What is passive cash-flow in commercial real estate investing?
Updated: Apr 20, 2020
The Passive Cash-Flow podcasts cover the meaning of passive income in NJ commercial real estate investing. Aaron Fragnito talks about real-world pitfalls and what investors can do to avoid them. The full transcript is below. You can also download the video-podcast on YouTube.
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Aaron Fragnito: All right ladies and gentlemen, welcome to the second episode of the cash flow podcast. We are going to talk today about truly passive cash flow, quite a topic for the passive cash flow podcast. If you want to learn more about what we do and how we do it, you go to people's capitalgroup.com. We talk about how we buy apartment buildings, how we work with passive investors and make mailbox money for those passive investors.
Let's break into it, what is truly passive income? Because I've been to a lot of these workshops, a lot of these guru seminars where they say, "You could buy a two-family property and hire a management company and earn passive cash flow." Sounds phenomenal. Sounds amazing. Yes, we all love that, but it's not passive cash flow if you have to manage a management company and you're on the hook for personally guaranteeing that mortgage. There's so many gurus out there that sell passive cash flow dreams, by buying income real estate.
I own 75 units, I used to own 100. Owning real estate is a full-time job. Managing a management company is a full-time job in itself once you get enough real estate units. Let me tell you, also managing a management company and trusting a management company is not an easy gig. We hired two management companies before we developed our own. We developed our own through necessity because the first management company we hired was a very reputable, large nationwide management company. They over-promised and under-delivered and they promised us they would keep our vacancy rate at a low of 5%.
Then, basically, when they own the building, our vacancy factor was 25%. The units were just not rented properly and ended up really over-promising and under-delivering. We hired another management company after that, a small management company, and they were family-run and seemed very trustworthy. They would meet tenants of the property, they would collect the first month's rent and security deposit. Then they would meet a new tenant at the same unit two hours later, collect the first month's rent and security deposit, sign a fake lease. Then they would meet someone else the same unit two hours after that, collect first month's rent security deposit.
You see the pattern, they'd meet six different people at the same unit six times in a day, collect all the money run off with the money and that was their strategy. They lied to us and stole from us. We had to take them to court we won. By necessity we started our own management company because we realized, management companies aren't going to care for your baby like you care for it. All right, it's very important that you manage your real estate very closely in this business that you really know what you're doing. It is very important to make sure you're getting every dollar you can out of these properties.
Through different ways to find out how to make more income through storage in the basement, laundry, parking, solar panels and figure how to get your cost down as well. Cut people off payroll or lower your expenses through energy-efficient appliances, tax reassessments, and lower insurance and other costs to owning the real estate. By keeping your costs down your income's up, you can really make top dollar in the real estate and that's the name of the game. The more cash flow you get out of the building, the more the property's worth, the large the refinance cash out is.
It's very, very, very important that your management company is managing your real estate to the tee. Getting every single dollar they possibly can out of the real estate, and saving cost and everything. Getting the best quotes from contractors, spending the least amount on materials. Management companies really are never going to care for your baby, the way you care for it. They're going to call a plumber when the pipe leaks, they're going to send an email or a phone call when the rent comes due. At the end of the day, they're just going through the motions.
Management companies don't make money, their goal is to put as little time as possible into as many units possible. If the management company has less than 1000 units under management, it's hard for them to make a lot of money. For a management company to be successful, they really have to try to put as little effort as possible with each property and to make the best ROI on their time and keep their lights on. I'm not saying all management companies are bad, there's certainly reputable management companies out there. I have worked with one before and they did an okay job.
They weren't stealing from me so that's good. A lot of management companies out there, even the big names, especially some of the big names, really just sit back and don't manage your properties that the way they need to be managed so that you can really force value into them. Force equity into them. Get better cash flow out of the real estate, lower your expenses and in turn, allow you to do a cash-out refinance, which is tax-free money at the refinance. We'll break into that more in another episode. Right now we're talking about what true passive cash flow is and the lies that gurus tell you.
The other thing is personally guaranteeing a loan. I've heard guru say, "Go buy a two-family property, hire a management company, passive cash flow." Not only is managing a management company not passive, especially if you have to fire them and hire a new one. It's also personally guaranteeing a mortgage, means you're on the hook for that mortgage no matter what. Whether the building goes into foreclosure and is taken away from you from foreclosure, you still owe the principal mortgage amount. Maybe you file bankruptcy, you still owe the principal mortgage amount.
A personal guarantee of a loan is a very risky thing to do. Seth and I do that to buy these buildings our investors don't. Again, we personally guarantee the loan, because we have faith and experience. We know what we're doing with our management company with the resources to reposition these buildings and manage them very well and make amazing cash flow. We're okay personally guaranteeing the loan, but our investors don't have to. We personally guarantee it, our investors don't. When we go and buy a $2 million building, our investors will own a piece that building but they don't have to personally guarantee the loan.
That's taking away a lot of risk, a huge amount of risk. By not personally guaranteeing the loan, you're essentially just investing in an asset that doesn't mean- no other ramifications of debt owed and in the new scenario. It's a very much more favorable position to be than personally guaranteeing the loan, which Seth and I do. If you go and you buy a two or three or four-family property, you might own 100% of it, but you have to personally guarantee that loan. If you don't manage it properly, if you get sick or you hire the wrong management company, and the thing goes downhill.
Now you can't get the units leased, and the building deteriorates and you stop paying the mortgage. This happens to people that don't know how to manage the real estate, properly. Now you personally guarantee that loan, you personally owe that principle back, so you really don't want to get into that mess. By working with People's Capital Group, we buy bigger buildings with a lot more tenants paying in. It's a safer investment to buy bigger buildings. The more tenants you have paying, the safer the building is. It's safer to own 10% of a 25 unit than 100% of a three-unit, okay?
It's better to own a small share of bigger real estate, not personally guarantee the loan, not be on the hook for management. Not be on the hook for the day to day operations, or managing the management company. Collect nice mailbox money. Collect nice K1 tax returns the end of your year and not to worry about it not to do anything. That's a true passive cash flow check. You're not on the hook for the mortgaging, you're not managing or doing anything, all right. Buying a building, managing a management company hoping they do their job right.
Where really they're just trying to collect the rent and call a plumber when the pipe leaks and put as little effort as possible so that they don't exhaust too many resources on your property. Because let's face it, the management company makes what $200 a month at most on a two-family property in a house. I mean, they don't get paid a lot. They can't put a lot of time into your buildings and it's understandable that they can't focus on every building as if it's their own. That's not what management companies are built to do. It's very hard to manage a management company and trust them.
You don't want to personally guarantee the loan. If you're sitting in some seminar, hopefully, you're paid to sit there, and they're telling you, "You could buy an income property and get passive income." They're full of it, okay? You can't- it's not passive income. You got to work, you got to file your taxes, you got to research the building, figure out who's going to be there. Hire the right management company, keep an eye on them, make sure they're keeping your costs low. Figure out different ways to make income on the property. If it doesn't work out, well, you're on the hook for the mortgage.
That's not what we do at People's Capital Group, we make it very, very simple. You don't have to personally guarantee the mortgage. You don't have to manage it. You don't have to do anything. It's like investing in a REIT but instead, you actually own part of a real estate, local real estate building here in New Jersey. You own a share of an LLC that owns a building. We start a new LLC for every building, our investors own a share of that LLC. It's a completely passive share. They don't have to do anything, they don't have to manage it or be on the hook for any debt, but at the end of the day, they get their share of the cash flow and tax write-offs and big cash-out refis every few years as well because they own a piece of the building.
It's a truly passive ownership position. Because you're investing in syndication, you're investing in a big building. It's also a safer investment than a two or three-family. Because if you lose your tenant on a two-family, you've lost half your income on the building, and now you're writing a check to the mortgage company to cover the mortgage every month. If you own a 25 unit and you lose two tenants, well, you're okay you're trying. You could still cover your mortgage, you can still probably make positive cash flow every month and you have time to lease out those units and get back to top rental amount.
It's very important to understand when these gurus are trying to sell you overpriced books and CDs, tell you you could build passive cash flow by buying owning and operating buildings. They're completely full of it. Even if you hire a good management company is not passive. If you personally guarantee the loan, you're managing the management company. It's so important also to understand that when you're investing in a syndication the transparency has to be there, so if you're looking then at syndications which is what we run here.
Syndication is when you pull capital together amongst a number of investors and you buy a building, that's what a syndication is. Then you reposition the building, you improve the value of the building and you refinance or sell it over time. That's what we do here at People's Capital Group. There are other syndications companies out there, many very reputable syndication companies and many of them buy out-of-state, trusting a management company to run their building the way they want. That's risky, I know a lot of popular names like David Lindahl who buys out a state, very big name. I've read his books getting started myself and he's very successful selling books and CDs and telling you what to do.
He himself has had trouble managing management companies out of state. He's had buildings that go downhill as well because of that. By owning the management company here in New Jersey, by managing all of our real estate in-house, by controlling our buildings 100%, we offer a different product to our investors. We offer a safer investment, we offer something we control, we manage. We are the management company, that way we know exactly what's going on with the building and exactly how it's being managed and we're executing a very precise value-added strategy.
If you are investing a syndication that does out-of-state investments, they're going to say, "Don't worry. We talk to our management company every single week and we get updates from them and we know exactly what they're doing and if anything goes wrong we'll just fire them and hire a new management company. It'll be easy." Well, it's very hard to actually fire and hire a new management company, the turnover is very confusing for tenants you tend to have. If you do that too many times your tenants lose faith in you and every time you fire a management company and hire a new one, they were probably doing a bad job.
Now, you're probably losing money on the building because you have too many vacancies or costs are out of control and there's some clean-up process with that. There's time and there's losses in cleaning up a building and fixing the mistakes of a past management company. By owning your own real estate, personally guaranteeing debt, signing on the dotted line for a mortgage, that's not passive income. If you're investing in buildings that way, it's fine but it's not passive income. If you want true passive income, go to peoplescapitalgroup.com, fill in your information, we'll get in touch with you, we'll talk to you about buildings we're buying.
We're buying new buildings every three to four months that means investors can put their capital to work every three to four months with us. Chances are if you contact us today, there's a building you can put your money into the next 60 days or so. peoplescapitalgroup.com will tell you more about that, how to do that, how to apply. It's very important that you don't fall for these guys selling books and CDs. We don't sell books and CDs, we really don't do coaching. People ask for it sometimes we'll give it to them for a cost, of course, but at the end of the day it's not something we push out to people, it's not something we're trying to sell.
We're a real estate investment company. I'm very busy buying, analyzing, looking, managing, repositioning apartment buildings. That's what we do day-in and day-out. We also have a residential division that makes over $500,000 a year flipping houses. We're busy, we're busy real estate investors and that's the type of people you want to invest in if you're investing in a real estate syndication. If they're running around selling books and CDs, then how good can they really be at repositioning apartment buildings? If they have to sell books and CDs to keep their lights on then maybe they're not the best real estate investor.
Maybe their time is a little too broken-out selling books and CDs and they're not focusing enough on repositioning apartment buildings. Be aware of the gurus out there, be aware of the promising of passive income and we're going to invest out-of-state in emerging markets or you could buy this book and you could figure out and-- for this $20,000 package of CDs you could figure out to buy income properties and collect passive cash flow. Well, my friends, the true way to passive cash flow is through a syndication, a syndicate. Where owning a silent share of the LLC, you own a piece of the building, not all of the building.
Another company's doing all the work, the operators doing all the work and that's what we do here. We buy the buildings, we own the management company, we split up the equity, the investors enjoy cash flow and tax write-offs, some big lump sums upon a refinance, but they don't have to do any of the work or personally guarantee the mortgage. That is true passive cash flow. My friends, if you want to learn more about how this works, you want to go to peoplescapitalgroup.com, we file your K-1s at the end of the year, our CPA coordinates to your CPA, all the tax filings are done.
It's a very turn-key situation, you don't have to worry about tax filing. Don't even get started on taxes, the headaches of that if you're an owner-operator of a building. These gurus say, "Own a building it's passive cash flow." What about tax season? There's a lot of work when tax season comes. We do it all, our K-1s are quickly sent out to our investors, our good investments, long-term investments very easy when it comes to tax season. Very easy when it comes to collecting your checks and getting financial information every quarter and monthly updates as well.
Be wary of the people selling you a $30,000 books and CDs, be wary of the people saying, "You could put your feet up and own a bunch of real estate and you won't have to do anything." If you're owning or managing a management company and on the hook for the mortgage, you are an active investor. If you are not on the hook for the mortgage, not personally guaranteeing the mortgage and don't have to deal with managing the management company, you're a true passive investor. Therefore you're really collecting money while you sleep, you're collecting passive cash flow checks. That's how the rich get richer.
Your money should be working harder than you're working, your money should be making double-digit cash and cash returns. If it's not, go to peoplescapitalgroup.com, sign-up for more information and we'll talk about what we could do, what buildings we have coming up. You have to qualify to invest but to qualify, you want to go to peoplescapitalgroup.com. We make it pretty easy to qualify and hopefully, you can fill up some information we'll get in touch with you quickly and see if you can qualify for our next investment opportunity. I