Featuring Jeff Brown of Brown & Brown, Inc.
Today we have the first part of an interview with Jeff Brown of Brown & Brown, Inc. Jeff is a Real Estate Broker with over 30 years experience specializing in real estate investments.
Doug: Thank you for taking the time with us today, Jeff. At this very moment, I have two clients that are interested in investing in real estate for the long term. As similar as their goals may seem, they are very different people.
One investor is a working gentleman in his late 30’s with up to $15K he could use for investing, which represents most of his liquid assets. We’ll call him Dick. He has other assets (401K, etc.) that he would rather not touch. He has the energy and inclination to fix up properties. His last venture in rental properties was difficult due to vacancy and tenant problems. He sold that property a few years ago.
The other investor is a retired lady in her late 50’s with up to $100K she could use for investing, which represents roughly half of her liquid assets. We’ll call her Jane. She doesn’t have the energy or inclination to fix up properties. She likes to travel, and would probably want to use a management company to handle her rentals.
Neither of them want properties with negative cash flow.
Dick is putting one child through college, with the other one starting next year. Jane sold her business, and she doesn’t have any income right now. Obviously, positive cash flow would be nice - but avoiding negative cash flow would be important.
Where should Dick and Jane start?
Jeff: First we have to find out where they are now. As you’re aware, my philosophy is based upon what I call Purposeful Planning. Where are you now? Where do you want to be? How long do we have to get there?
Sounds simple, but in execution we often find Point B to be more than a little elusive. ‘B’ is how much retirement income you require. Though it’s an objective number, it’s also has a very subject slant to it as you might imagine.
In San Diego you couldn’t pay attention with $15K. 
What can Dick do with that in Atlanta?
Doug: Not too much, but there are opportunities. I saw a duplex in the MLS today for $139K in need of some work… and others can be had for as little as $170K. Luckily we still have inexpensive properties here in the Peach State. Here it is:
Now trying to figure out where you want to be in the future can be very elusive. We know Dick is not as old as Jane, so he might have a little more time to work with. For the purpose of our example, let’s assume both Dick and Jane would like growth with as little negative cash flow as possible.
Although Dick doesn’t have much money to start with - he does have twenty more years… and the energy of youth for that sweat equity. That must be worth something, right?
Jeff: Absolutely – but I have an idea for these two that makes sense, and will end up making them more money than they might have otherwise. Let’s partner them up. They’ll both go on title. We’ll locate small fixers that can be turned around for Dick’s $15K or less. Jane will front the down and closing costs. They’ll split the profits 50/50 because Dick will make up for any unbalanced cash outlay by his labor. I’ve done this before with solid results.
This will allow Jane to make some quick gains right away instead of waiting for the market to go up. Dick will benefit by having the pressure lifted financially. It’s a win-win all around. The Plan of course has more detailed than this, but you get the idea. I imagine you can acquire the $139K duplex for starters. Would I be out of line saying there’d be the potential for at least a $40-50K gain there? For me to continue along this line, knowing that information is critical.
What do you think?
Doug: Very interesting idea! I don’t know about the flip angle, unless we are talking about rehabbing, leasing - then selling for maximum value. I guess it all depends upon how much work and expense would go into the rehab. In this particular case, the comps are in the $150-160K range… so to get a decent return on the flip, the purchase would have to be aggressive.
Anyway, if they did not want to partner up with anyone (which I can understand) Dick might be able to consider a property on his own… if the repairs are relatively inexpensive. For the most part, I guess Dick’s options will be limited if he doesn’t find someone to partner up with.
Now Jane, on the other hand, has many options. She has adequate reserves for your famous "Sominex" account, as well as adequate funds for investing… as well as additional equity in her home. She has no debt other than her home… and that is a modest debt.
In researching some possibilities for her, I have noticed several California investors buying new homes here in Atlanta in the $200-250K range and renting them out for $1200-1500 a month. On the surface, this appears to be a losing proposition, as a 90% loan at current non-owner occupancy fixed rates would have us losing several hundreds of dollars each month in negative cash flow.
Is this where your neg-am loans come into play?
Jeff: Talk about teeing it up. Jane wants an investment that doesn’t have negative cash flow, or at least very little. She has another $100K in reserve, which is great. Before we get to Jane specifically though, let’s explain how neg-am loans work. For many investors, and in the minds of many, mostly mine, neg-am loans have been the catalyst for much of their success.
I’ll cut to the chase. Today you can obtain a loan for a duplex in which you don’t plan to occupy, with a start rate of 2%, with a payment based upon a 40 year amortization. The actual indexed rate will be around 8% or so, leaving a gap of 6%. This means on a $100K purchase with an 80% loan, you’ll incur about $4,800 in unpaid interest which will be added to your loan balance. Let’s see what has to happen in the market for the investor to break even with this setup. The depreciation of the building, and all of the personal property will amount to about $4K. (CPA says so) If the investor is taxed at a state/fed rate of 33.3% this results in tax savings of $1,400 or so. Let’s further assume the investment itself is a break even for cash flow. (even though most of our investors are breaking even with only 10% down) So, $4,800 is added to your loan balance; but you save $1,400 in income taxes through the property’s ability to shelter some of your income. This means you’re still behind by about $3,400. Therefore if your property increases in value by 3.4% as a rough average over the holding period, the neg-am loan was neutralized. This is usually the point at which some investors take umbrage at either owing more than they originally borrowed, or stressing about a potential ‘recasting’ of the loan itself. I’m not going to get into recasting since it’s not an experience I’ve seen happen first hand since I began using neg-ams back in the late ‘80’s. The following however is the case for using them for the purchase of investment property. If you’re buying for growth and you can reasonably predict the market won’t exceed 3.4% in annual growth, don’t invest there. You wouldn’t grow much regardless of what financing you used anyway. The smart money moves with the opportunities. Put more simply, investment capital tends to go where it can grow. See, this isn’t rocket science. But in the end, that’s not the magic that makes neg-ams special. It’s the ability to buy two properties instead of one for the same capital outlay. Appreciation therefore is now compounding on twice the amount, even though you’re not investing twice the capital. Your actual capital growth is doubled. Whether the appreciation is 3.5% or 35% you’re still way ahead going this way. At least that’s my experience in three different states over the last 20 years while using this loan. I understand there are those for whom this approach is not an option, based on there own philosophy. That’s a totally legitimate point of view. However, as alluded to earlier I’ve been using this approach since the loan’s very inception without one hiccup along the way. Like any tool in any discipline, it must be used within a Purposeful Plan, and with the proper understanding of what that Plan is trying to accomplish. It’s not for everyone.
Be sure to tune in to Part Two of this series!
Jeff Brown is the force behind "Bawldguy Talking"; his real estate investment blog. He is also a contributor to the BloodhoundBlog.
[...] of you might know a little about him, as he is Jack in my interview with noted investment real estate broker Jeff Brown on my [...]
Left by Countrywide, LendingTree and Bear Stearns Mortgage | BloodhoundBlog: Real estate marketing and technology blog | Realtors and real estate, mortgages, lending, investments on January 8th, 2008