Source of Real Estate Deals with John Schaub #588

John Schaub

This week Bruce Norris is joined by John Schaub. John has prospered during three recessions, four tax law changes, and interest rates ranging from 6 to 16% in his 35 years as a real estate investor. His 2005 best-selling book Building Wealth One House At A Time assisted more than 100,000 real estate enthusiasts on their way to a successful investing. He recommends buying better, well-located houses rather than cheap houses and other management-intensive properties. John buys and manages his own properties and teaches building wealth one house at a time seminars each year. Here, students learn how to identify the best investment properties in their town. He also invests his time in those who cannot afford to buy their own home. He works with Habitat for Humanity and Fuller Center for Housing. Last year, he was honored for his reputation in the industry by being rewarded the Rhony Award.

Episode Highlights

  • Has John ever had a career outside of real estate in his life?
  • When did he become interested in the buying model versus the flipping model?
  • How were deals financed in the days he bought inventory from the builders?
  • How many of the homes he started with were kept as rentals or were flipped?
  • What’s the source of most of his deals?
  • What are attributes of a good rental property?
  • Who are the people John prefers to rent his properties?

Episode Notes

Bruce began by asking John if he ever had a career outside of real estate. John said no, unless you count dishwashing as a career. When he was a kid in high school, he would work in kitchens a lot and liked it. You start off in the kitchen, work your way up to fry cook, and before you know it you are assistant manager. He learned perseverance early on through this and learned he did not want to do this when he got older. He got involved in real estate while he was in college and managed an apartment building while he was a senior in college. He ended up selling the apartment building at a nice commission. At this point, he got his pilot’s license and started flying. The rest is history, and he has been in real estate ever since then.

Bruce asked what year he graduated college, which John said 1970. Bruce graduated high school in 1970, so John has been at it for more than 35 years. He wondered if John had an early mentors, to which he said he got lucky really early in his career. The first couple years he was in business, he was selling lots for a company out of Kansas City who had a big sub-division in the area. He sold a whole bunch of lots because the early 70s were a hot real estate market, a little like now. They sold out a lot faster than they thought. At one of his meetings where they were wrapping up a sub-division, John asked what they would do next. The person who owned the company asked what he meant by “we” since John was a salesman, not a family member.

They had 16 lots left in the sub-division, so John called them back up to tell them he wanted to buy the 16 lots from them. They ended up selling them to him, and he made about as much money off those lots selling them over the next two years as he did from his commission work selling the first 100 lots. He got into the business, then in the mid-70s they had a recession. Then, in the last 70s and early 80s they had the big inflation under Carter and Regan. John has been through several different markets, which has been very instructive.

John was really lucky to meet a guy named Warren Harding back in 1972. He took his class in 1973 as well as a couple other classes in that same time period. The people are not in business anymore, but they were very instructive and got John thinking outside the box. Before that, he was taking the CCIM classes as the realtor institute taught. They taught you how to do 10-year projections and how to manage your clients’ money. He didn’t have any clients, which he had a hard time figuring out. However, he did learn that ten-year projections did not work. None of the projections he did in 1973 played out. Sometimes you learn things you didn’t think you would learn, and one of these things was not to project ten years. You don’t know what the world will do, you just have to hope the deal you make today works and protect yourself to do it again.

Bruce asked John when he became interested in the buy and hold model versus the flipping model, which he said early on you do whatever you can to put food on the table. The first house he bought to flip was bought in 1973, and he still has it. Bruce wondered if this was because it didn’t sell since he has had rentals in this same category. John said it was a house that had a tenant in it. He figured when they moved out he would sell it, and the tenant ended up staying there ten years. This house made him more money than any house he had ever bought because the loan was so long. It had a 20-year loan on it, so it had been paid off for more than 20 years. The rate of return on your money is pretty phenomenal when you buy a house with a low down payment and hold onto it forever. Nobody believes the percentage, but this is a big number.

John was buying and selling at this, including an apartment building and a commercial building with a restaurant in it. He was not in the buy/sell business like Bruce was where he was flipping houses. However, he was buying whatever he could on which he thought he could make a profit. When he got into the house business, he was never a flipper since everyone was a buy and hold person. When there was a recession, he would buy a lot. In the recession in the early 80s, he bought 16 from one builder and 13 from another. They would load up during the recessions.

During a boom period, he does not buy as much. He does not sell much during a high period, but you do not buy as much unless it falls in your lap. He is always open to a deal, but he is not always out pounding the streets looking for 10-15 deals.

Bruce asked how the deals were financed back in the day when he bought inventory from the builders. John said they both had institutional loans on them, although the institutions did not want these houses. The builders did not want them either, and the institutions thought they would file bankruptcy on them. John was able to get in the middle and do something the builder would not do. John would rent the house, which the builder would not do. He would go to the lender and tell them he could rent the houses, have a certain amount of cash flow, and make payments of a certain amount. They would just need to modify the loans so he could afford to own them. You don’t have to own all these houses. During these downturns, the lenders do not want more inventory since they have all they want. You can make better deals during a downturn than during a hot market.

Bruce asked if these were all new homes he kept as rentals or if he flipped them. John said he still has a lot of them. Some of them were four in a row on one street. John does not like this because it starts to look like a duplex. He would sell off every other one; own one, sell one. This was how he paid off some of his debt. Back in the early 80s, it was not cheap. They were paying high interest and wanted to get out of this high interest debt, so they did a couple things to pay off the debt.

Bruce got started as a real estate investor in 1980. At the end of this year, he refinanced a free and clear house at 17 ½% interest to invest in real estate. He is familiar with this high number for that reason. People today do not have that high perspective. Most people today think that if interest rates go up to 10 or 12%, the market will fall off a cliff and die. Both Bruce and John know this is not true since there is a market at 10 and 12%-14%. He won’t say it is wise to borrow at those rates or to but at those times, but there is a market there. With rates going up again, we may see double digit rates again in our lifetime.

Bruce remembered people telling him we would never see single digits again. They were knowledgeable people, and they didn’t think we were going to get below 10 since we were hovering at 15 then could get on sale at 13. It is an interesting perspective since you probably have buyers right now hesitating at 4 ½. If the kids got into the business, they would see how it is a market today. They better watch it and not buy houses they really shouldn’t buy.

Bruce asked what the source of most of his deals were. John said it has been a few years since the first time he sat down to figure this out. About half of the deals came through brokers as well as the big packages from the builders. They could make a good deal on commission since there was a big buy-in involved. Some of the best deals he made came through real estate brokers. Generally this happened in the down part of the cycle when they could not buy them. Many brokers don’t buy property; they just simply act as agents. Even when it is a killer deal, they sell it to somebody else rather than buy it themselves.

He tries to get to know the agents in his town who are smart and have been around for a while. Most have been in business 10-20 years and therefore know who John is and what he buys. They know the advantage of selling to him is if they show him something that is a good deal, he will buy it. This, in turn, will give them a commission. They will get two shares of the commission if they have it listed. John deals with people who list a lot and tell them if they list something, you know the people will want to sell it right away and will take a low price. John will tell them to call him since he is not emotional and can make a decision in one day and they can close the same week.

John has never been a big direct mail person since he has never bought this type of volume. His volume has been 3-5 properties in a typical year. In the extraordinary years where people are just giving things away, sometimes he will buy 15-20. Typically, he will put together 4-5 deals a year. He does not need to buy the incoming calls you get by mailing out 1,000 pieces of mail a month. However, Bruce and John know people who do this very effectively and know it is a good way to run a business. However, John said this is not his business and not what he does.

John’s book lent Bruce to this opinion. When they were talking about one house at a time, it sounds doable. John’s book encouraged people who were not even in the industry to think they could buy one or two homes a year and follow the plan. There is a second edition of his book out on shelves now that came out back in 2016. There was a little excitement between 2006 and 2016. To most of the people who buy his book, he encourages them to buy one house at a time. Maybe they only buy 3 or 4 houses, but to a lot of people you won’t get more money from your real estate than you will from your retirement plan. Folks will buy a little bit, and it helps them a lot. They don’t need to buy 50 houses; 1-3 will be perfect for them.

Bruce asked what a preferable attribute is of a good rental property. John always thinks about who will move into the house before he buys it. You can pretty well tell who will move into that house by looking at the neighbors and driving up and down the street. John’s not a shy guy and will say hello to the people he sees walking down the street. He will strike up a conversation with them and ask them how long they have lived here and learn as much as he can about the neighborhood. You can tell by who lives there now the type of tenant you will attract when you rent that house, so make sure you like them. You want to make sure you are comfortable in that neighborhood. If you are afraid to talk to the neighbors, that is probably a bad sign.

John’s other rule of thumb is he has never bought a house he would never move into himself. He has never bought a house on a real busy street or a scary, loud, or smelly neighborhood. If you think of these things before making an offer, you can back into how much money it will make since you can see what your potential tenants do. You can know about how much rent you will collect on this house, and this helps you make an offer with mortgage payments each month that you can afford. If you think through it before you buy it, then you do not buy something that is going to cost you money, put you under pressure to sell, or lend it for too much money.

John rents his properties to people who have reached high quality income. Even if they don’t have a lot, it should be high quality. Whatever they do is steady. John is not looking for the hotshot salesman who might have something one month and nothing the next. John would rather have a nice steady amount each month.

The preferable properties are usually in more expensive areas. Bruce asked John if he sees his student bases getting to those properties after some other areas increase. Bruce wondered if there is a process to get to those properties. He had an evolution in what he ended up withholding. When people are starting, Bruce wondered if it is easier for them to start off with something that is a struggle to get the equity to get to the neighborhood or if it is not worth the effort going to the struggle properties. John said if it was not worth the effort, it was at least worth the education. If you think duplexes or other buildings have more cashflow, you should buy one and test that theory.

What John has found over the years is you get more gross income from some properties than others. A lot of these properties like duplexes or apartment buildings have higher gross income. Until you own one, you do not realize that your expenses are higher too since many times people do not take good care of the property. Many times they do not stay very long, which means you have buyer vacancy and more advertising costs. The one thing most important to John is it takes more time to manage those properties. The most valuable asset John has is his time. He passed up a lot of deals that were very lucrative because it would take a lot of his time. He is very sensitive to this. He could buy a house, put a tenant in there, and the average one stays pretty close to ten years.

It will take him some time to find that tenant. If they turn out to be a bad tenant, then he will have to get involved and kick them out or talk them into paying the rent on time. However, 90% of his tenants are good tenants. There is that 10% that will be a little more higher maintenance, but overall it is a pretty low maintenance business as far as his time requirements go. He sees the houses as more of a true investment than he does apartment buildings, motels, or commercial buildings. These are really businesses and are pseudo-investments. You have to stay right on top of these. If the air conditioner breaks in the dentist’s office, you need to get on that right away and cannot wait two weeks.

Bruce has been asked why he did not invest in apartment buildings, and he said what it comes down to is he does not want to live there himself. If he was in an apartment, his whole goal would be to leave. He does not want to have 100 of these people in one place who cannot wait to leave.

John manages all of his own properties. He has tried different things and having other people manage for him. He is so efficient at it and teaches a class on it. It is not rocket science, but rather common sense business. If you select the right people and give them financial incentives to do the right things, including paying on time and taking care of their house, then the management is not that hard. John said when he delegates to somebody else, what he finds is they rent to the wrong people. They are not as selective as John is. He will let a house sit empty for a couple months if he has to in order to find the right tenant. He is not in a hurry to rent a house.

This is one of the biggest mistakes a new investor makes. When they buy that first house, at some point they get anxious to rent it. They may end up renting it to the wrong person because they are in a hurry. He tells people to have at least a couple months’ rent in the bank before they buy a house. After they buy, then they would show the first two months’ rent payments. In most markets, if you work at it you will find the right person. John has sometimes turned down 5 or 10 people before renting to them.

Bruce found that well-located properties are really drivers of good quality people. Bruce typically never raises rents, but on one property he had rented it for $1,300. He then had a relative live in it for a few years and did not know what the rental market had done. He hired a friend he worked out with as a manager. Now, the property is worth $2,000. Bruce would have never thought this would happen. It ended up getting rented in only a few hours. If you have a tenant taking care of properties, it is easy to go to sleep and leave them alone, but this does cost you money. John and coworkers discipline themselves to raise rents once a year. They can negotiate how much they want to raise the rents based on the performance of the tenants. If they were great tenants, they will not raise the rents so much. If they do not like them much, they will raise the rents a lot and they will move out.

This is another advantage of having houses or a 10-unit apartment building. You could not do this in an apartment building. You could not charge apartment #1 $600, apartment #2 $1,200 a month, and get away with it. Bruce has a street full of rentals in Florida, so it’s a possibility people could talk to each other. In today’s world where you can look people up on the internet, they can see the commonality of ownership. This is one of the reasons Bruce is taking John’s weekend class so he can learn about taking title. John liked Bruce coming to Florida to take his class since it was a little different environment and laws.

Bruce next asked about the eviction process. In California, it can be crazy. Bruce asked how long the eviction process is in Florida. John said he can do it in 30 days if everything goes exactly right. You should figure at least two months since people move out, but you have to be good at it. You need the right dates on it and file the day that you can and follow through. Most people cannot do this in 30 days. In his 40 years of renting and with 1,000 tenants, he has only evicted 6 people. He has not evicted somebody in ten years, the reason being if he has a problem tenant that it is easier to buy them out. It is not an emotional or religious thing, it is just cheaper and better business. If you evict somebody, you lose at least one month’s rent, maybe two. If they tear the place up when you leave, you could have a $5-$10,000 problem on your hand. If you could write them a check and have them move out that weekend, that would be ideal. Typically, the reason they are not moving is they do not have any money. They probably won’t have any money in two months either when you get them out of there. You might as well get rid of them now since you could fix the house up and rent it. This way you might could recover some of your rent.

Bruce said when he started having Florida properties, there is a new type of insurance he has not had to deal with before: Hurricane. Bruce asked if this is something that is mandatory to have in Florida, which John said you do if you have institutional loans. You would think you would need it even if you were free and clear, although John said he does not carry insurance on his properties, neither wind nor flood. They have a lot of waterfront properties they do not carry on any of it since he has been there all his life and has the advantage of being there. Bruce has been in Riverside a long time, where the parallel may be earthquake insurance. Bruce does not carry this either. John said the last bad storm they had was 1961, and before that was in the 1920s. If you do the math, it is about every 40-50 years you have a storm. Statistically, it does not happen that often.

He has some houses three feet above the water that he has had for 40 years, and they have never had a flood or wind problem. Insurance is expensive; the first one he could have bought would have been $5,000 a year. Multiply 40 times 5, and that is the wrong number for nothing happening. John actually thought of starting an insurance company. Someone who could really assess from a practical standpoint or risk on some of these could make a ton of money. He won’t now, but if he were half his age he would certainly do it. Hey may even encourage his kids to do it since it is a terrific business. They re-insure and lay off the high risk stuff and keep what is safe. They’re smart this way.

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