Last weekend at the MIT FinTech conference, Kevin “Mr. Wonderful” O’Leary gave a great presentation on his investment philosophy and some of the things he’s learned over his career. At the end, audience members were able to send in questions – and I lucked out and had my question answered just before he wrapped up.

See his response here:

An interesting response – and maybe more interesting that this is just one area in which FinTech will impact real estate investing in the not so distant future. If you’re interested in learning more about some cutting edge companies and startups poised to shake up the real estate landscape, I recommend taking a spin through CRE Tech and signing up for their news bites.

Jake and his business partners own and operate an impressive portfolio of short term, Airbnb luxury vacation rentals throughout the south. We first met at our “day job” company, and before too long we were talking to each other on a daily basis about our real estate investments, and helping each other come up with new ideas to grow. We co-run a real estate investment interest group with monthly meetups, and continue to help each other reach our investment goals.

On how he got involved in real estate and Airbnb

I was interested in real estate probably starting in high school. I attribute most of that to my dad and other family members that have either made a career out of it, or have made personal investments. With my dad, I saw what it was like to act from an investor’s perspective – which is what I wanted to do first versus actively taking on a project myself.

My dad was a part-time investor, and I saw that some of his deals produced really good returns (while others did not). From his perspective, by being a passive “money guy,” you can make some solid returns with very little work. So while it’s a risk (just like investing in the stock market), if you have a good strategy and understand the deals you are getting into, there’s a lot of money to be made.

On his first deal

I started saying OK, long term I think there will be good opportunities in real estate, and I think a good way to get my feet wet is to invest in someone else’s deal and see what the returns look like. I connected with one of my friends who was starting a real estate company that invests in luxury vacation rentals. He started showing me some of the returns that he was seeing, and I decided to finance a deal.

The downfalls to this model are that (for the deals I was investing in), it required much more upfront cash than normally – mostly because of the furnishing costs associated with doing a luxury airbnb. Other than that, there are decisions you need to make upfront, similar to a “normal” rental property. For example, deciding if you’re going to do a gut reno where you can add a lot of equity, but will take a few months before you can get any renters in, versus doing something more turnkey where you can get going in much less time, but are paying a premium for the quality.

So when we were going through our first deal we decided to do something not quite turnkey, but close, just to keep things simple and rehab variables lower. Based on our forecasts, we thought we could clear 20-30% returns, if not higher. Compared to traditional rentals, the returns were a bit higher, but so was the risk. You have a lot more upfront cash required and you have to worry about regulations / policy, and also reliance on a third party website to drive all of your revenue. And if anything happens with that, what do you do next?

There’s a lot of unknowns in the airbnb model versus, for example, buying an apartment building, where you have long term renters in there and it’s relatively safe, and you have steady income for a 12 month period of time unless something catastrophic happens. With airbnb, you just don’t know what it’s going to be. It’s not predicted every month, we can forecast and we can plan, but you have to worry about weather patterns and people canceling and all these different things that are tough to plan for. So risk is higher, but there’s a lot of money to be made if you have that tolerance.

On how he and his partner structure their deals

Every deal is different in terms of equity splits and capital contributions. For the first deal, I came in with the down payment and all the set up costs. I was basically the bank. I was getting the benefit of the model and all the work, operations, communication framework and organization etc.. and they were getting the benefit of my capital.

On avoiding disastrous visitors

We have clear guidelines on what type of visitors we look for at our place, and have a sense of what will turn into a big bachelor party or something like that, which we try to avoid.There are red flags we look out for.

For example, you can look to see where someone’s hometown location is. If their home base is Boston and they’re looking to rent a four bedroom home in Boston for one single evening, you can infer that they may be looking to throw a party.

On creating an efficient operations machine

You have to consider the costs of managing resources, whether onshore or offshore, and the time it takes to coordinate and manage them.

If you’re worried about stress and time, this is not the model for you if you’re comparing against long term traditional rentals.

You either have a lot of time committed to do the ongoing operations and management, or you’re paying someone to do it. And even when you’re paying people, it still takes time to manage and coordinate everything. Every time a guest leaves, which is typically a 2-3 night stay, we have inspections, supply and inventory restock, cleaning, guest reservations and communications and correspondence etc.. There’s a huge checklist that has to be worked through every single time we have a unit turned over.

At this point because the company has expanded so much, day to day operational tasks and anything related to the property management is either outsourced or done by an employee of the company.

This is important from an ongoing maintenance and turnover perspective, but also when we’re doing the rehab and getting the property set up and furnished.

We compete with luxury brand hotels, and are looking for visitors to say “okay we have a four bedroom luxury home that’s decorated just like it would be if you stayed at the Ritz or the Four Seasons, but we can get this home on a Saturday night for $1,400 vs. $2,600 for four rooms at the Ritz or 4 Seasons.”

So it’s a win-win for everyone. With our house, you have a kitchen and living room and you can all be connected in the same property, versus four rooms scattered throughout a huge tower in New Orleans.

By competing with the luxury hotels, we can’t necessarily just go to IKEA and put random crap together. People want to see 50 inch plasma mounted on the wall with no cords hanging out. They want to see a nice glass table, high end cutlery and cooking utensils, and on the walls they want to see nice looking paintings and artwork. We’ve tried to do this the most economical way possible, but need to maintain a certain luxury appeal.

On having great pictures

It really makes a difference – and it’s not even just about the reviews afterward. It’s about getting people on the listing because of the pictures, so of course the pictures have to be professionally done. We’ve tried to do the pictures ourselves and it doesn’t really work.

[Editor’s note: for some insight into how important pictures really are to an airbnb success, listen to the “How I Built This” podcast episode with AirBnB founder Joe Gebbia]

On cleaning in between stays

We go with a cleaning agency.

Because of the volume we do – sometimes we need seven cleanings done on the same day – it’s not really possible for one person or even one team.

These homes can take three hours for a single person to clean. We

pay a premium versus hiring people independently, but we’re guaranteed that there is a body there to do it.

On the downside, the risk with that is you don’t always have consistency.

I met Craig through a friend last year, and have watched him go from thinking through real estate investing as a passive income strategy to attacking the Indianapolis market and acquiring his first two properties. Below are some of his thoughts on choosing a market, investing remotely, and helpful resources for education and networking:

On his tech background and how he got into real estate…

Craig: I had worked for a startup through college and then considered continuing with that when I graduated. In college, the advice I got was essentially to go into either investment banking or management consulting if I wanted to stay in business. I chose management consulting, and did that for a few years before deciding it wasn’t for me. So a few years out of college I quit my consulting job and just moved to San Francisco with the goal of finding a job at a startup. I was interested to see if I could make a career out of that. I did a bunch of research on potential startup jobs and ended up at this awesome company called TellApart – an advertising technology company. I had a ton of fun working there and met a bunch of really smart people.  

Long story short, Twitter acquired TellApart a few years ago. It’s still Twitter’s largest acquisition to date. I didn’t have a ton of equity in the company because I was kind of low man on the totem pole when I joined. Still, the acquisition was worth enough to me where I had to really start to think about how to invest my money for the first time in a meaningful way.

I had a few friends who were thinking about real estate, which I always thought is this scammy thing where it’s these slimey gurus pitching their programs and it just kind of turns you off. But I had a few smart people I trusted really look at it and then I decided to take a look at it for myself. After reading a bunch and digging in and doing research for about a year, I decided to pull the trigger and see if I can get better returns in real estate than I was getting in the stock market or other opportunities.

And that’s essentially where I’m at. I did research for a year and acquired two properties in Indianapolis, which is where I grew up. They’re both almost done with the rehab and probably will be rented within the next couple of weeks. I’m still learning and still in the middle of things there. But it’s exciting to think that within the next month or so I’ll start receiving rent checks for both properties and really start to get the payout for all this work.

On the resources he found most helpful for education and motivation

Craig: Looking back the resource that provided the most value to me was Rich Dad Poor Dad, which I feel like most people had read at point but I hadn’t. That was really motivational. I think Bigger Pockets was great for networking. I just cold messaged people after they were posting things I thought were thoughtful. A ton of them agreed to meet with me. I talked to three or four people who’ve been on the podcast. I met my mentor from BP, and several other folks who have been helpful along the way. I definitely think from a networking perspective that Bigger Pockets was actually surprisingly good. From a raw educational perspective I think the Bigger Pockets Book on Managing Rental Properties covered all of the basics.I don’t think it’s necessarily comprehensive, it’s not sufficient to stop there, but it will give you a good idea of why this works in different scenarios, but I think for me  the whole point is when you finish reading you really want to take your investments to the next level.

On choosing Indy as his market

Craig:  So if you actually if you look up on bigger pockets I did an in-depth forward looking analysis of what I thought the top MSAs were to invest in real estate in. And eventually after doing this crazy in-depth analysis I decided that as long as you’re in a top 20 market, they’re not all that different from each other, and what becomes much more important is relationships and having an idea of the neighborhoods, and just being able to build a network out there. The people you work with are going to significantly impact your success – especially for an out-of-state investor like me – much more than the actual market you choose.So you can be successful in the best market or the 20th best market or anywhere in between, it’s just important that you want to have a connection that market. So I live in San Francisco, which is not a good market for cash flowing properties. I don’t know any smart investors out here doing that. So the next best market for me was Indianapolis, because that’s where I grew up and my parents still live there. And Indianapolis is a great cash-flowing market. So that’s how I ended up in Indianapolis.

On investing out of state

I think there are a lot of ways you can do it. It’s definitely more difficult than investing locally. So if your local market is better I would stay local, but there area lot of things you can do to make long distance investing easier on yourself.

One option is turnkey – just going with a company that supposedly does everything for you and you can just buy at market price. Based on my research, I’m not a huge fan of turnkey in general. So what I did is kind of like a hybrid turnkey / do it yourself model. I have a local partner who I pay a fee to who manages rehabs for me. He’s not a GC, he’s a project manager and interfaces with the GC and the subcontractors and everyone else around. And then he will also be my property manager too. So he’s going to have been involved in the project from the beginning. I pay him a fee to manage the rehab and then he’s taking a percentage of the rent once the property is finished. So that’s my model to avoid going the turnkey route, but not to go full on DIY, which I don’t think would have worked for an inexperienced out of state investor.

So so far this has been working out pretty well. I don’t get as good a deals as guys who are really on the ground hustling, but I get much better deals than turn-key. I’m also much more confident that the work going into these distressed properties I’m acquiring is being done well than I would be by trusting a turnkey provider.

Also, I really like my day job. I think a lot of people and real estate are doing it to get out of their day job. I’m not. I’m just doing it because I think it’s a good investment. And I want to spend my time with my family and I want to focus on my job. So paying the project manager allows me to do that and I think it’s worth what I pay him.

On why he picked a single family rental strategy

My target properties are single family homes in Indianapolis rent for at least $800. I prefer them to rent for $1,000. In Indianapolis, small multifamilies are usually in a war zone. So if you’re buying a duplex or quad in Indianapolis, most of the time it’s in a really bad neighborhood. For whatever reason it’s just kind of how the city is laid out. On paper the price to rent ratio and all that to look amazing but in practice most experienced investors will tell you that your paper returns aren’t going to be your real return. So that’s one of the reasons I focus on one single family.

Another reason for me is that Indianapolis tends to be a pretty boring real estate market for single family homes and there’s always going to be a market for them if you want to unload them. So being new to real estate investing, I didn’t know if this is going to stick long term, and I’m still not 100 percent about that. So it’s kind of an easy way out for me as well. The price of these houses are not so high where making a mistake on a single home is really going to hurt me too much.

So those are kind of all the factors that led me to single family, and then I also have rent minimums for two reasons. For one, with certain rent thresholds in Indianapolis – or any market – the quality of tenants improves significantly, and the headaches to manage goes down, even if you’re hiring a property manager. It’s not uncommon for a property manager to fire their clients because the properties they’re being asked to manage are just not worth the percentage of the rent that they’re getting. So that was important to me being out of state. Second, the other piece is that when the rent is too low, your expenses can catch up with you too quickly. Some costs don’t change based on the type of home. For example water heater in $500,000 home is the same as $50,000 home, so your capex and repairs as a percentage of tends to go down as your rents go up.

On his long term plan for real estate

My long term plan is to generate enough passive income to cover my cost of living in the Bay Area, which is very high compared to the national average. It’s going to take a while to get there. I think I’m probably going to do a few flips while I try to replenish the capital I put into the rentals, and then I’ll get back to buying more single family homes and repeating that cycle.

And then at that point I’ll probably have to take a look back and assess how scalable I feel this is and maybe look into multifamily. There are others that have come up that seem like a better option. The funny thing is once you start getting into real estate and you’re actually purchasing a  property and working on it, people are more interested in sharing what they’re doing. You also start asking much better questions.

It’s still a bit surprising to me all the different ways you can make money in real estate. I’ve learned at least a dozen different strategies to generate passive income in real estate that I wouldn’t have anticipated going into it. So I’m just keeping an open mind, I do think I’ll stick with this for a couple of years or so but then at that point I’ll probably take a step back.