TLP45: What New Questions Should LPs Be Asking in 2022 with Whitney Hutten

[Whitney] With the market today, hearing the words inflation's at 8.6%. At least that's what's being disclosed to us by the government. Many can argue that it's actually much higher than that. We're hearing the words recession is on the horizon. The Fed is aggressively raising interest rates. We're in the second week of July, and I believe the Fed is announced that they're going to raise interest rates again. The federal funds rate another point three quarters of a point, which can definitely impact the markets and the cost of capital to borrow. When I talk to investors every day, and me, myself included, these are things I'm considering as a limited partner investor.

[Jake] That was Whitney Elkins - Hutten, director of Investor Education at PassiveInvesting.com keep listening to hear how Whitney views the current market and why it's actually still a great time to invest and why having investing principles will keep you successful. The limited partner shares in the potentially outsized returns of a well-planned and executed investment, but as a passive investor and has the maximum leverage on their most precious asset their time, and that is why we're here together. 90% of the millionaires out there built their net worth with real estate. However, 0% of the billionaires are hands on managing the real estate assets because there simply isn't enough time. My name is Jake Wiley and for the past 16 years I've been investing in real estate and I've learned a thing or two. But the most important lesson is how to leverage the expertise and time of others to maximize your investment potential. Welcome to the Limited Partner Podcast. [Jake] All right, welcome partners. Again. I'm your host, Jake Wiley. This week I'm joined by Whitney Elkins Hutten. Again, this is actually the second time on the show and she is the Leader of Education at passiveinvesting.com. And we brought her back because the markets are definitely changing and we're looking at, new questions, new thoughts, new ideas around investing in the marketplace. So I thought it'd be a great to bring Whitney back, but to start off, Whitney, welcome to the show.

[Whitney] Thank you so much for having me on again.

[Jake] this will be a lot of fun. I guess, since you've been on the show before, we don't have to dive too much into your background here, but I would be interested kind of right off the bat to just get your take on the changing market conditions and the dynamics that you guys are seeing and your pivoting towards, over at passive investing.

[Whitney] Yeah, definitely. Well, and just for people that didn't get to see listen to the previous episode. You know where I'm at now. I'm the director of Investor education at Passiveinvesting.com, but it wasn't always like that. I started off in real estate in 2002 completely by accident. I was an accidental landlord. I had a house and my relationship had fallen apart and I had to pay all the bills. So, I stuffed it full of roomates. And I completed the rehab on the property and then sold it about 11 months later. And then, we went through my journey last time on, how I transitioned into more buy and hold real estate and then complimented with flipping. And then each time just kept hitting that ceiling of achievement with how do am I gonna utilize my time? And that's really when I transitioned into both active and passive investing but in commercial assets. And, you know, that's what's led me to my journey now here as the director of education. Now as far as like where we are with the market today, I mean, you're hearing the words inflation, I mean, inflation's at 8.6%. At least that's what's being disclosed to us by the government. Many can argue that it's actually much higher than that. We're hearing the words recession is on the horizon. The Fed is aggressively raising interest rates. We're in the second week of July, and I believe the Fed is announced that they're going to raise interest rates again. The federal funds rate another point three quarters of a point, which can, definitely impact the markets and, the cost of capital to borrow. When I talk to investors every day and me, myself included, these are things I'm considering as a limited partner investor. Things look very scary, right? You can hearken back to the quote from Nathan Rosschild back in the early 18 hundreds. Like, there's blood in the streets and the blood is our own as well. But as investors, we need to learn how to navigate this environment and continue to invest because there's definitely some, opportunities here. Both a recessionary environment as well as an inflationary environment.

[Jake] Yeah, I think that's a really great point. And it is scary because it's unknown, like you don't know what's happening. Fun fact is that, my wife and I had put on our, like our vision board, our goal, that we were not gonna become like old, antiquated people and we were gonna invest in cryptocurrency in 2022. So we did, and then it's just going straight downhill, right? We weren't educated, but we were just trying, and it, thankfully, it wasn't a lot, it was just dipping our toe in it. But the idea was always to kind of keep ourselves fresh. But, I digress a little bit there, but the point that you're making about being able to invest in really any market, the majority of fortunes are made in down markets, right? It's being really strategic in thinking about how you're gonna invest because as you invest, right, those that get scared and they just pull their money outta cash, right? Like, you come back and, you've got inflation and you've got cash and like it's worth less than it was.

[Whitney] Absolutely. Well, there's some fundamentals here that I think I can use at any point in time during any market cycle. So, when we look at, the Carnegie, the Rothschild, the Vanderbilt. Their portfolios were built on pillars and principles. It's not just about, chasing the hottest trend investment. I think through this as an investor and really how I evaluate an investment, initially is fairly simple. And I'm not talking about doing the due diligence on the investment, but what I'm looking for in this particular market are seven principles that any investment must have. One, it has to be able to preserve my capital, meaning that it needs to be backed by a hard asset. There needs to be the ability for me to affect a business plan on the asset. So, assets that aren't evaluated on that operating income or expected gross income. Maybe just comparable analyses. I'm tending to stay away from those right now. I'm looking for assets with very strong capital and operational reserves on them. That way I can protect my capital. 2.) I'm looking for assets with cash flow from day one. Now the cash flow may not be maximized right now, you know, depending on the cost, the debt that is placed on this asset, but I am looking for assets to cash flow right now in this environment. I know people that are still making tons of money in development deals and high appreciation deals, but I'm looking for consistent home runs, not necessarily at Grand Slam every single time. I'm looking for assets that I can harvest that cash flow on a regular basis. This is why I love commercial real estate and residential real estate. In order to protect that cash flow, I guess what the asset actually has to have, it has to carry a large amount of operational and CapEx reserves to protect that cash flow. 3.) I'm also looking for assets that have high equity potential on them. Now, I'm not talking about just market growth or market appreciation. I'm talking about the ability to pull the three net operating income levers on the asset. The income on the asset, decrease the expenses, as well as add additional streams of income. I'm just kind of running down my like little checklist here. 4.) I'm looking for assets that have tax benefits to them. Now, how can I take advantage of depreciation, accelerated depreciation, bonus depreciation? Does that asset allow me to have the ability to defer depreciation recapture, as well as capital gains tax into future years. Utilizing maybe like a Like-Kind exchange or a 1031 exchange. Now those are what I kind of call the four pillars within these seven principles. And then on top of that, I have a couple of rules. 5.) Rule number one, especially in this environment, it needs an inflation hedge, meaning I need to have a pretty reliable way to increase my income on the asset to offset any expense increase. This is why I love commercial real estate. In multifamily, as an operator we can increase the rents on annual basis. Self storage, we can do it on a 30-day rolling basis on our car washes, we can do it, on a weekly or monthly basis. And on our hotels, we can do it on a daily basis. We can adjust with the environment. 6.) Another rule is smart use of leverage. Okay. If I had any sort of warning sign for investors right now, they need to be extremely knowledgeable at the type of debt that an operator is using on to acquire the property if they're using debt at all, are, what kind of LTV is there on the property? Is there fixed rate debt? If it's not fixed rate and it's a floating rate debt, is it caps? Make sure there's caps here and that the project's being underwritten at the max capped rate for the entire hold of the project. And it is conservative. If it's not a fixed term debt, make sure that the debt at least extends for the length of the business plan with options to extend that debt further. So, our business plans are about five years long, three to five years. Our debt minimum is five years. That gives us time to be able to acquire the asset, reposition the asset, and sell the asset, execute our business plan. And then, again, you wanna make sure that you're arbitraging interest rate environment appropriately. And then the seventh principle. I know I'm going through these super fast cuz I know we'll probably dive down a couple rabbit holes here. 7.) Is making sure that you're working with operators that are seasoned. A lot of operators right now, haven't necessarily been through the 2008, 2009 crisises, but they've seen a lot of lumps in the past few years. So make sure that you are asking about the performance through Covid. What did it look like? Their performance through any sort of like environmental disaster or weather disaster. 'Cause those things have happened to operators in the past few years. Also look for operators that have very strong business knowledge, maybe they don't have 20 years in real estate as an operating group, but I bet you, you can find operators out there. I know for us, like our founders have been investing in real estate since 2013, but even before then, they have a very deep bench of knowledge and just how to manage a business, how to grow a business, how to rebrand businesses, those are the things that you're looking for right now.

[Jake] You're right, we are gonna go down some rabbit holes. We did, you really kind of hammered on debt. And I think that is the X factor right now because, let's face it, rents are still rising. They might be stabilizing, assets are performing, they're still a housing shortage. But the issue is debt. And I think you spend a little bit of time talking about debt and some of the factors. One of the things you mentioned, which I think is really interesting, I want to get a little bit more information on it, is the interest rate arbitrage or hedging. Can you go a little bit deeper on what you guys are doing there?

Whitney] Well, yeah, so I mean, let me just set it in principles, right now. Is, I know investors when I hop on the phone with them, they're scared. They're just like, well, what happens whenever interest rates go up to 7%, 8%, 9%, maybe even higher? Well, this particular recession is inflationary driven. So even though the government is disclosing an 8.6% inflation rate, that was at the end of May, arguably it's probably much higher. We're gonna see a higher rate disclosed here very soon. If I'm borrowing at 5% or 6%, I'm getting paid 3% to hold the asset, whether I rent it out and put a stream of income on it or not. So that's huge. Now, if we're actually, can argue that inflation's actually probably closer to 14 or 15%, you can see how that arbitrage very much works into an investor's favor.

Yeah, it's a good point, right? Because it's not really a cash flow benefit at the moment, but it is an asset benefit to saying, there's a school of thought that like when you're in a high inflationary period, you wanna put as much debt on things as you possibly can, because basically the cost of the debt goes down dramatically because inflation is just eating it away.

[Whitney] The inflation erodes the debt. Let's just say, maybe, if somebody has debt on their primary house, maybe that's probably the most tangible. And, example, for a lot of people they may not wanna refinance right now, right? They're, if they refinanced in 2020, 2021, they might have a, 2.5% interest rate or a 3% interest rate. And they have so much equity stuck in their house and they don't wanna refinance right now and take that cash out because, oh my gosh, I've now had to pay 5% or 6% on my primary residence, you're still getting paid and it's really hard for the brain to kind of figure out that math. You're still getting paid, you're still able to arbitrage that interest rate environment. Now, what happens when inflation drops back down to two or 3% we need to be able to reposition the debt on the property because then we'll be upside down the other direction. And so what you want, either personally or, investing professionally, you wanna make sure that you are with a seasoned group of operators that are, one, keeping their eye on that. Number two, have a deep bench of relationships into government sponsored entity markets, into the general capital market as well, to be able to navigate out of that debt in the most appropriate time. Also you wanna make sure that they aren't putting debt on your investments that have long lockout periods or high prepayment penalties so they can be nimble in to leverage that interest rate arbitrage.

[Jake] Yeah. So the one thing I do wanna clarify, right, when we were talking about like the whole personal home example, is that if you pull the money out and you put it into something that is working, an investment that's working for you, you win. Right? If you pull that money out and you just go spend it, that's a loss, right?

[Whitney] This idea. I mean, it might be fun, but — JW: [Jake] I think about that a lot is out there and you know about depreciation. You probably heard me talk about depreciation on the show a lot because there is depreciation recapture, so it's not a completely free lunch. Meaning that like you'll read a book somewhere and they'll be like, real estate is magical because the government lets you take these expenses against your property every year, and it's called depreciation. And it's true. Every year you can file your tax return and like you have this like mythical depreciation expense that offsets your income and then you know, you could have zero income, it pays zero taxes, but when you sell the property, You pay it back. And again, it's not a capital gain, right? It's actually like ordinary income. So if your income went up, it could have a detrimental effect. Now and again, like this is a very similar situation where in an inflationary period, there's a net benefit there for you, but it's not a free lunch. And there's a lot of books out there that'll make it seem like real estate has this magic wand with depreciation that like you can just offset all your expenses and you never pay taxes ever again. It's like, it's not exactly how it works. [Whitney] Yeah, I would agree and I think investors need to understand why the IRS wants to partner with us on their asset because they know the government understands that investors can solve these type of housing problems, business problems, better than the government ever could, and they want us to keep the assets in good repair. So, they know the asset breaks down over time. For residential real estate, you know the schedule's 27 and a half years. For commercial real estate, like a self storage building, it's 39 and a half years now. We even get as real estate investors, we can actually even hire an engineer to perform what we call a cost segregation analysis. And in this particular analysis we can actually kick anything that's gonna break down in 20 years or less. And fast forward it to the early years of the project, like in the first five years. And you can do this on your own personal holdings, like investment holdings. I have two rentals that I purchased last year and I did a cost segregation analysis on 'em. It's amazing. And the IRS says, oh, Mr. Investor, you just sold these assets. You know that benefit we gave you? We're gonna take it back because you sold 'em. You're no longer helping us solve the problem. So, the same thing happens, the passive investor. So what is the passive investor to do here? And that is to continue to reinvest into future assets, either through a 1031 exchange, continuing to trade up. And you can do that passively, if you stay with the entity that you invested in or, you can kind of go through, quote-unquote, I, the term lazy 1031 exchange and exit a passive investment. Take all that money and that's capital that's been distributed back to you and reinvest it into another asset with depreciative losses in order to continue to kind of kick that tax can down the road. But yes, that depreciation isn't there as like a hand me a free give out, it's there to help us solve problems, is what it's there for.

[Jake] Yeah, I think that's sometimes when you look at the goverment. And the things that they do, you're like, there's no way they were smart enough to figure something like that out. But there is public policy that it's enacted through tax law. And this is one of those examples,

[Whitney] They're trying to modify behavior utilizing the tax law.

[Jake] That's right. And it's not, the IRS out there thinking like, well, how do we do this? Like, like that would be very detrimental to all of us. But it's public policy, right? So they want investments, they want the money to move, they want housing. And in the past, like the solar tax credits, there's a reason for that. The reason it's in taxes is that they are in influencing behavior in a way that they want and encouraging people to roll. There is actually a strategy behind there and it'll blow your mind to think that the government's capable of that sometimes.

[Whitney] First started trying to, really understand the tax world. One of the people that I followed, and I still follow him today, is Tom Wheelwright. Love them, hate them, but you know what really hit home to me was when he said that the IRS tax code is a treasure map. And a lot of accountants are scared of it, and so he challenged, investors actually go find an accountant that's not scared of it and actually sees it like a treasure map, and that's the type of person that you wanna be with.

[Jake] I like that. Right, because there's a lot out. I am a CPA, so I put my CPA hat on here for a second. The caveat is always that the investment needs to make sense first, right? You mentioned it earlier, kind of like flashy. Here's the latest trend or whatever, never invest based on a tax strategy. The investment makes sense on its own merits, and then the tax is kind of the juice, right? Like it juices the deal. But if you ever invest specifically for taxes like the government is also hip to that and that is not a letter that you want to get.

[Whitney] I was just gonna, a quick, like little story. I was talking to an investor yesterday and he was showing me, the different type of investment he's in and what his goals were. You sharing me what his goals were and he was like, number one is cashflow, number two is capital preservation. Number three is tax benefits. But when you looked at the assets, and I'm not a financial advisor, I was not in an advisory role with him, but just, really kind of peeking over his shoulder and I'm like sitting there going, I'm like poking holes in the theory what he had invested in. I'm like, if you say cash flow is your number one goal, you have all these assets here that have high depreciation on a very low cash flow. So you know, you as an investor, I think this goes back to what you're trying to point out. You have to understand what your goals are, what your risk tolerance are, and make sure you're aligned to the investment that you go into. And again, don't let the tax tail wag the dog

[Jake] Yeah. And it goes back to your principles, I think, really that you articulated very well, is that if you know what you're looking for and you stick to your principles, yes there may be opportunities. A tax strategy, juices the deal for you. Fantastic. You need to stick with what are the fundamentals, right? And, we're talking about assets, tangible assets. Not my cryptocurrency blender that they can produce income, right? And like, they can produce income whether you show up or not, right? And as a passive investor, that's what you're looking for. I think you articulated that very well. But I'm gonna switch gears on you a little bit here because passiveinvesting.com and we think about the business, like it started really as a multi-family syndication group, and it grew up and, recently you mentioned this earlier, self storage, hotels, car washes. Let's talk about that diversification strategy and one, why you did that and then two, maybe what some of the benefits for potential investor would be.

[Whitney] Yeah, definitely. So, when passiveinvesting.com was founded, it was founded with the principle that it was never saying passive income through multi-family. That was never the founding principle. It's in the name itself. It's building an equity, private equity firm that helps investors diversify across many assets that generate passive investment as well as equity growth that are low risk and very well conservatively underwritten. And now we do believe that these assets, generally should be backed by real estate or hard asset. So we started off in multifamily in 2019. We were looking to bring on hotels. We all know it happened in like February, March of 2020. We push pause on that to really watch the market over the next couple years until we really felt comfortable it was the right time to get into hotels. We've just recently opened up hotels this year. Now again, some people, it's kinda like the iceberg analogy. You just see what's on the tip, right? Passiveinvesting.com is in hotels that this has been in the work since, like early 2019, so very, quite a long time. Car washes, that is another thing that we've actually been, looking at and underwriting for about 18 months now. Our strategy there is to build out a portfolio of about 150 to 200 car washes and not just any car wash but express tunnel car washes. So we're looking for a very specific asset in a specific location, and I'm really excited about this space. It's gonna be more like market consolidation that we started to see in the very, early years of self storage and, consolidation in 2009, 10, 11. And so I'm very excited about that where our exit strategy on this, once we get the portfolio built out, the assets reposition as well as our branding to go onto them, we are looking to either IPO the portfolio or, potentially exit the portfolio to REIT. And so that can be very, enticing for investors. And again, it gives it a diversification play that's gonna be more of a high cash flow asset with underlying real estate to generate some modest appreciation. On the hotel piece, we're very focused on the limited services. That particular asset through COVID did very well. When we're talking about your Hiltons, your holiday ends and your Marriots. We're not talking about your full service wedding venues or conference centers. We're not talking about your budget hotels. We're talking about, that very stabilized asset that sees both residential or, travel to, that type of customer, but also has the potential to be a good corporate head corporate hotel as well. And so we're really looking at the overlap of those two type of customers that could be, potentially visiting the hotel. And so we're excited about that. In this space right now is grossly undervalued cause of COVID. So, in the next few years there's gonna be an amazing opportunity to pick up some of those properties for our investors in Self Storage. Self Storage is such a darling. It's again, in 2008 11 as well as in 2020, it proved to be a very recession resilient asset class. It compliments very well with multifamily and especially whenever we have the fundamentals, in the multi-family space where, you know, housing. There's not enough housing being delivered to actually saw the housing crisis. People don't depart with their assets or with their things, their belongings. And so we're looking to pick up, self storage in those particular areas where we already hold assets and it gives us, a nice ability to kind of cross market our self storage with some of our assets. Case in point, we're closing a property in the Lake Norman area or excuse me, in Mooresville, I should say. And that's close to one of our Braxton at Lake Norman property. So we're gonna have some unique opportunity there to do a lot of kind of cross marketing between with our multifamily tenants. So there's a lot of different things here in play. But there's again, this is really to give investors kind of a one stop shop to be able to, diversify their portfolio both on markets and across deals and across asset classes.

[Jake] Well, I think that was a great explanation because there are different value streams and we talk about hotels during COVID. I mean, I know there were people that were willing to give 'em away, right? Occupancy was down to like 2%, right? And it was like, I don't, we don't even know what to do here. And like, we don't know if it's ever coming back. I remember it was a scary time.

[Whitney] It really depends. That's very location dependent and asset dependent. I mean the budget hotels as well as the full service hotels saw that type of, vacancy as well as hotels that weren't well positioned in areas that had like more, I don't, how do you put it? Where the politics were, where were they gonna stay shut down. You saw a higher vacancy in those areas as well as again, what we're looking for are hotels, we have an investment open in Hilton Head, South Carolina. That's an amazing travel destination, and it's also an amazing corporate destination. And so whenever that corporate starts coming back, we picked up the hotel only with the travel piece in being underwritten when the corporate starts coming back. That's just gonna be an added bonus for our investors. So we're actually underwriting in those areas, looking in those specific areas where, there's a lot of concentrated travel in that area. We have, 3 to 10 million people that can visit at any point in time pretty reasonable driving distance to this particular hotel. So a lot of local travel. We're not looking to pick up hotels in Maui. So that's kinda maybe a better way of putting it.

[Jake] Well, Whitney, this has been another great episode. We've learned a lot. Thank you for coming back and kind of giving us an update. But I always like to close out my shows with a bit of gratitude, and I know you're probably familiar with this from before. I guess who, maybe somebody new or something new you, like you have a shout out to a little bit of gratitude helps you along the way.

[Whitney] Oh my gosh. I'm just thankful of every day, like for my family for believing in me and supporting me and entertaining all the wild ideas that I might have and just actually kind of stepping alongside with me being willing to walk this path and journey to financial independence and financial freedom and location. I talk to so many investors where, the spouses aren't quite aligned or there's a little bit of friction there, and I'm just so thankful that my family is like, ready to jump in the two feet and just go with me on this journey.

[Jake] That's awesome. Makes a big difference. I feel the same way about my wife. But again, thank you so much for being on the show.

[Whitney] Thank you, Jake. Thank you so much.

[Jake] I hope you've enjoyed today's episode and I'd actually love for you to contribute to a future episode. If you have a question you'd like answered or a topic or a guest to bring on the show, please email me at jake@thelimitedpartner.com. Now, I realize there is a lot of lingo that's thrown around on these shows, so I've created a cheat sheet for you with the top 26 terms that come up most often. Head on over to thelimitedpartner.com/lingo for the list. Enjoy and we'll see you next time.