"Sherman & Associates is very good at keeping you informed."
- Klara G.
An Interview with Jay Sherman
David Engel recently interviewed our President, Jay Sherman, about his 2010 investment strategy. Below is a transcript of the interview.
|David: Jay, you recently announced that Sherman & Associates is retrofitting properties with environmentally friendly and energy efficient materials. Why did you decide to go green?
Jay: I decided to go green to be a part of the message that we need to improve our local environments and leave a smaller carbon footprint on our planet.
David: Are there special builders you work with or can any contractor decide to be "green"?
Jay: There are very few developers who know energy efficient materials and design. I was fortunate to partner up with someone who is a master in green construction.
His name is Ken Rexrode. Right now, he is finishing up the Fallbrook Pueblo. It's the most energy efficient home ever built in San Diego County, maybe even all of Southern California. And it's been getting a lot of attention lately. I have here a copy of the North County Times... it says that his latest development is "72% more efficient than the state energy code requires."
SDG&E said that Ken's home was the most efficient home that's ever been built by far. It's also one of the few houses in San Diego county that's LEED certified platinum.
David: What is "LEED Platinum"?
Jay: LEED is a system of rating buildings based on energy savings, water efficiency, carbon dioxide reduction, and several other factors. The ratings are: LEED certified, Silver, Gold, and Platinum. Platinum is the highest rating you can get. The U.S. Green Building Council is in charge of awarding the ratings. It's a big deal when they give out a Platinum rating. We're very proud of Ken.
David: Isn't "green" more expensive? How do you get people to spend extra money in this market?
Jay: Actually, it's less expensive than you may think. The $27,000 solar system Ken used in the Fallbrook Pueblo will cost nearly nothing after federal, state and local rebates. And there are plenty of other rebates available.
Even if you pay a little more for a green home, the extra costs are simply added to the sale price... which is covered by the mortgage. The monthly payment isn't much different than the mortgage on a similar, non-green home. Plus, the amount you save on your energy bill will make up for the extra costs in the long run... maybe even sooner if there's another energy crisis.
David: Long term, I agree that going "green" saves money. But we're in a recession. Why would somebody spend the extra money right now?
Jay: Yes. We are in a recession. But, buyers are already spending hundreds of thousands of dollars on a new home. The trend is that more and more people are willing to make an "extra effort" to help the environment.
I remember just 15 years ago... there were no recycle bins on my street. Now, on trash day, there's a big recycle bin in front of every driveway. We're seeing people's habits change. And I think green housing is a change that's starting to catch on.
David: Is your strategy to retrofit a home and sell it right away?
Jay: Yes. That's one of them. My other strategy is to buy and hold. It depends on how much "under market" I can buy the property. If I calculate that after repairs, a property is going to have 30-35% equity, I'll fix it and sell it within 6 months.
But if I come across a deal that has more collateral... and I can get positive cash flow of at least $200 (after debt services of tax, insurance, vacancy, etc)...that's certainly a keeper. I would add that property to my portfolio and keep it at least 5-7 years... or however long it takes for the market to boom again.
David: Sell a property in 6 months? That seems kind of fast, especially now.
Jay: Actually, selling the property is the quickest part. There's a lot of demand right now. If the numbers make sense, finding a buyer is no trouble at all. I know a lot of investors in San Diego and Riverside who are looking for deals. And there's a lot of first-time home buyers out there.
David: Alright. If selling is the quickest part, where are the rest of the six months spent?
Jay: Here's how it breaks down: Getting the home takes 30 days to close escrow. It takes another month or two to retrofit the home. Half-way through renovations, we'll start advertising the property to buyers and collecting offers.
If we are going to sell the property to a buyer who is trying to qualify for an FHA loan, we need to follow the "90 day no flip rule." The rule states that any resale of a property may not occur 90 or fewer days from the last sale. So, we have our first 30 days of escrow on the front-end when we buy the property--then the potential 90 day period. On that 91st day, we could begin an escrow to sell the property. Realistically, we are looking at 5 to 6 months to get the investment sold.
David: Whose money do you use to buy the properties?
Jay: We have a group of private lenders who lend anywhere from $5,000 for the non-secure earnest money deposit to begin escrow... to $200,000 toward the purchase and retrofit cost of the property. Instead of the bank, they hold the deed of trust.
David: Isn't that risky to have people - not banks - fund your mortgages?
Jay: There is always a degree of risk in every type of investment, however, when compared to the stock market, there's much less risk. A lot of our private lenders come to us because they're tired of watching their IRAs go up and down with the volatility of the stock market. They're also tired of the 1% to 2% returns they're getting from safer investments like CDs or savings accounts. We're that middle ground between the bank and the stock market. Not only do we pay our private lenders anywhere from 8% to 10% on their money, we give them more security than a stock broker could ever offer.
David: How do you make this safe for your private lenders?
Jay: We provide five layers of security to our lenders. The first layer is the deed of trust or mortgage. That gives them the right to take the property back in a worse-case scenario. If a stock crashes, there's nothing to take back.
The second layer of security is a promissory note that I personally sign.
The third is title insurance, which protects from any unforeseen liens or disputes on property ownership.
The fourth layer is a hazard insurance policy, which protects against damage to the property.
The fifth is an ARV report (After Repair Value report). This shows how much a property will be worth once it's retrofitted. It's a detailed plan to increase value to a point where there's equity of at least 30%. I want to point out that most banks would be happy with a 3% to 20% equity cushion.
David: But homes that had plenty of equity a couple years ago have dropped so far in value that they have no equity, or even worse they're completely upside down. How do you safeguard against this?
Jay: I'm glad you asked that. We're safe from market dips because we have an equity cushion of at least 30%. The fact that we buy fixer-uppers and we pay all cash allows us to get deep discounts... at least 30% below market value... minus the cost to retrofit.
This equity cushion also allows us to pay our lenders 8% to 10% interest.
David: A lot of people got caught up in the market recently. They lost a lot of money. How do you plan to win?
Jay: I look for real value when I buy. That includes observing everything around a property, not just the property itself.
I start with the neighborhood. Is this a cookie cutter neighborhood or do the homes have different designs? Neighborhoods with custom homes tend to appreciate better.
I look to see if the neighborhood is already established. Are there good schools around? How close are the shopping malls and entertainment centers?
How well their homes are manicured... their landscaping... How are people's cars parked?
Basically the image of the neighborhood is where I start. There's a thing called "pride of home ownership," and you can tell pretty quickly whether you have a lot of renters or owners on a block.
David: What about culdesac homes?
Jay: Culdesac homes are great. I'd rather buy a culdesac home because there's much less traffic. It's much more conducive for families with small children. They can be outside with their children... running... playing ball in the street... rather than a corner home with a stop sign and more car congestion and exhaust fumes.
David: What do you look for in the economy around the home?
Jay: I find out if there are any developments that have already been issued permits. These could be retail, schools, public parks, or anything that indicates growth on the horizon.
Where is city hall talking about putting the next library or airport? What are the zoning regulations around the investment? What's the annual income for individuals and businesses in a certain zip code?
If the investment is in a new area that is close to an established city, I envision how travel between the two places will change in 20 years. Experts predict the rail roads will become popular again. So, I may plan an investment around new tracks or stations.
David: How do you find all this information?
Jay: I frequent the City Planning departments where I invest. The local Chamber of Commerce. State Departments of Finance or Revenue. Economics Departments of major financial institutions. Local area real estate boards and utility companies are also good sources.
David: As a general rule, where is the safest place to invest?
Jay: Established areas with above average income.
David: You said in a recent interview that you try to make every deal a "win-win." At the same time, your strategy is to buy houses at least 30% under market value minus repairs. Don't the sellers have to lose by giving you the houses for much less than they're worth?
Jay: Not at all. The sellers are the banks, and the properties are distressed. If they were listed at full value, they would stay on the market forever. We're helping the banks clean up their books.
We're also doing the neighborhood a favor. We clean these homes up, which helps the atmosphere and attitude of the neighborhood. It also increases the value of other homes nearby.
Before we come in, the properties are depressing the neighborhood. Broken windows and dead lawns are a real drag.
David: What makes you different from other investors, or, say, a fund manager in charge of their clients' investment capital?
Jay: 1. We visit our investments in person.
2. We invest our own money. Did you know that only 43% of fund managers own a stake in their funds?
3. We ensure our private lenders their money back in case of an early withdrawal need without any early withdrawal penalty. We just ask for a 45 day notice, however, it usually occurs a lot sooner than that.
4. We're totally transparent. We're willing to answer any question about our business and our backgrounds. We fully disclose the details about our investments.
I wanted to point out an interesting study that was done recently by New York University's Stern School of Business. The study indicates that what hedge funds tell the public isn't always true. The study, which examined confidential data provided on the condition that specific company data would not be revealed, found that 1 in 5 hedge funds lied about either the assets they controlled, the performance of their fund or even the dicey legal backgrounds of their principals.
David: When do you get your paycheck?
Jay: My real paycheck is what's left over in the house after I sell it. Private lenders get their money first after a sale. However, I do take out a small contingency fee on the front end.
David: Wow. I'll bet that's really an incentive for you to increase the value of these properties and sell them quickly!
Jay: Yes it is.
David: You mentioned IRAs earlier. Can your private lenders invest with the money they have in an IRA?
Jay: Yes. An individual needs to convert their traditional or ROTH IRA account to a self-directed IRA. My associate, Kaaren Hall, handles this part of the business. Kaaren is an expert in converting traditional IRAs and ROTH IRAs into self-directed IRAs.
Over my career, I've created four self-directed IRA accounts to purchase real estate. I think this is a better way to plan for retirement. I am a big believer in controlling my own money and having it invested in something tangible, not in something that is splintered off into a thousand different directions. I like that there are no hidden fees, and I don't have to worry about whose hands are on my retirement money.
David: What single accomplishment are you most proud of?
Jay: Buying my wife's dream home by mastering the sale of two of my rental properties at the height of the real estate market in 2006. Then, rolling all of the profit into our current home, tax free, through a process called a 1031 exchange.
David: You've advised on a lot of deals. Why do people keep coming to you for advice?
Jay: I have studied under the best teachers, and I give my clients real, candid answers. I also have first-hand experience investing around the U.S.
David: You were successful investing out of state in 2006, 2007, and 2008. Why did you come back into California?
Jay: The market indicators are pointing back to Southern California real estate. There is an out-migration going on right now, meaning that more people are moving out of California than moving in.
But in a few years, that's going to change. Those that have left will realize that Southern California is an affordable place to live again. When they come back, they'll be looking for the energy-efficient homes that are becoming increasingly popular.
Also, we expect California building regulations to get tougher on energy-efficiency. This is already happening in Texas. By the time it happens here, we'll be ahead of the curve.
David: I see you got your degree from San Diego State University. What did you do after college? Did any of it have an impact on how you do business today?
Jay: After college, I traveled around Europe for 6 months on a hot air balloon team. I wasn't ready to face the real world and get a job. Little did I know, my lackadaisical journey across Europe would turn into the most important exposure to life I would ever experience. It truly opened my mind up to other ways of thinking.
David: Where did you grow up? Do you have any fun facts about your youth or life?
Jay: I grew up on the island of Maui, in the town of Lahaina. And I was the first person in Maui's history to have a Bar Mitzvah in Lahaina.
David: Why did you get into real estate?
Jay: I liked the idea of investing in something tangible. With individual stocks or mutual funds, "value" is just something on a piece of paper. There's no control of your financials. I'd rather be in control of my retirement than some fund manager.
Plus, the pressure to support my wife and children was building up. My wife wanted to get her PhD, and I needed to pay her tuition.
I liked that real estate gave me the ability to make the large amounts of money that I needed. And I liked that I could control my investment because I owned the property.
David: Where did you learn how to invest?
Jay: Seminars, mentors, and reading. I read everything I can get my hands on about real estate.
Also, I go to a lot of real estate meetings, and I listen for answers. The gems are there, one just has to be patient and diligent. A teacher of mine once said, "Leave your ego at home--there is always someone who knows more than you and wants to share that information with you."
David: Do you have a favorite book about real estate?
Jay: The Best Real Estate Advice I Ever Received by Donald Trump. Not only did I love this book, I picked up a lot of gems. There are 100 tips from 100 top experts that Donald Trump personally selected to share from their years of real estate experience.
David: Over your 9 year career, is there one lesson that stands out above the rest?
Jay: The wise investor places their money in something solid like a mortgage or a deed of trust.
David: Thank you, Jay. I appreciate your time. I'll let you get to your next meeting. I believe you're wanted across town right now.
Jay: Thank you, David. It's been a pleasure.