With rising interest rates and rumors of a recession coming in 2023, how safe is it to jump into real estate next year? Sure, some real estate prices are coming back down in some areas, but are we going to see a repeat of 2008? Are there still ways to make money in real estate, even if prices come down? How can we know our money is safe? Special guest, Lee Arnold, owner of Secured Investment Corporation, joins us to give his secrets to real estate success over the last 27 years and how you can protect yourself and still increase your wealth.
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Is The Current Real Estate Market Doomed?
Interview With Lee Arnold
I brought on a special guest. This guy is incredible. We should have had him on the last couple of years, at least, Lee Arnold. If you should know anything about Lee, many of you know that we’ve advertised Secured Investment Corporation on this show. They offer a very great fund that’s very good for those of you. Even if you’re a non-accredited investor, they have a non-accredited fund. He is not only the owner of the parent company, Secured Investment Corporation. They’ve also got so many subsidiaries of companies, everything from property management.
They even do 150 fix and flips a year. They got over 150 employees and contractors working for them. They’re a real estate brokerage. They’ve even done philanthropy. They also have a Jesus conference. They’re not great in business but they’re also great and passionate about life and much of the message that we share on the show. I’m very excited to have Lee on our show. Welcome.
Chris, thanks for having me. This is fun.
We’re sitting across the table having a chat, aren’t we?
I have to tell you that people say that I often look like Putin sitting at the end of this very long white desk. I’m not sure I’m comfortable with that reference but I thought it was funny.
You’re in Moscow, not Moscow but Moscow, Idaho.
I’m up in Coeur d’Alene, Idaho. I’m about 100 miles South of the Canadian border to give people some proximity. We’ve been up here for about thirteen years now and we love it. It’s a beautiful area. Come and visit us sometime.
I still have a trip I need to take up there with you. We got to make sure we get into the springtime of year when we can get up there and thaws a little bit.
Come July, August and September. It is beautiful.
That’s a deal. One thing I didn’t mention on this is you’ve been doing business in real estate since 1995. When we graduated high school, you’ve been doing this. Tell us a little bit about your backstory.
My backstory is I grew up on a farm. My mom was a stay-at-home mom. My dad was in human resources at a utility company so I had no background in real estate and investing money. They still live in the same house that I grew up in. He never had investment properties so I didn’t know what I wanted to be. I was eighteen years old. I graduated high school. I’m working at a grocery store making $3.90 an hour and I saw an infomercial that if I go to the DoubleTree Hotel, they’ll teach me how to get rich in real estate. I went to this little two-hour presentation and at the end of it, they convinced me to give them all of my money and then some.
The advantage of that is it had to work because I didn’t have a backup plan. From that training, I went out and bought my first house. I partnered with the pharmacist at the grocery store where I worked at. I like to tell people that my first deal was financed by a drug dealer because that’s clever. We did that first deal at a $35,000 purchase price. We put $15,000 into it. I did all the work. I was a farmer and we sold that thing for $79,000. That was transformational for me because, on one flip, I made almost three years of income that I would’ve made at the grocery store. At that point, my plans for higher education and all of those things went out the window and I said, “Real estate is going to be my career.” That’s been my path for the last 27 years.
One flip in real estate can make almost three years of income working at a grocery store. Click To TweetI know you do lending and teach people too. You have a whole education course that you do. You’re teaching people how to actively do real estate investing.
I’ll tell you, Chris, that the first deal that I partnered with my pharmacist on, our agreement was he put up all the money and I do all the work because you could only bring 1 of 2 things to a partnership and that is either time or money. I had the time and he had the money so I did all the work. In 6 months when we were done, I’m slaving away at this house 50 hours a week to get it ready for sale. At the end of it, we split the profit and I’m like, “What did you do?” I didn’t have any ill will but I said, “One day, I want to be that guy and I wanted to be a lender.”
That was my motivation to fix and flip properties and build up a portfolio of real estate so that we could be the lender to other real estate investors like me who have great deals but maybe don’t have a lot of money down or don’t have great credit. They want to move ahead in advance and need a funding source. That’s why we created Cogo Capital about fifteen years ago. We’ve been a nationwide private money lender now for fifteen years.
We are about to pass over $1 billion in capital deployed across the nation. It’s rewarding for two reasons. 1) We’re helping people get access to financing that could never get financing from a bank. 2) We are lending money on properties that no bank would ever touch because of the condition. Through that, we’re beautifying neighborhoods, making them safer and improving property values. That’s rewarding for me.
That’s the thing I want to bring up because, with your Secured Investment Corp. business, you have lending funds as we talk about with the sponsorship of the show and everything. The one thing I want to get is your take on what’s going on. You’ve got a finger on a lot of different pulses here. You’re the eyes and ears of what’s happening in the marketplace. People are saying, “Is real estate going to tank?” Depending on which part of the country you’re in because there’s often that California wave that ripples from West to East. Everybody is wondering what’s going on. What’s your take on the real estate market right now?
The real estate market is hurting badly and that’s a true statement across the nation. We are a nationwide lender and we lend money to the people that buy fix and flip houses so we see the turn time on these loans. If you go back to ’21 and ’22, people were able to get in and get out of properties in 90 to 120 days. In this market, they can get the property turned in 90 to 120 days but it might take them 90 to 120 days to get it sold. Simply with interest rates rising, what the Feds did in Q4 of last year was three consecutive 3/4 point bumps and then a half point on December 14th is the average cost for a buyer to purchase a home.
They’re going to be looking at a rate somewhere between 7.5% and 8.5% interest. That sounds shocking when you’re coming out of a 3% rate environment. I remember when I started flipping houses in ‘95, the first conventional bank loan I got was 9.5% and I was pretty excited about it. Rising rates are not the problem. The problem is rising rates in an environment. Three means that affordability has disappeared. For the market to settle out and even out, prices have to fall to accommodate affordability. That’s the critical component here.
I believe Q1 and Q2 of 2023, we’re going to see a fractured market. Things are going to slow. The next thing we’re going to see is sellers who desperately need to sell are going to start slashing prices to the point that they can but they’re not going to be able to slash prices below what they owe. That’s the issue. I did an analysis. If you took a property purchased in 2021 with a buyer that could afford a $1,800 mortgage at a 3% rate, they could buy up to a $460,000 house. If you take that same buyer at $1,800 a month and put them into this market, they can only afford a $280,000 house.
They want that house but that house needs to be priced at $280,000 before they can afford to buy it. This property value needs to decline. The issue is that this person bought the house in 2021 and they owe $480,000, which I believe is going to lead to a lot of loan modification and workout programs. We’re going to see an uptick in default filings, both in judicial and non-judicial markets and a slight uptick in foreclosure. I’ll put it in these terms to give you some baseline.
In 2019, 60% of the properties we acquired as a company was purchased at a foreclosure auction at the courthouse steps. In 2020, COVID hit. We have a nationwide moratorium that has no foreclosure and no eviction. As savvy investors, we started going direct to the seller because the auction was no longer in play as an acquisition strategy. We continue to go into those wells so we don’t need an auction as an acquisition play. As more and more of these properties start coming on the default list, we’ll be going direct to the seller and negotiating with them rather than waiting for it to come to the courthouse steps.
We’re going to see a big uptick in default filings but we will not see the same corresponding uptick in actual foreclosures at the courthouse. Not all of them will sell to a third party. Some of those will end up reverting to the lender. As you know, when a property doesn’t sell at auction, it becomes an REO property or Real Estate Owned. We have not seen REO properties on the MLS for 36 months. We need those properties on MLS to establish the new dollar per square foot so that Zillow will pick it up and start giving accurate Zestimates, which is funny but the uneducated public believes the Zestimate to be the gospel of value.
If you’re trying to sell a house above the Zest price, the consumer is going to look at it and go, “You’re overpriced.” Zillow needs REOs to hit the market. We need REOs to hit the market to get the Zestimates in line with actual value. A lot of things have to take place almost simultaneously to get the market correction in line. Economists are anticipating that if there is a recession, it’s going to hit Q3 of 2023. I don’t believe there’s going to be a recession. Certainly, there’s going to be a pullback but a recession is two consecutive quarters of negative GDP growth. I don’t see anything that supports that.
It might be a half of point increase over zero but it’s not negative so it’s going to hurt. The Fed chair has openly said that he is throwing the real estate market under the bus to get inflation under control. The minute inflation hits 2.5% or 3%, they’re going to start dropping rates again. It’s going to be a little bump. Nothing we experienced in 2009 and that was something from another world. I don’t think we’re going to be there. I’m pretty bullish on the market this year.
There's not going to be a recession, or at least something similar to what we experienced in 2009. Click To TweetWhat are you guys doing to reduce your risks, especially if you have lending? You said the flippers are having a hard time trying to figure out how to navigate this market. They’re not flipping as easily as it was. It’s not as easy as the seller’s market for them. What are you doing to try to hedge your risk with something like that, especially with your fund?
It is to our investors’ credit that I lost everything in 2008. In 2008, I was doing large-scale development. I was developing luxury homes in Park City, Utah, on the backside of Deer Valley. It was 14,000 square feet and $25 million homes. Three of them were under construction when the market turned. When the market turns, the government is not creating loan programs for luxury home buyers. The luxury home market always tanks first because there are fewer of those buyers.
Also, wealthy investors have much of their wealth tied up in the stock market. As the stock market is tanking due to the recessionary downturn, they’re seeing their net worth dropping by millions of dollars and they stopped spending on luxury homes. I got killed in ‘08. The good news is I did not file for bankruptcy. Everybody told me to but I did not. I went to every creditor. I negotiated with them and said, “Here’s what I got.”
We came out of 2008 and ’09 scraping the bottom of the barrel but I learned a lot. Here’s what I learned. In a recessionary downturn, the federal government is always going to create programs for affordable housing. Affordable housing is defined as any sales price that sits below or beneath the FHA cap, which is established by the FHA. You can Google any county in America and it’ll tell you the FHA cap.
As a company, we said, “We’re not buying any house where our anticipated retail sales price exceeds the FHA cap because this represents affordable housing.” Eighty percent of the buying public fits under the cap. Any sale over that, you eliminated 80% of your potential buyers. We took that same discipline and applied it to how we underwrite our loan portfolio. I don’t do ground-up construction, commercial or multifamily. I do single-family, 1 to 4 units on less than half of an acre with less than 2,800 square feet with less than 5 bedrooms and 3 baths that fit in the FHA cap. Here’s why. Chris, do you know what you call a private money lender in a recessionary downturn?
I would say broke, depending on whom they’re lending to.
The answer is landlord because when you lend people money who don’t pay you back, you have to foreclose to get possession of the property that was the collateral. If you are lending on collateral that can’t cashflow ground-up construction and you’re only 70% of the way through construction, nobody can live there. If the Certificate of Occupancy has not been issued by the county, you can’t cashflow it. It’s uninhabitable. In a large-scale commercial, if the market tanks in the midst of that development, they don’t have the funds to finish it. What I saw in 2008 is half-built developments all over the nation surrounded by a chain-link fence and they sat there for 3 and 4 years.
Why? It’s because nobody would lend fresh capital to complete the project. When you focus on affordable housing that’s habitable, you have an asset that will cashflow by the borrower making their monthly payments or if you have to regain possession of that, you can develop cashflow by putting a tenant in there and managing it as a rental. We are looking for properties that fit those five-point criteria. Those are FHA cap for 2,800 square feet or less, 5 bedrooms, 3 baths or less, less than half of an acre and residential 1 to 4 units. That’s it. If you send me a deal that does not fit in that box, I’m not going to lend on it.
With that discipline in underwriting, many of our competitors in this downturn have stopped lending because they’ve got money in all of these unfinished developments and commercial projects that they know that if they finish it and then try to get takeout financing at today’s rates at 8% or 9%, it’s not going to cashflow. They’re looking at their opportunity costs and loss costs and they’re saying, “It’s cheaper for us to pull back now and let it sit there unfinished than it is to pour more money after this thing and hope that we can rent it up, lease it up and get it cashflowing.”
For us, as a company, I want properties that have good roofs, working HVAC systems and plumbing systems that are in place or we are going to be lending to a contractor that has the ability to get those things in order. We try to keep our renovation budgets on any deal nationwide less than $50,000. If we do end up taking it back, we could very quickly make it habitable and get tenants in there.
That is the number one thing that our investors appreciate. I’m not concerned with the recession. As property values are declining, rental rates are rising. Why? With rates at 8%, home ownership is nonexistent for the bulk of people who need housing so they’re flocking to rents. We are seeing an adverse reaction on the rental side that we’re seeing on the property value side. As an organization, we are in a massive buy mode in our local markets. We flip a lot of houses. We also own a large portfolio of rental properties but we only do it in two counties, Spokane County, Washington and Kootenai County, Idaho.
I learned from my grandfather, a farmer, who said, “The best fertilizer for the garden is the footsteps of the farmer.” I’ve been lending money long enough to know that the projects that have the highest risks are the ones where the principal lives thousands of miles away from the asset. They can’t drive by it, go meet with contractors or do any of those things. We have a full-service construction company, property management company and real estate agency in these two markets.
We control and dominate this market and have no interest in owning or controlling any other market nationwide. We will lend there but we will not actively buy fix and flip. If I can’t directly influence, oversee or persuade the local market, I’ll never be going to buy it, especially with investor money but I will certainly lend to you if you have a great deal that fits our underwriting guidelines. You are a proven principal that can see a project to completion.
I see two things there. One, you’re little lending box where you have those criteria. It’s so critical because it’s a safer place to play. I also hear another thing you’re saying too, which is you’re diversifying your company, Secured Investment Corp, in general. You had the in-house property management and in-house brokerage. You’ve got fixed and flips, lending, private equity and all kinds of stuff going on that no matter what’s going on in the marketplace, you’ve almost created your safety or conglomerate.
One of my favorite quotes is, “Don’t leave your success in the hands of others.” When you are relying upon other people to follow through, perform and do the things that they’re promising to do, that’s fine. Ronald Reagan is one of my favorite presidents. He used to say, “Trust but verify.” You are lending especially to somebody you never lent to before. How do you verify? We do a great job underwriting background checks. We do a full underwrite and credit scores that boil down to competency.
Don't leave your success in the hands of others. Click To TweetWith the advent of fix-and-flip shows on HGTV, everybody believes that after a 28-minute show, they are an expert flipper but they’re not prepared for the unseen, hidden things that always arise in a fix-and-flip job. To help alleviate risk there, we put together an education edition. We train people nationwide. It’s called the Lee Arnold System of Real Estate Investing, where we teach people how to buy the very properties that we buy.
If they go find the properties that fit in that box, we will lend them the money. If they come through our education, we will give them preferred financing because they’ve invested the time to learn the right way to do it. Over the last ten years of doing it this way, we have been watching trends within our portfolio that people who come through our education have a significantly lower probability of default than those that don’t. If push came to shove and we’re in a full-blown recession where liquidity is a premium, all I would do is say I’m not lending to anybody who’s not a student of our education division. I’m not saying that now but if push comes to shove, I would always lend to my student base before I would lend to the general public.
You created a solution for your eighteen-year-old self, didn’t you?
Well said. When you’re eighteen, you think you can do anything and know everything. I often say the only reason I’m on this show speaking other than somebody else is I’ve probably lost more money than all of your audience. My dad used to always say that some people learn when they feel the heat. Other people learn when they see the light. He said, “Lee, you’re somebody who doesn’t learn until you get third-degree burns.” Over 27 years, I got third-degree burns like crazy.
We’ve created all of our surrounding entities to help alleviate the risks that exist in all of these areas that put our investors in peril. If we don’t underwrite correctly or lend on assets that can’t cashflow, we’ve become very disciplined as a result of that. That’s why we’ve been able to produce double-digit returns for our investors for almost the last ten years running. I know there are other funds and operators out there that promise 15%, 18% and 20%. If you can give me 10% consistently while keeping my risk at the lowest possible point, I am all in.
There was a time when I used to chase high yields and high cap rates but those come with their risks because the higher the cap, the lower the quality of the property, the area and the tenant mix. Whatever cap rate you’re chasing is going to be chewed up in cost-paying staff to go solve the problems. If I can get 10% consistently, I’m doubling my money every seven years.
If someone wants more information on this education system, where do they go?
The best place to go would be FundingTour.com. We always say that it all starts with a funding tour and that is the introduction of all of our various programs and opportunities. We do an eight-hour virtual presentation every Wednesday and Saturday. It is taught by some of our trainers. They’ll introduce you to our buy box, our strategy for direct-to-seller marketing, our system software and technologies that we use, the lists that we acquire, how we go about writing offers, underwriting files and getting property inspections. All of that is covered in that eight-hour session. For anybody interested in real estate investing, Funding Tour is the best place to go or even go to LeeArnoldSystem.com. Anybody who needs funding would go to CogoCapital.com.
We got SecuredInvestmentCorp.com as well for those that want a passive income from those funds. Lee, this has been such a pleasure to have you on. Lots of great information. This is something people should read twice. You dropped a lot of good nuggets that give people that wisdom you have learned over those 27 years. I appreciate you being on the show and sharing that with us.
It’s my pleasure, Chris. I would encourage all of your audience to be very cautious about the long-runway investment opportunities. If it’s not cashflowing going in, I would be very hesitant on a long-term play that doesn’t have any cashflow. In the market that we’re in, there are great investment opportunities and development deals out there. If you’re 24 to 36 months away from cashflow and I would play it safe right now, stay in the cashflow game because in the recessionary downturn, cashflow is fuel and it fuels every other aspect of your enterprise. Now is not the time to be betting on future value. Play cash. Cashflow is the name of the game.
That’s one thing I learned from 2008 when I almost went bankrupt. It’s the same thing. I focused on that appreciation and all the big luxury stuff and that did not work out too well.
It’s funny because in 2006 and ’07, we were looking at investment prospectus and we included appreciation as part of our return on investment. Every prospectus I’ve done post-2008 does not include appreciation as part of our investment analysis. It’s cashflow and depreciation. Those are the only two things that add value to us because they are guaranteed. I’m going to get cashflow and be able to appreciate all my taxes. If I get appreciation, great. That’ll juice my yields but I’m not going to underwrite or bank on it as an investment philosophy.
It’s such a wise thing to do. Lee, I appreciate it having you on. Everybody, go check out his stuff. If this is something that spoke to you and you feel like 2023 is the time for you to win and take action, do it wisely. Whether we’re moving in recession or not, it doesn’t matter. Opportunities are knocking on doors and you could be at that forefront where people will look back at you 5 or 10 years from now saying, “You had that opportunity. You did it. That’s amazing.” You could be the opposite where someone says, “You didn’t take advantage of that. Why not?” The choice is yours. It depends on what action you take. Go and make it a wonderful and prosperous week. Take action. Get results. We’ll see you later.
Important Links
- Secured Investment Corporation
- Cogo Capital
- Lee Arnold System of Real Estate Investing
- FundingTour.com
About Lee Arnold
Lee Arnold has made millions in real estate since 1995. He is the owner of Secured Investment Corporation, which owns a variety of companies ranging from lending, real estate acquisitions, real estate brokerage, property management, fix & flip, investment funds, and even non profits.