Mastering Multifamily Deal Math: Insights from Cody Davis on Analytics and Underwriting

to your seats. >> All right. >> We've run about seven versions of this event over the years. So, usually in the offseason, this is the first summer one. Uh because it makes zero financial sense to shut down your resort in the middle of summer peak uh season. That being said, I wanted to do the heat here, but we did seven versions practicing for this multi-day event. The one thing that I learned is that the best part of these events by far is lunch in the breaks. Everyone's favorite part is like we got to hang out. We got to you get the best questions answered. So, I tried to break this into a lot of like a lot of like a little bit less speaking, a lot more hanging out. So, I hope that you guys are enjoying that because that is a very intentional thing. Uh the next one is going to be Cody again. He's going to go over math. Um I also had a limited number of um already downloaded pictures of Cody. So this is the uh you guys see Cody and his awesome bicep. Uh that was one of three photos that I had of him available already in the system. Uh Cody is going to talk about math. Um Cody and I will often trade off in the mentorship talking about math. And I get about almost a perfect 50-50 of people like, "Oh my gosh, you explained it and it clicked for me in a way that it never did." And then I'll have the other half of you be like, "Oh my gosh, Cody came on and did a guest presentation. He clicked for me in a way that it never did." Cody and I process math correctly in totally different ways. Uh, since most of you have seen me talk about math a ton, I very intentionally gave this one to Cody. Um, also Cody always has uh I always have a little uh giant post-it note for Cody to do the math on. So if you're far away and you can't see, there's some seating. You guys can move your seats and and creep on up. Otherwise, I'm going to go bring the little the little whiteboard here for Cody. And Cody's going to talk math. His tenants occasionally spell uh math with an E. That's meth. It's a drug joke. I'm funny. Um, but Cody's going to talk about uh math, the analytics, and what uh what actually makes a deal a deal. >> There you are, sir. >> Deal. Do I even have a marker? >> I upgraded you to Sharpie. We got name brands now because we're a real company. >> Uh, can anyone see this past the post? What is the best spot for this? Uh, >> should I move this over? This over and then that goes here. >> Yes, that's probably smart. >> Assuming that you're going to want to use this. >> I'll try. >> There we go. Sharpie there. Sharpie there. Okay, before we jump into numbers and everybody's eyes gloss over, I would like to share the reason that all this works is because when we got started, we would do a drill. And I never told Christian, but the reason I made us do this drill is because my memory was terrible. However, it did help us go really far. Number one, whenever you go into an encounter, you go into a meeting, you have an intention. So, I have a goal from this encounter. I've been asking a few people I've been chatting with already, what is your goal from this weekend? If everything worked out exactly how you hoped, what would you take away from the weekend? What is your objective? And then after a meeting, I would always ask Christian because I would forget what we talked about. I would say what was your takeaway from this meeting? And I tried to propose it as, hey, this is me trying to be intentional, make sure that you're learning. It was just me trying to recap what we did. So going into every meeting, we would have an objective. It would be, I want to learn how this person built this development portfolio or how did this person get financing to do this? How did they own half of the town? This is a super generic name so I can share it. But one time we met up with an owner and asked, "How did you build the Great Wall of Gary? There's a guy named Gary who owns a strip through the middle of the state that goes all the way through the central Washington." And he bought a a railroad track. So we asked how he did that. You look up his name and it just pops up for miles and miles across the state. It's incredible. We would have an intention going in and a takeaway coming out. So going into this, the way I'm going to structure it, I've done this again and again where I've gone through math at these presentations, but I want you to think about what you'd like to take away from this. And after I'm done sharing for probably 20 to 30 minutes, might go faster. We'll see how it goes. Ask your questions. Get your takeaways. Don't leave the session with unanswered questions would be my request. All that to be said, I'm going to go through a few things and if anybody has any questions at any time, please stop me. Also, if I confuse you, please let me know. First thing we're going to talk about is NOI. Is anybody here familiar with NOI? Is anybody here confident enough to tell me what it is? >> What does that mean? That is your final income minus all of your expenses minus your your debt >> almost. >> So NOI net operating income is your income less your expenses. What does that mean? Even simpler put >> it's our cash flow with no debt. That is all it is. So if you're thinking about an it's your cash flow before your debt. Why does that matter? The reason it matters is because we're going to use debt. So that is the maximum number we have to service whatever loan we're going to negotiate. So if you're ever doing underwriting and you're thinking how much could I afford to pay, make it less than that number and you are set. And if you want more cash flow, you make your payment a bigger gap from that number. But this is the thing people get confused. They talk about cap rates and NOI and rate factors and a lot of people on the internet don't even understand what they represent. All it is is your cash flow with no debt. Now that that's out of the way, let's jump into cap rate. So I'm going to write that up here. >> All right. So now we have a cap rate cap percentage. What does this represent? in that unit as a percentage of profit. >> Can you make it simpler? And the reason I'm asking these questions is because majority of us are in the program, right? So these are things we've seen. If no one had seen this before, I wouldn't want to bring it up like this. >> If you had no debt, >> exactly. >> Which means it's your cash on cash return if you pay cash. It's exactly it. The reason this matters is this is going to show you your dividend expressed as a percentage. When doing purchases in real estate, it should be really important you to make it as simple as possible, apples to apples comparison. There's different asset classes, there's different debt products, but at the end of the day, when you're looking at something you want to buy, we want to make it as simple as we can. And this number is going to tell you expressed as a percentage what's the actual income that I'm going to get relative to what I'm paying. How much disposable income will I have in relationship to my purchase price? It's also how people value deals. But we're going to leave it at that for now and jump into the next thing. So, I don't think I've ever met a mortgage broker who knows what this is, which is ridiculous because that has everything to do with debt. Yet, people don't even know what it is. Your cap rate is your dividend. That's your net income expressed as a percentage of a purchase price. Your rate factor is your realized cost of capital expressed as a percentage. If we're just spitballing here and we don't even know, which one would you want to be bigger, your dividend or your cost? >> Dividend. Why? >> I don't like cost. Yeah. There was an owner we met with and they just don't pay bills. So, their properties go down and their profits go up. That's not a good business model. When you're underwriting deals, you want your income to be higher than your debt cost. And the nice thing is we make it really simple. People online have asked questions, "Well, what about property taxes?" There's people that buy in Texas where taxes are double what they are here. What about your insurance bill? What about utility costs? That's all factored into NOI because your NOI is your cash flow if you have no debt. Take it one step further. Your NOI divided by your purchase price shows you your dividend expressed as a percentage. That's the equation. NOI divided by price. That's going to give you your dividend. Now, we just have to make sure our debt cost is less than that expresses the percentage. We want apples to apples comparison. For those who are writing notes, the equation, super simple, I'm going to use letters. You don't have to use letters. It's your principal and interest times 12 12 months in a year divided by your loan amount. If you can remember this, you will be smarter than 99% of mortgage brokers. So again, the equation, it's one thing to know how to calculate something. It's your principle and interest. It's just your monthly payment times 12 divided by the loan amount. A lot of people know how to calculate stuff. You bring up cap rate online and people say NOI divided by price, right? Or NOI divided by value, but they don't actually understand what it means. And my objective here is everybody at least comes with their questions and can get an understanding why it matters, why it works the way it does. Because if you can do that, there's this saying I have come to find true. Math doesn't lie, but people do. Seems consistent. And if you know how to do the math, people can't lie to you. They can try, but you're going to be able, even if it takes you a few minutes to work it out, you can find when people lie. And majority of everybody is going to lie at some point. It's just important to know what they're going to lie about and to what extent. This helps you fact check people that are trying to steal. on this deal right here when we bought it. One reason that we had a good learning lesson, we didn't know what we didn't know. Talk about the the box drill, right? For anybody who knows that, that was in the bottom right corner. We did not know what we didn't know because they had two bank accounts. We didn't know everything. We didn't see everything. And so, you know, that threw off our numbers. If we knew how to really calculate and and met with other owners that owned these types of deals, we probably could have fact checked them on some stuff, but we didn't know how to work it out. We didn't know how to check things. And so, my encouragement, really get to understand this and how they work together. Does anybody have any questions on this as of right now? >> Can you give an example with maybe one of your properties on house math maths? >> Absolutely. I'm going to use my first deal. I bought a 12plex in Quincy, Washington. Does anybody know where that is? >> Yes. >> I didn't know either. So, I brought it up to my very first mentor. It was actually Christian and my boss at the time. And he said, "What the heck is a Quincy?" Nobody knew. But I ended up buying the deal for 1.125 million. I'm going to use round numbers. I'm going to take off the 25. 1.1 million. It's about 100 grand down. It was 10% down. And so, I owed about a million dollars. Anybody can check this math. It's going to be true 100% of the time. On a 30-year am at 6% interest, if anybody wants to throw it into a mortgage calculator, the payment on a million dollar loan is about $72,000 a year. Based on this formula, which is the formula, it's also called a it's a rate factor. It's a mortgage constant if you ever want to look it up. If we have a $72,000 annual principal and interest payment on a million dollar loan, what is our true cost of capital? >> Yep. 7.2. Whoever said that, amazing job. So, we took the 72 grand, my actual payment, my principal and interest, we divide it by the loan amount, and that's going to give what's called a rate factor. And now it doesn't matter if you borrow $100 or $100 million. That rate factor for that interest rate and that amortization will always be the same. It's just a math formula. It's not going to change on you. So once you start to see trends and you've done it a few times, it's going to be consistent. So if my cost to capital on that deal is 7.2%. We took the actual annual payment divided by the loan amount. What's my cap rate have to be to break even? 7.2. >> Okay. What's it have to be to break even? >> 7.2. >> Okay. So, let's say the cap rate is 7.2. What's that mean? >> You're going to struggle. >> Well, okay. So, here's the thing. >> You're not making money. >> Well, this is where I really want to dig into questions today. If your cap rate and your cost of capital are exactly the same, you make no money and you lose no money on the debt. You would only earn a spread on your down payment because you're paying cash for a portion of the deal. If I put 100 grand down on that deal, I'm going to earn the cap rate on my investment, 100 grand. So, I'm going to earn 7.2% cash on cash return. That is how every investment calculator calculates stuff. Whatever you put down, you're going to earn the cap rate on the investment. The question of if the cap the cash on cash return goes up or down depends if your cap rate's higher than your factor rate. Do I make money on the debt or do I lose money on the debt? That's it. So you can make a spread on other people's money. You can also pay a spread on other people's money. The thing you got to understand, you're always going to earn the cap rate on your investment. But if you are making money on the loan, if your cap rate, your dividends higher than your cost of capital, then your cash on cash return is going to explode above the cap rate. And if you are negative margin here, if I bought below a 7.2% cap rate, my return would go down >> because you're paying more for the investment. >> Exactly. The investment is not producing a high enough dividend to service the debt that I took on. practical application markets like California, Seattle, New York, cap rates are pretty low. People are borrowing at the same interest rate in California as they are in Kentucky. So what do those markets make you do? Put more money down, right? Borrow less money, right? So maybe instead of putting 20% down in a a market like Quincy or Kentucky or Indiana, they're going to make you put 35 to 50% down because you're actually losing money on the loan. So they say, "Oh, if you're going to lose money on the loan, borrow less money." That's how people make their deals work. So that's a practical application, real world situation. Anybody have any other questions before I move on? All right. Last year I used the whole sheet, so I'm going to save a few pages for Christian this time. I want to work through an actual deal. Is anybody willing to find a deal really quick on Crexy or Zillow, Phil? >> Yeah. Purchase pricey expenses. What do you need? >> Yes. >> For I just wanted a contract for it like >> Wow. So 425. >> Okay, that's the price. >> Y. >> All right. >> 11 units. 425. >> Hold on. And we're going to put this right here so I don't forget. >> All right. >> Expenses. >> Okay. >> 21,000. >> Should we start with the income? >> Oh, income. Uh 5,750 a month. >> Okay. Can someone annualize that because we will always want to underwrite on an annual basis. something 2006. >> We can use a calculator. >> I don't have one. >> 69 69 >> $69,000. All right. >> All right. >> Okay. So, >> that is our income. Now, what's our expenses? >> $21,000. >> Okay. So, does that include vacancy? >> No. >> Okay. And then for vacancy, can we put like% 3500 bucks? >> 5%. Yeah. >> Okay. And then we're going to subtract all this out. 3500. Sorry, I know I broke the trend of K. What is that total? What's our Y? >> Uh, you have a calculator 78 74,500. How do we go up? >> Sorry. Sorry. >> Sorry. >> 44500. >> I'm going to quote you on that. >> All right. And that is our NI. I'm sorry if you can't see it in the back. That is the the number. So, let's just work through our last page. What is our cap rate? How would we do that? That's our cash on cash return. When we that is our cash on cash return when we pay cash what would be our cap rate what's the formula >> divided by what >> all right so if we take 44500 divided by Phil's purchase price >> 10.5 >> 10 that's pretty high you buying in the ghetto >> oh okay >> no >> all right >> it's yeah it's a block from like 12 unit. That's uh it's a seven cap area. >> Well, this is really important. If the cap rate in a market is seven and you're getting a 10 and a half, is that good or bad? >> That's great. >> Why? >> Because you're making money. >> Well, you're making money, but what does it represent? What's your cap rate? >> It's your cash on cash return when you pay cash. So when you refi, it's going to be it's going to increase your price by a lot. Increase your total value. >> It increases the value. But this is what I want you to understand. If a market return is seven, which is what he said, and he's getting 10 and a half. He's doing better than the market. He's doing better than an average deal. It doesn't mean this is valued on a 10 and a half cap. It just means that's what he's buying it at. So, if we wanted to figure out the actual value of the property, knowing it's a seven cap market, what's this thing worth? >> Anybody can answer. >> When I when I did the math on my calculator, it was 470. So if we take 44500 divided by 0075 >> which means he has $210,000 or about 35% equity at close >> doesn't suck. >> So now what's your debt? >> Uh 6.1% for five years over 20. >> Okay. Okay. So, we got a 20-year amortization at 6.1% interest. What's your payment? >> Well, yeah. I mean, I haven't gone through. >> I need you to do the 20-year advertised math in your head. >> Yeah, I know. >> Right now. >> Okay. So, my first problem was 430 and it was almost the exact same terms. It was like 3500 something. >> Can someone plug it into a calculator because I want to use actual math >> numbers? All right. because we're either going to poo poo your deal or accept it. >> How much money? >> 20% down. >> So he put 20% down, >> 6.1% interest on a 20year >> M. >> All right. So based on what Matt Wang said, it's 24.55 a month. What's the annual payment? >> 29,460 >> 29, >> 460. >> 460. >> Can we talk to the weather guy? >> Yeah. >> I'm gonna save you paper this year, though. All right. So, I just want to remind you it's 6.1% interest for the loan, but it's a shorter amortization. What would be our rate factor? And this math, by the way, if you ever wonder how I do stuff in my head, somehow I just remember to do step by step by step by step. And you can do it with a calculator. You do not need a fancy calculator online. If what is our rate factor? Remember it's our annual debt payments divided by how much we borrow. >> 8.6. >> Okay. So our rate factor of 8.66. >> So this is the beautiful thing about math. If you use the right formula, it will work 100% of the time. Unfortunately, we didn't use the right formula when we bought this place. Hence the shirt. We effed around and we found out. Um, this is the fun part though. Your true cost of capital is 8.66%. He's earning 10.5%. If we take the return and we subtract this cost of capital, that is going to show us our margin. In this case, he has positive spread, which means that every dollar he borrows, he's going to make money. If he paid cash for this deal, he would earn a 10.5% cash on cash return. I have a suspicion your cash on cash return is going to be significantly higher because you have a margin here. If you wanted to actually walk through exactly what he is going to earn, what we would do, we'd figure out the difference between your dividend and your cost. We'd multiply that by how much we borrow. You divide that by your initial investment, and you add it to 10 and a half. So, if we want to do that, >> again, >> so yeah, let me uh >> let's do it. >> All right. Can you write down this the I need someone to write it down. So, >> 1.86 is the spread. >> All right. you make 1.86% spread. That's just the difference between your >> sorry >> 1.84. All right, write that down. So, what we're going to do, this is how every calculator works. If you can just remember this, and this is recorded. >> Yep. >> Perfect. I don't expect anybody to remember this on the first try. >> 1.84. >> Yeah. >> Okay. What's our loan amount? 34,000 >> 340. Okay. $340,000 and our spread's 1.84%. So if we multiply the loan times the spread, what do we get? 6266 >> 6256 >> All right. >> What is that divided by your initial investment because this what this represents everybody this is important to understand and I would encourage you to rewatch it and we'll go into questions. >> This I did not get this right away. This is how much money you are cash flowing because you signed a promisory note. You are getting paid to be in debt. That's all we do. We go into debt and we buy something that pays us more. This is the actual math. So this divided by your down payment is what? How much did you put down? >> What what's the number? >> Okay. So if we take this and we divide it into our down payment, it's 7.36%. What's our down payment? >> Okay, 7.36%. Our cap rate's 10 and a half. You add those together, that's your actual cash on cash return. What that means is you buy this deal, you're earning about 18% cash on cash. That's the actual math. Take the spread as a percentage, add the cap rate. That's your cash on cash return on any deal. All this complicated roundabout way to do the math that you never have to do again in your head is to illustrate that you're either making money on someone else's money or you're losing it. You never have to do this in person. You have a spreadsheet. But if you understand why things work the way they do, why a return could go up or why it could go down. The only thing that's going to determine it is if you have positive margin, >> technical difficulties. >> It it it works. You have to make sure your cost of capital is less than your cap rate. If you can do that with these equations, you're going to go far in real estate. That's also why I've been able to structure uh the current portfolio. Ash and I just added it up. It's about $37 million for us and we have less than 100 grand invested. That's without doing a bunch of crazy syndications. We own over 50% of every single deal that we have. So majority of the portfolio is just us. But that this is why you don't have to be able to rattle through the numbers like that. That's not what's important. Understanding why things work the way they do is important. And if you can make money by borrowing money, by making sure your dividends above your cost, you can buy unlimited amounts of real estate. That is the solution that Christian and I were looking for when we asked how could we buy everything. >> Yeah. question. This might be for later, >> but Phil, with that 21K annual expenses on that deal, >> what did you factor into that? And it's okay if you want to talk about it later, but >> Oh, no. Well, that So, that's >> I don't know yet. Okay. >> Because the owner doesn't have profit loss, doesn't that's just the number he said. That's his expenses. So, >> I just got this under contract like literally an hour ago. So, I'm still due diligence. Haven't gone through it all yet. So, I don't have all the answers. >> Okay. But my >> you don't just believe what they tell you. >> Well, so I I actually I factored because I owned a 12 unit literally across the street. I kind of know what >> the number should be and it lines up roughly close >> like all right well there's so much I paid 850 for my 12 unit. This is half that. >> Yeah. >> For 11. So I'm like all right there's plenty of meat on the bone on this. Even if he's off by 10 or 20% I don't care because >> now >> you know you made it work on as well. >> Yeah. Exactly. And based on the math, you're going to get about a 18% cash on cash return. If you plug these numbers into the calculator, you would come up with the same thing. Well, that should not be the end goal for folks. What's really cool about this opportunity is you're getting it at a 10 and a half cap in a seven cap market, which really means you have your 30 plus% equity position to go back to the bank, pull your down payment back out, and now you have an infinite return. That's where the real money is in real estate. So, congrats Would you say that's probably a better metric than like the 1% that people like to go by cash flow? >> Yeah. And we haven't even jumped into debt coverage ratio yet, but a 1% rule, you buy something for a million, 10 grand a month income, that's going to mean very different things in Washington versus Texas versus California. There's variable expenses. So just looking at a gross income as a percentage of a purchase price is a bad idea. you've got to look at the actual NOI, the the income after those expenses. Now, as part of the presentation, um we we can go into debt coverage ratio, but I want to go back to what I mentioned in the beginning, having a goal going in, getting actual takeaways coming out. Who here has questions they're willing to share about math and really just understanding how it all works? >> I heard two statements, but you didn't know there was this Right. >> Something tells me they had to know that and they didn't disclose that. >> What our attorney told us was it's a buyer beware state and we dropped it at that. >> No, but here here's what I'm thinking is you just taught all of us how to do what you get away which isn't good but anyways teaches us what to look for. And the point is what were they putting on the other account? Just any major expenses putting modest expenses. >> We didn't see it and hiding the other. Is that what they were doing? >> Didn't see it. So, we don't know. But the the point of it is if you look at every deal in your market, you're going to start to see trends. You will see averages. And then when you see something that stands out, if it's too good to be true, it probably is. From an operational perspective, you're not going to operate a deal at 30% if everyone else is at 50. We did not meet with owners that owned stuff like this. And so there was no way we could have projected that because we didn't do the proper due diligence before we bought it. There there's just steps you got to do. And so underwriting every deal in your market, meeting with people who have owned the type of assets you want to buy, those are all steps that will help you not make the mistake like we did on this asset. >> Curtis, when you're talking to the brokers or the owners, are you going over this math saying, "Hey, this is why the numbers Yeah. So, I negotiated a debt product for a building we bought years ago. I don't own it anymore. 12plex and afraid. And the broker, funny enough, it was Eric. He's going to be speaking later. He brought us terms and it was 5.5% interest 25 year. I walked through this math and the cap rate was below the factor rate. So, what we ended up doing is I said we can't do 5 1.5%. We can do 4 and a.5%. And it can't be advertised over 25 years. It has to be interest only. Something worth noting, if your cost of capital is only interest, it's an intereston loan. The formula principal and interest times 12. Well, there's no principal. So, it's just the interest rate. So, our true cost of capital was only 4.5%. Interest in that situation. You do the calculation 5 and a half% interest 25 year. It's a heck of a lot higher than 4 and a half%. So what we actually did in that negotiation, I told Eric can't do it. This is why I don't want to earn 6% and pay whatever it was 7%. I don't want to be paying the seller to borrow their money. I want to get paid to borrow their money. And we got it accepted. But it's very simple once you go through it again and again because I've been going through this for five years now, right? Like I don't expect anybody to just be able to gloss through it like that. But if you practice it over and over, you understand, okay, cost has to be less than dividend. How do we calculate it again and you just keep doing the reps and practice these deals, you can negotiate the debt terms down with owners, and that could be an intro period. We've bought deals and I bought one about a year and a half ago where we had an intro period at a lower interest rate, allowed us to cash flow, just own it with my wife. We bought it day one and we made the interest rate at a point where it would cash flow day one with time for us to get the income up so we could pay them what they really wanted later. Just had to show a path of how we could grow together. Like I was talking about with the owner meeting, show a path where we can grow to where they want to be. >> So another way to to look at this, you could either adjust your interest rate or you can adjust your purchase price, right? >> You could. So there's a few ways that you can increase your cash flow, right? Does anybody know them? Talked about them on the platform a lot. >> There's well there's only four ways, right? And so if we remember there's only four ways. Makes it very simple. >> Okay, we could raise revenue. >> Income expenses debt service >> lower expenses. >> Okay, so we could increase revenue. We could lower expenses. Talked about debt. What about debt? reduce total cost. >> Okay, so we can reduce the cost of the debt or >> amortization >> that that reduces the cost of the debt >> or we could borrow less money. Those are our only options. There's only four categories. So if you're struggling to make a deal work like this, I mean, you got a great buy based on this math. However, there's only four ways to improve it. There's four categories. You could increase revenue, you could decrease expenses, which maybe you can't do on this one. You have to look at a deal-by-deal basis. That's what the seller of this place was saying. You can decrease expenses. Not even showing us all the expenses. So, you know, obviously that was wrong. It was a bad assumption. You could borrow cheaper money, lower the interest rate, or you could lengthen out the amortization. That falls in that category. Or you could borrow less money, which means put more down. My pockets are empty. I can't do that. So that would mean a lower price. >> You put more down and you don't have that down payment. You're still paying for that debt. It's just >> Exactly. Yeah. And that's the thing you have to be aware of, right? You have these four categories. Doing one may not work for this deal. You may have to operate in the other ones. You may not be able to increase the revenue. It may be a class A deal, top of market. We bought a class A project and it's our biggest asset today. It when we're all said and done, that asset will be worth about $18 million. We can't raise the rent. It's brand new. It was already occupied. There's nothing to do. So, we have to decrease the cost of capital. That was the only solution on that one. Decrease the cost of capital, seller finance to a point where we have margin, and then hold it for a long time. It's all we could do. But it's going to fall in these categories. is it makes it very simple because that's all you can really do. >> Yeah. >> So like we were talking about over there, there's certain markets that don't have a >> You're right. >> So this is part of our strategy why we started building in Washington. We buy based on cash flow for equity growth. We're not buying for just one or the other. We're buying based on the cash flow, but we're buying for appreciation because appreciation, like Christian mentioned, is how you really build up a big balance sheet. It's how you can become exceedingly wealthy. The problem is people build for that, but they don't have the cash flow. They're not basing their assumptions off of positive income. So, if you're buying in a low cap rate market, you're in California, maybe the cap rate's 4%. What does that mean for your cost of capital? Has to be less than four. That's hard to do, but it's not impossible to do. What that really means is you're going to be on an interestonly loan and maybe you have two to three years at 2 and a half% and then you have two to three years at 3 and a half%. Gives you time to get the net income up so your cap rate actually goes up, right? You can move the net income up over time, but it doesn't happen overnight. So, if you're in a really expensive market, I'm still buying in an expensive market. We bought some assets for 235 a door. That is not free, but we made sure that the cost of capital was less than the dividend it produced. >> Commercial banks are going to not have that same flexibility. >> You're right. They're not. >> Or you get a blended rate. An example of something that we're working on. You have the seller and we've already done this. We did this on an 8 unit. I've done it on a couple other assets that uh we haven't even shared online, but where the seller will finance a second mortgage at 0% interest, 10%, 20%, 30% of the purchase. If your cap rate is five and your cost of capital from the bank is six, but you have, you know, a third of the deal at zero, what's your total cost of capital? It it could be actually lower than five. So, there's ways to make the numbers work. Even in an expensive market, it doesn't have to be black and white. Seller finance first mortgage. You can do seller finance second mortgage. You could have two seller finance mortgages. You could do a second and a third with different terms behind the bank. There's a lot of ways to play the game, but you have to know the premise is one number has to be higher than the other, otherwise we lose money on the debt. If you're in a market where you just can't sell that, but you see an upside. >> Well, you asked about if there's just a market where you can't find sellers to do that. There are going to be people who will do this in every market. If you're talking like SoCal or, you know, LA, there's people that will do that in every market, but they're probably not lining up just to talk to you. You find their phone number, you pick up the phone, and you go meet with them. A lot of the relationships, a lot of the deals that I'm doing today, I've been working on for five years, seven years, I would say longer, but I was in high school longer ago than that, so I can't can't lie. But you get what I'm saying, right? It takes time. And so that's where broker relationships can come in handy because you can get a deal done pretty quickly with a broker in the meantime. But while you're buying deals through brokers and letting them know what you're looking for, build the relationships on the side. Cultivate owner relationships along the way because five years is going to pass whether you like it or not. So all the all the math which you just did that's in our calculator, right? >> Correct. So this math is all on your calculator. It's very handy. You don't have to ever do it again. But if you understand again how the calculator works, you will be able to more intelligently talk about this stuff with owners, with brokers. Mortgage brokers don't even know what a mortgage constant is. It's crazy. They don't know how to use it. Mortgage constant again is another word for a rate factor. >> One thing I want to make sure we go over that service coverage ratio is the other big thing that's really important to understand. Can you give >> I'm in all right. >> I know what that is. Yes, sir. >> If I handed somebody a portfolio today that cash flowed 20,000 a month and it was zero down, who would take that deal? >> Are there any important questions you'd want to ask? Let's assume it's fixed rate debt >> and oh the clip. Let's assume that it's fixed rate debt 30 years. You're cash flowing 20 grand a month after your expenses, your standard stuff. >> Nope. Doesn't price doesn't matter. If it's fixed rate, it's going to advertise. Whatever. You got 20 grand a month. What is an important question? >> How big is the total loan? >> If it's 50, if it's only cash flowing 20 grand on a $50 million loan, >> maybe more so than the total amount of debt, what is the total monthly debt payment? pay debt service. >> 20,000 a month cash flow with no debt doesn't suck. 20,000 a month cash flow when you have a $20,000 a month mortgage payment, you know, that's pretty good. You're Well, no, it's after the debt, right? So, if I'm cash flowing 20 grand after making a $20,000 payment, I'm chilling, right? Every month I save another mortgage payment. How scary do you want to go? What if it's 40,000 a month you're paying? You're still cash flowing 20. What if you're paying 100 grand a month and you're only cash flowing 20? What if you're paying 200 grand a month, you're cash flowing 20? There's a metric for this and it's called debt coverage ratio. It's how tight are you on making your actual payments. If your payment is 20,000 a month and after you make that mortgage payment, you have 20,000 left over. That's a pretty safe place. Every single month you make a payment, you save a payment. >> That is called a two debt coverage ratio. And >> 2.0 >> 2.0. And the way that a debt coverage ratio works, it is something to one, right? So it could be 2:1, could be one to one. One of the ones, I'm going to write it out for you, is your actual mortgage. So 1x debt coverage ratio DSCR >> that means you got 10,000 a month in NOI coming in 10,000 a month going out you have no cash flow at one if you ever heard of a DSCR loan maybe they say I want to be at a 1.2x what does that mean >> that's 1.20% 20 20% more >> exactly. So lenders say you need to have a 1.2 debt coverage ratio. A lot of investors don't even know what that means. >> Christian says 1.25 and 1.5. >> Okay. Yeah. 1.25. Let's use that math. >> Every time you talk this >> 1% is basically break even. >> So 1x you're breaking even. 1.25 25, which is a bit more conservative than one. It's about 25% more conservative. All that means is if we're trying to get to two, right, it's going to take you four months to save a mortgage payment. If your mortgage payment is $1,000, you're going to save 25% of that mortgage payment, which means you're cash flowing $250. If you are at a 1.5 and your mortgage payment is $1,000, 1.5 debt coverage ratio means you cash flow >> $500. This is a a measure of your risk, right? It's one way to measure risk. If you are at a one, which a lot of people are right now, which is crazy, your net operating income is exactly what your debt payment is. That sucks. I had a a YouTube live with someone that talked about being at a one debt coverage ratio, which means it works as long as nothing goes wrong. >> Yeah. If if anything happens outside of standard operating expenses at a one, you will lose money. >> Nothing ever happens, >> right? Nothing happens. >> Everything's perfect. >> There's no way your roof is going to blow. >> There's no way my roof's going to end up in my front yard. It's not going to happen. So again, the one >> if you're >> Yeah, the one is break even. If you have anything after the one, that is your margin. If you're at 1.5, every time you make a mortgage payment, you save half a mortgage payment. So it takes you two months to build a reserve of one mortgage payment. It's all about risk. So I I mentioned the whole thing about cash flowing 20 grand a month. It could be great. It could also be a curse, right? There are going to be sellers who are like, I will hand you this portfolio. There's a seller in Grant County right now. I would call him an owner, but he's a desperate seller. He is willing to hand me a portfolio that will cash flow $15,000 a month. The question you got to ask, how much is the payment? A 1.1 debt coverage ratio is kind of scary for $15,000 a month. It's why I wanted to ask the question that way. There's always another question you got. You got to turn the rock over. You actually have to underwrite it. The amount of NOI. We can go over the equation. It's your NOI over your debt cost. How much is my net operating income above and beyond my actual cost of capital? So, NOI over annual debt service, principal and interest times 12. That's your formula. But this is what it represents. You're looking at risk. You want to make sure you have enough disposable free cash flow to service when things go wrong because they do. >> So, do you typically like get borrow money in addition to the purchase price as a reserve? >> I have. Yeah. But again, you know, on this you need to underwrite all your debts. You could get a first loan. So, an example, I bought a RV park with Christian. It's over there. I sold it to Christian. Christian sold it to Matt. Matt might sell it to one of you. We'll see. We'll keep it in the family. >> So, bought it for $373,000. That was the purchase price. We got a loan at close for 525. There are people out there that are just going to look at what's my debt payment on the purchase price. If you borrow more money than your purchase price, you have to look at the total cost of capital. That could be with a first mortgage. It could be with a second mortgage, but you have to actually underwrite all of it. What's your actual annual debt payments? There are people that don't count their heloc. I've got a buddy who always forgets he has a heliloc on the property. Like you, it is debt. It's not your first mortgage, but you still have the payment. So, you have to look at the actual total cash out on your mortgage payments to do this calculation, right? Otherwise, you're going to put yourself in a position to be surprised. And later, we ended up actually getting a loan mod to 650 on that deal. So, we had to now calculate the new 125 in debt that we had. So after after you've done a few deals now, do you kind of what's your DSCR that you like to see on deals? And like what's your your range of like if I had this this is like a home run? >> Yeah, I like to get to 1.5 within 18 months. >> So a lot of my mortgages right now, I'll give you an example. that one guy that I owe 10 million to my payment. Yeah, I'm going to round down. It's 52 grand a month, but let's put it at 50,000, right? To hit a 1.5 debt coverage ratio, what would be my cash flow? >> 1.5. >> If I'm a 1.5 debt coverage ratio and my mortgage payments 50,000, >> the NOI would have to be 75 grand, which would mean the cash flow is 25 grand. It would take two months at a 1.5 debt coverage ratio to save another mortgage payment. >> That would be ideal. >> Same with you, Christian. >> Yep. That's the same target would like to see within 18 months of the 1.5. And when I do a cash out refinance, I don't like to bring it beyond 1.5, maybe down to 1.4, but I try not to max. I really want to hold my portfolio at 1.5 long term. That is a great place. I have a few deals that are above two. I have a few that are working their way up. On an average globally, I like to try to hold 1.5. And something worth doing for those who are starting to build their portfolio up, I would look at your, it's called a schedule of assets. You've got your total assets listed out. List out your NOI. List out your debt service. you can actually come up with a deal by deal uh debt coverage ratio and you can have a blended ratio for your whole portfolio. And so something that we built out for our portfolio is we look at everything as a whole each one like if there's a red flag and it's a little bit light like we need to go spend some time and attention on that deal and fix it. But we like to look at the whole portfolio as a whole try and keep it above 1.5. You will probably not be there. in the first year, but if you can get there within two years, you're doing pretty good. >> We all good? Nobody has any unanswered questions. >> Have you run into >> Have you run into to banks calculating DSCR a little bit differently than how you're underwriting it? >> Absolutely. Yeah. And I found brokers that will calculate it a lot different than uh they should, too. basically get the broker underwriting and throw it in the trash can, right? Like everybody's going to do it a little different, but whoever has the money makes the rules, right? That's that rule has been around for a long time. So, you need to figure out how the lenders are going to play that game and then underwrite to that. You still have to do proper underwriting. Some lenders don't know what they're talking about. >> That is just a fact, right? And some lenders aren't going to be the right lender for that type of deal. So, they're going to be extra aggressive or conservative. But make sure you're doing your good underwriting. And if they played a little different, negotiate harder with the seller. >> Just say, "Hey, the bank's underwriting it here. There's got to be something that I'm missing. How do we fix this?" And then you get a better price or a better rate, right? So, >> you have a question. Oh >> um it should be in the platform but however >> uh the the formulas itself are pretty simple. Do you have something to write it down because I can go through all these really quickly. >> I took some pictures. >> Oh okay. >> We will also send out the recording of this when we're done. My editing team will package this. I'll send that out to everyone. I also have the calculator and a bunch of other free resources that we will send out as well. So you will have access to all of this super easy for that >> question. Are we going to do another one? >> How much time we got? >> A couple minutes before lunch, but lunch is long. >> Well, I'm not going to hold everybody from food because then I'll be the least favorite person of the day. >> But math before lunch this time. That was something we learned from the last sleepy. >> So you had you have something you want to go over really quick? >> Yeah, I I'm looking I'm looking at a property. >> Okay. >> In Ken, Texas. >> Colleen, Texas. >> Yeah. I know I know the area very well because I spent a good portion of my life uh near I would never call it Fort Kaso. This Fort Hood, Texas. >> Okay. >> They're asking for 1.5. >> All right. >> My offer is 1.2. I've already talked to the broker about that. >> So, we're buying how many units for 1.2 million? >> 32 units. >> 32 units >> for 1.2 2 million >> million two. >> The NOI that they say on here is is $114,182. >> What did you underwrite? I want to use your underwriting for this one. >> I haven't completed it. >> Okay. So, 114,000. >> Yeah. >> Okay. So, we're going to go through this and I want somebody here to walk me through what we're doing. >> 32 units 1.2 And then 114 NI. So what's our cap rate? >> Uh the cap rate is uh 7.61. >> Well, not at 1.2. We're doing your purchase. So 114,000 >> 9.5 cap. >> Yeah. Always got to underwrite >> what >> to your deal, right? Because as soon as you adjust this price, your percentages are going to change. We got to make sure we're using accurate percentages. So, it's >> 9.5 >> 9.5. Okay. So, 9 and a half cap rate. That's 9 and a half% cash on cash return if we pay cash. That's before our debt. That's all that means. What's next? How much money are we putting down? >> 35%. >> Okay. Which is how much money? 35% times 1.2 million. >> 420. 420. All right. So, on the 420,000 just off of this, what's our cash on cash return so far before we look at the debt? >> Well, >> what's our cash on cash return as a percentage? It's 9 and a half%. Right? Because we paid cash for that portion of the deal. >> 399. >> Okay. So, you're making about 40 grand in cash flow just off your down payment before we get to the debt. That's the important thing you got to remember. You're earning the cap rate on your down payment. So, what are your debt assumptions? What's your interest rate amortization? What's your month? >> 6.5 interest rate. 6 and a half% interest on a 30 grand >> year fix. >> Okay. So, what's your payment? >> Probably going to be your payment is probably going to be annual debt service is going to be about $54,231. >> Okay. So, our annual debt service is $54,000. So, if we want to go through the whole complicated uh basically go through become a calculator, right? We take the debt service divided by the loan amount. It's going to give us our rate factor. >> If we want to figure out what our actual like if we wanted just a little shortcut, we could Wow, Union's popping. >> See? So, if you want a shortcut on this for what the calculator is also doing, this is equally important to understand. You take your NOI, you subtract your debt cost, it's going to give you your cash flow. This is just a little hack I've learned along the way. So, if we have 54,000 in debt payments, 114,000 NOI, what would our cash flow be on the deal? >> 60 60 grand, right? And if we wanted to figure out a cash on cash return, again, we just took this minus your annual debt payments. You have 60,000 a year in cash flow. >> Well, we could take that, we could divide it into our investment. 60 grand into 420 is what? 14 >> 14.4. Is that what you said? 14.3. >> So that means we have positive margin, right? We ended up making an additional 4.8% cash on cash just because of the debt. >> So 14.28%. >> Yeah. Cash on cash return. But that's only because your cost of capital was less than your cap rate. So in that situation, if you're good earning 14.3% cash on cash to own this deal, then you'd proceed. >> It's a good deal. >> Well, if if it works for you, >> but 14.3 may not be good enough for Christian. I'm not saying it's not. Maybe he wants 30. >> What's the market cap rate? >> Market cap rate was 7 Okay. Market cap rate >> 6.89. >> So if we have 114,000 NOI and a 6.9% cap rate, what's our value? NOI divided by the cap rate is >> 1.6. >> So it's worth a million650 the day you buy it. If those assumptions are correct, which means you would have doubled your money because you've got $450,000 in upside on a $420,000 investment. You turned 420 into $870 and you're getting paid 14.3% on your money while you wait. So that's how all the math can work. your calculator will give you the exact same result if you know if you put in the same assumptions anybody and they call it u pencil whipping you can make any deal look great on paper if your assumptions are wrong so will your returns >> so basically you get the T12 your rent roll and uh the rest of the information that shows the actual financials on it, your expenses and everything and determine if they're actually making that 14act for the year. >> Yeah. The quality of your inputs determines the quality of your outputs. If you're using bad information, you will get bad results and you will be surprised when you lose the property. >> So, example that I got AOI sent to me and the guy is putting $150 in there as an expense. ization is putting depreciation in there. >> Those aren't actual realized expenses. The question of amortized debt pay down and depreciation, that's not a legitimate opex here. That is for tax purposes, writing stuff off and paying down your debt on the note. Also, >> so here's just a little thing. I know we got a wrap. we got to go eat. If sellers are adding in a bunch of unnecessary expenses, it drives their NOI down. If it drives their NOI down, it pushes their value down. I'm not going to correct them. Let them be wrong and then walk into it. You don't have those expenses and all of a sudden you have day one equity and more cash flow. You do not need to be right with these people. Let them be right. I think what he's trying to do is he's doing it more for tax purposes. >> That's great. But if you can buy it off of that, you have extra NOI in your deal. >> So now you're just worth more money. >> Yeah. >> All right. >> I'll take the little micel. >> All right. Thank you, Cody. >> Did the thing >> everyone that's that's the basis of the map. Now, a couple a couple quick pieces and then we'll wrap for lunch. When you are doing these deals, you are not going to know everything at the time that you write an offer and go under contract. You're going to be reasonably certain that your numbers are correct. Due diligence is for that. Your refundable money is to when you look at a deal, you're like, "Hey, I believe that this math makes sense. This lines up with the inputs that I have." You write an offer. You go under contract. Huge mistake people make. They try to get every single number before they go under contract. And it is the most painful thing for me when you guys bring a deal to the mentorship call or someone emails me a deal and then three weeks later they bring it up again and then two weeks later they bring it up again. I'm like it has been over a month that we are still underwriting the same deal. Your timeline from if assuming let's assume that we had a basic P&L. We had we had basic financials on the property. I've had a conversation with the broker. We've got one round of questions answered where there's a couple of items like the one that you just brought up. You're like, "Hey, I noticed there's a couple of extra expenses in here." We got some clarity. If we are reasonably certain that this deal is going to work based on the numbers that we have, make sure that it is your deal to lose. That is the point where you write a contract. Due diligence is where you prove the assumptions were true. So, you do not have to know everything to go under contract for a property. One of the biggest differences between people who analyze deals and people who buy deals is that one piece. You actually do have to write an offer at some point. You will also not know everything when you write an offer. We went under contract for those two deals that I've been talking about in the long view. We have P&Ls. We've looked at a lot of financials. We will 100% discover new things when we're in due diligence that we don't know upfront. We've done our best to factor for them. Hopefully, we'll do our due diligence and the numbers are going to be a little bit better and we were extra conservative. Most likely outcome. We could get into a bunch of the units and figure out, oh my gosh, there's a major problem. You don't need to know everything to go under contract. That is why we have that due diligence period. There is a point where you're going to prove the math is true. Also, hopefully really encouraging while we'll send out the calculator and you have all these notice that there was no equations that go above algebra 1. The most complicated that we got was A * B equals C. That's the NOI cap rate. Same equation for debt service coverage ratio. Say basic basic basic algebra which I love about real estate. Once you get the terms down and again we'll give you guys a copy of this presentation have the calculator. But once you know what the terms are, the actual math is not complicated math. It is very very very simple algebra which makes real estate really doable. If you guys are wondering what uh I like to see day one on a deal, ideal universe, if it's a relatively simple deal, I I need to see positive cash flow. I would like to see it around 8% or higher. Sometimes it's way higher, but it has to be really good on the upside for me to want to go significantly below 8% day one on cash on cash return. most important metric to look at when determining where how is a bank going to look at this. If I'm negotiating everything at par, that 1.25 debt service coverage ratio, if you are buying there, it is almost the guarantee that the bank will like the deal. That's a really good starting point going into a deal. 1.25. The first thing I personally look at when you guys send me something to look at is always where are we at day one? How far off 1.25 are me? And then everything comes after that. A cool thing happens with debt service coverage ratio if you get to the point Cody just referenced one seller he has $52,000 a month of mortgages. So when you're talking like hey I'm trying to get to like a a.5 debt service coverage ratio. If you're paying a ludicrous amount of money in mortgage and half of that is what you're paying yourself that's freaking awesome. That's a lot of good margin. It's one thing that I really like about the real estate is so keeping that margin between what I owe and what I have to pay myself and pay my investors is in my opinion the most true cash flow metric that you can follow. It is the first thing I will look at. Loan factor rate Cody covered quite a bit. I want it to be positive or near break even day one. If you have an operating plan where that gets positive really quickly, it's the least important of the three upfront. As long as we have positive cash flow day one, we have a decent debt service coverage spread, I'm okay if the loan factor rate is, you know, like, oh, we're losing a one point on every dollar we're borrowing, but we're making way more on the money that we had invested. As long as we are positive, you can get paid to buy the real estate. When you look at where are we at at the end of the project, you should be very positive on loan factory. All of them should be green lights all the way through. Day one loan factor rate, you should know where it's at. It doesn't have to be a positive spread on the loan factor rate for every deal as long as you have day one cash flow, long-term fixed rate debt, and you get it into a position where the spread on the debt is positive in a relatively short period of time. Guys, that's it for math. Um, all right. There's sandwiches in the back. There's also chips. I know I get a lot of complaints about too many carbs at these events, but you know what? It's it is what it is. Um, if you guys want any other food, there's awesome restaurants around. Again, you guys can drive over to do. You guys can walk down to the alderbrook. We have a reasonably lengthy lunch. I try to leave these to socialize. So you guys have a blast and we'll resume