Outlook for Owning Rental Properties

Mike: Hey, it’s Mike Hambright from FlipNerd.com. Welcome back for another exciting Expert Interview where I interview successful real estate investing experts and entrepreneurs in our industry to help you learn and grow. If you haven’t checked out the new Flipnerd.com yet, please do. We have hundreds of properties listed on the site, hundreds of vendors listed on the site and it’s really shaping up nicely. I think you’re going to love it. So go check out FlipNerd.com.

Today I’m joined by Rick Sharga who is the executive vice president of Auction.com, the country’s largest online real estate marketplace. Rick is a 30 year veteran of technology marketing and real estate and a frequent guest on all major news networks. But today he’s here with the best of all of them, FlipNerd.com.

Rick has briefed the Federal Government, the Federal Reserve and large banks such as Citi Bank, JP Morgan Chase, Deutsche Bank, and many more. Today we’re going to discuss the outlook for rental properties and where the real estate market is headed overall. This is a topic that Rick talks about frequently with major news networks and today he is going to share it with us.

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Hey Rick, welcome back to the show.

Rick: Nice to be back. Things have changed quite a bit since we last talked.

Mike: For both of us, I’m sure. So for those that don’t know, Rick has been on the show before. This is going to be Episode 216. The first time Rick joined us, I was brand new. We were Episode 4. So 212 episodes ago. I’m sure we have both improved with time, my friend.

Rick: Well, it’s good to know that I knew you before you were rich and famous.

Mike: Yeah, something like that. I think I might be more broke today then I was but anyways. Hopefully that is not going to be true. We’re glad to have you back and you really have your ear to the ground as much as anybody in the real estate investing space and because you have done so much with REOs and trustee sales and large banks, you probably really are at the forefront of being able to predict what’s going on. So, it’s exciting to talk about these things today.

Rick: Glad to be here and do what I can.

Mike: Yeah, well Rick, just take a couple minutes to tell us more about your background and maybe even a little bit about your role with auction.com.

Rick: Well, thanks. I’m executive vice president. I actually have a pretty interesting job. I get to go out and do exactly what you and I are doing today on a broader scale. I work with our auction.com research team out of New York who puts out a copious amount of materials on both the commercial and residential markets. And I’m out talking about housing trends on a regular basis. I get to talk to the press. I get to talk to regulatory agencies, government agencies and really represent auction.com across the spectrum of the entire real estate industry. Whether it’s talking to real estate investors, real estate professionals, agents, and brokers, lenders or as I mentioned the press and government agencies.

So, part of the reason that I do keep my ear to the ground and my finger on the pulse or whatever clichés we like to throw out there, when it comes to the real estate because that’s my job. I did it for a couple of years at a company called Carrington Mortgage Holdings before I got here. Carrington owns and operates about 16 different businesses that are in the real estate mortgage industries. And before that I was with RealtyTrac for about 10 years, the world’s largest published database of foreclosure information and that’s really where I cut my teeth in the real estate industry.

I came to auction.com, as you and I had talked about, because I believe it’s inevitable within the next 10 years. The overwhelming majority of real estate transactions are going to be done online. They may not be done by auction, but they’re going to be done online because the next generation of homebuyers and sellers are going to demand it. At auction.com, from my perspective, had a huge head start compared to anyone else in the industry. We sold over 50,000 properties last year, about 1,000 of them commercial and the rest were single family residential units. Since the company was formed in late 2007, we sold $30 billion in assets.

Mike: Wow, that’s awesome.

Rick: We are kind of getting the model down and ready to go in the market.

Mike: Just like everything in life, there is very little that I buy without doing some research online. I mean, other than impulse type buys, where you’re at a store and yeah, I’ll take that. But quite frankly, even sometimes, I did this the other day, I was at REI, we’re about to go on a trip to the Canadian Rockies and I needed to get a raincoat and they didn’t have my size. I’m like, I’ll just pull it up on Amazon.com and of course they had it and it was like $40 cheaper. So I just ordered it with a couple clicks of a button.

It’s inevitable that would go into housing. I would think that probably its a much more common phenomenon today where people are finding the houses that they want to look at this weekend and telling their realtor, if they’re represented, these are the ones I want to look at versus in the past realtors would say well, here is all the stuff that is available. People can kind of self-serve more now today than ever.

Rick: Well, I think, ultimately it will be a hybrid model, Mike. I don’t think I would move my family cross country, even across town, without being able to look at the neighborhood and kind of get a feel for the property.

Mike: Right.

Rick: But there is no reason that the transaction itself can’t be executed online.

Mike: Sure.

Rick: We have been referred to by some people in the press as the eBay of real estate. And that is probably not a bad analogy. But I do think, and you and I were talking about this before the show, that the ultimate model is probably one that is determined by the consumer. It’s sort of like the financial services industry. If you work with Charles Schwab, you can do self-serve, you can buy all your own stocks and do all your financial planning with all their tools. Or, you can get some help from them and pay a fee per service basis. Or you can go full brokerage, they’ll do all the work for you and make all the recommendations, all the choices, and you pay them their fees. I wouldn’t be at all surprised if real estate ultimately had the same online model.

Mike: Sure, sure. And of course most of your history is working more with investors that are more often than not represented by an agent or they’re an agent themselves facilitating their business and they’re able to… maybe they’re cash buyers or they are just able to move a lot quicker. Maybe talk about how that has evolved. I know we’re going to talk about, you and I were talking about this before the show, that… so, myself, I started seven years ago and I was classically kind of trained to buy deep and never even think about paying close to retail value.

But then there is this subset of people that are buying rental properties and they’re willing to pay a lot more for them because financing is cheap again and they might be able to get long term fixed mortgages and they just have a very different model for evaluating a deal versus someone who is going to fix it and flip it and try and resell it or even wholesale it right away because they may have a 10, 20, or 30 year or more horizon to where they don’t care what the value is today. They just care about cash flow or what their next best investment alternative may be.

A lot of people are getting dismayed by the general stock market and more interested in real estate than ever right now. So maybe just talk to us about where things are going and this kind of rising of the rental investor that, the type of person that wasn’t there just a few years ago.

Rick: It seems almost like a horror movie, doesn’t it?

Mike: Yeah, we are going to have to get like a big drum beat. Like we are kind of doing the intro for the rising of the rental investor.

Rick: The [press] is always the last to know, it seems. So, there was a lot of buzz about the institutional investors coming in to the single family rental market a few years ago. I was at Carrington at the time and we were really the only movers in that market and got out quickly because the prices went through the roof. It got to where, if you didn’t have your own capital, and you were raising capital then the prices of the properties blew up the models. Those early models were based on a three to five year hold.

Part of your return on investment was going to come from the rental itself, although not much. A big part of it was going to come from home price appreciation and the prices rose much more quickly than anyone guessed because investors jumped in much more rapidly than anyone had guessed. What’s interesting to me, though, is that when the institutional guys got involved, they were already somewhere in the neighborhood of 12 million single family units being rented. Single family homes. Now that they have done what they are probably going to do, the number is up to probably 13 or 14 million. But the increase hasn’t been nearly as huge as what you would have expected based on all the ink it’s gotten.

What we are seeing now is the institutional guys are backing out. They’re not exiting the market entirely but they’re buying less volume. They’re being replaced by both individual investors and a new category that I have dubbed as the super regionals. So these are companies that are professional businesses, they have business processes in place, that look very much like the institutional guys. But they don’t have nearly the scale or volume of a Blackstone or colony or an American homes for rent. They are somewhere between mom and pop and Blackstone. And that category is set up for people that are buying 300 to 3,000 properties in the region and managing them as an ongoing business.

All of this, and the same thing with your members, who I guess are primarily individual investors, is being driven because home ownership rates continue to plummet. We’re at a 20 year low in terms of home ownership rates across the country. Part of this is math. We’re starting to see household formation level up after being flat or negative for a few years. Junior is finally moving out of mom’s basement. I guess she gave him the Xbox and said you’re out. A higher percentage of those new households are rental households. And the availability of rental units across the country is hugely constrained. Rental units are occupied 97% across the country and that is an all-time record.

When the prices continue to go up there is not enough availability to meet demand and so investors are voting rather largely to move into that category and to take advantage of, what I believe, to be another three to five years in the cycle before it re-corrects and we start to see a rise in home ownership again.

Mike: So you think that is what will happen? You think it will last about three to five years down the road before people will start to redefine the American Dream again. I think, maybe you can give some perspective on this, my guess is that there was this movement over the last several years where people have been told for a long time that the American Dream is home ownership, instead of the American Dream being some level of less debt than financial freedom. It’s okay to rent, it’s okay to be a renter. You don’t necessarily have to own it. Obviously, there are some pros and cons but

Rick: I’m still a little bit old school in that for the average American, the surest way to financial security in the long run, is still to own a home. Its sort of forced savings and maybe a return as a strict investment isn’t great. But I know if I tried to sell my home after owning it for 15 years, that I’m going to walk away with a check. If I had rented those 15 years, I would be walking away with nothing.

Mike: Sure.

Rick: From a generational standpoint, it’s still good.

Mike: As long as you didn’t continually refinance your house every couple of years.

Rick: [inaudible 00:12:58] a different show on financial irresponsibility.

Mike: Right.

Rick: But, I think we’re in a really unusual time period right now. Everyone blames the Millennials, I’m going to give them a little bit of a pass here. Generation X, the one that preceded the Millennials, has the highest home ownership rates of any generation. At the peak of the last housing boom, they also got clobbered when the market turned. Homeownership rates right now, if you’re looking at the high end of that 25 to 35 or 35 to 40 year old demographic, their homeownerships rates were decimated. I’m wondering if any of those people will ever come back into homeownership.

What that means is the next generation and the next wave of homeowners, the Millennials, has to take up that slack. Ultimately I believe they will. They’re a larger population base than the boomers. So they could potentially be the largest group of homeowners in U.S. history. They’re taking longer to get into the market. They’re staying in school longer because jobs aren’t great. They’re getting their first real job later because the market for employment isn’t great. They’re getting married later. They’re having kids later. So all of the trigger points that would move them to homeownership are happening later.

So I do believe ultimately we will see them enter the market at similar percentages to what we’ve seen previous generations do. But I believe there’s going to be probably another three to five years where the numbers just aren’t as strong as what most economists would have forecast.

Mike: So Rick kind of summarize that into what that kind of means for property owners, rental property owners.

Rick: I think you’re looking at another three-plus years of rates continuing to go up on an annual basis. There is a huge market of potential renters of families who prefer single family dwellings to apartments, but would rather rent the dwelling than take the risk in their mind or get into a long term financial commitment that homeownership requires. So I think this is an unusual period in homeownership history in the U.S., if you will. I don’t think it will continue to be as skewed toward rental long term as it is today and will be over the next couple of years.

I do think we will plateau at a higher level than we were when we entered this. In other words, if we started with 12 million single family homes being rented, we may plateau at a rate of 16 million or 17 million. It won’t go up indefinitely, but it won’t go back to 12. There are a lot of opportunities. I should point out, since the title of your business is FlipNerd and not RentNerd–

Mike: But there are some misconceptions about that, I will say, that we embrace all real estate investing. It’s not just flipping houses.

Rick: It was mostly a joke, Mike.

Mike: I have to clarify that. I actually have to clarify that. Oh no, we keep rental properties. It’s like, well, yeah, I do too. Go ahead, I’m sorry.

Rick: We are seeing… we survey, most of the people that buy on Auction.com are investors. A huge number of them are individual investors. So, we survey them every month to find out what their intention is with the properties they’re bidding on. Are they going to flip, are they going to hold? What we’re finding, a couple interesting things. One is that the people that are buying at live events, offline foreclosure auctions at the courthouse steps, sheriff sales, those folks are much more inclined to flip than to rent, almost universally. We had a little bit of an aberration in Texas last month, I think that might be because of the oil price issues and a little bit of a change in investor psychology.

And the online people, the people that primarily buying bank owned properties are much more inclined to hold than to flip. There are some regional variances that I think are important for your members. States like California, Washington, Arizona to a certain extent, where you have high property values and very low inventory of existing homes for sale. They will skew very heavily toward flipping. We’re talking to investors who are basically telling us the property prices are too high to rent out at a profit. But there’s so little available existing home inventory that if they can buy something just a little bit below market value, they can probably overprice it and still sell it once they’ve repaired it and brought it back to the market. So you have to know your local market, this isn’t just a renter’s market.

Mike: Sure, sure. So what are your thoughts on, I know that you have your ear to the ground a lot with institutional investors and I know that you know all those guys. But, I think there is this phenomena that’s happening, maybe you have stats behind it to match my gut feel, and some of what I’ve heard of, just the mom and pop type person that just doesn’t like the stock market anymore, doesn’t trust it anymore. It’s becoming easier than ever to buy rental properties. I think there are more trustworthy property management these days. Technology allows you to invest somewhere without physically being there. It was hard in the past, you just had to trust somebody.

It’s a little bit different now where all the stars are aligned to make property ownership, rental property ownership, easier for mom and pop type shops than ever before. Of course, with interest rates as low as they are, in a lot of the markets you could essentially buy at full retail value and they still cash flow nicely and you are building equity over time. So talk about that phenomena of the smaller person that is able to accumulate rental properties easier than ever before.

Rick: You know, it’s funny, I was on a panel locally, not too long ago. The moderator was Bruce Norris and besides being a real estate investor he is also a hard money lender. He was telling me, and he had just had a meeting with somebody, where he was talking about hard money interest rates below 10%. I didn’t think I would live long enough to see hard money loans where they didn’t have double digits on [inaudible 00:19:07] decimal point.

So if hard money loans are that cheap, imagine what traditional financing is once you have a rented property. We have seen a movement because of the market opportunity, because of the availability of capital. It is very affordable, of more and more individual investors are moving into this rental space. Given current market trends, it makes an awful lot of sense. Technology is important. The availability of technology is certainly a factor.

I really do believe, to a certain extent, that part of the reason we’re seeing this is because of the growth of the professional property managers. It’s kind of a class of service providers. I know Carrington is one of the biggest corporate entities in the market and they manage between 5,000 and 10,000 properties every month on behalf of bigger investors. We have a group of individual investors that we call our VIP members here at Auction.com.

And I know one of them, for example, lives in California. All of his rental properties are in Oregon and Michigan and he has basically built his own network of service providers in those areas. But those are markets that he likes and understands and they’re much more affordable than what he would be able to buy locally. He’s an individual investor, so that’s kind of the model you’re seeing as we go into the market today.

Mike: Yeah, and there is kind of this rise of the franchise property management companies. That they can roll up your reporting just like a financial services company would to where it doesn’t matter where, as long as they have a presence there, you could have properties in Chicago and Indianapolis.

Rick: I urge you a little bit of caution about the franchise guys because the quality of the service is going to be entirely dependent on that franchisor, or franchisee, I think. And you hear about spectacular service in one market and awful service in the market right next to you because of the individual who is running that business. So you want to check the local references on those.

Mike: But that aside, you can see how things are moving along to where people start to become agnostic as to where their rental properties are.

Rick: Right, it’s much less important. And financing, your other point, one of the interesting things that I have watched… I’m fascinated with these hedge funds. They’re brilliant at making money. So, Blackstone entered the market buying these properties at below market values, is now making money on the rents, and ultimately will make money selling the properties. Oh, by the way, they’re one of three or four huge financial institutions who have now introduced financing for individual investors [inaudible 00:21:59].

Mike: Yeah, in fact they’re one of our show sponsors here, B2R.

Rick: It’s a great product. It’s a brilliant model. These guys are going to make money on the rents, when they sell, and if they sell to someone who does the financing, then they will make money on the financing too. There is a lot of short term financing available out at very competitive rates from companies like Blackstone, like Colony, like [inaudible 00:22:22] that’s oriented exactly at the kind of buyer we’re talking about right now.

Mike: Right. So Rick if you had to sum up in a couple of minutes where you think the opportunities are for rental property investors, buy and hold real estate investors, what do you see over the few years to come?

Rick: You mean regionally?

Mike: Yeah, I guess everything comes down to the local market ultimately. Where are the pitfalls and where are some of the better areas?

Rick: So, again, I think what you said is really critical. It does come down to your local market and the expertise you have at the local market. The other pitfall… there are really three pitfalls that I see individual investors make in this area. One is the over value of the property. If you’re buying a property to rent, it can be less life threatening than if you’re buying it to flip because if your margins are a little bit off you can probably make them up over time or at least offset some of the damage over time.

Secondly, people are woefully bad at estimating what the cost of repairs might be on a property and getting it ready for market. Slapping on a fresh coat of paint and putting in some cheap carpeting often isn’t going to do the job if you’re trying to get a family to rent the property. Make sure you get that number right.

The third is what we have been talking about. Its much more difficult to manage these properties than people really anticipate. You have to know who’s going to answer the phone at 3:00 in the morning when the hot water heater bursts and where you’re going to get that spare part and what does your supply chain look like and what kind of insurance you have, etcetera. Those are kind of the pitfalls.

The opportunity, I believe exists in every major market and a lot of secondary markets as well. We’re seeing a lot of activity in the Southeast and Midwest where property values haven’t escalated quite as rapidly. You can still buy properties affordably and walk away with a 10 point return on investment on an annualized basis. You’re not getting your money like that in a lot of other investment choices today. It’s less critical that you really buy smartly, but the smarter you can buy the better your long term outlook is in terms of ROI as well.

That’s also important to keep in mind. If you’re buying in Indiana, you need to be buying with a much longer term hold strategy opposed to California or Nevada. You need to know what your horizon is as an investor. That’s what I always tell people on Auction.com. If you’re going to buy something, it isn’t a question of whether you are going to be successful buying the property. That’s only step one. You need to know what to do with the property after that.

Mike: That’s the easiest part when it’s a rental.

Rick: It really is.

Mike: Great, well Rick, I know a lot of things have changed at Auction.com in terms of how your model is changing to evolve more and more towards consumer base, but you still serve a lot of real estate investors. Maybe you can just take a minute and plug Auction.com for those that haven’t used it that are real estate investors, in terms of what is available to check out your platform.

Rick: I would hate to do that, Mike. Do you do a sales pitch? No seriously, thank you for the opportunity.

Mike: I will say, I have actually sold a number of properties on Auction.com in the past ourselves and had great success with that.

Rick: I appreciate that. We have been in business as Auction.com since late 2007. We really started the online platform in 2008. Since then, we have sold over 165,000 properties and the numbers continue to go up every year. I mentioned we sold 50,000 last year and we’re on pace to do more than that this year. So at any point in time there’s between 15,000 and 20,000 properties available for sale on the website. We do auctions literally every day of the week besides Sunday and they’re done regionally and by types of property. So if you’re in California, we’re probably doing auctions on Tuesdays and Thursdays. If you’re a commercial investor, we might be doing sales on Wednesdays and Thursdays. That is all laid out on the website.

It’s free to subscribe, there is no cost for people interested in subscribing. You register for auctions on properties you are interested in and at that point it works just like eBay. We have a scheduled auction that will take place over 48 hours. You want to be online at the end of the auction to prevent anybody from coming in and sniping you at the very end of the auction. One of the things we do to prevent that is, which is a problem on sites like eBay, if someone makes a bid within the last minute of the scheduled auction, we will automatically extend the auction somewhere between three and five minutes depending on where we are with that particular property to give the other bidders a chance to come in and be able to counter bid.

It’s a great experience if you are looking for the type of properties we have on the site. Right now overwhelmingly are the residential properties that are distressed inventory. They are either a property scheduled for foreclosure sale or properties that the banks have repossessed and are trying to dispose of. We are making a transition on our commercial side of the business. Right now about 50% of the assets we sell are traditional non distressed assets whether it is retail facilities, hotels, office buildings or multi-family units. And part of the reason for that, and Mike as you know, the pool of distressed assets is shrinking. So as that market shrinks, we are going to move pretty rapidly into selling more traditional assets both on the residential and commercial side. Right now there are a lot of bargains available on the site for people who are interested in looking.

Mike: Fantastic. Yeah, so for those who are interested check out Auction.com. Rick, thanks so much for your time joining us today. We appreciate you being here.

Rick: Well, we’ll have to do it again before you get another 216 episodes.

Mike: Yeah, we won’t have to wait 212 episodes. We will have you back before then. Thanks so much, my friend. Great to see you.

Rick: You too.

Mike: Have a great day.

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