Nobody wants to lose money when investing. Many passive investors are good at creating equity but horrible at generating cash flow. What use is there in being able to be hands off in investing if we continuously lose money? In this episode, the author of Resilient Women in Life and Business, Whitney Elkins-Hutten, sits with Lauren Wells to enlighten passive investors on how not to lose money in passive investing. She emphasizes how valuable a successful business experience in real estate is to guide you in your passive investing journey. Whitney also provides insights on the red flags in real estate. Tune in and arm yourself with another tool to be resilient in your life and business today!

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How To Not Lose Money As A Passive Investor With Whitney Elkins-Hutten

Joining me on this episode is Whitney Elkins-Hutten. Thanks for joining me, Whitney.

It’s a pleasure to be here.

Whitney is the Director of Investor Education at PassiveInvesting.com and a co-author of the international number-one bestseller, Resilient Women In Life And Business. She’s the host of the Passive Investing Made Simple and Multifamily Investor Nation YouTube show and podcast, as well as a partner in over $800 million in real estate, which includes 6,500 residential units, 7 express car washes, and more than 2,200 self-storage units across 11 states.

She has done it all and practices what she preaches. I am so excited to have you here, Whitney. Tell me a little bit about how this journey started. You’ve been very heavily involved in passive investing, educating about it, and doing it yourself, which we don’t see very often at this scale. I feel like people passively invest to be involved in not just one asset class but multiple and doing it at scale. How did this journey begin?

It began back in 2002. I bought a house with a significant other. The relationship fell apart about a month later, and I had the house. I had all the bills and everything under my name. I panicked a little bit and stuffed into the house full of roommates who didn’t mind living in a construction zone. The house hadn’t been redone since the ‘60s. Imagine green shack carpet and psychedelic painting all over the wall. There were beautiful hardwood floors underneath though. People did a lot of the rehab myself but paid my friends and beer, sushi, and pizza, and put the house back together in eleven months. I thought I had to sell it at that point in time. I was like, “Get out from underneath this thing as quickly as possible. Don’t let it sink me.”

When I sold the property, it dawned on me that I hadn’t been paying my housing bill a whole entire time. Property, insurance, taxes, and all of that principal interest, taxes, insurance, I hadn’t been paying all that. My roommates had been covering that. My roommates had been covering all the utilities. I’d been putting cash in my pocket every month. I walked away with over $52,000, which doesn’t sound like a lot of money, but you need to make that in eleven months. For someone traveling 80 hours a week for my job, that was amazing money.

I was like, “How many more of these projects can I do on the side?” I spent several years doing what we called live and flipping and house hacking and got good at building up buckets of equity. I learned how to leverage the IRS Tax Code, the 121 Exclusion, in order to keep a lot of those earnings tax-free. My husband now joined me in my antics, as I call it, and we did several projects together. It dawned on us one day that we were good at creating equity but horrible at creating cashflow.

That was what was going to unlock the golden handcuffs for financial independence or financial freedom, but we didn’t have the vocabulary. You have ever been sitting there yearning for something, and then you’re just like, “I wish I could find somebody doing this.” I didn’t have the network. I didn’t have the vocabulary. Once I finally landed on the vocabulary, I started digging into this world of people that are curating wealth from themselves and financial independence apart from stocks, bonds, and mutual funds.

The world opened up for us. We built a portfolio of over 30 single-family homes. We bought an apartment building. There are several things and milestones along the way, but it all led to one pivotal point where we were very active in our investing. It still required our attention and our time. Here I am. We’re both working full-time. We have a small kid at home. I’m a guardian of my grandparents. My mom’s health is ailing. I was like, “I don’t have any more time. I can’t scale this any further.” We were then like, “Do you remember those two deals we did in your self-directed IRA? What were they called? Passive deals? You invested in a multifamily building.” That’s when the light bulb came on for us.

We’re like, “We got to go bigger, faster, and with less of our own time and resources.” When we finally started to unlock those keys, it dawned on us that we could not only scale our portfolio, cashflow, equity, and tax benefits. We did so without as much time involvement. We were leveraging other people’s knowledge and expertise in that area, but we could also diversify our portfolio a lot better as well. Fast forward to our personal portfolio side, which you mentioned, I also have a passion for educating people on how to do this for themselves. That’s what I do here as the Director of Investor Education at PassiveInvesting.com.

I love that. That switch from active to passive is a big transition because, like you said, you were cashflowing, but you were also very involved. I want to talk about making that transition. There’s a lot of trust that goes into it, trust in who you’re investing with and confidence in what you’re investing in. I’m sure you’re thinking, and I wouldn’t be thinking, “How do I not lose money?” I know when I’m in control, and maybe that’s my type A self, that if I lose money, it’s something in on me. I can do everything. I’m more in control so I can mitigate that, or so you think. How do you flip your mindset and build that trust? What are the ways not to lose money as a passive investor?

You hit the nail on the head. The first thing as a passive investor is you have to learn how to vet the operator. Everybody has their vetting spreadsheets, but when you look at those big, long spreadsheets, there are so many people out there sharing their spreadsheets on how they perform due diligence on a deal. They’re trying to get at 7 to 8 red flags. I want to level set everybody’s expectations. I still have some active real estate investments. I’m reminded every year when I have to place a tenant or make a larger repair that there’s a reason why the majority of my portfolio is built with partners. We are going through that pain point, dealing with some plumbing issues at one property and trying to sell another one.

Bringing it back to performing due diligence on the operator and the operating team and trying to suss out these red flags is how you don’t lose money. If one of these red flags is in a deal, it’s more than likely a deal breaker, at least for me. The first thing is making sure you know that the team has a successful business in real estate experience. If they don’t have any success in business or real estate, you should think twice about, “Do you need to take the hard-earned dollars that you’ve traded time for to invest there?” Everybody has to start their business somewhere, but if you were the operator, find somebody who has that track record, knowledge, and expertise. Partner with them until you’ve built it for yourself. That will help get you as an operator to the next level.

You don't lose money if operators perform due diligence and suss the red flags. Share on X

I want to ask a question about that. When you look at someone who has a track record in the past years where we were clearly in a booming market, as someone evaluating, do you look at that and say, “Anyone made money in the last three years?”

We all look like geniuses.

All these operators out there who started years ago look amazing. I’m not saying this because I’m not a fan when people are like, “You haven’t been in this long,” and it’s like, “A decade,” but they want 25 years. Have you been through a downturn market? Have you been through a recession? Is that something you think about when you see sponsors who have done very well, but it’s been only in the last 3, 4, or 5 years that we were in a huge flourishing market?

It is something forefront of my mind. I want to understand how somebody has been tested. This is how I approach this. All my questioning with an operator is, as the investor or a limited partner, I’m hiring a COO of my real estate business. I might have multiple COOs. I might work with multiple operators as anybody should. You can vary your operator, your market, and your deal as a limited partner. I’m hiring a COO. I’m giving up that day-to-day operational control. We’re not talking about the operating coordinator. I’m talking about a COO. That is what I am looking for, somebody that has high-level knowledge and expertise.

How far back have they been investing in real estate? Have they taken some hard knocks? How did they deal with them? I’m not looking for an A-plus scorecard. I’m looking for somebody who has been challenged in business or real estate and can be nimble with the environment that’s at hand. I want to understand that they can navigate all these choppy waters ahead of us. Not a knock to people that are new. If somebody is new, somebody on that team has to have this knowledge or expertise. They have to have a strategic partner. If I’m looking at somebody that’s only been operating since 2019, maybe they went through COVID, but who’s the strategic partner there that helped them get through that can navigate those waters? That’s what I want to see. I want to see that depth in that bench.

 

That’s number one. What is their track record? What is their performance in the space?

You can take a lot of business skills and tangibly bring them into real estate. It’s a little harder to take real estate skills and then create an operating business. It’s a little harder to go in that direction. It’s fairly easy to take operating skills and pull them into real estate.

I love that.

Number two, are they full-time or part-time in their business? I have a choice as a limited partner. I choose to invest with people who this is their prime time. They are watching my money as if it’s my money, not theirs. They’re building this wealth not only for themselves but for their investors. Limited partners have a choice. If somebody’s doing this part-time, their attention is going to be divided elsewhere. I’m also looking for teams that have at least two managing partners that are unrelated, more if possible. That’s for succession planning. If you’re scaling your own business and you’re just a solopreneur, you know what happens if you have a huge life event.

Have at least two managing partners unrelated to you so someone can take over in case a huge life event happens. Share on X

We were talking before the show. We’re both moms and we had kids that were in the hospital. We are the solo operators. That’s a lot of hats to wear. Is there more than one managing partner, and ideally unrelated? If people are related like a husband and wife, and I know some amazing husband and wife team, but think about it, if they don’t have a third partner and something happens to one of their kids, guess what? Their attention’s diverted as it should be to taking care of that family emergency.

That’s a question we get all the time, and it’s super important. What is the succession plan? What happens? If it is two people who are related, if something happens, typically, it affects both of them in their lives. Their attention would be diverted.

We’re getting down to the brass tacks of the actual deal. What’s a red flag for me is if the deal doesn’t have a preferred return or if there’s a preferred return but the GP has slid in a catch-up provision. That is a hard pill to swallow for me. I’m looking to work with operators that have well-underwritten their business plans and are confident that they can deliver a preferred return to their investors and do so without putting in a catch-up provision that allows them to get paid prior to the investor getting their capital back.

It’s like a skin in the game essentially.

Business alignment, are the limited and the general partners truly aligned for performance? Modeling a refinance in a proforma is another big one. If a business plan is predicated that you have to pull money out of the deal in order to make the deal work, that’s a red flag for me. It’s not necessarily a deal breaker. Oftentimes what I’ll do is I’ll request the proforma, the actual underwriting document, and I’ll go in myself and back out that refinance on that spreadsheet. If the numbers still work, great. We still have to talk about what happens to the lending then because the lending still carries on. There’s still another hurdle to come across to work through there. If the numbers still work with backing out that refinance, you still might have a deal to look at.

If that was one of your red flags prior to COVID, now you’re probably doing pretty well if you weren’t predicated on a lot of refinance.

Exactly, which is a deep value-add strategy and a little hard. All these deals were picked up with bridge debt. I get it. I understand why operators were looking at bridge debt. It created more cashflow on the deal. They could execute their business plan repossession into more permanent debt in 24 to 36 months, maybe even do an exit. They do so without being locked out for a long period of time and do so without paying a prepayment penalty. Now, interest rates have risen. Did they underwrite this new interest rate environment? I can almost guarantee you that nobody in the past years knew where we were going to be now.

I know many operators that are renegotiating terms on their deals. They’re securing rescue capital or even going a HUD route just to maintain the property, getting maybe a HUD loan on the property in order to maintain it. Past that, how is the distribution? Are they return on capital or return of capital? There are pros and cons to both structure, but at the end of the day, just penciling out the numbers, an investor’s going to make more money and it’s going to be more business aligned that have a return on capital structure as opposed to a return of capital structure. That’s just something when I talk to investors. They don’t understand.

 

Do you want to clarify for people who might be reading and not understand what you’re saying when you talk about that, return of versus return on?

It’s slightly difficult to understand, and then I’ll do my best. Essentially, on a return of capital account, you’re not getting the preferred return on the deal. You’re getting your capital count reduced to zero, and then the pref is calculated. Whereas if your capital stays invested, your full capital account stays invested, and the preferred return comes first, now you’re getting a full pref, say it’s 7%, on your capital that’s invested. The pref comes first and gets paid first. If there’s extra cashflow, perhaps your capital count is now being reduced, but that profit is coming first, not second.

That’s an important concept to understand, and it’s something that when you move from active to passive. Working with more sponsors or operators is a question you should look into.

Think of it like this. Say you own your own private real estate, your own rental. Are you taking the cashflow and putting it in your pocket to reinvest and spend, or are you taking the capital and considering you paying back your down payment, and then you take your return? If you sell the property early, that return becomes lower on the back end because you replenish your capital. Whereas if I consume the capital and then I take my capital out on the backside when I sell the property, my numbers are probably going to be larger on how I book those numbers. There’s a reason why operators do it and why some investors like a return of capital structure potentially for tax benefits, but at the end of the day, I wouldn’t let the tax tail wag the dog.

That leads me to my next question. Do you look at the tax verifications? Are you going to get what tax form? Is it K-1? Is it going to be ordinary income tax? For us, we issue 1099. It’s considered qualified dividends. That’s more favorable. Do you look at that when you’re evaluating, or is that a nice to have but not something you consider a deal breaker?

Exactly. That’s nice to have. It’s not necessarily a danger to the dealer, the business plan, and the operator’s ability to perform. That’s what we’re getting at. What are those 7 or 8 things that are going to put the business plan most at risk? How can we eliminate those? Once we’ve eliminated those, now we’re getting down to what aligns best with your investing goals, your risk tolerance, and your timeline. Do you get a 1099 or a K-1? Do you get monthly or quarterly distributions? That’s all going to align with your goals, timeline, and risk tolerance.

I like how you phrase that. Essentially, these first 7 to 8 red flags are about evaluating the sponsor and the business plan, and what could potentially put those things at risk and your capital, therefore, at risk. The second part is like, “They check all these boxes or 6 of the 7. They passed,” then you can go into, “Now does this align with my portfolio, my strategy, tax benefits, all of that.”

A lot of the time when people are evaluating, they mingle those two. It would cloud your judgment because this is more tax beneficial and you’re seeing all these great things, but there could be something in those first seven buckets that should be sticking out more but you clouded your judgment because you’re looking at the tax benefits or whatever it might be.

Exactly. I’m part of a mastermind. There’s a deal being evaluated in the mastermind, and everybody’s like, “Look at the numbers,” and I’m like, “Hold on. We’ve got a red flag here.” For me, it’s a red flag, it’s a no-go. It’s related to the operating partner in the business plan. There’s something fundamentally there that I’m like, “This could put everything at risk.” That aside, whether we get a 25% or 30% IRR, this is going to put the whole thing at risk. It doesn’t matter if this goes wrong, those returns never materialized.

That’s a great point because we’ll get people who are like, “I’m going to get 17%, 18%, 19%.” Like you said, it goes back to looking at past performance. Are they using leverage? What is their track record? Who is involved? What does that team look like? What is their succession plan? If there’s something wrong there, like you said, it doesn’t matter if you can get 18%, 20%, or 24%.

Will you is probably the better question. Are you better off going with something that’s going to give you 10% and clearly checks all these buckets? That also probably plays into your phase of life. What are your goals? There is something to be said about being more aggressive, but can you afford to be more aggressive? Is this your first investment? These are all things that I think about when I’m talking to people. Every individual is so unique and their risk tolerance is as well.

You hit the nail right on the head. I know people that are swinging for the fences in their twenties. If you just didn’t lose capital for the first ten years of your investment career and hit maybe financial vitality or financial independence level, once you get there, you can start taking a little bit more risk until it’s time for retirement. A lot of people have been trained. We’ve all been trained.

I was just going to say that’s interesting because what you see is when you’re in your twenties, you’re just, “Go big or go home,” and then you’re in your 30s.

Everybody says you have time to make it up.

Yes, but now being in your 30s, you might have more responsibilities of mortgage, kids, all of that, and you are less risk averse. What would happen if you did exactly what you said, and you did build that financial freedom, and you enter your 30s where you can take more risks because you do have that track record of success? That’s interesting. Honestly, I’ve never thought of it that way. I’ve always thought of it the opposite way because that’s what I see and that’s what I’m around.

That’s what we’ve been told our life, “Go 100% stocks in your twenties. You got time to make it up when the stock market crashes.” I wish I had the money back, trust me. More importantly, I wish I had that time back. I wish I had learned how to do this. This is why I’m so excited for my daughter, even though she’s like, “Mom, stop talking about investing at the dinner table.” I’m so excited for my daughter because she now has these money skills. She knows how to do this. She’s going to be able to put these to use so much earlier in her life. She’s already investing alongside me. I wasn’t doing this. I was investing and my dad would help me buy stocks of Coca-Cola and Dr. Pepper when I was six years old. Let me tell you, that didn’t get me anywhere.

Are there any other things that you would say are red flags or things that you take a look at before making a decision whether or not to invest, or before looking at if this is a fit for your portfolio?

Two more. One is no co-investment from the general partner. You want to look for a co-investment above and beyond the acquisition pay. Everybody has to get started in the business somewhere. Who’s that strategic partner and that key partner that is going to make that investment, put their money on the line, and has skin in the game? If they have significant skin in the game, they’re going to take better care of that asset because they’re taking care of their money too.

Also, the business as a whole.

The last one is to make sure that, if it is an adjustable rate loan, it’s capped. I would go one step further that only there’s an interest rate cap, but there’s a plan to pay for the next cap or the cap extensions if they need it. Not many people are talking about this now. The price of interest rates caps is stabilizing, and I even heard in some markets, coming down. What has gotten a lot of people in hot water in the past months and will continue to probably through the end of 2023 into early 2024, is they purchased a property using an adjustable rate loan. Maybe they were smart, and they put an interest rate cap on it. If they didn’t put a cap on it, they’re in trouble now. Maybe they did put a cap on that rate, but did they underwrite to the fully capped rate from day one?

People are doing that now. They’re still using bridge debt, which is fine. They’re paying for the cap, and they’re underwriting at that cap from day one. That can be smart business. There’s a business case for that. Where people are still getting into trouble even if they have an adjustable rate loan, they got capped, they hit the cap, and they might still be eeking out a little bit of cashflow even now is that what happens when they have to go get that permanent debt or pay for another bridge loan to keep your cashflow going and pay for that cap again.

I’m just throwing out some numbers, and you guys don’t quote me on this, but it gives you the perspective of a $15 million property. Before, that cap on a $15 million property probably cost you $100,000, maybe closer to $70,000. That interest rate cap on that property nowadays probably easily will be $1.5 million to $2 million. That’s 10X to 20x times the cost. That’s where we’re seeing a lot of operators. The asset’s still cashflowing, but they have to pause the cashflow on the asset because they probably have to pay for another cap going forward here in the near future. The bank actually might already be escrowing for that cap now, adding it to the mortgage payment.

Those are just some things, and there’s nothing you can do about backward-looking other than trying to come up with another solution for the debt and lending. If you’re evaluating a deal now looking forward, make sure that the fixed rate debt, if it’s there, great. Again, there’s always a business case not to use it. If it is a bridge debt or floating rate debt, there is a cap and it’s fully underwritten at that cap now starting from day one until the day they close.

That leads to the last topic that I want to cover briefly. Now, it’s a very different economic climate or investing climate than a few years ago. What would be your strategy as a new passive investor who doesn’t want to lose money? I do believe that there’s a lot of opportunity now, but if this was your daughter, what would be your advice to her starting now?

There are always the headlines. I don’t invest according to the headlines. I stopped doing that several years ago. I had to go back and look at the principles. What are those underlying principles that Ray Dalio, Warren Buffett, the Rothschilds, and the Vanderbilts all invested by? How can I put myself in the best position to hedge the market, whether it’s going up, down, or sideways? There are seven that I’ve landed on. Four we can cover pretty quickly now, but I am happy to go through all seven.

I challenge everybody. List out all of your investments, stocks, bonds, and mutual funds. I help people work through this in our boot camps here PassiveInvesting.com. We go through opportunity costs. We also go through how to survive a recession in one of our bootcamps. Break out all of your assets, holdings, properties, and passive investments and grade them on these categories. How well are they going to preserve capital?

 

When you’re underwriting and performing your due diligence, these are the things that you’re trying to figure out, “How well is my capital going to be protected?” Two, how stable is the cashflow on that asset? What is the plan to grow it? I talk to investors all the time. You probably do too. They’re like, “I don’t need the cashflow now. I got a great paying job.” I don’t want an investor that was like, “I want to make tons and tons of money now, and I’ll worry about the cashflow later.” I’m like, “You’re swinging for the fences.” You can always take the cashflow and put it back into more investing.

If you need to or if something happens in your life, a year or two from now, you can flip that cashflow on. You can start consuming it. I always look for cashflow. I look for ways that the property is going to produce equity. There’s natural market appreciation, but more importantly, I’m looking at how the operator is going to increase the income, decrease the expenses, and add additional streams of income.

When they do that on an institutional-grade property, then they can control the value of that property and make money on that property in a declining market. I know it sounds weird for people who are new to passive investing. That is how operators, if they can increase the NOI of the asset, even in a market where the cap rate is expanding or the market is softening, they can still make money on the asset.

That’s what you want to look for. How does that particular property or investment produce tax benefits for you? Everybody says, “I don’t want to pay the IRS man.” It’s moreover creating velocity with your money because you’re going to take those savings and pump it right back into your wealth building. That is how people start hitting these hockey stick growth curves with their investing. It is constantly taking the cashflow, the equity, and the tax savings and pumping it right back into its investing. The first 5 or 6 years are like watching the paint dry, but then you start hitting this hockey stick growth. Part of that is leveraging the tax savings, utilizing depreciation, accelerated depreciation, bonus depreciation, and utilizing 1031 exchanges. I don’t let the tax tail wag the dog.

I personally don’t go into an asset just because of the tax benefits. It is a great nice to have. The other thing we already touched on is what the smart use of lending is. We already picked that one apart in our red flag. How does that asset head to inflation? We use the true term of inflation hedging with real estate. It is putting permanent debt or variable rate debt on the property and letting the inflation of the dollar erode the asset and the lending on the asset.

You can also look at it in a different way, “How often can I increase the income and expenses and pass that through to the end customer, essentially outsourcing all of my bills on that property and boosting my income?” Number seven, it comes right back full circle, the operator. A lot of people might be scratching their heads. They’re like, “I’m doing this all on my own. I don’t need an operator.” Guess what? You are the operator.

You have to be the expert in your area of investing, in your market, and in your strategy. The ways that you’re going to hedge inflation is by making sure that your investments have as many of those pillars to them. When I finally landed on these seven pillars, I went back and graded all my assets. I could tell you my most volatile assets that were total nail-biters for me to have in my portfolio only had 1 or 2 of those pillars. I was like, “I have to reposition my money and get them into assets that adhere to more of those pillars.”

You have to be an expert in your area of investing, market, and strategy to hedge inflation. Share on X

This is such a great conversation. If people are interested in learning more about passive investing or want to connect with you, where can they do that?

It’s pretty simple. You can join me at PassiveInvestingWithWhitney.com. You can get a free eBook on how to get into passive investing called Passive investing Made Simple. You can get a free checklist if you’re not into reading eBooks. I got a two-page checklist, the CliffsNotes version. You also can get access to my calendar. We can talk about all things passive real estate. You can also find me on LinkedIn, but the easiest way to get ahold of me is PassiveInvestingWithWhitney.com.

I’d be curious to see how many people reach out on LinkedIn or book some time with you. I’m always throwing it out there, and very few people come through. This real estate community is so helpful and encouraging. I urge you. If you’re reading this and you want to get started with passive investing, find some time on Whitney’s calendar. She is a wealth of knowledge and super successful on her own and with helping other people. Thank you so much for joining us, Whitney.

Thank you so much for having me on. It was a pleasure.

Thank you, everyone, for reading. If you enjoyed the show, share it with a friend, subscribe, or leave us a review. Until next time, thank you.

 

Important Links

• PassiveInvesting.com
• Resilient Women In Life And Business
• Passive Investing Made Simple – Apple Podcasts
• Multifamily Investor Nation – Apple Podcasts
• PassiveInvestingWithWhitney.com
• LinkedIn – Whitney Elkins-Hutten

 

About Whitney Elkins-Hutten

Whitney Elkins-Hutten is the Director of Investor Education at PassiveInvesting.com, co-author of the international #1 bestseller Resilient Women in Life and Business, host of the Passive Investing Made Simple and Multifamily Investor Nation YouTube shows and podcasts, and a partner in $800MM+ in real estate — including over 6500+ residential units (MF, MHP, SFR, and assisted living), 7 express car washes, and more than 2200+ self-storage units across 11 states—and experience flipping over $5MM in residential real estate.