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February 14, 2023

Astounding Financial Lessons Taught By Life With Lane Kawaoka [EP140]

Today we have Lane Kawaoka on the show! Do you want to invest in real estate but don't know where to start? Have you wanted to learn from someone who's been through it all and achieved incredible success? Lane shares his story of how he started as an engineer and progressed up the ladder as a seasoned investor.

In this episode Lane shares;

  • how he started investing in Seattle in 2009 with a residential property and now owns over 8,500 units
  • how many high net-worth individuals are attracted to real estate for the tax advantages
  • why he likes preferred equity in today's market

Table of Contents:

The Man Behind Simple Passive Cashflow, Lane Kawaoka

Darin: Lane Kawaoka lives in Hawaii. He started simplepassivecashflow.com to help others achieve success with real estate investing. Lane's been at it since 2009 and has a ton of insight to share with others. He hated his job, and he wants to teach others that there's another way.

Just a little bit on how we know each other, and then we'll get into it. This is the first time that we're actually talking, but Lane is all over social media. He's got a website, a very clever name, simplepassivecashflow.com. I'm sure that attracts a lot of people to him to get invested. I'm interested in hearing about his experience because he's been doing this for a long time. With that, can you share with the listeners how many properties and how many units you're invested in?

Lane: Yes, so assets under ownership, $1.2 billion, 8,500 rental units, which a lot of that was picked up prior to this year since we've cooled off on acquisitions with interest rates skyrocketing on us. We're focusing on managing the 8,500 units. But that's where we're at today. That's the cattle grading system, I guess.

Darin: It's crazy though, 8,500 units, 1.2 billion. Share with the listeners how you got started. I believe it was through single family, but let me know and let the listeners know how you got started.

Discover How To Save Taxes and Build Wealth

Lane Kawaoka’s Linear Path

Lane: Yes. I guess my story, I call it the linear path. So a lot of myself and my investors, we are all taught to be good boys and girls, be good with their money, and be frugal. You go to a restaurant, you never order soft drinks because that's the ripoff. And you study hard. And I guess I was good at math and science, so I became an engineer. Or maybe I was smart and I realized what was the highest-paid profession without going to grad school or getting a doctorate. Started working for the man in 2007, when I graduated from the University of Washington.

I was a construction supervisor at the time, and I hated my job. So I quickly just tried to find all kinds of ways to get myself out of the rat race. That's what I talk about. A lot of this financial dogma that we're all taught, like buying a house to live in, for example, which I don't necessarily think is a good idea for people who are good with their money. I will walk that path, that linear path. And 2009 I bought my first house to live in, and then I started to rent it out. And that was where this all started. That's where I got this taste of cash flow.

Darin: 2009. So you bought your first house. And then when you decided to move from that house, you ended up renting it?

Lane: Well, so this was my unique situation at the time. I was single in my early 20s. I worked for a construction company and we traveled all over for work.

How Lane Kawaoka Get Into Rental Property Ownership

Lane: So I had the liberty of being a complete bum and just living off the company dime for four to five years. So I didn't get paid too much. I mean, maybe I guess inflation-adjusted, it might have been multiple six figures, but at that time it was barely six figures. But I was saving every single dime of that. I had no mortgage, I rarely spent any money on anything other than coming back home on Saturday, which is my only free time bar tab. That was my only expense. So all that money went into buying more and more rental properties. The first property again was in Seattle, Washington where I lived. And then the second was a duplex in Seattle.

And this is what I talk about in my next book, which is the phases of rental property ownership. Well before multifamily or commercial properties come in, most people, they get involved in buying a house where they live. Because they can feel it, touch it, and feel comfortable with it. But in 2012 I realized as the market started to appreciate, and we all thought the game was over in 2012 and fast-forward 10 years and they're still here. I started to look in elsewhere in more cashflow markets where the rental value ratios were better. So I bought rental properties in Birmingham, Atlanta, Indianapolis, 1031 Exchange the Seattle properties. And eventually, in 2015, I had a portfolio of 11 of these single family homes.

The Stages of Rental Property Ownership

Darin: So when you say linear, it's because that's the path that most people take when they're getting into real estate. They start with a single family home, then they buy a residential home to rent out, then maybe go into duplexes and fourplexes, and then grow from there. Is that what you're referring to?

Lane: Yes, and then eventually I think people come to the second stage where they realize appreciation is gambling, easy come, easy go, especially if they go through some kind of micro-recession. Then they realize they need to invest in secondary and tertiary markets for the cashflow component. So a lot of the investors may start investing in places like Seattle, Hawaii, and California. This is just where the high-paid jobs are, where high-up credit investors typically live because those are the epicenters for jobs, or the high-paid jobs especially. But then they move off to where I did in 2012, where you're buying rental properties in these lesser-known, less sexy markets. But then eventually they get to this third stage of rental property ownership where you realize these rental properties are a pain in the butt and they're certainly not scalable.

If anybody wants my kind of track record with those rental properties with 11 of them, I had maybe an eviction or two every year. Some kind of big catastrophe that happened every quarter, like a tree fall on the house or some kind of rain out in the basement. Not a huge deal, because I had a professional property manager that babysits my property. And I think that's what all passive investors should do.

5 Step Process Ad

Why Lane Kawaoka Prefers Scalable Properties

Lane: But all this handholding the property manager and misalignment in how they're paid when they have vacancies, it's just not scalable. And for 11 rentals at a few hundred dollars of cashflow each, that's like a measly $3,000 a month.

Now in my early 20s, that was great beer money and that was certainly on the path to leaving my day job, but I don't know what American family can survive off $10,000. So I mean, today we work with mostly accredited investors who really need $15,000, $20,000 a month. You're just not going to cut it with these rental properties. And if you scale to 20, 30 rental properties, which one could perceivably get 10 in their spouse's name, 10 in their name with Fannie Mae, Freddie Mac loans. But after that, you just get garbage lending options, portfolio loans with high loans to values, bad interest rates. But also it's a pain in the ass. Managing these rentals is not scalable.

And then when you start to compile on there the fact that all this debt's in your name, it’s a high liability, as we joke in our accredited investor circles, "can you tell me any good freaking reason why you would want to own rental properties?" Now, I say that as an accredited investor, and I don't want to poo-poo any non-accredited investor's mindset, because I went through that in 2007 to 2012 when I was broke.

The Journey of Lane Kawaoka Towards Simple Passive Cashflow

Simple Passive Cashflow
Photographer: Mukuko Studio | Source: Unsplash

Lane: But everybody gets to a point, and I feel this is very important, to move through the stages of wealth building. I call this the journey to simple passive cashflow. And for a lot of investors nowadays that I work with, they're already an accredited investor in their 40s and 50s. They jump over this stuff. But I think it's very important to understand going through this.

Darin: Yes, I mean, there's a lot of different learning lessons. One was that early on you saved money to invest. I think that that's important for listeners that if you want to get into the game. You need to sacrifice now and put some money aside to get into these deals, or else you're just going to keep on wanting to be in it and you're going to be left behind. Secondly, you mentioned scalability. I've met a lot of people that have gotten to that same number, 10, 11, 12 single family properties. And then it just became a full-time job and they couldn't scale anymore.

That's what led them into the larger multifamily. So I think that your linear phases definitely make sense. The other thing is that you didn't mention this word, but maybe you can share it with the listeners, forced appreciation. So you mentioned appreciation in the single-family, if all the neighborhood homes go up, then your home appreciates as well. But with multifamily, there's forced appreciation. So can you talk about that?

Lane: Yes. I mean, up until this point, I was just a mom and pa amateur investor from 2012, '13, '14, even. And I was just buying properties to turnkey rental, effectively, and just cash flowing from there. I was just getting market appreciation.

How Lane Kawaoka Apply Force Appreciation

Lane: There's two types of appreciation, market appreciation, and like how you were saying, Darin, the forced appreciation. Market appreciation is just good damn luck. You're buying in the right place, or this is like your amateur buddy who buys a place in Bay Area for 800 grand and now it's worth 1.2 a couple of years later. What I say to that is, "Well, good luck. I mean, good job, buddy. That's easy come, easy go." And we're starting to see how that tide goes up and down.

But when you start to include forced appreciation, so when we go into a multifamily apartment, we'll change out the flooring, new appliances, new paint job, not huge facelift things. But $5,000 to $6,000 of rehab into every unit to bump the rents up a couple of hundred bucks, which doesn't seem like very much. And it takes a long frequent time, because we're not kicking people out, we're just going through the natural cycle of a tenant.

And if you've owned rental properties, you understand that people typically move out every other year or so, on average. Every year some will stay, and I guess you'd like to see that, but on average, especially when you're working with larger numbers and you get to steady state, 100, 200, 400 units, you're going to get the more stability in the turnovers. But over time, two to three years, you can get to typically most of the units and bump your average rents.

We track it on a monthly basis, the average rents. Sometimes it goes down a little bit because we'll get rid of 20 people and then it's vacant for a small portion. But we want to see that trend pick up, and typically maybe $50 every quarter or two.

Do Your Homework Ahead of Time

Lane: It's kind of like watching grass grow. But when you look at two, three years, certainly five years down the road, drastically increase net operating income. And in the commercial real estate world, it's these evaluations that what the property is worth is evaluated off a simple formula, which is the net operating income divided by the cap rate. So I mean, people can get their calculator out, if you can bump a building's net operating income by 50 grand, just a measly 50 grand every year. Let me do that. And then it's at a five cap, you just created a million dollars of value right there.

Darin: Yes, it's crazy. The other thing is share with the listeners. It's not really guessing. So you could say appreciation, "Okay, well, you're just going to buy this apartment building. You're going to put some money into it and you're hoping that you can bump the rents." But the reality of it is not that. You do your homework ahead of time and you look at the surrounding properties, and other properties are already getting those rents.

Lane: Yes. I mean, we use, and I'm sure a lot of operators use the same thing, it's the CoStar report. It's the big data house that apartments.com owns. There's a lot of good data that's available. It's kind of an expensive data source if you ask me, but it's very good data. And on a one-off basis, it could be wrong, but when you're comparing multiple apartments and you're just getting general ranges, it's very good data.

Why Lane Kawaoka Keeps Choosing Real Estate

Lane: Of course, you have to verify it with actual walking into some of the comparables and doing your own rent comps and being sneaky secret shoppers. But you can pretty much get a good idea of what the product across the street or within the same submarket will get to prove your business plan.

And this is the complete difference in venture capital, which is something that I'm looking at personally myself. But I keep coming back to this type of real estate. Because unlike venture capital where you don't know what the hell the revenue is going to be or expenses, this is why I think millionaires and billionaires come back to real estate because it's the easiest type of business out there.

Some don't even consider it a business, but it really is a business. It's just a really simple one. And it's just been time-tested over time. Aside from the fact that everyone talks about they're not making any more land, it essentially is a commodity that people need a place to live. And the population is generally growing, certainly in the places that we invest in, like Texas, Alabama, and Phoenix.

But this is why one case study, one example we've done, we went into a deal in Atlanta. And we always underwrite the certain assumptions that the rents are going to go up 2% every year, maybe 2.5. And that takes into account inflation but doesn't take into account market appreciation, like how we're talking about earlier. When we do the underwriting, we're just assuming for conservative forced appreciation. And we can model that.

The Importance of Projecting Realistic Growth

Lane: We know how the rents are going to tick up over time. And if we sell it this year, it's going to be this much and if we sell it at this year, it's going to be this much NOI, and at the sales price.

But that's how we've more than exceeded projections. I think we 2.5X people's money and that in three years. And I'd like to say that our rehabs were really good and we did an excellent job executing the business plan, but part of that was market appreciation. And I think you get that when you just assume that your rents are going to go up just by a modest amount as opposed to assuming that it's going to go up 4%, 5%, 6% year after year after year, which it has in 2020 to 2021. But from 2023 onward, I don't know. I wouldn't be using anything much higher than 2.5% even in super hot markets like Phoenix, for example.

Darin: Yes, Phoenix has been, what, 15%, and it's got to be slowing down at some point.

Lane: Yes. I mean, these proformas are useless, in my opinion. If anybody's playing with spreadsheets, it's like video games. When I use a 15% annual escalator, I might show a 400% return on investment. But if I show a modest 2.5% rent escalator, that 400% goes down to 80%. These are the small, minute cells on the spreadsheet that drastically impact your projected returns. And I think most people who are passive investors understand this, who's screwed around with their own retirement calculator. They might use 8%, but if they have some wine while they're doing it and they play around, what does 13.5% look like, looks like they'll be retiring tomorrow.

How Lane Kawaoka Approach Investments

How Lane Kawaoka Approach Investments
Photographer: Mathieu Stern | Source: Unsplash

Lane: But I think that's where a lot of this and what I teach my folks are like, well, don't just look at the proforma, because that doesn't mean jack. Anybody can put any number on this pitch deck. And that's what a lot of people do. It's like dating. Everybody looks pretty good. I don't know what people use these days, match.com or Tinder or whatever. But everybody looks good in their profile picture. That's why you got to go on the date. But unfortunately, as a passive investor, you're unable to do that. But what I tell people is at least you can look under the hood at what the assumptions used to get to that number.

Darin: Right, exactly. So I think that I totally get what you're saying in terms of these are proformas that never are they accurate, that you exceed the returns or you under-deliver. But they are important to know going in. You still need to review these proformas, but then look at the assumptions that the GP is putting into that investment opportunity. Are they aggressive, or are they not?

Lane: Yes. Unfortunately, you're not going to get it a lot of times, which is the hard part. And I think a lot of people here are like football fans, it's like all the guys on the desks are making their predictions, but you don't know if the first guy's assuming the running back's going to have 250 yards, the second guy's assuming that the running back's not even playing, the third guy assumes the kicker's going to make six field goals. We don't know what's going into their mental model, essentially. It's hard.

Why Lane Kawaoka Dislikes Using Retirement Funds

Lane: It's stacked against passive investors, which is why I always feel like unless you become an underwriting specialist, which most passive investors are not, you have to just build relationships with purely passive accredited investors. Go off track record and experience of other passive investors to verify that.

Darin: Yes, and it is hard because there's people that over the last 5, 6, 7 years could have a great track record. And who knows how deals are going to fare over the next 3, 4, 5 years under those same circumstances. So hey, one of the things I read about you, which was different than a lot of people that I've talked to when people talk about where do you get funds to invest in these deals.

There's three big buckets. One is, hey, if you've socked away money in after-tax savings, there's two, there's untapped home equity, and then three, there's retirement funds. And a lot of syndicators that I've talked to, have 20, 20-plus, 20%, 30% that may invest in the deal using retirement funds. I read somewhere that you do not like retirement funds and that you advise your clients not to use retirement funds. Is that correct?

Lane: Yes.

Darin: And why?

Lane: We can dive into this, I mean it's a complicated thing, right? It's very personal based on people's situations, but I find most people, investing in their retirement funds doesn't make sense. And it gets into do you want to be, the bad thing about investing in retirement funds is you don't get the passive activity losses. You get it, but you can't use the damn thing on your personal tax return. And for most of my clients, it's like that's a big part of this.

The Passive Cashflow Trifecta

Lane: This is the simple passive cashflow trifecta, which is getting better returns outside of Wall Street. But then the taxes, for a lot of the high-income earners, it's the taxes that are going to move the needle more than doubling their money every five years which is still great. But the taxes is where they're going to save multiple five figures a year on taxes. And then another thing is infinite banking, but that doesn't move the needle nearly as much as the deals and taxes.

So if you're investing through a retirement fund, the way they normally say or the way they trick you into going into the normal 401(k) garbage, mutual funds, et cetera, which is where all this nonsense comes from, is investing in a retirement fund because the growth is tax-free. But my argument is, well, when you're investing in real estate that gives you losses, the gross should be tax-free already. So that argument is negated. And I think this is what's hard for people. Even going back to the guy with one rental property, most people just have one rental property that are in our world. Most people don't have any, I guess. But finding real accredited investors and how they're using these tax techniques and how they're building portfolios is very hard.

And it's a lonely world out there for purely passive accredited investors. But these are the kinds of things that we talk about. And these are the counterintuitive things, like don't use your retirement account. Take the money out. And my argument would be the only people that should be really considering using retirement accounts such as Roths, and solo 401(k)s, are people who two things need to be present.

Lane Kawaoka on How to Handle Taxes

Lane Kawaoka on How to Handle Your Taxes
Photographer: Towfiqu barbhuiya | Source: Unsplash

Lane: They need to make in that highest tax bracket, which 2023 and beyond, $360,000 AGI, married, filing jointly, and they have a significant amount in their retirement accounts. What's a significant account? Well, I don't know. It's different for everybody. I would probably call it a quarter million, half a million, or more. If it's less than that, it's a pain in the ass. Just withdraw that thing, because I mean, that's where I was. When I finally woke up to this stuff, I was already taking loans for my retirement. I only had like 60 grand in there. I just pulled it out because it was just a pain.

But let's walk through this. Why the $360,000 AGI threshold? Well, if you're making less than that amount, you don't pay that much taxes. You probably should just pay your taxes on it today because my whole thought process is you're going to be in a higher tax bracket in the future. You're going to have to pay your taxes at some point. Pay the taxes today, get it out of that stuff so you can get access to all these passive losses to do all these other cool things on your taxes today. Get the benefit today, because of time, the value of money, et cetera.

Darin: So, do have a break-even point in terms of if you pull it out, you're going to pay a 10% penalty, you're going to pay taxes on it, but then you're going to have the benefit.

Taxes Will Go Up in the Future

Lane: You're exactly right, the 10% penalty if you're not to age 60-something or whatever. But that's small potatoes, guys. If you're making 10% or 8% in your garbage retail stuff and now you can get access to stuff that's 15%, maybe even 20%-plus, that 10%'s going to be break-even in six months to 18 months, not including any of the tax benefits. So I mean, that just blows that 10% penalty out of the water. And I don't like how they call it a penalty.

Darin: Right. You get a 10% penalty, but then you're going to also pay tax on it. So say you pull $100,000 out, you're going to pay a 10% penalty. Let's say you're in the 37% tax bracket, you're going to pay 37 grand in taxes.

Lane: That's correct.

Darin: So now you're 53,000 after tax.

Lane: Yes. So the first thing is that 10%. So let's move that off the table. The next thing is what you're talking about. You're going to have to take it as income. And you're exactly right. If you're in that higher tax bracket, it may not make sense for you to take it out. But I'm going to walk through these steps one by one, these situations. If you're in that lower tax bracket, $360,000, married, filing jointly or less, you don't pay that much taxes. Just take the damn thing out now. Then because you're in a lower tax bracket now then you probably will be in the future.

And the second thing is, I mean, I'm sure we all think the same way here. Taxes are probably going to be going up in the future. It ain't probably going to be staying the same.

The Importance of Being Knowledgeable of Tax Techniques

Lane: I mean, the government entitlement system, and how do you pay for all these stimulus programs? But I don't get political because I think that's a waste of time. But I'm just speculating that taxes will go up, and that's the second point why you take it out. Now as you mentioned, now it gets a little complicated and personal.

And this is where I tell people, "Well let's get on the phone. Let's hash out your personal situation as opposed to just listening to a whole bunch of random podcasts about random situations." But if your situation is a higher income earner over that $360,000 AGI level, now we have to scratch our heads and think a little bit. Because yes, you're going to be taking that nut punch, right, that 37%. I would probably still argue that it may make sense. See, here's what I say. My gut working with all my clients is it makes sense to bring you down to that level, or maybe just leave yourself at that threshold.

And this is why we say if you're higher than that amount, then it may make sense. But then I would probably argue, well, maybe there's some more exotic tax techniques such as land conservation easements, oil and gas, and other things out there that the wealthy will do. Because yes, you could put it into a self-directed IRA. And that's what all the self-directed IRA marketers want you to do is put it there into their schemes so they can make commissions and assets under management piece with that. But all I say is if you make over $360,000, stop and think about it. At least have a discussion with somebody who knows this stuff, unbiased.

Misconceptions Towards Retirement Accounts

Lane: I ain't going to get paid if you do solo 401(k) or self-directed IRA. I don't care. I'm just going to tell you when I would do. But it may make sense for you to push it, especially maybe you might be good on this financial independence path. You've got your net worth to 3, 4 million and you're going to retire in four years.

Let's just throw it all into a retirement plan now. And when your income goes down because you're not working your job and your AGI goes down, now we start leaking out $300,000. But then that second component comes in. A lot of people that come to me, they're in their 40s and 50s and they've blindly put their money in these retirement accounts, like good little boys and girls, and now they're kind of screwed, but now we have to work through this problem. And that's just what we do in real estate. We work through the problems. And they may have a couple million, a million dollars in their retirement accounts. And they're going to be like, "Oh shoot, it's going to take us a while to actually get access to the money to get into useful stuff."

Darin: Get it out, right.

Lane: Instead of the Wall Street garbage that they're already yet. I tell that to them after the fact, after they start working on it because if not, I'll offend them. But that's the truth, right? I think all of us listening know that those are retail products, and all those retirement plans kept you locked up in the cafeteria of all the cafeteria options. And we want to try and get out of that. But I mean, there are a lot of situations, right?

Lane Kawaoka on His Experience Towards Taxes

Darin: Yes, a lot of different situations. And then you have the other situation if say you're a syndicator that has excess depreciation that's been allocated to them so they have carried forward losses, well, that's a good time to be able to pull money out of retirement. Because that could cover the tax that you would've paid. You still pay the 10% penalty, but instead of paying the 37%, you've got losses that can cover over that.

Lane: Yes. But I mean, I'll just experience share. I mean, for myself and even passive investors who've dumped in more than half a million dollars into these real estate investments or more than a dozen deals, it always seems like they're passive activity loss. I mean, guys, go look. If you guys are in a dozen-plus deal, go look at an 8582 form. You probably are swimming in a few hundred thousand, maybe half a million-plus of losses.

Some of the bigger fish out there have a million-plus of losses. It really does seem that I think people, in the beginning, they're like, "Oh my god, when these deals double my money, I'm going to have all this depreciation recapture and I'm going to have to pay the tax man." That's not really how it seems to work. I mean, I've been through several of these rollovers, and it just seems like you just keep getting more and more of these passive activity losses.

Now, I know a lot of that was in the Donald Trump 100% bonus depreciation, but the bonus depreciation really doesn't give you too much more. I mean, it gives you a little bit more.

Lane Kawaoka’s Outlook for the Year 2023

Lane Kawaoka’s Outlook for the Year 2023
Photographer: Help Stay | Source: Unsplash

Lane: But you still aggressively write off the deal. Passive investors get that, you get to a point where you're just kind of untouchable. You stop freaking out about hoarding passive activity losses. I mean, case in point, I was worried about running dry on my passive activity losses at one time too. And I started to invest in the pref equity side of some deals, just to hoard some K1 losses here and there.

But then I looked at my 8582 form, and I'm like, "Is there a mistake here? I got a couple commas of losses?" I'm like, "Oh, that's going to be a while since I drained that out. But I ain't going to get off this." We call it the golden hamster wheel. "I'm not going to stop investing. I'm going to keep growing my damn money." Because these investments, especially workforce housing, is the backbone of America. It performs well in recessions.

Darin: What's a good time, you said you're not going to stop. But in 2022, you take a pause. What's your outlook for 2023? I have some people that are saying there's going to be all these great deals that are going to be coming in 2023. What's your outlook?

Lane: Yes, so the interest rates went up and took the wind out of our sails. I quite frankly can't make the deals work. When my debt service coverage ratio drops down and I have to pay all this extra money to cover the debt, it takes the cash flow away. And some people will make the argument. There was an article the other month about going into negative cashflow deals because you're getting better deals. To some extent, it's all individual deals and submarkets.

Inflation Is a Temporary Thing

Lane: But we've made the decision with 8,500 units, we're just going to huddle right now and focus on continuing value-adding what we have and just waiting for interest rates to come back to earth. Because I do believe it's a temporary thing. I mean, why did this all happen? Because inflation skyrocketed, and the Ukraine war. And COVID in China exasperated the supply chains, which further exasperated interest rates or inflation.

So now you're seeing the Fed pump interest rates up to create unemployment and to slow down the economy. So things come back. And we're starting to see signs of that. And I'm seeing signs that there is light at the end of the tunnel, which makes me believe that interest rates will probably come back to earth sometime next year. But I think as an operation group, we're moving away from the value-add deals a little bit in the long term.

Darin: Into what?

Lane: Just getting on more of the debt side, more secure, pref equity, and getting more into developments, I think. Where does this come from? I asked the question five years ago with my passive investor money, where am I going to put it? Sure, I'd like to invest with some operator who's been around since 2008.

The truth is they're not out there, guys. If you find one, let me know. But they're probably an institutional operator. So two things happened here. This is just my speculation. And if people have another idea, please email me and let me know. But my speculation is once operators get a decent track record, they either move to a different asset class, which is what I mentioned.

Moving Towards a Different Direction

Lane: We are going to more fund manager roles at pref equity, lower risk, lower return, and we're going into development. Or some other people I've seen, and I personally know these people, I've watched the pedigree of these people or the trajectory of these people and their companies.

They go to different asset classes like office, industrial, and more institutional asset classes, because the truth is multifamily is great and it's easy to get into, but that's the problem. Everybody and their mother is in multifamily real estate. And there's a lot of these guru groups that get a bunch of amateurs in it. Which is why it's super hard for me, we've moved past that billion-dollar asset mark.

Even when we went over the half-a-billion mark, that's when we started to hire employees that had industry knowledge. But there really isn't stopping somebody who hates their day job as an accountant or engineer or a doctor, of all things. Who has no business background, to get into buying a 100 or 200-unit apartment complex.

And when I see that, I want to get the hell out of that industry. I think it's very similar to you see a lot of amateurs buying short-term rentals. When anybody can just do it, that's the time to get out of that type of thing. So sure, we'll continue to use our capital group and maybe our broker connections to stay in this world. But in my opinion, I'd like to get out of this stuff. And I saw the writing on the wall maybe four years ago with one of our class C properties, is like I just want to stop dealing with freaking tenants. They're very unreliable.

How the Pandemic Affects the Different Asset Classes

Lane: I mean, when you have 20% of your tenants, which is typical for rougher properties, especially in the re-stabilization period that's just something I just don't want to really worry about anymore.

And this is why we've moved to more class B over the years. I don't think class A, the meat is on the bone there, but class B is that sweet spot still. But you still run into this delinquency. And now you're seeing all the rent moratorium evictions finally running through the court systems. Probably be up by next summertime after going through a year of that, the state eating that piece. But again, that's why we like the development. That's why we like the debt side because we don't have to deal with the freaking tenants, the variables.

Darin: Right. Now, you mentioned other asset classes, I mean, office, and industrial. You didn't mention retail. But between office and retail, industrial stayed hot. But COVID definitely had a major impact on both office and retail. And there were a lot of institutional players in that world. And on the debt side, I've heard people saying that they think that some of these large institutional players that have raised really large funds will start to buy assets, all equity.

Then wait for the capital markets to, like you mentioned a number of times, come back to earth, interest rates come back to earth. And then they can refi at a lower rate and pull capital out and pay back investors at that standpoint. So it seems like a tall order, but we all know that these institutional funds when they raise the capital, have these huge funds, they have to do something with it because the clock starts ticking.

Choosing the Least Amount of Disruption

Lane: Yes. And that's how their operators get paid by deploying capital. But they have a huge advantage over somebody like myself because their cost of capital is a lot cheaper than mine. When my investors invest with me, they expect to make pretty damn good returns. When the big institutions and REITs go buy assets, they're working with a gazillion mom and pas that have zero expectations. And that's why they can bid a higher price essentially than I can. And that's why I'm sitting on my hands right now.

I don't want to poo-poo on multifamily real estate like you mentioned industrial stayed pretty well. But the thing about industrial is you always think, how can this industry get disrupted? I mean, right now Amazon is buying up a lot of this stuff and it's making the prices propped up. But what if Amazon just decides, "Screw these warehouses, we don't need it. We'll just somehow get these magical drones"? They'll change the game, right?

And then as you're the guy owning 50,000 square feet, it's like, "Oh shoot," right? There's little chance of that happening obviously. But I think there's a lot lower chance of some kind of disruption in multifamily, especially workforce housing, with dudes renting apartments for $700 or $1,200 a month.

Darin: The other thing is, I know somebody that is in the industrial space and he was like, "Darin, man, you guys are so much better situated in the multifamily space."And I'm like, "Why?"

The Importance of Having a Diversified Asset Class

Darin: He's like, "Well, our deals typically are five-year contracts with rental bumps built in. But if we have true inflation, you can reset the rates annually with annual leases, and I can't. It's already baked into the contract. So we could end up not being able to push the rents anywhere near the ability that multifamily has."

Lane: Yes. So on that same spectrum with less sticky tenants, it going with that theme. As I mentioned, with the majority of our portfolio, we're staying put and playing more of a defensive strategy or that debt strategy too. But for a small minority, we're getting involved in hotels now. And something I'm learning that we've developed brand new, we just finished our 230 unit in Huntsville. And the lease-up phase is a year, which is what you want to project, typically.

Darin: For a hotel?

Lane: For apartments. We're at 50% now, I think a few months in. So we're good, and I'm sure we'll get it in the summertime, we'll get it filled up. But with hotels, you're 100% occupied the day you open. There is no ramp-up. And as soon as something changes in the economy or there's a big event, your average daily rate is how they measure it. It goes up and skyrockets. But at the same time, if there's a pandemic, you're a little bit more exposed. But I guess what I'm realizing as an operator and passive investor is it's good to be diversified into these different asset classes.

Multifamily is great. The cons are everybody and their mother does it and they bid each other up, and it's very incestuous. But I can't really fathom some kind of market disruption where the demand just tanks.

The Lessons Lane Kawaoka Learned Through His Experience

The Lessons Lane Kawaoka Learned Through His Experience
Photographer: Unseen Studio | Source: Unsplash

Lane: Sure, they can overbuild that stuff, but you can see that coming. You can look at your CoStar report, what inventory's coming online in the area.

But I think it's good to diversify in different asset classes. And the common theme is you're providing utility to human needs or basic needs.

Darin: So you've grown through the different processes or different phases, as you mentioned. What are some of the learning lessons that you've learned as you've gained that knowledge? I mean, you started out with single family, and then you've continued to scale. How does that knowledge play out for you over the years?

Lane: One big lesson learned is I'm just a little entrepreneur, I'm an engineer, but I don't have industry knowledge of being a property manager for decades. Which is why after half a billion, we start to hire professionals to do what we were doing. Become more of a professional private equity company and emulate the large guys but keep that small-town feeling, and direct to the passive investor. But the biggest thing overall is, and I don't know if it's a lesson, but you never know who's reliable. Everybody's a fake-it-till-you-make-it person until you get into bed with them.

And this is why I tell passive investors really the only people you can trust are other passive investors that aren't going to get paid some stupid referral fee or just spewing off like, "Oh yes, this person is good." But when you come to find out that referral source hasn't invested with anybody, let alone that person they're referring.

You Can Find the Right People Along the Way

Lane: This is what makes this really hard in the private fund, the private equity space, is verifying track record and experience. But once you do, you start to realize it's a small world. And once you start to grow your colleagues and investors, contacts, you start to realize it's a very small world and you stop taking chances with a bunch of random strangers out there.

I've lost some money and gone through ups and downs and deals with people we don't work with again. And I look back, and although at the time I didn't have the network that I have now to make sure that doesn't happen or do a real reference check. And what I say is a real reference check is somebody I personally know. We're bros, and my bro knows the track record of experience because he's invested with somebody or done business with them. That's what I'm talking about the gold standard. And that's why I say maybe it's nothing I could have done at the time, it's just what people have to do.

They have to lose money a little bit in the beginning. But now people bring me deals all the time and I'm like, "Well, who is this joker? Where'd you find this?" Everybody just goes on Upworks and finds the same VA to make some pitch deck, whatever, who makes a PDF in their mother's basement. This is real estate, it's all marketing, and shadow games. Until you can find people to verify track records and experience, you don't have anything.

Investing Requires a Lot of Time

Darin: That's a great point. I mean, I've had people contact me on Instagram and say, "Hey, do you want to help raise capital for this deal?" I'm like, "I don't even know you, man. Next time you're in Dallas, let's get together for coffee. I don't even know who you are or what you've done." So hey, what do you like to do for fun outside of work?

Lane: I don't know, Darin, man, I struggle.

Darin: You just work, that's it, man? Come on.

Lane: I have a young kid now.

Darin: How old?

Lane: I guess by the time this air, maybe a couple of years old. So my time is filled up with this, that. And I'm realizing, "Wow, no wonder all the investors are in their 40s," because they have kids in their 30s, and then just nothing happens. All focus goes to this, which is why thank goodness I started investing prior to having kids or getting married.

Darin: Good for you, man. And you live in a really tough place to live. Where do you live?

Lane: Hawaii.

Darin: Hawaii, yes. Violins are playing for you.

Lane: So when there's snow and all these things, I'm not worried about that type of stuff. But yes, that's something I struggle with. I mean, I just work all the time. And we're still trying to get that business where I'm totally hands-off. We have the C-suite is hired out. But I still like to interact with the investors. And one of my big things was to create a boutique company where people know each other. I'm from Hawaii, everybody just knows each other.

There’s Risk in Every Investment

Lane: It's like family. It's 'ohana or you East Coast guys, it's kind of like cheers. Everybody knows our freaking name. That was the vision that I wanted, and to invest with a cohesive group that if distributions aren't made, they understand. They get it. They understand what happens and they know that we have their backs and we're acting as fiduciaries.

And by the way, the other nine deals that they're in are doing swell. I mean, most deals go really well. I mean, I would say maybe 10% of the deals, it takes a while to get it back on the rails. But you never lost investor capital and I plan not to do that. I'm doing everything in my power to avoid that.

But I mean, in every investment there's risk, and I think that's where trust comes into this.

Darin: Right. So 8,500 units, what's the next big stretch goal?

Lane: I don't know. I mean, I don't really do that number count. My marketing team says, "You need to get to a certain number," but I just tell them they got to just work with what they got. But I don't know, man. I mean, I'm just trying to just guide what we have to a safe landing. And then if we get some more, we get some more. I think my goal is I would rather get off the train of setting the expectation that we're going to do all this value-add and go through all the headache and turmoil of dealing with tenants and doing the more heavy, medium value-add. And maybe we don't double investors' money in five years.

The Idea of Simple Passive Cash Flow

The Idea of Simple Passive Cash Flow
Photographer: Alexander Grey | Source: Unsplash

Lane: I would rather get on the side where it's just more on the debt side, more secure. Something where people can feel comfortable putting a larger amount of their net worth. Because the truth is, for new investors, I mean, I see what they're doing. I mean, they're just putting in a small manini we say that in Hawaii. It's like an insignificant portion of their net worth, 5%. Whoop-de-do. Dude, this ain't freaking magic. Even if you double your money in five years on 5%, that ain't going to change your life. Now I get it, you're trying to get proof of concept in the beginning.

But I would rather create the product where you feel comfortable because it's backed by a hard asset. You're just getting monthly payments. The whole idea of simple passive cashflow from when we started this whole concept, mailbox money, something you can rely on. And the principle is safe, that if you can hit 12%, 10% reliably with a good Sharpe ratio, then why not take that all day long?

I mean, this is what we teach on the consulting side, is if people can get your net worth to $4 million, $5 million net worth, and a measly 4% rate, you're FI. Now double that or triple that with 10%, 12% and now you're living like a king at 4 million. And I think that's where most of my investors, it's not about the investments, but it's about tying the taxes and the infinite banking together and really optimizing what this is. You don't need one of these outlandish developments or venture capital. You don't need to do that.

How Lane Kawaoka Build A Long Lasting Legacy Wealth

Lane: You just need to have the majority of your money making low double digits or 10%, and you're cool. And that builds long-lasting legacy wealth, especially if you're already a frugal person already.

Darin: Right. And if you're getting the tax benefits, right?

Lane: Exactly. I mean, most of my investors have ran 37 miles at a 27-mile-long marathon. It's ridiculous. And maybe that stems from me here. Why do I have no freaking hobbies? Why do I keep doing this? I mean, it's just no different than my investors. The reason we got to this point is because were frugal with their money. We knew the value and we worked hard. But the problem is you never know which day's your last.

And until you have a death in the family, a near-death experience, maybe some people do mushrooms or go to a psychologist or whatever. You don't start actually enjoying what you have until you lose it or something like that happens. And if people have a million dollars net worth, you could probably cash flow that thing at six figures and quit your day job. People won't do that, but you could.

Darin: Yes, I agree. People won't do that. And I also agree with what you said before about people will test out. First of all, it takes a long time to get somebody to agree to part with any of their capital to try something new because it's scary. They haven't done it before. But when they do decide, they typically are taking a small portion of their net worth. And then it could be a 3, 4, or 5-year hold before they end up proving the concept.

Meeting Other People Helps You Get Information

Darin: And they had all their capital sitting in a low return elsewhere. So in any event, hey, if people want to reach out to you, what's the best way for them to do that?

Lane: Yes, they can hit me up, email lane@simplepassivecashflow.com. Check out my podcast, Passive Real Estate Investing, via Simple Passive Cashflow. And yes, I think I live the same path as you, Darin. This stuff works and people come and drink from the river. I guess use that analogy. But a lot of people don't take that jump. And I think what it is, it's the community. That's why we do events. I think in a couple of weeks we're doing the annual Hawaii retreat for our investors. And I always feel like that was a big thing for me back in 2015.

Going back to my story, in 2015, I was just picking up single family home rentals. I didn't live in my mom's basement, but essentially I was just all by myself, and I just didn't talk to anybody. As people say in Japan, "hikikomori" just played video games, even though I didn't play video games, I just read about real estate and looked for deals. But I just kept to myself.

And I think that's what a lot of people do, especially post-COVID. Everybody's just like loners. And it's super important, especially when your net worth becomes a million dollars or greater, is you got to get your ass out there. And you got to meet people to verify where you can put your money, more importantly, you're going to stay away from. If not, you're just going to get the garbage on the crowdfunding websites put up by broker-dealers who are making the cut on that.

Lane Kawaoka’s Telltale Story of Investing

Darin: Yes, I mean, that's huge. And also, those people that are in your world that are not in your surrounding network that can show you the way and teach you. Because if you have the highest net worth of your little network, then you're not going to learn anything from those people. They're going to learn from you. But you got to get out there and meet other people. And I've had plenty of people that have taught me, "Hey, you got to read this book, you got to look into infinite banking." You mentioned infinite banking three times. I didn't know anything about infinite banking. And I set up a plan like three years ago. But I would not have known anything about it if I didn't get around other people.

Well, I appreciate you coming on. Definitely look this guy up. He lives in a very cool place. And he started from humble beginnings. It's the telltale story of invest in real estate and waiting. Because you invested in real estate and then you start compounding it and you take those gains and you roll it into other properties. The next thing you know, this guy's got 1.2 billion in assets under management. So Lane, again, appreciate you coming on. Listeners, till next week. Signing off.

How To Reach Lane Kawaoka

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Darin Batchelder

Wealth creation through real estate provided me with a new passion to get the word out and let others know that they have an alternative to investing in the stock market.

If I can inspire and educate just one person to take action that results in life changing wealth creation then the work to launch and grow this podcast is well worth the effort.

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