531: How to Identify a Good Real Estate Deal

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I grew up with a very different perspective on personal finance and investing than most. My parents were immigrants, and when they arrived in this country, they didn’t come with any preconceived notions of conventional financial wisdom.

My father grew up dirt poor in India—that’s really poor and he had never even heard of investing as a kid. But he was blessed with a tremendous intellect and used it to rise from nothing to truly live the American dream.

He came to the U.S. in the 1960s on an engineering scholarship and started working as a bridge engineer in Minnesota. When he finally began making a little money, he was confronted with the idea of investing for the first time. 

Until then, life had always been hand-to-mouth. So he was approaching investing like an alien coming to this planet for the first time with an unbiased view on anything financial.

With that perspective, the stock market didn’t make sense to him. He wanted cash flow that would immediately improve his quality of life. Intuitively, it felt smarter to buy “streams of cash” than to “gamble” on stocks.

So with whatever money he could scrape together, he bought small rental properties. Nothing glamorous—mostly low-income houses and duplexes in Minneapolis. But guess what? It worked.

Before long, he started making real money and quit engineering altogether. The apple didn’t fall far from the tree, I guess. Years later, I would also walk away from my career as a doctor to become a full-time investor.

My father did really well. By the 1980s, he was having million-dollar years—that’s a lot now, but back then it was a lot more!

But then came the ’90s. Like many others in the dot-com era, he got in over his skis. It seemed like everyone was making easy money in the stock market, and he got greedy. 

Unfortunately, he sold a large chunk of his real estate portfolio and went all in on tech. And of course, we all know how that story ended—the bubble burst and so did his brokerage account.

So there he was, in his 50s, starting over again after being obliterated by the dotcom bubble. He was terrified. But he knew what he had to do. He had to rebuild the same way he had built wealth the first time: cash-flowing real estate. Today, in his 80s, he’s still at it.

To be clear, his real estate career wasn’t all smooth sailing either. This isn’t a fairy tale. It’s real life.

For example, in the late ’90s, Alan Greenspan suddenly cranked up interest rates, creating a situation not unlike what investors faced post-COVID when the Fed raised rates at record speed. 

That hurt him, but each setback brought lessons, and he kept moving forward with an asset class that he trusted. Eventually, he recovered. We were always comfortable, and my dad made enough to pay for 3 kids’ college tuition and medical school for me while still living comfortably, traveling, and enjoying his life. He’ll be the first one to tell you that he only ever made money in real estate and that’s what he believes in.

Now, why am I telling you all this? I’m telling you this story because it shaped the way I see investing. Unlike most, I grew up hearing that the stock market was risky and that real estate was the safer, smarter path—pretty much the opposite of what everyone around me grew up with.

And despite my own challenges from the post-COVID rate hikes, I can still say without hesitation that focusing on real estate has served me better than following the traditional investing playbook.

Still, no one wins all the time. Every investor loses money sometimes. Surgeons have a saying: “If you haven’t had a complication, you haven’t done enough surgery.” That’s as true for the best surgeons in the world as it is for the best investors.

So what do you do? Sitting on cash guarantees you’ll lose purchasing power to inflation. Money markets barely keep up.

For me, the answer is to keep investing with discipline. Real estate is my medium, and like my father, I learn from my mistakes and keep moving forward. 

I still see it as the greatest wealth-building asset in the world—just look at how many billionaire real estate investors there are.

But wealth doesn’t build blindly. Every project I invest in has to have underwriting I believe in. Beyond that, I pay close attention to macroeconomic shifts and form my own view on what comes next.

Right now, I believe in the right markets, real estate has bottomed out. I think we’re on the buyer’s side of the cycle. 

I also believe interest rates are headed lower—both because the Fed has signaled it and because the Trump administration will do everything possible to keep them moving in that direction. And for real estate investors, investing in a descending interest rate environment is nothing short of a gift.

So now I look at the deals in the right market. That involves underwriting and understanding what all those numbers mean. In this week’s episode of Wealth Formula Podcast, my guest and I break down how you—even as a passive investor—can do your own due diligence.

Transcript

Disclaimer: This transcript was generated by AI and may not be 100% accurate. If you notice any errors or corrections, please email us at [email protected].

 I’m a numbers guy. I always say you have to run the numbers if you’re gonna make any sense out of out of a deal. But I also tried to emphasize very, very strongly that you had to look not only at the numbers, but beyond the numbers.

Welcome everybody. This is Buck Joffrey with the Wealth Formula Podcast coming to you from Montecito, California reminding you that there is a website associated with this podcast called wealth formula.com. That is where you go to take advantage some of the resources of wealth formula that are not on this podcast, for example, uh, an opportunity to join the Accredited Investor Club.

Um, I highly encourage you to do that, especially towards the end of the year here. Lots of tax mitigating investments coming through. Now, these are all private investments and they are limited to accredited investors. Now, an accredited investor is not something that you have to apply for. It’s something that you are or you are not.

It depends on. Your financial situation. If you make, uh, $200,000 per year for two years in a row with reasonable expectation of continuing to do so, you are a credit investor. If you’re filing jointly, that number goes to 300,000. The other category is, of course, simply having that worth of a million dollars outside of your personal residence.

If you meet those requirements, congratulations, you’re an a credit investor and you can sign up for investor club at wealthformula.com. And it’s free to join and basically gives you an opportunity to see private deal flow that you are not going to see anywhere else. So go to wealth formula.com and join Investor Club.

Now I wanna tell you a story, okay? Uh, I wanna tell you a story. I grew up, uh, with a very different perspective on personal finance. Uh. Investing than most. And, um, uh, some of you know, my parents, uh, were immigrants, uh, and they arrived in this country without any preconceived notions of conventional financial wisdom.

Why? Well, I. My father, uh, grew up dirt poor in India, and, uh, some of you might know that, that that’s really poor. That’s, that’s very poor. Uh, so he never even had that concept or even heard the word investing as a kid. The one thing he was was he was blessed with a tremendous intellect, very, very smart guy.

Got himself through, um, you know, high school and college by tutoring, that kind of thing, um, you know, top of his class, uh, and finally used that to come to the United States. And honestly, he truly did rise from the ashes to live, uh, the American dream. So. That was in 1960s. Uh, he came to the US in the sixties, uh, on an engineering scholarship and started working as a bridge engineer in Minnesota after he got his master’s degree.

And when he finally, uh, began making a little bit of money, he was confronted with the idea of investing for the first time. You see, again, until then, life had always been hand to mouth. He was approaching investing like an alien coming to this planet for the first time with an unbiased view on anything financial.

And with that perspective, the stock market itself didn’t really make sense to him. You know, to him it looked a little bit like a casino. It looked like you put money in, then it might go up, it might not, you know, it might go down. What he really wanted was cash flow. That would immediately improve his quality of life.

So with whatever money he could scrape together, he bought small rental properties, nothing glamorous, low income, you know, single family homes, duplexes in Minneapolis where he was so. Guess what? It worked and before long, he started making real money and quit engineering altogether. The real story there is not that he quit, but that his boss found him doing, spending too much time on real estate, uh, and decided that maybe he ought to find, uh, another, uh, job or maybe just go into real estate altogether, which he did.

Okay, so. That story’s funny because the apple didn’t fall far from the tree, I guess, uh, years later. Um, I would also walk away from my career as a physician and become a full-time investor back to my father. He did really well, right back in the eighties. He was having, he was having some years where he was making a million dollars a year, and you know, that’s a lot now.

Back then, that was a lot more money. And that was a million, making a million dollars in the eighties. That was, that was, you really had to do well. But then came the nineties and like many others in the.com era, he got in over his skis. You see, the thing is he looked around and everyone was making easy money.

Everyone was making money in the stock market and he got greedy. So unfortunately he sold. A large chunk, if not most of his real estate portfolio and went all in on tech. Oh, this man knows nothing about, you know, that market. Right? He knows nothing about technology even though he’s an engineer. He is a bridge in bridge engineer.

He is just good math and physics and stuff like that. But no, he’s not a tech guy. And of course, uh, when it comes to the.com era anyway, we all know how that ended, the bubble burst. And so did his brokerage account and basically his life savings. So there he was in his fifties, starting over again after being obliterated by the.com bubble.

He was terrified. I could tell I saw it in his face. I kind of tried to stay away. Um, but he also knew what he had to do, you know, I mean, come on, you gotta do something. So he rebuilt the same way he had built the first time around, which was. Starting to accumulate cash flowing real estate, one single family house and duplex at a time.

And you know what? He’s in his, uh, well, gosh, you know, he is in, uh, his mid eighties, um, and he’s still at it. Now, I don’t wanna romanticize this real estate career entirely because the reality is, like in any career, it wasn’t all smooth sailing either. It’s not a fairytale, right? It’s real life. So for example.

I remember in the late nineties when I was in medical school, Alan Greenspan, who was the fed chair, suddenly cranked up interest rates, creating a situation not unlike what investors faced post COVID. I recently when the Fed raised rates at a record speed, and you know what? That hurt him. Um, and he lost money, but each setback brought lessons and he kept moving forward.

Ultimately with an asset class that he trusted because he knew what went wrong, you know, and do the dotcom thing. He didn’t know what went wrong. He couldn’t really, um, I mean, he didn’t know anything about these companies and he couldn’t kind of just, you know, get under the hood and figure out what he did wrong and learn from him and move on.

So he did this, uh, you know, uh, eventually he recovered financially. Um, I have to say that I’m, I’m, you know, he was comfortable enough. He sent. Three kids to college, including me, who he also sent me to medical school. Yes, that’s right. I didn’t have any loans in medical school. And you know what? He’ll be the first one to tell you that his lesson, uh, the financial life was that he only ever really made money in real estate.

And that’s, uh, what he believes in. So why am I telling you all this? Because you see it really ultimately shaped the way I see investing. You know, and like most, I didn’t grow up hearing that stock. Uh, the stock market, um, was sort of the, the safe thing to do that stocks, bonds and mutual funds were sort of conventional wisdom.

I learned that the stock market was really risky and I actually saw it with my own eyes when he got obliterated. Um, so. What the view that I had, the lens that I was looking at was pretty much the opposite of everyone that grew up around me. And so for me, the default was real estate and despite my own challenges from, you know, post COVID rate hikes, et cetera, I can still say that without hesitation, focusing on real estate has served me way better than following a traditional investing playbook ever would.

Still, the thing is you get in the space. And you have a bunch of wins. You have to remember that no one wins all the time. Every investor loses money sometimes, and that is just reality. I don’t know anybody who’s been doing this for a long time that hasn’t lost money. And, you know, surgeons of a saying, you know, I am a, of course an ex surgeon, and the saying is, if you haven’t had a complication, like a surgical complication, you haven’t done enough surgery.

Now that’s as true for the best surgeons in the world as it is for investors because sometimes things happen. Things happen. Like this post COVID rate hike thing, it happened, right? Just like, you know, uh, a surgeon does everything right, ends up with an infection, and all of a sudden you got, you know, dealing with all sorts of other complications or whatever.

It doesn’t mean. Something inherently was done wrong. Sometimes things happen and you just have to deal with it. So what do you do? Right? So what do you do? It sounds like it could be potentially scary, but you know, the thing is you don’t have a lot of options sitting on cash guarantees. You’ll lose purchasing power to inflation.

Think about that. Your money is sitting in the bank and inflation is going well. It was up to like what? Eight, 9%, you were losing eight, 9% of that money per year. You weren’t sitting on safely, you were losing money. And even when inflation is relatively stable at two or 3%, you are losing money. Money markets, well, they barely keep up, right?

So for me, the answer is to keep investing, uh, with some level of discipline. I mean, for me, that real estate is my medium. Like my father, I learned from my mistakes and keep moving forward. And that’s what you just have to do is like you invest, you learn, you move forward. You have successes. You figure out why you were successful.

You probably, more importantly, when you don’t have success, you have to, you have to learn from that too. Especially that, um, but I still, still see real estate as the greatest wealth building asset in the world. A consistent wealth building asset that if you stick with it. Uh, you know, is, uh, generally speaking, I think a very good trajectory to be on.

But that being said, wealth doesn’t build blindly, right? It’s just that you can’t just say, oh, real estate, I’m just gonna allocate some money to real estate. And boom, every project I invest in has to have underwriting. I believe in, you know, it has to be in the right market. It has to be a place where there’s a need for jobs.

Um, I have to pay attention to macroeconomic, uh, world, uh, and, and where we’re at right now. I believe the right, you know, that, that in the right markets, real estate has bottomed out and I think we’re in the buyer’s side of the, uh, cycle, right? I also believe interest rates are headed lower, both because the Fed has signaled it said it’s gonna lower rates him, because Trump administrations, Trump’s administration will do everything possible to keep them moving in the right direction.

So. Basically investing in a descending interest rate environment, which is nothing short of a gift for real estate investors, but I gr digress. The point I’m trying to make here is that you have to get the macro, but then ultimately you start looking for deals and you gotta get into the underwriting and you gotta understand some of that stuff.

You know, even as a passive investor, you don’t have to know the absolute nitty gritty of everything. But there are some things that you should be looking for when you look at that underwriting. Those are the kinds of things we’re gonna talk about, uh, with my guests today on Wealth Formula Podcast. When we come back from these messages.

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Today my guest on Wealth Formula podcast is Frank Gallinelli, founder of Real Data, longtime real estate educator, an author of what every real estate investor needs know, but cash Flow. This works to help generations of investors understand the numbers that really drive real estate returns. So welcome, uh, Frank, how are you doing?

Great. Thank you. And, uh, thank you for having me on your show here.

Yeah. Well, let’s start, uh, with real data. Uh, you started this company. What’s, what is real data for people who don’t know what, okay. What was it and, and how does it work

and how did I get here too? Yeah, right. Because we’ve been around, uh, for, for a very, very long time.

Uh, real data, uh, started off and still is. Primarily a software company. Uh, and I, I can tell you the, what I purport to be the interesting story of how that actually came to be back in the early 1980s of all things. Uh, but we produced, uh, analysis software, Excel-based models that have really expanded beyond, uh, uh, to, uh, to quote a popular commercial beyond your, uh.

Your father’s Excel model, uh, but also, uh, eventually morphed into an education platform. We, uh, have online video courses, uh, that, uh, uh, that we offer, and we also try to maintain a, a reasonably active blog on our website with educational content articles that are of use, I think, to real estate investors of, of all levels of expertise.

Now, back in the early eighties, I was a, a, um. Actually it was late seventies. I was a commercial, uh, sales manager. I was a sales manager in a commercial real estate firm and everything was going along very nicely. My mentor and my boss was one of the, uh, originators of the CCIM program. So that’s how I learned income property analysis directly from him.

Uh, mighty my own business. When one day, uh, uh, my sister calls up and she’s owns and running was, was own and running a real, uh, retail business. Her partner died and her partner was the finance guy. She knew nothing about finance, so she said, would you mind terribly just, you know, dropping your current career, uh, moving, moving out of where you currently live, coming down here and help me, uh, run this, uh.

Uh, this retail business, the finance side of it. Uh, now the equipment that they were using to do this at that time, uh, might not have been outta place in a, uh, uh, in the Museum of World War ii, uh, uh, you know, things that came off a, uh, an airplane. Uh, the, you know, even the, even the adding machine, I think had a crank handle.

So that, that inspired me to s see, you know, what can we do computerizing. This business now computers, personal computers were just becoming available. So that’s, I started with that and then of no sooner getting into that, the opportunity came up to acquire a piece of commercial property and I decided, well, let me use this computer thing with some other software that also had just come out called a spreadsheet.

And it was well before Excel, uh, came out and I did that. After I did it and we closed the deal, bought the property, and so on. A couple of my colleagues from the real estate business, uh, looked at this and said, Hey, how did you do that exactly? S was born a software company. I decided if this model was gonna be of some use to me, might very well be of use to other people in, uh, income property investing.

So. Kind of packaged it up, sold it, and it evolved, you know, decade after decade. We’re, right now, I think in, uh, in version 20, after, after, I can’t even count the number of years now, more than 40 years. So we still have that, uh, we still have that software out there, but, you know, in the, uh, uh, at some point in the middle of providing that software.

I finally recognized that people who were calling up for support were very often asking, you know, not which button do I push to make the software work correctly, but they were asking content related questions, right? Like, why is my IRR so high? Why is my IRR so low? Or, you know. You know, why aren’t you counting, uh, a mortgage interest as an operating expense, things like this.

And I realized that there were a lot of people out there even using our software who maybe didn’t have a, a, a clear picture of what it was that they were doing and what, what it was that they were understanding from the results they were getting from our analysis models. And that kind of launched me off into the, into the, uh, uh, second phase, if you will, of my, uh, commercial real estate career, which was education.

I got invited to by McGraw Hill to write a book, which you do. There’s no accounting for Taste It. That’s now it’s third edition and it’s, it’s been very successful. Uh, and that in turn got me invited to teach this stuff in the, uh, Columbia grad school. So that’s where I got from, where I was to where I am.

Well, uh, so, you know, our thing or two about underwriting deals and, um, you know, let’s, let’s focus on some. Some questions relative to today and some practical use. For example, like, you know, right now, uh, higher financing costs still laying in on deals. Uh, we’ll see where that goes and their instability.

Uh, you know, even in that part of it, how do you see investors adjusting their underwriting, I guess in part for the higher. Uh, financing, but also sort of a, a climate in which there is a lot of, uh, uh, lack of, uh, uh, clarity in which direction things are moving.

Yeah, there, there, uh, there is a lot of uncertainty out there.

We do see that among the, the people that, uh, that use our software or are aqui about our software, uh, to use it. So there, yeah, there, there is a lot of uncertainty and of course, uncertainty always has a negative effect on every kind of market. And the real estate market is no, is no different in, uh, in that regard.

Uh, I wrote a blog post kind of on this subject mm-hmm. Not too long ago and said, you know. Beware of wishful thinking. Yeah. That’s, that’s, that’s one of the, that’s kinda one of the warnings I think you have to have to be concerned with, uh, in the current market environment. The belief that rates are going to come down a lot because they just came down a little, uh.

That can be, that can throw you a curve because, uh, you may be thinking that, okay, I can, I can go ahead and, and make some kind of a deal right now without doing my, uh, uh, my homework as carefully as I ought to because I’m not gonna worry about it. I’m, I’m gonna be able to refinance this in a, in a year or so because the rates are gonna be coming down.

Right. So I think that’s, that’s kind of the, the wishful thinking that, uh, that, that comes into play here. And we see people still. Even though they, they should be forewarned because of the uncertainty, they should be forewarned to, you know, not to take shortcuts on due diligence. So on still making some kind of the classic mistakes that they make, uh, uh, all the time.

Uh, you know, uh, the wishful thinking that, uh, revenue and operat expenses mm-hmm. Are, are real and recurring and, uh. Uh, not taking into account that maybe things won’t always be the same. Almost kind of think back to 2008, right? When, uh, when homeowners always believed that home prices would go up Yeah.

Until they didn’t. Okay. So we’re in that kind of environment now where I think we have to take a, a really more careful look. Uh, if you, if you do your homework and if you do the, the analysis of the financials carefully, I think you can still. Make good deals, even in this kind of an environment.

Yeah, yeah.

Um, beyond, uh, performance. Um, well, let, let, let’s stick with performance for a bit. Um, what’s the most dangerous assumption you see people making? I mean, this might go back to your last

Yeah. It really, yeah. It really, it really does it in a sense that making the assumption that, you know. Things are going to work the way they always worked in the past.

That, that your operating expenses are not gonna go up as fast as your revenue. So your revenue will continue to try to, you know, outstrip those operating expenses. Um, uh, they make a mistake. One mistake I, I’ve, I’ve seen happen time, the memorial, really, it is not accounting for property management cost.

Yeah. When they analyze a property, you know, I’ll hear people say, oh, oh yeah, I don’t have to worry about that. I’m gonna manage the property myself. So I gotta tell these, these, these folks, when they, when they give me that explanation that, number one, you’re telling me that your time has no value, which I hope you don’t really believe, and maybe you’re forgetting the fact that when you try to close this deal and the, and the commercial appraiser goes out there, if you didn’t make an uh, account for a property management cost, that appraiser is going to make.

That, that assumption, and of course that’s going to probably change your entire estimate of value because now your NOI is gonna be less than you thought it was.

Yeah. Um, all of this is, you know, again, just coming back to today’s situation, I mean, it’s just like, how do you even, I mean, okay, you, you had the fundamentals of the property, but when you have such things as cap rates and uh, insurance.

Property tax changing so quickly in some markets and, and um, and obviously interest rates, um, you know, maybe they go down, maybe they go up. We don’t know how much they go down by if they do go down. I mean, it just seems like a, and sometimes it’s, it’s, it’s a real guessing game. Like, so how do you make sense outta so much, so much, you know, lack of, of clarity.

When you’re modeling.

Yeah, I do tell people, and I made a, I’ve made a, uh, in my, in my, uh, courses at, at, uh, Columbia and also in my online courses, one of the big things I, I always emphasized was that, you know, you’ve gotta, you’ve gotta look at the data. I’m a numbers guy. I always say that, uh, you, you have to run the numbers if you’re gonna make any sense out of, out of a deal.

But I also tried to emphasize very, very strongly that you had to look. Not only at the numbers, but beyond the numbers. Okay. Yeah. That you had to, had to take a look at some qualitative factors, which I think sometimes, uh, folks will get in, you know, kinda get wrapped up in the, uh, in the, in the, in the qualitative, the quantitative, pardon me, the quantitative analysis.

Uh, they miss this. I think my, I think my Columbia students. Probably were relatively convinced that I was a nutcase, because on the first day of class I says, well, this is the closest thing to a class in art appreciation that you’re gonna get in the finance curriculum. Yeah. And I said, because you’ve gotta begin to learn how to look for the picture behind the picture.

You know, the painting behind the painting if, if you will, uh, I would give them these three. Uh, these three words that I would, I would put up on a, on, on the, on the screen in this big auditorium, you know, for almost every class perspective, discernment and clarity. I say, you know, there are things beyond just calculating your bottom line.

Cash flow. Cash flow’s important,

yeah.

But there are other things that you have to look at. There are certain qualitative factors that come into play here, and if you ignore those things, you’re setting yourself up for failure. And of those three, the one that I used to really emphasize the most, I think was, was discernment.

Uh, looking at the financial data and trying to figure out, yeah, what’s the backstory here? You know, are we looking at tenant quality? Are we looking at the direction of the local economy? I had an example. I used and every year I almost had the, I always had the same experience. Uh, with this example, I, I would give them these case studies.

They were all invented case studies, but they were all, each one was designed to try to illustrate some kind of a purpose. And so I would, I would give them all the numbers about the leases on this mixed use property. And one of the tenants in this mixed use property, one of the major tenants was a, it was, was a restaurant.

And, uh, so the students would invariably come back with all their spreadsheets and all their numbers. I wouldn’t tell them what the property is worth, that you figure out what you think you might wanna pay for it. And I would, uh, I would, you know, get this, uh, this assignment and they would come back and, uh, they would do their numbers.

Now, part of the information, uh, that I gave them about this restaurant, uh, was that the food was lousy and the service was even worse. But he had guy had a five year lease, you know, and there no option and all the rest of it, so. My students would come back having dutifully taken all the lease data that I gave them, all the market data that I gave them about this location, and they would crank out the numbers as to what the rate of return would be and what they would pay for the property and so on.

And the thing that always, that always happened that I always looked forward to was that, that at least one person would raise his or her hand during our discussion of this case in the class and say, you know what? This case is all bs. And I said, oh really? Why is that? He goes, I don’t care what numbers you gave us about the lease on that restaurant, this guy is gonna pull a, you know, a Grapes of wrath.

He’s gonna throw grandma on the back of the pickup truck in the middle of the night and you’re gonna walk over there one day and there will be no restaurant there. And now have you planned for the, uh. Uh, rollover, uh, uh, vacancy. Have you planned for the leasing, uh, commission? Have you planned for, you know, the, uh, the fit up allowance for a new tenant and all that?

Have you put all that into your pro forma expectations mm-hmm. For how this property is really going to work? If you haven’t, then you’ve missed the whole point of this case study because you ran the numbers based on what the lease has said, but you didn’t look at. Tenant quality. You didn’t look at the, the, the backstory of what’s really going on here.

So, although I, I, I remained the guy who’s all about the numbers, I says, well, you’re gonna have to have a different set of numbers that you wanna look at here. A numbers, a set of numbers that’s based on what is more likely to occur than. What, what it appeared to be, uh, just on the, on the lease data. So, you know, you gotta figure that you have this alternative reality that you’re going to have to prepare for if you’re really going to look at this property and learn how to analyze the property.

And, and, you know, and one of the things I also at, with those, those, those three, uh, that mantra of three things, I, I would also emphasize, uh. You know, uh, uh, a point of view. I said, you’ve really gotta make sure that you’re looking at this from everybody’s point of view. That not only as the, as the potential buyer of this, but also as all the interested parties in this potential transaction.

Because if you wanna try to figure out how to make this deal work, or how to make any deal work, you’re gonna really have to be looking at it from everybody’s point of view,

from the uh, standpoint of multifamily real estate. You know, our, our group is involved in quite a bit of that. And when we look at properties and, and maybe this is kind of the, you know, the, uh, equivalent of bad food or good food or whatever, um, we start, not with the property, but we start with the market and the demographics of the market.

We look at, okay, what is population growth? Okay, a number one, population growth, well, I should say number one, jobs, and then number two, population growth. With the anticipation of more jobs, because ultimately that’s something we can’t necessarily, you know, put on a spreadsheet. We just, I mean, you can to a certain degree with anticipation of, you know, what you think your rank growth might be or whatever, but.

That, is that sort of the equivalent of what you’re talking about when you say looking outside of those numbers and the spreadsheet?

Yeah, absolutely. That’s sounds like you may have read my book, but I think that’s, that’s one of the first chapters that entire Yeah, that entire set of, of parameters that you just, that you just mentioned, said you’ve really gotta be know, kinda like the, the guy in the in, in the musical that said, you gotta know the territory well, you really do have to know the territory because it’s not just about the building, it’s not just about the.

Just take a look at the jobs and the market dynamics. Uh, you have a major employer who might be moving out. Well, if you do, then you have a whole new set of parameters that you have to deal with with your multifamily property. ’cause now you’re gonna have people who are perhaps getting laid off and unemployed, can’t pay the rent.

So the demand for, uh. Uh, for, uh, uh, apartments is going to, is going to shift around. On the other hand, let’s say you’ve got a situation such as we’ve seen recently, uh, where there are no listings, no, no houses to be bought. So what do people do? They have to rent apartments. Mm-hmm. So a kind of a, a counterintuitive, uh, aspect of, of the single family real estate market is that, you know, when, when things are.

Bad in terms of inventory availability in the single family market that pushes people toward apartments. Because if you’re gonna go someplace, you’re gonna have to find someplace that you can go to. And so, yes, all of these things come into, into play. Is that you, are you paying attention to the local politics, into the local budgeting process?

Uh, example I use in, in, in, in one of my books is that, you know, what, if they’re planning now to build a new high school, what’s that gonna do to your taxes? You’re gonna have to pick up, you’re gonna have to pick up, uh, the expectation of an increased property tax expense. So don’t just look at your current property tax expense, but try to try to look forward on this.

Nobody’s got a crystal ball. Nobody’s gonna come up with a perfect set of assumptions and. Perfect set of, uh, of numbers, uh, to make these projections on, but you have to be more attuned into, you know, what, uh, what’s going on in your marketplace. So, yeah, absolutely.

And you also have to have some sense of, you know, what your convictions are in terms of really what, what’s happening with the market, what’s happening with rates based on.

Your understanding of macroeconomics as well. And you know, you kind of have to look at the big picture. And if you look back, um, just a few years ago in multifamily, it was a kind of a big, uh, big shock with interest rates going way up. And it was not just for multifamily, but uh, uh, that that’s something that, uh, you know, if, if you could have predicted that, that you would’ve made a.

A lot of people made some big moves and, uh, unfortunately I don’t think anybody could have predicted that, but, but you do have to make some assumptions and, and I guess that is, uh, that’s the ongoing challenge, right? So,

yeah,

absolutely. Yeah. So, um, you know, you’ve, you, you’re a big advocate I know for stress testing.

Can you share maybe some examples of how running downside scenarios can change the way you look at a deal?

Absolutely. I think, I think, uh, uh, we even built a special module into our, the pro version of our software specifically to, to deal with that issue where you could, you know, you could take a one page where all of the assumptions were, you could ratchet each, you know, assumption up and down to see how it might affect the bottom line of the investment because.

You know it, it’s dangerous to assume that all of your assumptions, even if they’re accurate today, are going to remain accurate in the future. You know, you has to be thinking about, okay, yeah, I can run the numbers about on what I know right now, and I can run them going out based on what I think is going to happen with the numbers that are accurate today.

But then you have to ask yourself, you know, stuff happens. What happens if I lose a key tenant or two? How’s that gonna affect my bottom line? Uh, what if I have to replace a furnace or, or, or an AC unit sooner than later? Mm-hmm. And what, you know, as we discussed a moment ago, what happens if I get, uh, an out of the, uh, you know, uh, uh, greater than ordinary property tax increase?

You know, I got here, I got to two months notice that my property taxes are going up 20%. If you can test out, if you can stress test, uh, the, the potential, um, holding period and plug in some of these, some of these options, you know, see what happens if you, if you do lose that 10 or two, see what happens if you do have a big capital expenditure, uh, or an un, an unplanned increase in opex, test these out and see what it really does to your.

To your cash flow more than anything else. And when you do that, you say, well, you know, I don’t know the exact probability of any one of these things happening, but let’s say some of these things feel more likely than others. And so let me do my pro forma going out with these various scenarios. And if I look at these, I might get a, I might get a sense of.

The need to put some of my regular ongoing cash flow into reserve rather than simply taking it out. This saying and treating it as if, you know, that’s my, that’s my income for my in pocket income, uh, for this year. Yeah. Look at these different stress, these things out. Try them out and say, well, okay, it looks like I got a, you know, a possibility of losing that tenant in year four.

So maybe in years one, two, and three, instead of taking my cashflow, putting in the, you know, putting it into my checking account, my personal checking account, maybe I want to maintain a reserve account. Put it in there if nothing happens. Fine. It’s still my money, but if something does happen, then I don’t have to go looking under sofa cushions, you know, to find the cash that I need, uh, to cover these things.

Stress testing is, is, is I think, an essential, you know, alternate scenarios. I’ve always said, again, in my courses, in my books, all the rest, that at the very least, uh, what you ought to be doing when you do a performer that goes out a number of years is to, is to. Do a best case, a worst case, and an in-between scenario because in real estate as in life in general, things are usually not as good as we hoped for or as bad as we fear.

It’s usually somewhere in the middle. So if you can kind of identify where the middle is, then maybe you can ask yourself, oh, can I live? Being in the middle, is that, is that an acceptable, uh, return on an investment, an acceptable scenario for me as an investor? If it is, then maybe you got a little bit more comfort going forward.

So a lot of professionals, um, invest passively, um, into syndication, such as in our, you know, our group. Um, if you had to boil it down, you know, with with, you know, they, they really are not digging that deep into these metrics. I mean, we certainly provide, um, we certainly provide the underwriting and give the story of, of the demographics and stuff like that.

But if you, if you had to boil it down for those people, which numbers should they never ignore?

Okay. Well, uh, as you, uh, maybe word my, the title of my book is What Every Real Estate Investor Needs to Know About Cashflow and 36 Other Key Metrics or Investment Measures or whatever. Mm-hmm. The title is there.

I don’t suggest that anybody wa you know, try to examine 37 different metrics before making a decision, but I think there are maybe four, you know, 3, 4, 5 that are, uh. Absolute that you absolutely need to take a look at. Um, first of them is cashflow. Now I’m not saying so much cash on cash return. I know a lot of the people that that we talk to think that that’s really what they wanna look at, but I, I think that’s, could be too easily misleading.

But cashflow itself in terms of dollars, I think is probably the, uh, the gold standard of, of what to look for. Uh. It doesn’t necessarily mean that a negative cash flow is a deal killer because you may be in a situation where, where you’re buying a property, where you have a, uh, uh, maybe a value add scenario that you have really worked through, and yet you know that you, if you can get through the, uh, the negative cash flow period, that you’re gonna have a stable and very profit profitable investment.

But I think you need to know. Projected realistically what is likely to be your actual cash flow.

Yeah. And, and just to, just to add one thing to that, one of the things that I noticed, um, you know, we’re, we’re in the business, um, you know, of, of value add, uh, commercial, a lot of times in, in the past there, there has been like negative cash flow, but right now because of the corrections in the market and a lot of the, um, a lot of the properties that, you know, you can, that, that are distressed.

Um, you know, one of the advantages right now, I don’t know, I don’t know if you’re seeing this, is that you, you can in, in, in many situations buy properties at today’s interest rates and actually from day one, have positive cash flow, which is actually kind of a nice situation for, you know, we, we, for a while that was really hard to do and, um, just your comments on that before you go on to the next.

Yeah, I think, yeah, I think, I think you’re right. There are, there are situations out there. You gotta be careful. You gotta be, you know, yeah. Look, and you gotta, again, always, always run the numbers with a conservative mindset, but if you do, it’s not impossible, I think, to, to find those. It’s a, again, it’s, uh, getting back to my, to my blog there, I, that wrote a recent article about how, you know, if you really do a, a conservative and careful analysis of the, of the data that you’re coming up with, then you’ll.

Be able to identify opportunities, opportunities like that. If I may return to your, your question about the, the, the metrics. Another one, and this is one I find curiously, that a whole whole lot of people I talk to just, just never gets on their radar somehow is debt coverage ratio. Mm-hmm. Now, I can’t imagine why you wouldn’t want to take a look at the debt coverage ratio on a, on a, on a potential investment.

And I can think of at least a couple of reasons. Uh, the one that comes most immediately to mine is that if your debt coverage ratio isn’t adequate, uh. You’re not gonna get the financing, so you might as well go home, uh, and you know, game over kinda thing. But even, you know, even if you are getting the financing, I suggest, and in our software, we look at the debt coverage ratio on a year to year basis.

Uh, uh, you know, we can go out 20 years and look at what is it each year, uh, in our projection because we’d as owners. We wouldn’t wanna be in a position where our, where our debt coverage wasn’t adequate, where it didn’t have at least 20 or more likely 25 to 30%, uh, wiggle room to make sure that. We can, we can, uh, accommodate, uh, surprises.

So it, you don’t wanna not pay your mortgage obviously, so you wanna make sure that your NOI is going to be at least 20%. No lender is gonna give you a mortgage if you don’t have at least 20%. And that, I think the current, the, the current standard is, is, is 25%. And, uh, and, uh, I think prudent investors even look for a greater, uh.

Amount of, uh, amount of leeway in their, in their ability to cover their debt. So I would put that right after cashflow as a key, uh, metric that you really ought to be paying attention to. Um, my next one would be internal rate of return. IRR. Now, there’s a whole lot of people who don’t like that. They think it’s, they think it’s like witchcraft or something, you know, that that’s like magic, that, you know, it, it depends on maybe being able to predict the future and, and all the rest, but.

The one thing that IRR has of over a lot of other ways of, of evaluating the uh, uh, the worth, the viability, if you will, of an investment opportunity, is that it takes into account simultaneously both. The timing and the magnitude of cash flows, the interaction of how those two things interact with one another.

Uh, I’ve given plenty of examples in my, uh, in my, uh, uh, articles and so on, uh, where you can see how, you know, if you look at a 10 year holding period with two different series of cash flows, which. Add up to the same amount, but timing is different. It makes a big difference on, on your rate of return because sooner is better than later, obviously.

So that if you’re, if you can see how the interaction works between the timing and the amount of the cash flows, and you can see that through the internal rate of return, that’s ano, that’s one of these metrics that is, is a good one to use with stress testing. Because if you, you know, if you, if you, uh, adjust your, your parameters, if you adjust your, your timing on, uh, on, uh, revenue or revenue increases, uh, expenses and or, or in, uh, uh, when you make expenditures for capital improvements, for example, if you could play around with those and see how they affect your internal rate of return, you get a better sense of, well know maybe, maybe if I can, maybe if that roof will last me another two years.

That’s not such a bad thing, you know? Uh, uh, whereas, you know, the total number of dollars may be the same involved in every one of these scenarios, but the actual effect on your overall return and how successful you’re being as an investor, um. Is, uh, uh, I, I think is king. So I think a lot of

people don’t quite understand.

IR just, oh yeah. I mean, and so I mean, to, to the extent that, you know, if just to give the 1 0 1 on it, I mean, you know, annualized return is, is fairly easy. You’re just kind of doing some arithmetic there. But IRR is taking into account, um. The time value of money. Can you explain that a little bit just in simple terms for people to understand?

Yeah. It tell you the time, value of money issue is, is is really pretty straightforward. And I’ve got a couple of, you know, if you wanna get a little bit more into depth, anyone, uh, who’s listening wants to get a little bit more into depth, they can go on our website blog. And I’ve got a couple articles there that really walk you through, uh, how to understand what IRR really means.

But time, value of money simply says that, that, uh, a dollar you get today. Is more valuable than a dollar you have to wait for to get tomorrow. So if you, if you loan me a hundred dollars today for, and, and, uh, and you want to get paid back, well if I pay you back right away, well that’s different then if I pay you back five years from now.

Because if I give you that a hundred dollars back five years ago, you have less buying power with that. So the longer you wait to get a return, the less valuable that return is to you. Because it has a lower buying power. You, if you get the money back sooner, you can reinvest it and earn more money with it.

But if you have to wait till later, you haven’t, you’ve lost the opportunity. There is an opportunity cost to waiting to get your money. And IRR is sensitive to that. IRR, you know, basically fills in the blanks for you and tells you what that opportunity cost is. Uh, uh, having to wait to get for your, uh, your, your return.

Uh, any other guardrails or, uh, you know, non-negotiables, uh, for people to look at other than those main features you just mentioned?

Yeah, I think, I think what it gets down to basic, you know. Basic discipline, if you wanna call it that in the, in, in terms of, uh, your investment activities. Uh, one of the, one of the key things that I’ve always, uh, uh, urged people to do, and I’ve, again, uh, I, I go over this in, in, uh, in, uh, the prologue to my, to my case study examples is, uh, the subject of clarity.

Knowing in your own mind why it is. You’re investing in a particular piece of property. ’cause there are different reasons, different motivations, uh, that might direct you toward a particular piece of property. And the type of property, uh, that, that you get and, uh, really needs to be in sync with your motivation.

If, if you’re, if your, if your motivation is that you’re wanna build long-term wealth ’cause you’re thinking about your retirement, or maybe you’re, you know, you’re. A young couple and you’re thinking about putting your kids through college, the kind of property that you might be looking at, and the kinds of metrics that you’re gonna be looking at will be different from someone who is looking for a quick turnover, A quick hit.

Okay. Uh, that individual would be, would be looking at at different metrics and making different kinds of assumptions. Uh, if you’re looking at just something that provides you an ongoing annual cash flow, that’s a different, that’s a different motivation also, and directs you toward a different type of property.

If you’re looking at triple net lease property. Uh, this may be something that you think of, and again, if you’re looking, uh, to, to protect your, in your retirement, ’cause you may be willing to accept a lower rate of return as a trade off for the security of a triple net lease property. You don’t have to worry about what happens to the property taxes.

The tenant’s gonna be taking care of all the maintenance and management of it. Uh, you don’t have to worry about the insurance cost because the tenant’s gonna be paying that. So in, in a situation like that where you need security. You’re willing to trade it off against some, uh, uh, degree of the return.

Well, that’s fine, but you can’t do any of these things until you first have a clear mind of your own. What do you wanna do and why do you wanna do it? So if you can answer that question for yourself, I think you’ve, you’ve overcome the first hurdle to being a successful real estate investor. Yeah.

Uh, where can we learn more?

Tell us. Uh, and, and you know, part of the, one of the questions I guess is, you know, is the. The software, is it appropriate for retail investors as well, or is it just, uh, you know, large operators and, and, and that kind of thing? Um, you know, what, what, uh, who is it, who’s it for? And, and where can we learn more about, you know, that and everything else you’re doing?

Okay. So, in regard to the software, real data.com is our website, and you’ll see, uh, you’ll see. Several different applications that we have there. We have a professional, uh, level of the income property analysis, and we have what we call express, which is, uh, generally comfortable for, for people who are dealing with, with, with multifamily or very small, uh, commercial properties.

But I will tell you that. Our typical user is the entrepreneurial investor. Uh, we don’t really, uh, uh, uh, deal as much with the institutional investor or the, or the, or the, uh, uh, you know, the one with, uh, dealing with large holdings. I mean, we do definitely have some, but I think our, our, our typical demographic, if you wanna call it that, is the entrepreneurial.

Investor. Yeah. We also have some, some software for, for developers, um, whether income property developers or, or the subdivision land developers, condo developers, that kind of thing. So there are some applications for that, but kind of our flagship product has always been our income property development.

So we have, uh, uh, income property analysis. So we had basically two levels of that. One that’s a little bit more for, for the entry level and one that really does, uh. Extensive analysis you can do as, you can go in as deep as you want or as light as you want. We even have, within, within the software, we even have kind of a, you know, kind of a quick and dirty analysis if you just wanna get an idea of, is this even worth looking at in, in more depth.

Uh, then on the learning side, on the educational side, and this has been a, you know, a big thing for us, uh, especially over the last couple of years, I’ve got, I used to teach this, as I said, at Columbia as an adjunct. I did that for 14 years, I think it was. And now over the last couple of years, there have been a number of professors, uh, who have been either assigning or, or recommending our online video courses, which take you through.

Actually more than the stuff that I taught in, in, in the grad school because I kind of morphed the grad school material and then based on, on, on requests that I had, uh, we added more and more content to it so that we added stuff on development. We added stuff on partnerships and, and on value add and, and that sort of thing.

Uh, you can go to learn, do real data slash courses. And you’ll see the inventory of, of those courses. And we do make special, uh, if anybody out there is listening to this is in the education field, we do make special pricing for student groups so that, uh, it becomes, uh, you know, considerably more affordable for those who are, who are in college.

Um, I’ve done that with the, uh, university of Alabama. I’ve done that with, uh, uh, even with Columbia after I stopped teaching in person.

Frank, thanks so much for, uh, all your time. Frank Gallinelli, founder of Real Data. Um, appreciate being on the show today and, and, uh, giving us all this, uh, useful information.

Well, thank you. Thank you for having me. It’s a pleasure talking with you today.

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It’s not necessarily as, uh, you know, difficult as it sounds. It’s a handful of things you should be looking at in the underwriting, but beyond that, beyond the underwriting, I think that it’s really important to think about a few other things, right? I mean, you’re really wanna make sure that you’re in the right market.

You wanna make sure there’s jobs. Jobs mean population growth. Um, you know when when markets get frothy, you start seeing places like Oklahoma City starting getting really expensive. Well, that never turns out well. Um, and then perhaps one of the hardest things to do is to have some idea in which way the winds are going to blow and the, the economy.

The challenge with what happened in, um, you know, after COVID with interest rates was that it really fooled everybody. I mean, even the Federal Reserve, as you may recall, they thought, uh, they said that inflation at that point was transient. And so, you know, it’s hard when. Uh, you know, the, the actual United States Federal Reserve gets it wrong and tells people the wrong information.

Um, hopefully that doesn’t happen to that degree ever again, but sometimes those things are gonna happen. You have to use your best, uh, your best gauge of what’s going on. Personally, I think right now, uh, we’re looking at, uh, rates that are gonna continue to take down as unemployment goes up, uh, as ai, uh, continues to take over jobs.

I think that, you know, there will be an ongoing and growing need. For housing in the working, uh, working man sector. In other words, you know, not poor, but not rich. And that’s where we’re at. So, um, that’s it for me this week on Wealth Formula Podcast. Hopefully you enjoyed the show. Our investor club is available to you, obviously by signing [email protected].

That’s it for me this week on Wealth Formula Podcast. This is Buck Joffrey signing off. If you wanna learn more, you can now get free access to our in-depth personal finance course featuring industry leaders like Tom Wheel Wright and Ken McElroy. Visit well formula roadmap.com.