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The Essential Guide To Passive Investing Resources With Brian Davis

April 24, 2024

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Creating Wealth Simplified | Brian Davis |Passive Investing Resources

 

Feeling overwhelmed by passive investing? Unlock financial freedom with the right guidance! Join Chris Seveney and Brian Davis, co-founders of Spark Rental, for expert insights. Brian shares his experience finding great deals through his investment club. But that’s not all! He unveils valuable resources to equip you for your own passive investing journey. Go beyond the basics of diversification and investing. Learn where to find the tools you need to succeed! Take control of your future with this passive investing deep dive.

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The Essential Guide To Passive Investing Resources With Brian Davis

We have a special guest. We have Brian Davis from Spark Rental Co-Investing. Brian, how are you?

Chris, I’m doing great. Thank you so much for having me.

We spent twenty minutes talking shop on things and so forth, but we are ready to roll with this episode. I brought on Brian, who runs a co-investing passive investing group and wants to target and speak a lot about that because we’ve gotten a lot of comments and questions from people wanting to learn more about passive investing and where to go to get information. The information is so key, unlike years ago, when if you want to invest, you’d have to pull out the newspaper and look at the stock ticker. You now have the internet and too many resources. Brian, thanks for coming on.

Chris, I’m so happy to be here. Thank you for having me on. This is going to be a lot of fun.

Why don’t you tell us a little bit about yourself and what you’ve got going on?

Short version is many years ago, I graduated college and had no idea what I wanted to do. I accidentally fell into a job with a hard money lender and was doing hard money loans back in the mid-aughts when it was just one giant party in real estate. I saw these guys make money and I’m like, “I can do this too. I’m smarter than these guys. I’m going to go in. I’m going to start buying properties.”

I did and I made a whole bunch of stupid, avoidable mistakes that didn’t need to be made if I had only gone out and gotten a coach, a mentor, a senior partner, anybody to tell me what I was doing. Fast forward, 2008 was obviously a total disaster for me. I ended up switching careers, but I kept on doing a bunch of properties.

In 2015, I moved abroad. I still had most of those properties. The early ones that I bought, the really bad ones, the ones that I messed up with. I realized when I moved abroad how much I was subsidizing those properties’ returns with my efforts. I could no longer do that anymore once I was living halfway around the world in Abu Dhabi.

It opened my eyes to how not passive those investment properties were and how not passive that income was for me. Even though I had a property manager, I still had to manage the manager. I ended up just getting rid of all of those properties at a certain point, but we had already launched Spark Rental, and one of the things that we do and did at Spark Rental was teach people how to invest in real estate.

That left me feeling out of alignment, out of integrity. I’m teaching people how to invest in real estate, but I’m not investing in real estate myself anymore. I no longer even own any rental properties at that point. We started experimenting with going in on investments with some of our students and some of our audience members and with partners around the country, boots on the ground, and investing partners.

We started with some single-family investment properties and we quickly realized that was way too much work. We were just doing it as a teaching exercise. We weren’t making any money from ourselves on these, other than the returns and the money that we were putting in ourselves. We had to scrap that, but we went back to the drawing board and it was around that time that I had been experimenting with syndication investing personally.

I went to my partner, Deni, and said, “The single-family investment properties were too much work to do co-investing with our students. What if we tried doing it with a passive real estate syndication?” She shrugged and said, “Sure. Let’s give it a try with a pilot deal.” We did and it was great. It was wonderful.  It was exactly what we were looking for, and it wasn’t a ton of work for us because it’s a passive investment, but it’s also a good teaching tool. It’s a good way for people to invest small amounts collectively to reach that high minimum investment. One of the downsides of syndications is that the minimum investment is typically $50,000, $100,000, sometimes $250,000, or even $1 million.

It makes it hard to diversify, but if you have a whole bunch of people all going in on that together, you can invest $5,000 a person. While that’s not chump change, it’s also not $50,000 or $100,000. It makes it a lot easier to dip your toe in the water. It makes it easier to diversify and spread your money across a lot of different deals. That’s what we’re doing now. It was originally just something we did with our core students. Now, we’ve opened it up as just a flat-fee investment club that anyone can join. We get together every month and we have fun vetting these deals together.

Creating Wealth Simplified | Brian Davis |Passive Investing Resources

Passive Investing Resources: It’s much easier to diversify and spread your money across different deals if you have many people coming together who can each invest $5,000.

 

First, I will say from the beginning of what you said, I don’t feel too sorry for you that you’re living in Abu Dhabi and having issues with your properties. Where were the properties located? Were they back where you grew up?

They were in Baltimore, which is my hometown. It’s where I grew up. We’ve moved around the world a little bit since then. We spent four years in Abu Dhabi and four years in Brasilia. We moved to Peru. We’ll be here for at least two years total, maybe longer. We’ll see.

I don’t feel sorry for you on that front. I’m just going to jump right into it. Let’s talk a little bit about, the investment club that you have, Spark Rental. You mentioned you get together and do the due diligence together. It sounds like you have people within the club of varying degrees of education, probably some very experienced, some just learning out. They get to see what else. Can you share some of the ah-has or experiences that you had when you were vetting some of these deals?

Absolutely. A couple of points. One, we have found that by investing as a community and as a club, we get together and vet these deals together every month. It’s like having 30 different experts all picking apart these deals together. It becomes almost a hive mind where we have people who inevitably ask great questions that would never have occurred to me, but we all benefit from those great questions.

Everyone comes at these from a different angle, perspective, worldview, and experience level. As you said, we have some people who have never been in real estate before, and other people who have invested in dozens of deals and dozens of properties. I’ll give you two really quick examples. One, we were getting a deal in Dallas and I’ve never been to Dallas. I don’t know anything about Dallas, but we had a woman on the call who lived five minutes down the street from this apartment complex. She was like, “Guys, I drive past this apartment complex every day on my commute to work.” I can tell you that there is a shortage in this area of housing for young professionals, which is what this apartment community was serving.

She said, “This is a great deal.” We never would have known that ground-level perspective, but we got that benefit because we were vetting these deals as a community. We have another woman in our club who works in the insurance industry. Every time we bring on a sponsor, she grills the hell out of them, “Why did you only forecast a 4% rise each year for insurance premiums? Don’t you know that it’s going to be way more than that?” I love that.

She’s an industry insider and knows what’s going on and the trends we’ve all seen as real estate investors. It’s been an ugly couple of years for insurance premiums. In some cases, we’ve seen insurance premiums double for commercial properties or go up 50%. It’s crazy. That’s one point. The community aspect is way more valuable than we can ever communicate in our landing pages or marketing materials.

Analyzing Risk In Deals

There’s no way we can capture that in a little five-bit marketing copy. That is where so much of the value of our investment club comes from, that community element to it. As far as a-ha moments, we’ve all gotten a lot better at analyzing risk in these deals as we’re bringing in different sponsors every single month, looking at their deals, grilling them, and analyzing the deals.

A few standout risks that we really look for, it almost goes without saying that there’s sponsor risk at the top level because a really smart, experienced, and a high integrity sponsor can salvage a very flawed deal. The opposite is true of inexperienced or incompetent or lower integrity sponsors. They can take a pretty solid deal and make it fall apart.

A smart, experienced, and high-integrity sponsor can salvage a very flawed deal. The opposite is true of an inexperienced, incompetent, or lower-integrity sponsor Click To Tweet

At the top level, there is sponsor risk. You obviously want to vet sponsors very carefully, but when you start drilling down into individual deal risk. A couple of the high-level risks that we focus on nowadays are property management risks because if you can take a great deal, a great property bought at a good price, but if you have bad property management, the property is not going to end up cashflowing well because they’re going to have too many rent defaults, too many vacancies, turnovers are going to take too long.

We always ask sponsors, “Who is going to be managing this property? How long have you worked with them? If it’s in-house, how many of these other properties have you managed yourself in this market? What’s your experience and track record with these? If it’s outsourced to someone else, have you worked with the same property management firm on twenty other deals, for example, or is this your first time working with this property management firm?” It’s questions like that, analyzing property management risk.

Construction risk is another big one. Same thing. “If it’s in-house construction, how many deals have you done in this market? What’s your track record with these? Do you always go over budget? Do you always blow your timetable? Or do you have a sharp track record of success with these? Likewise, if you’re outsourcing it, there’s a big difference between outsourcing it to a brand new company you’ve never worked with before versus always working with the exact same team. They’re great. They’ve done 15 deals with us and we know them inside and out.” Those are two different things.

There's a big difference between outsourcing it to a brand new company you've never worked with before versus working with the exact same team. Click To Tweet

Debt risk is, of course, a big one. That’s one of those things that sponsors weren’t paying enough attention to. I see you grinning. All these sponsors who went out and they just took out these variable interests, short-term bridge loans, they were just assuming that rates are going to stay low forever because they have been low for so long.

Rates and prices will just keep doing this.

Just up and into the horizon. Of course, history proved them wrong. 2022 and 2023 were a rude awakening for a lot of sponsors and a lot of LPs. What’s the debt profile for the deal? What’s the LTV? How long is the debt term? We were looking at a deal last year that had 2 or 3-year bridge debt and yes, they were buying an interest rate cap, but still, so short-term.

I don’t know that it will be a good market for selling or refinancing within the next 2 or 3 years. It might not be. We ended up not doing that deal. In the very next deal that we were looking at, the sponsor was assuming previous financing from the seller. It was fixed interest financing at 5.1% with another nine years remaining on it. The calculus there is so different. Sure, I have no idea if it will be a good market for selling within the next 2 years, but within the next 9 years, I’m pretty sure there will be a good moment to sell. We’re going to be okay at some point in the next nine years. It’s a different calculus.

I’ll stop droning on here, but cashflow risk is another one that we’ve seen. How conservatively are they forecasting things like rent growth and expense growth? There are a lot of markets right now where rents are declining. Rents don’t always go up and that being said, historically, it’s very rare for rents to go down. This is one of those exceptions, at least in some markets. Of course, they’re not going down in every market, but even in markets where they’re rising, they tend to be rising pretty slowly right now, whereas some expenses have been rising quite sharply. We already talked about insurance. That’s a big one.

Labor costs, too, have been rising much faster than rents in most markets over the last couple of years. Things like repair costs, maintenance costs, property management costs, if you’re outsourcing that, or even if you’re not, if you have to pay employees. Those expenses have been rising a lot faster than rents in a lot of markets. You end up with this pinched cashflow, so lower NOI, lower property valuations. If you end up with negative cashflow, the deal is in real trouble. We’re sensitive to analyzing all of these high-level risks when we’re trying to vet a deal together as a club.

A few things that I resonate with a lot of what you said, first, when you start with the sponsor, think about getting on an airplane. When you get on an airplane, do you want a pilot on their first time flying a plane or do you want a pilot who’s been flying for twenty years through every storm, every snowstorm, fog, ice storm, lightning, you name it. Same thing with a sponsor. One that’s like this is their first deal. People have to start somewhere.

Now, with pilots, there is license training, and you’re probably a little more comfortable. With funds and syndications, somebody who’s got a pocket full of cash can start a syndication. There’s a difference there, but that’s the way I like to look at things on a sponsor. I think about it because we’ve had some stormy weather, as you mentioned. Those experienced pilots are getting through it. Those who had very little experience may not get through it.

The other thing you mentioned that I want to dive a little bit deeper into is, you mentioned the investment club, the person in Dallas, or people with certain experience. The thing I’ve seen a lot in real estate, and maybe this is just me, but there are a lot of real estate investors who have egos, who want to do it on their own. You’ve got one group there, then on the opposite spectrum, you have another group of people who literally can walk them to the edge, but they just can’t jump because they’re jumping alone. What I love about things like an investment club is that I remember in elementary school where you’d all hold the parachute and then run underneath and back up.

Hopefully, everyone did that. If not, people are like, “Where’d you go to school?” You did it as a team, but within a club, it’s like everyone’s holding, “We’re jumping in together.” When you’re doing things with other people, typically, it gives you a little more sense of security. That’s the interesting thing, too, because like I said, there are people on one end of the spectrum who always want to do it themselves. There are some people would never want to do it and sometimes those people together, again, opens up many more opportunities is what I think.

Diversification

When you invest with other people in these, you can invest small amounts in each deal, opening up so much more you can do. Diversification is one of our core values as a club. We mean that in every sense of the word. Geographic diversification. Many different cities, markets, and states sponsor diversification. We’re trying to bring in a new sponsor every month. Property type diversification, mobile home parks multifamily and retail and industrial storage, all of the above. When you can spread that money out across so many different types of deals, at the end of the year, it’s just numbers on a page as far as how it all performs.

As opposed to having to put all of that money into one single deal because the minimum investment on a deal is $50,000 or $100,000, then you’re nervous about how that deal is performing. If it’s going sideways, that’s stressful. My way of looking at this is just as a form of dollar cost averaging where I’m investing another five grand in a new deal every month.

I know that at the end of the year, one or two of those will probably underperform and then 1 or 2 of those will probably hit it out of the park and overperform. Most of them will form this bell curve in the middle, but it’s a low-stress wave investing because, again, it’s all just numbers averaged out on a page at the end of the year, rather than this one deal that you put so much money into. It’s high stress if that deal doesn’t perform as expected.

Diversification is a key component because I was talking to somebody and they mentioned they were listening to a podcast where there was a gentleman who has significant money. He’s invested in 20 different syndications, all with like $50,000 minimums, but he said 18 were multifamily out of the 20. When you talk about diversification, it’s great you’re in twenty different offerings, but if they’re all the same asset class, that’s like investing again in airlines where I’m just buying Delta, American, United in Spirit, or whatever. You’re still in that one asset class. Granted, you get diversification, but if that asset class has challenges, then you’re going to have challenges, which, as the person mentioned, 12 out of the 18 have paused distributions or whatever is going on.

Another thing that you mentioned regarding diversification, and again, I think this is a critical component, is most people who are, I’ll call it, in the financial industry, when you talk diversification, usually say never put more than 10% or 15% of your net worth or the money available into one investment. What’s happened over the last several years, even decades, is that whether you’re an accredited or non-accredited investor, people are taking all the money they have and putting it into one investment.

I’ve seen people who get the level of accredited and they have a $50,000 mint, but they only have $50,000 and they put it in because they think, “Yes, I’m accredited. I can invest in this institutional offering.” All of a sudden, it goes belly up and they’re like, “Uh-oh.” First, let me define accredited for people who are reading who don’t know, it’s a net worth over $1 million or over $200,000 a year in income.

Now, the interesting thing, I don’t know if you know this, Brian, those numbers are from 1982. They haven’t changed in years. The SEC is talking about updating those because this is exactly what’s happening. In all these syndications, the minimum is getting much higher. In the past, it’s, “You’re credited. It’s okay for you to lose money.” They’re out there to protect the everyday consumer.

Now, all of a sudden, in some areas like California, Boston, New York, and DC, $200,000 a year is really good money, but there are a lot of people making it or a couple making $300,000. Take any county probably around DC, and the average income there is probably very close to hitting that number. Same thing with California.

The diversification component is critical in regards to being able to invest smaller amounts in different offerings, and that’s one thing. What they are offering that we’ve always done is, “We’ve got a $5,000 minimum.” I used to always when you’d post on BiggerPockets, “Where can you invest with $5,000?” I’d always reply, “You can invest with me as well.”

Not self-promote, but I tell people, “I know a guy who has the same last name as me that if you click on the link, will bring you to that profile, but I’m not self-promoting.” No, that’s great. Remind me, how long again have you been doing this investment club? You’ve given great insights, great nuggets of information. I was going to say, where do you see it going over the next 12 months and the next maybe 3 years?

Spark Rental Investment Club

Technically, we started the club around 2020, but for the first two years or so, we were just experimenting with those single-family home investments. In our current form of investing in syndications and co-investing, going in together on these syndication deals, we’ve been doing that for about two years.

None of the deals have gone full cycle yet. I say that there’s a note that’s about to mature at the end of the month. We will finally be able to say one of these has gone full cycle. That is where we’ve been up to this point. Where we’re going, one of the things that we started doing is getting together every month to vet a deal and have that deal flow component. We’re also getting together once a month for an educational presentation.

We’ll bring in some outside experts to present to the club with no sales pitch attached to it. That’s one of the problems with webinars. It feels like a giant sales pitch, but people are paying to be a part of this club. We certainly don’t want them to feel pitched to when we bring in experts. For example, we brought in our own CPA to break down some of the nuances of tax strategies for passive real estate investors. Things like how does depreciation recapture work and how can you protect against it? Things that a lot of people find confusing, even if they have been in this space for a little while. That was fun. We aim to do that thing once a month and add that educational component to it.

You talked a minute ago about accredited versus non-accredited. Historically, one of our core values has always been inclusivity and only featuring deals that allow non-accredited investors. That does limit us in some cases because, as you know, a lot of sponsors only work with accredited investors. As we grow, we’re talking about creating a sub-club within our club of accredited investors and periodically featuring some deals just for those members, in addition to our regular monthly deals for everybody. I don’t think we’re quite there yet, as far as just the size of the club.

As we expand, one of our other goals for the club is to get more of those preferential profit splits by hitting the higher investment thresholds. In some of these syndication deals, they’ll say, “All right, the minimum investment is $50,000 or $100,000, but if you invest $500,000, we’ll give you this higher preferred return and this better profit split in when the property sells.”

We’ve hit that with one of the deals that we’ve invested in so far. We want to be hitting those with every deal that we invest in. Our members can invest $5,000 or more and still get the same return splits and the same higher preferred returns that they would be getting if they were investing $250,000 or $500,000, whatever the minimum is for those better return splits if they were investing by themselves.

That’s one of the benefits of doing some of those tribes and these groups. Other people, I’ve seen models of funds of funds do the same thing where it’s, “I bring in ten people because I want to go hit. It’s not the minimum on this, but let me get this extra. It helps everybody.” Somebody who’s a sponsor, we’re not opposed to it at all because somebody is going to come cut me a $250,000 check, whether it’s 1 person or 10 people that are part of a group that’s for us. Cash is cash. Most sponsors should appreciate that.

As we wrap up this episode, sometimes I like to ask a unique story of a good lesson learned you have in real estate. It sounds like maybe you’ve had some with your rentals in Baltimore or whatnot. Do you mind just sharing one story that you shared in the past with people who are just like, “I hope I don’t have to go through that again.”

Passive Real Estate Investing

When I first started investing, I didn’t have a ton of money. I was in my twenties, and I didn’t know what I was doing. I bought in D minus class areas in the city because that’s what I could afford. I had this mistaken notion that would give me diversification. What I didn’t realize was that it was an expensive lesson to learn, and that lower-income rental properties have a niche skillset that’s required to invest in those. The average person should not invest in those, and I’ll give you a couple of reasons for that.

For one thing, it’s really hard to find decent, much less good, property managers who are willing to work with you on those properties because they get paid as a percentage of the rent collected. They get paid less for those properties, but those properties are inevitably 2, 3, or 4 times as much work as the A or B-class properties and tenants.

Why would property managers work four times as hard for half the money? They wouldn’t if they had a choice in the matter. The most skilled property managers don’t work with those properties. That leaves you with the dregs of property management. A lot of people get mad when I say that, but that has been my direct experience. That’s a lived experience and it’s also been the experience of almost every real estate investor I’ve talked to who has worked with very low-income rental properties.

Creating Wealth Simplified | Brian Davis |Passive Investing Resources

Passive Investing Resources: The most skilled property managers don’t work with those low-rental properties, leaving you with dregs of property management.

 

These hidden risks just don’t show up on paper when you’re calculating returns on some of these lower-income rental properties. Crime is another one. I can’t tell you how many AC condensers have been totally ripped apart for the copper tubing inside in some of these areas. It’s not just direct victimization of crime like that, where there are people stealing things from your properties. There’s also the indirect impact of that where I’ve had plenty of good tenants in some of these houses, of course, but a lot of the good tenants will leave because they don’t feel safe because the crime is so bad.

All these hidden costs show up with lower-rent properties and it’s not necessarily a politically correct thing to say, but it’s something that people need to hear if they’re thinking about investing their own money in these types of properties. I’ve seen it across the board, higher turnover rates but higher turnovers mean a lot more expenses because every time there’s a turnover, you have to repaint the units and often recarpet the units.

It’s just everything. All of these things add up to making a much more difficult time earning money on some of these properties. There is a segment of people that can make money off them. They have a true niche skillset that, if you’re just starting in real estate, you don’t have. I would caution novice investors away from lower-end rental properties. This is probably too politically incorrect of a lesson to be shared on this show, but you were asking some of those hard-won lessons and that’s why.

I think it boils down to that the margin, in paper, will look like it’s going to cashflow very well because a rental payment is so low, one tenant goes in there, causing $4,000 in damage. You’ve just lost 7 months of rent and it took 2 months to do that work and get somebody in there. You lost a year. I had one outside of Aliquippa, Pennsylvania. I had taken it back and I liked the outside of the house. It’s a nice, big house, but it was not in a good area. I turned it into a rental. I had major issues with the property manager. The tenant wasn’t paying. The tenant left in the middle of the winter, left the window open, and caused water to pipes to freeze.

The property manager is like, “It’s good to go get it rented again.” I spent $15,000 getting everything rented, then it’s not renting. I finally had somebody go check it out. Half of the drywall is missing in certain areas of the ceilings. They painted everything and left it completely open because of where they reran the pipe.

Same thing in a vertical wall. I call the PM. I’m like, “You seriously had somebody go in there and finish painting this unit when the drywall wasn’t done.” The plumber had to go back and I wanted to get the painter in there and I’m like, “Oh my God.” They then tried to charge me after the fact, like $2,000 more. I’m like, “You got to be kidding me. Go ahead and sue me.” We ended up reaching an agreement and we walked away.

With lower monthly payment rentals or lower cost rentals, everybody says they look great on paper, but they don’t. I will tell you, look at anybody today who’s over the age of 55, look where they’re living or where they’ve lived the last 15 to 20 years and if they own a house. Now, most of the places where they own a house most areas would probably never cashflow at any point in time if they were buying it now or when they bought it, but I guarantee you they got seven-figure equity. To get that much cashflow, you’re never going to get there. Cashflow is nice. You can get rich off cashflow, but you build wealth off equity is what I like to say.

You can get rich off cash flow, but you build wealth off equity. Click To Tweet

Thank you for coming on. That is going to be a wrap for another episode of the show. Thank you for joining us on the journey to unlock the full potential of your financial future. We hope the insights have opened your eyes to new possibilities and helped you take a step closer to your dream of generating passive income. Remember, the path to financial freedom is not a straight line. If you liked this episode, make sure to share it, like it or follow us on YouTube. Brian, thanks again, and I hope you stay where you’re currently located and have wonderful weather. Do not feel bad when you’re living outside the country, investing in the US. Take care.

Chris, thank you so much for having me on. This is a lot of fun.

Yes. No problem. Thank you.

 

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