Hello, my friends and welcome to another episode of Ask Marco where I answer your investing related questions. If this is your first time here, remember to hit that subscribe button. So each and every week you are notified of when we put out a new episode.
So today’s question comes from Clay and generally his questions about diversification in multiple markets and he says, hello, Marco. Loved the podcast. Keep it up. Thank you. First question, we have five properties in New York state in the same city. The cashflow is great and reliable, mostly 10% cap rates or one and a half to 1.7% rent to value ratios, which I will explain in a moment. He’s saying these are C plus to B minus neighborhoods. I’d like to buy 20 additional properties, but not sure if perhaps I would be better off diversifying away from the same city that I’m currently in, perhaps into Indianapolis or Memphis. For example. Money would not go as far and returns would be lower, but I’d be diversified.
His second question here is all of my loans are residential. As all of my properties are for family or less. I have six loans currently but will easily surpass 10 if I am to reach my 25 property goal. In this case, would you recommend commercial loans? Everything I see and hear is 10 loans or less. It seems to be the magic number for residential above which you have to go commercial, which doesn’t seem to have as favorable terms. I look forward to your answers. All the best, Clay.
Clay, thank you for your two questions and there’s probably more buried in there if I was to really just think it through, but let’s talk about the first thing here. I guess the first question that I would ask is what is your overall strategy?
Are you focused on building a real estate portfolio strictly for the cashflow and focused on markets that will give you that? It sounds like what you have right now is producing very good returns. I don’t know what the cash flows are like, but your cap rate and your rent to value ratio is very high. So that right off the bat tells me that you’re probably in C class neighborhoods because it’s hard to find a number of that high in better neighborhoods such as your upper B and eight class neighborhoods. And there’s nothing wrong with that. Everybody has their preference and everybody has their strategy. So if you want to stay focused in your C class neighborhoods and you’re, you’re doing well and you’re successful there, and maybe yourself managing these properties, so you have the ability to have your own personal control over the portfolio, that’s great.
You know, fantastic and keep up the good work. But if you want to expand, then what you’re essentially doing by applying geographic diversification is increasing your cashflow reliability and decreasing your market risk. So the goal of diversification regardless of the investment is generally to reduce an investor’s overall risk. So diversification in real estate is pretty easily achieved by purchasing income, producing properties in different markets around the country. And these are markets that are geographically diversified. So typically they’re going to be in another state or just far away from the existing market that you’re in right now. And real estate investors also realize that diversification tends to reduce both the upside potential as well as the downside potential of their portfolios. And I know this sounds a little counterproductive or counterintuitive, but you have to remember that the reason investors want to diversify is to protect their real estate portfolios under a range of economic conditions.
They want to avoid being committed exclusively to a single market’s economy. And that’s the whole reason for diversification. So I guess without knowing more, I would say if you are very comfortable with your local market and you are confident about its future over the next two to five to seven to 10 years, which I know is a crystal ball question, but if you know enough and a lot about what is going on there and you feel very confident about the future prospects of that market over the next 10 years, then maybe keep crushing it there. But if you want to diversify, even if you want to do some diversification where you have let’s say 50% of your portfolio locally and then the other 50% in another one or two markets, there’s nothing wrong with that. You have I think nothing to lose and probably something to gain, but you probably are not seeing a lot of appreciation or at least not lately just I’m guessing here, but I’m thinking it’s New York state, so you’re probably in kind of a more expensive metropolitan area or part of the Metro area, but you’re also focused on lower-quality neighborhoods just to bumper boost that cap rate and your cash on cash return.
If that’s true, then you’re probably not going to see a lot of appreciation and that’s okay. I’m not suggesting you speculate or chase appreciation, but if that’s part of your strategy and that’s part of what you want to build into your portfolio, then yes, look at some other markets, even if they’re hybrid markets where you have a good balance between the cash flow and the appreciation potential of that market. That will probably set you forward a little bit and it’s really a matter of just doing some market research and neighborhood research on the markets you’re looking at. You mentioned Indianapolis and Memphis. We can help you with that. We’re in both of those markets and have been for probably 15 years. We have a lot of information on our website, what’s going on in those two markets, but you could do some research online through Google.
I’m going to Zillow and there are a various number of other websites that provide market information and market data, so the comment I didn’t understand is what you meant by money not going as far. I don’t understand why that would be the case. I don’t know what variables you’re looking at unless you’re buying in very inexpensive areas and your investible capital is not going to acquire as many units in another market. That’s the only thing I can deduce from that comment. Maybe you’re buying properties at 30 $40,000 a door. That’s very cheap. But also it’s a neighborhood that’s a, I don’t want to call it very low income, but that’s probably what you’re looking at. Right? So to your second question, you’re saying all my loans are residential because they’re four family or less. Okay, so these are conventional loans. Oh, by the way, one more comment about the previous question.
As a very general rule of thumb, what I do and what I suggest people do is purchase three to five rental properties in a particular market and do that across three to five markets. So it’s three to five properties in three to five markets and that provides very good broad geographic diversification and it also gives you a portfolio of up to 25 properties. And if your goals are larger than that, that’s fine. But interestingly enough, your goal is 25 properties. So you could pick three markets and invest in seven or eight properties in each one. Regarding your question about financing here with conventional loans, there is a 10 cap, there is a maximum of 10 conventional loans per borrower. Now if you are married or you have a significant other, you can theoretically get 10 loans each and the key there is that you don’t co-borrower meaning you don’t co-sign and you qualify separately if you can, so that allows you to get 10 and allows your partner to get 10 so together you can get 20 conventional loans when you’ve exhausted the conventional financing, which are your Freddie Mac and Fannie Mae loans.
Then you could look at other lending options and these are typically asset-based lenders or portfolio lenders and they will often have no cap. It’s an unlimited number of loans. The terms are going to be fairly similar. They’re often 30 year fixed rate mortgages with let’s say a slightly higher interest rate. Could be a point or so, maybe a few extra fees on the front end, but they give you the ability to continue financing and acquiring real estate. When you get to the commercial loan space, that’s not typically favorable because unlike residential loans, the terms on conventional typically range from five years or less to as high as 20 years. And then they set an amortization period that’s longer than the term of course, which could be 25 years or sometimes 30 but these loans will have other terms and conditions that may not be favorable for someone who is looking to buy and hold their rental portfolio for a long period of time or indefinitely as part of their trust.
So I don’t think you need to worry about the financing piece of this all that much. You could do a commercial loan, a blanket loan, there are lenders out there that will take your portfolio or part of your portfolio and refinance them into one mortgage that is covered by multiple properties, multiple assets. And in doing so, you take those conventional loans off your credit report and that frees up that quote-unquote slot that you have on your credit for those 10 conventional loans. So there are strategies for you to free up that space on your credit profile. So you can continue to get conventional financing, which by the way is the cheapest form of mortgage financing that’s out there. It is basically government-sponsored entity financing because it’s sold and traded on the public market.
Okay, so just to wrap that up, if that helps. Fantastic. If you have more questions, clay, just contact my team here at the office and speak to one of the investment counselors and they can kind of navigate this for you a little bit further than what I’m doing here in the past 10 minutes, so that’s it. If you have any questions about real estate investing or financing, you’d like me to try to cover that on the show. Just go to passiverealestateinvesting.com and click on the Ask Marco button or just go to AskMarco.com and remember to subscribe, share the show with your friends and family and other likeminded people. Visit us on iTunes. If you can leave us a rating and review, greatly. Appreciate it. Yes, I do read them all. Thank you for listening. I’ll see you on the next episode.
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