used to live in DC. You can see the effects of an anti-landlord states right there. It’s insane. California, DC, I think even New York City is pretty anti-landlord. We have clients investing in those states and sometimes they feel the pain. That’s really cool that that’s one of your indicators. You touched on something briefly and you called it neighborhood quality. Can you explain what that means and then just further that by going into how do you identify neighborhood once you’ve identified the market.
We will classify neighborhoods into three basic types. We’ll call them A, B and C but you can also take it further and call them a D class neighborhood, which is to me a war zone. I don’t even know if there is an F. There’s really no formal definition to this. People talk about neighborhood categories. They have a general idea of what they mean. We can have a conversation about As, Bs and Cs and have a rough idea about what that means but there’s really no technical or formal definition. We can talk about it in this way. This is, in my opinion, a very accurate way to look at neighborhoods. This is how we try to classify all the properties that we sell that we post on our website for investors to see. They’ll typically have a letter grade of anywhere from A+, you’ll probably see C+ on our website, maybe the occasional C but we don’t want to be involved with anything less than that.
Let’s talk about three of them. Let’s talk about C neighborhoods. C neighborhoods as a general rule of thumb are going to be neighborhoods where you find properties that are often, not always, but often around $70,000 or less. Again, this is neighborhood specific because that same property that you find let’s say in Birmingham, Alabama will be probably $40,000 to $50,000 more in the market like Dallas for the same type of neighborhood even though the price has changed. This is just general rules of thumb, general guidelines. Cheaper price is so often under $70,000 in most of the markets that we’re in. They have higher rent-to-value ratio so that’s what makes these C class neighborhoods very attractive. They have high rent-to-value ratios. They look great on paper. If you look at the pro forma or the income and expenses, it looks fantastic. They’re very attractive for that. You’ve got to step back and look at the forest not just the trees to stay on point here and make sure that you’re looking at the whole big picture, not just get mesmerized and sold on a particular property.
Generally speaking, maybe anecdotally speaking, but there are property managers that will tell you this too, C class neighborhoods as a general rule have higher turnovers and higher vacancies than having a rental property and tenants in an A class neighborhood. I don’t have specific numbers but you’ll tend to find that tenants in C and D neighborhoods are more transient. They have higher turnover, higher vacancy. A big factor is that often you will have financing issues. The reason for that is there’s not a lot of sales in C class neighborhoods so you don’t have as many comps or comparables for an appraiser to use when it comes to actually financing properties. Often, you will find that properties in the C class neighborhoods, which could be $40,000 to $70,000, are going to be all cash sales. There is no financing. You’re just coming in. You’re buying all cash. Maybe you’ll refinance later and that’s the end of the story there.
I’m not a big fan of C class neighborhood properties. However, there is a place for them. We do sell some of them and investors do want them but it’s not where I would start if you’re a new investor or you’re just starting out with a small portfolio. If you’re seasoned and you have a larger portfolio, it might be the right product next to fold in. Let’s jump to the other end of the spectrum here and let’s talk about A class neighborhoods. With A class neighborhoods, you typically have more expensive “prices.” Often, this is going to be over $130,000 to maybe $150,000, depends on the market. Your rent-to-value ratios will be lower. That is not necessarily a negative thing even though they don’t look as great on paper as properties in C class neighborhoods and maybe the Bs. What you have to realize is that you have a premium-type product in a premium-type neighborhood, lower turnover, better demographic. You have a higher quality tenant. They tend to stay longer, less vacancy, less turnover, less cost when they do move out. Your lease up is less expensive. They’ll tend to stay for three years or more and there are very few financing issues in A class neighborhoods because they are usually full of comparables. There’s a lot of homeowners. It has a high percentage of owner-occupied homes. You have lots of comps. Appraisal issues are very uncommon in the A class neighborhoods.
It’s really the great place to invest in terms of quality and stability and tenant demographics. People are sometimes turned off by properties in A class neighborhoods because the cashflows are lower. I’m talking in terms of your cash-on-cash returns. The cashflow might be attractive because the numbers are bigger. A $130,000 home ideally would rent for $1,300 a month, maybe $1,200, maybe $1,400 but in dollar terms, it looks good but in percentage terms, it doesn’t look as attractive. Somewhere in the middle you have your B class neighborhoods. It’s like the best of both worlds, if you will. They’re like hybrid markets, a good middle ground. Often, these are $80,000 to $130,000 properties, market specific, moderate rent-to-value ratios. You’ll often find a 1% or maybe a 0.9%. In today’s environment across the country being in a seller’s market with a lot of growth, you’re going to find these RV ratios, the Rent-to-Value Ratios, around 0.8%, 0.9%. They used to be 1%, 1.1% but we’re just seeing a lot of rapid depreciation in markets across the country. They still look good on paper. Properties in B class neighborhoods are attractive. They still have relatively low turnover, low vacancy, and they’re still easy to finance because there is a fair amount of available comparables for an appraiser to work with. Those are your neighborhood types from A through C.
When I lived in DC, the running joke was if you got a Whole Foods, you’re in an A class neighborhood. Whole Foods would go up and all of a sudden, everybody would be in an A class neighborhood. Are there any businesses or maybe amenities or non-quantitative indicators that you might look for to classify neighborhoods as A, B or C? Or not even classify, maybe just a higher quality neighborhood than normal?
If you see merchants that are upper end, Macy’s, Nordstrom, Starbucks, that type of stuff, then chances are you’re in the middle, upper middle income type of demographics. Those are going to be your Bs and As. You’re not going to find a lot of C class neighborhoods in those areas. Percent of owner-occupied homes will tend to be higher or much higher in those types of neighborhoods especially the As. You don’t have a lot of rentals in A class neighborhoods. The flip side is if you look in C class neighborhoods, you tend to find the dollar generals, a lot of fast food restaurants. You’re not going to find any big name brand stores. There will be some but you’re not going to find a lot of them. You can just drive around the neighborhood or you can go to Google Street View and just go around, virtually driving around and take a look at the types of stores that you’ll find. That gives you a good idea. At the end of the day, if you look at that and you look at the demographics, which you can pull online, and you look at the percent of owner-occupied home, home ownership, that will give you an idea of your As, Bs and Cs. Those are the things that we look at to try and classify neighborhoods. It’s not an exact science.
It’s nice to hear that somebody else uses Google Street View because they always tell you to drive the neighborhood and I always use Google Street View. I’ve had people say, “You can’t really do that. You have to go physically be present.” That’s good to hear I’m doing something right. Marco, what I can say is that it’s awesome that you provide all of that analysis for your clients because that would be a lot for somebody that is busy and they have all their family activities on the weekends. That’s just a lot for somebody to get down into the weeds and really understand what they’re getting themselves into. Really neat that you started a business that provides that type of service and really holds investor’s hand all the way through the process. Marco, where can people find you?
They can find us in one or two places. Our main website where we have all of our properties is NoradaRealEstate.com. We have a sister website where we host our podcast the Passive Real Estate Investing show and that’s simply PassiveRealEstateInvesting.com. Either one of those sites will link to the other one. You can find tons of free information, eBooks, our podcast, contact forms, etc. Everything is there.
Thanks for coming on the show today, Marco. I really appreciate it.
Thank you, Brandon.
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