The 3 Stress Tests Every Real Estate Deal Must Survive

Summary

Radical Wealth Plan – Episode Summary

Podcast: Radical Wealth Plan
Host: Paul Morris (with Joey Sakovich)
Episode Title: The 3 Stress Tests Every Real Estate Deal Must Survive
Date: January 20, 2026

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Episode Overview

In this episode, Paul Morris and Joey Sakovich break down the essential process for analyzing a real estate investment deal, emphasizing the three critical "stress tests" that every property must survive before purchase. Designed both for newcomers and seasoned investors, the conversation cuts through complexity by focusing on practical frameworks and real-world examples. The episode dives into deal underwriting, value-add strategies, and, most importantly, the methods for protecting against the most common (and costly) deal killers.

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Key Topics & Insights

1. Setting the Current Real Estate Context

[00:14–02:03]

• Interest rates have doubled in the past five years (now 6–7%), dramatically changing deal viability.
• Residential mortgages are usually 30-year fixed; commercial loans are typically much shorter (5, 7, or 10 years).
• Many investors bought properties that "worked" under old rates, but are now in trouble as rates reset.

2. The Essential Deal Analysis Spreadsheet: The Eight Elements

[01:27–01:53] Paul lists eight numbers every investor should use to analyze a deal:

• Gross rent
• Vacancy rate
• Operating expenses
• Net operating income
• Debt service
• Cash flow
• Cash invested
• Cash on cash return (sometimes referenced as cap rate)

Quote:
"Not all eight of them are very complicated. And there’s only eight." — Paul [01:17]

3. Why Most Investors Lose Money

[01:53–03:02]

• It's rarely about buying in the wrong neighborhood; it’s about buying "a bad deal that looked good on the back of a napkin."
• Underwriting reality, not optimism, is crucial for deal survival.

4. Framework vs. Advice: Underwrite Reality, Not Optimism

[03:09–03:45]

• Ignore pro forma appreciation — if the deal needs appreciation to work, don’t do it.
• Focus on cash flow and value-add opportunities.

Quote:
"If the deal doesn’t make sense without appreciation, I’m not doing the deal. That’s one of the things: define the win." — Paul [03:28]

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5. Value-Add is the Path to Protection and Profit

[03:48–06:58]

• Value-add strategy: Buy properties that need improvement, not "done, done, done" at retail pricing.
• The renovation budget creates a pricing buffer. If the market drops right after you buy, your improvements can still generate equity and possibly maintain your profitability.

Anecdote:
Paul describes buying the "Ugly Duckling" in a hot market, instead of the finished product. When the market corrected, the retail buyer got hurt, but Paul’s renovation budget allowed him to maintain or even gain equity.

Quote:
"That’s what protects me. And that’s why I always say that I make the money on the buy." — Paul [08:48]

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6. Defining Each Line Item — The Eight Essentials

a. Gross Rent

[10:39–11:43]

• Simply the total rent collected (monthly or annually).

b. Vacancy Rate

[11:43–13:32]

• Always include a vacancy assumption (at least 5–7%) — even in hot markets. One turnover can mean several months empty, especially in small properties.

Quote:
"You still have to work in at least a 5% vacancy. Here’s why: Somebody is eventually going to move out and you’re going to have to paint and you’re going to have to make it." — Paul [11:21]

c. Operating Expenses

[13:32–15:53]

• Use the real number, not the "fantasy number" from the broker’s packet.
• 30–35% of effective rent (after vacancy) can be a good rule of thumb unless the building is new.

Quote:
"I’m going to tell you, when people put the package together, it’s the fantasy number... I call that all fantasy. ... How much have I spent total in the last 18 months? Divide that by 18 and give me that number. Reality." — Paul [14:06 & 14:54]

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7. Cash Invested, Cushion, and Value-Add Budgeting

[15:56–18:48]

• Paul puts more cash down (30% vs. 25%) and adds additional cash to cover future improvements and operational cushion.
• Avoid buying fully improved properties at retail unless you’re aware of the risk in downturns.
• Capital allocation examples:
  • For a $1M property, put 25–30% down, reserve $200K for improvements, plus ~$50K as an operational cushion.

Quote:
"I want to have a cushion because I’m not buying that property that is in A+ condition because I don’t want to end up like the guy that bought at the top of the market with no room to move." — Paul [16:15]

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8. The Three Stress Tests Every Deal MUST Pass

[20:49–33:26]

1. Vacancy Stress Test (COVID as an Example)

[20:49–22:47]

• Ensure your numbers work even with higher-than-average vacancy.
• Properties in high-demand neighborhoods and entry-level price points are more resilient.

Quote:
"Here's what entry level into a great neighborhood is: you have the nicest unit for the least amount of money into a great neighborhood. And when you've got that, you have lots of demand." — Paul [21:17]

2. Expense Shock Stress Test

[23:26–29:32]

• Prepare for unexpected large expenses: roofs, plumbing, electrical.
• Solve this by line-item budgeting, due diligence (e.g., sewer scopes), and building expenses into the model over a few years.

Quotes:
"I put it in line item by line item. So I buy the Ugly Duckling building, I get the roofer up there... I'm putting it into the 2, 3, 4 year category." — Paul [26:44, 29:05]

3. Rate and Refinance Stress Test

[29:44–33:26]

• Don't rely on short-term loans (5, 7, 10 year); always plan for interest rate increases.
• Fixed, long-term debt is safer—even if it costs a bit more.
• Always question whether your deal can survive a rate hike or a need to refinance in a tough market.

Quotes:
"The last stress test is the rate and refinance stress test, which people did not take... I do not have a crystal ball. And I will tell you, five years ago when rates were 3%, I was getting 30 year." — Paul [29:44, 30:39]

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Notable Quotes & Memorable Moments

• "We make money on the buy." — Paul [08:48]
• "Most investors... lose money because they bought a bad deal that looked good on the back of a napkin." — Paul [01:53]
• "Underwrite reality, not optimism." — Paul [03:09]
• "Expense shock stress test is just go line item by line item. ... I’m treating it like it's happening now or... budgeted into the next three years." — Paul [33:02]

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Timestamps for Key Segments

• The Eight Essential Numbers – [01:27–01:53]
• Value-Add vs. Retail Example – [03:48–09:02]
• Vacancy Rate & Realistic Assumptions – [11:43–13:32]
• Operating Expense 'Fantasy' vs. Reality – [13:32–15:53]
• Three Stress Tests – [20:49–33:26]
  • Vacancy – [20:49–22:47]
  • Expense Shock – [23:26–29:32]
  • Rate/Refinance – [29:44–33:26]

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Episode Tone and Takeaway

Paul Morris brings a practical, straightforward tone—eschewing theoretical optimism for hard-earned, reality-based frameworks. The advice is approachable yet rigorous, illuminated by real-life deals that went wrong for others but right for him due to careful upfront planning and disciplined "stress testing." Joey Sakovich’s interjections ground the conversation in common investor concerns and reinforce Paul’s methods.

Final Note:
If you internalize and routinely apply all three stress tests to every real estate transaction, you’ll protect yourself from the mistakes that sink most investors—even in challenging market conditions.

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Listen for: Concrete steps, detailed explanations, and clear, repeatable frameworks—so you can analyze deals like a pro and survive any market.

Transcript

[A]

Joey Sakovich, Paul Morris, welcome to Radical Wealth Plan. Woohoo. We are going to tackle something big and that is we're going to analyze a deal in 20 minutes or less. Let's go.

[B]

Let's not waste a minute.

[A]

And one point of reference is that, you know, rates, depending on product type, you're dealing with somewhere between 6 and 7% right now. Just five years ago you were looking at rates that were about half that. So when you do this analysis before, you're buying things that right now don't make sense, that rate adjusts on you, you're in a world of pain.

[B]

Yes.

[A]

So let's go, let's go.

[B]

All right, so let's, so, you know, let's first set the context of this particular deal and, and any expectations that go along with that.

[A]

Okay, so we're going to do, we're going to do definitions. I'm going to talk to you about eight things. Some of them are very obvious, some of them might not be. And I'm going to tell you, if you're early into this, if this sounds like something like, oh, wow, this is just too complicated. I say put the pause button on too complicated. Because here's the thing, not all eight of them are very complicated. And there's only eight.

[B]

Yes.

[A]

So let's hit the easy ones. We'll hit the ones that are a little less complicated. Yeah. And there's only eight. So let's go, let's go.

[B]

All right, what are those eight, those eight elements that you want on the spreadsheet, Gross rent.

[A]

And we're going to get into each one of them, but I'll just throw them out there. Gross rent, vacancy rate, operating expenses, net operating income, debt service, cash flow, cash invested and cash on cash return, which people of course refer to as a cap rate.

[B]

Most investors, they don't lose money because they got the neighborhood wrong. Right. They lose money because they bought a bad deal that looked good on the back of a napkin.

[A]

Yeah. And one of the things we're going to do is we're going to talk about the exact stress tests that kill most deals. It should kill most deals before they kill you. Yep. Okay, so I mentioned this before and that is basically, you know, same time, five years ago, rates have doubled. Now one of the things with commercial property that people don't understand is that commonly in residential, very common, what you're dealing with is a 30 year mortgage. And it might be a 30 year fixed.

[B]

Yep.

[A]

For commercial, you're generally not getting a 30 year fix. You're getting a 5 or a 7 or a 10 year. Now, rates were less than half five years ago. So if you bought five years ago, even if you have a seven year adjustable, you're looking at a world of pain coming in two years.

[B]

Yep.

[A]

That's going to crush your deal. It could crush your deal if you didn't buy it. Right.

[B]

Rates change the math. It breaks a deal. Don't give us advice, give us a framework of a good deal.

[A]

Okay. And so then what we're doing is we're underwriting reality, not optimism. And one way that we do that is when I look at pro formas, they're looking at, at appreciation. I never look at appreciation. So it's possible the market goes up, it's possible the market goes down. So I don't even think I'm being that conservative by just saying no appreciation. We know over time real estate appreciates, but the deal doesn't make sense without appreciation. I'm not doing the deal. That's one of the things define the win.

[B]

Define what a good deal looks like.

[A]

So you need a deal that's going to pay you monthly. And essentially what that means is it cash flows. Sure. The only way in these markets that you can get something to cash flow is you have to buy something that has at least a simple value add. And what I mean by that is if you have a property that's in a very good neighborhood and it's done, done, done, you're going to be paying full retail. Now, when you buy something that's on the market, by definition you are buying retail. But one way to avoid buying retail, even when you're buying something on the market, is you buy something that has value add. So now in that deal, in that $1 million deal, I'm not buying, I'm not buying a property that's a million dollars. I'm paying $1 million. It's worth $1 million. Why is it worth $1 million? Because it's throwing off this much rent. I'm buying that property that essentially is worth $1 million because the rents are depressed, because there's something wrong with it. Because I can put $200,000 into it. Now I'm into it for a million two. And I can justify rents that really match a property that's worth a million five. And that's how you, you really protect.

[B]

Yourself, by affecting the value, future value, bringing future value to it.

[A]

Correct. So, for example, I have bought property in all markets. I can never determine exactly what is the top or the bottom of the Market I, sometimes I'll have a sense like, you know, it's so overheated, it just feels like the top of the market. But that's been happening for a long time. So buying I couldn't, I'm not sitting on the sidelines. I'd be on the sidelines forever. So I'm protecting from a market correction by buying something that's value add. So if I buy it on the last day right before the market crashes, I'm now in that $1 million building that's really worth $1 million. But I know if I put 200 grand into it, it's worth a million five. Let's say the moment I buy it, the market crashes. Now I have a million dollar building. It's unusual for something to go down 20% in, you know, a short period of time. Let's say it takes a big hit. Now it's suddenly it's worth $800,000. I take that $200,000 that was earmarked to put in the million dollar property. It's not only worth 800,000, I put that $200,000, I put that $200,000 into the property. Now I'm at a million two and I've harvested some value so that we're really, I have a million two into might not be worth a million five as I had hoped, but it might be worth a million three. It might be worth a million two fifty. I'm still ahead of the game today. Yes, today. And then later it goes on and on and on. But I don't have to sit with that million dollar property that's taken the immediate hit. It's now worth 800,000 and I've got to wait, wait, wait, wait, wait for appreciation to fix the error.

[B]

You're affecting the, the appreciation or the capital value of the property.

[A]

Correct.

[B]

With your investment.

[A]

So at a period of time, for example, I'll give you a real example for a period of time when I was buying houses in Joshua Tree and it was right before there was a market correction, they were selling the done, done, done house at a million one like ready for short term rentals like beautiful tricked out and, and the, and the numbers made sense because you're getting so much short term rental income that it justifies it. I could have run out and done that. And in fact the, the buying, the one that's the Ugly Duckling is essentially keeping me out of the rental market. I can't get in the rental market because I bought the Ugly Duckling. Nobody wants to rent it, that's why it was selling for $500,000 while the other one was selling for a million one. But I knew for 250 grand I could get it to be just like the million one. Now market shifts. We didn't know that the guy that's sitting at a million one, his property is now worth $850,000.

[B]

And he has no upside in it.

[A]

There's no upside.

[B]

He can't bring anything because it's fully realized.

[A]

Correct. On the other hand, now I bought this, you know, dump for $500,000. I have the $250,000 set aside. If the market had stayed the same, I would put that $250,000 into it. I'd be into it for 750. I'd be at 1:1. Boy, that sounds great.

[B]

Right?

[A]

But that 1:1 got crushed all the way down to $900,000. So now my $500,000 dump, I add $250,000 to it. I'm at 750.

[B]

You're still ahead of the game.

[A]

It's still worth 900,000. And so that's what, that's what protects me. And that's why I always say that I make the money on the buy.

[B]

Absolutely. As most good investors do.

[A]

Correct. And there are times, there are moments in time. Like, for example, if the market had not cr. I, I didn't see the market crash coming. Let me, Let me be clear about that. And when I saw the person buy the house for a million one, I was a little jealous because they are. They are buying at a million one. When you do all the short term rental math. Okay, yeah. They're getting 20% return on that. Okay.

[B]

Cash on cash.

[A]

Yeah, cash on cash. And I'm buying with leverage. Yeah, but they're cash on cash. And I'm buying this $500,000 dump. Now I gotta call the construction guys. I gotta get all these things done. And I'm out of the rental market while he's collecting, you know. Now we didn't see the crash coming when the crash came. Got hurt very badly. They got hurt very badly. I just kept going, you know, okay, well, we. Geez, we. Sweetie, we gotta get the pool permit. That takes a while. It's. Everything is taking longer. And there's a lot of room for mistakes. There's a lot of room for, you know, it didn't go exactly how it wanted. There's the old adage of it always costs more and takes longer. When you're buying the $500,000 property, you put 250,000 into it and your. Looks like it's going to be worth a million one. You've got a lot of room for error.

[B]

Yeah.

[A]

And the truth of the matter is, personally, I'm great at identifying that property, great at creating the vision for it. I'm not great at the execution. So I have to have somebody else that can execute.

[B]

Manage that.

[A]

Yeah, they can. They can execute all of that, get all of that construction done.

[B]

Got it.

[A]

That's it. The definitions, please. Okay. Gross rent. That's a simple one. That is simply the amount of rent that you collect.

[B]

So monthly, Yearly.

[A]

Yep. How many. You know what, what's your rent? If it's $2,000 a unit, you've got four units, $8,000 a month. There you go. That's your. That's your, you know, $96,000 a year, $8,000 a month gross rent. We've got that covered. Now let's talk about a vacancy assumption. And one of the things that people do is they will literally leave the vacancy assumption out. And here's why. I've got four units. All four units are filled. We are in. That's. Let's use my property in Culver City. I mean, it's in such high demand, you know, there's no vacancy. Okay. You still have to work in at least a 5% vacancy. Here's why. Somebody is eventually going to move out and you're going to have to paint and you're going to have to make it.

[B]

It's off the market for a period of time.

[A]

Right. It could be off the market even in a hot market for two months. Because I got to get in there, I got to clean it up, I got to paint it, I got to. Oh, a couple of things are. Need to be tweaked. And then you put it back on. You want to make sure you're getting a great 10. You're not going to take the first tenant that walks through the door. You're taking a bunch of applications, you're sorting through them. So, you know, people really look at a 7% as a vacancy rate, acceptable vacancy rate.

[B]

7%.

[A]

Oh, yeah, yeah. As sort of an average vacancy rate. And I'm talking about in places where there's a lot of demand. I'll go as low as 5% in, like, Culver City because it's just super high demand by self def 5%. So now I take my total rent, which we said was $96,000 per year, and I do that times 0.9. If you want to be really conservative. That's a 10% vacancy rate, or 0.95, if you want to be a little aggressive or somewhere in between and you just pull out your calculator. You know, it's. Let's just do $100,000. Okay. So you'll be $100,000 annual rent. You're looking at $95,000 or $92,000 as your effective rent. And your effective rent is basically your gross rent minus your vacancy rate. And people leave that out.

[B]

Yeah. And it's tough with smaller amounts of units. You have four units and one vacancy and, you know, moves to 25 real quick. Right. 25% vacancy for as long as it takes. Right. So larger unit buildings, really, they. They level out the vacancy rate a lot. A lot easier.

[A]

Now, let's talk about operating. Let's go. Because that's very important. Yep. And. And you got to go for the true number, not the fantasy number. I'm going to tell you, when the people put the package together, it's the fantasy number. And I'm going to give you an example again. You know, I'll use one of my own properties in. In Palm Springs. And, you know, I'm trying to figure out, how much is this place costing me Now, I wasn't renting it, but I still wanted to know, what are the operating expenses?

[B]

Got it.

[A]

So I call my bookkeeper and I say, hey, what are my operating expenses? And she's doing this thing where she's, you know, categorizing it. Oh, and, you know, you did this one thing that's really a capital improvement. And, you know, oh, there's this other thing, you know, that was for maintenance. And so what's your. And I'm. I'm sorry. I call that all fantasy. So when she was giving me this whole breakdown, I go, oh, you know what? Never mind. How much have I spent total in the last 18 months? Divide that by 18 and give me that number. And she, being sophisticated is like, dude, that's. That's not your. That's not your operating expenses. It's got all this other stuff. I'm like, no, fantasy. Give it to me.

[B]

Reality.

[A]

This is reality. And so that's where I'm very conservative on that stuff. And I will say to you that a really good rule of thumb, it can be as high as 35% of your effective rent. So now you take your rent.

[B]

Yep.

[A]

And you lower it by a vacancy rate, and now you lower it again. So again, you know, round numbers. You're looking at, you know, at a Hundred thousand dollars of, of gross rent. You're looking at about, I mean, you know, 30,000. You know, 30,000. Then you, you're, you know, 30, 35,000. You can really, you can take your, you can take your effective rent, which is vacancy and your, and your maintenance. Now, how old is the building? If it's a brand new building, your, your maintenance rate is going to be a lot lower. But I'm not buying brand new buildings because it doesn't have that great upside in it.

[B]

Got it. And, and that doesn't include that service.

[A]

That's correct. So let's use our million dollar purchase again. Generally you're putting down at least 25%. Generally I am putting down about 30%. So now I'm at $300,000. I want to have a cushion because I'm not buying that. I'm not buying that property that's in a plus condition because I don't want to end up like the guy that bought at the top of the market with no room to move. So I'm building in a cushion too.

[B]

So that's to improve or to carry?

[A]

Yeah, yeah. It's not to improve because I have a separate budget to improve.

[B]

Okay.

[A]

Okay. So I use that million dollar example and I'm going to put $200,000 into it. And I've done all the math. I know when I'm done, okay, I'm going to end up with something that's worth 1 million 5, assuming that the market doesn't go up at all and doesn't go down at all. If I were looking at, you know, at that million dollar purchase, yeah, I could get into it for $250,000. I'm probably going to put $300,000 down so that my debt service is a little lower. I've got more equity, it creates a bit more safety. And then I'm going $50,000 just on the sidelines as your cushion. Yeah. Not including the 200 grand.

[B]

Got it.

[A]

So now you're really, you really are talking about a lot of cash. Okay, so you get the, you get the million one. It's done, done, done. You don't really need the cushion. You can go in with a, with a 25% down and start up the.

[B]

Engine day one and let's go.

[A]

You know, that's to make the math easier again. Let's say somebody buys the beautiful building, you know, for a million dollars. It's done, done, done. You know, go ahead, put your $250,000 down. I would have some cushion. You don't really need $50,000 cushion. And then you don't need any, any cash laying around for improvements because it's already improved.

[B]

Right.

[A]

And this sounds great to investors. And then the market shifts and they get their head handed to them because.

[B]

They'Re holding that fully realized, depreciated asset.

[A]

It's, it's, it's fully done, done, done. And therefore there's no room to move. Right now I'm looking at the exit. It's not apples to apples because my, my whole deal is actually a much, it's actually a much more capital intensive deal. So would, to compare apples to apples, we'd have to say, okay, look, look it, you only have $250,000 to spend, so what are you going to get? And in that instance, I'm really looking at a $500,000 buy. Okay. Now I'm putting down 125.

[B]

Got it.

[A]

Okay. I've got 25, $30,000 in cushion, and I've got about $95,000 to improve. So now I've got the $500,000 building. I'm putting about 95,000 improvements, which you can do a lot.

[B]

Sure.

[A]

Okay. And I've still got my cushion. And at the end of that, you've got your million dollar buyer. He's got a place that's worth $1 million. And now you get hit 20% decrease. Now you're at 800 grand. Your $250,000 just bought you a building that, that's, that's 800 grand. You could be, you could be underwater in terms of rents. I'm taking the same 250. I'm buying the $500,000 place. I'm putting $120,000 down. Let's say I've got a little bit of a cushion and I still have room to move in terms of improvements. Now that $500,000 building is worth $750,000 $800,000. Now you take the market, you take the market, crush on it. You know, right now I'm back down to 700 or 650. I'm still, still, I'm still even. Put it to you that way, I didn't lose my 200 grand.

[B]

You're playing with your equity, your equity in the property.

[A]

Right.

[B]

No, that makes perfect sense.

[A]

And in that particular instance, what I'm talking about is, I'm talking about buying like one minute before the market crashes. You have to like, you have to buy all the time, you have to buy all the time to be the guy that, that buys the peak or to be the gal that buys the peak. And you have to buy all the time to have the bad fortune of buying at the. At the. At the bottom. But I do.

[B]

Well, we've seen people, you know, sink their sh on that.

[A]

Sure, yeah. Built into this, you know, And. And here are your three stress tests. The three stress tests are a vacancy stress test. We saw that in Covid. So things shifted. It got weird. Right.

[B]

People stopped paying their rent.

[A]

Yeah. So. So do you have that cushion? And in the example I gave, that.

[B]

Sunk a lot of small investors.

[A]

Yeah, in the example I gave, I had cushion. Now I will say something else saved me too. And that was when you're at an entry level into a great neighborhood. Here's what entry level into a great neighborhood is. You're basically, you have the nicest unit for the least amount of money into a great neighborhood. And when you've got that, you have lots of demand. When you have, like, the nicest unit in the nicest area. Now somebody can't afford it, okay, they quit paying rent. Maybe they leave. What are you going to do? Now you're. Whoa, I got. I got to fill that. I got to fill that $5,000 unit with what, $3,500? I've already taken a huge kick in the pants. Now if I. If I have something that's definitely nowhere near as nice, but it's still in the good neighborhood. And at 1800amonth, you look at everything else, it's 800, 1800amonth. It's garbage. My 1800amonth has new paint, new security, new. Because I've built it into the model. Now I'm coming out at 1800. It's. It goes like this.

[B]

You're always going to be the least expensive in the most popular area.

[A]

Yeah, right. And then if somebody cannot.

[B]

It has more value.

[A]

Somebody can't make their rent, they decide, you know, this is too expensive. I'm going to go to my moms in Nashville, whatever that is. Open up, filled up.

[B]

Oh, absolutely.

[A]

It's not the same as that. As that top. And that's why, you know, with 600 units, my people were paying the rent. You know, they didn't, you know, they didn't open up the. The, you know, I was gonna say New York Times, but they didn't open up the LA Times and go like, wow, the economy is terrible. You know, I'm not going to set my rent check in. They're like, I'm happy to be in. In a really nice place that's in that's safe, that's in a nice neighborhood. And if I leave here, somebody is going to come right in. So these people were paying the rent.

[B]

More gratitude.

[A]

Yeah, absolutely. I'm going to talk about another one that people talk as talk about a stress test, and that's the expense shock test. And here's the thing. I believe that you really get your way out of that expense shock test if you're really, really doing your due diligence. Oh, wait, there's a big sewer line break. Like, what do you have to pay to, you know, Nowadays they run the camera through the sewer line. Yes.

[B]

That costs probably around 500 to $600 to do a sewer line inspection.

[A]

Okay, scope. We're doing that, right?

[B]

Yep.

[A]

Okay, so is my sewer line going to break, you know, within the next few years after I buy the place? I mean, you're gonna really see, you know, I mean, these things are possible. But if you're doing your due diligence, then I think the, and I think the expense, the expense shock test is, is less. You do your possibility.

[B]

You do your best to, to abate any big problems like that roof, electricity, plumbing, all are the systems that really can take a building down.

[A]

I'm going to tell you that, that when we talked about expenses and the reality expense, that's, that's where people are getting sunk. Because I really, I. I really haven't bought a building where you, you go back and you look at the pro forma, you're like, oh, you know, wow, the expenses are exactly what. Yeah, the, the expenses are, you know, a little less than they projected. That's just not happening.

[B]

No, there's a lot of aspirational thinking in a lot of the presentations.

[A]

Correct.

[B]

That sellers, Sellers representatives make.

[A]

Correct. And all I did was because, remember what my bookkeeper did is she's like, oh, well, that's a capital expense. We're not going to count that. These are. We weren't marketing the property. I was just asking. And she was still, you know, segregating all that. I'm like, no, no, no, no, no. How much, how much dough have I written? How much money came out of my checking account?

[B]

Keep it simple. Money out, money in, money out.

[A]

Last 18 months divided by 18. That's my real number. And that's not what you're getting on the pro forma. So I will say that the expense shock, okay, is not shocking me in the same way because I know the pro forma that I'm getting is not accurate. I know it from experience. I Know that, that, you know. Oh, well, just so what's going to happen is, is generally these buildings that I buy have a lot of deferred maintenance. So I get the roofer up there. He goes, yeah, you know, look, you could have two to five years left on the roof. Okay. When I hear that, I'm like, roof leak. You know, it's been an extra bad rain this season. The two to five just went to eight months. I'm, I'm booking that.

[B]

Yeah. Is there a, is there an equation or the variable that you put in for, for those kinds of events?

[A]

I mean that's, it's, it's, it's such a great question. I put it in line item by line item. So I buy the Ugly Duckling building, I get the roofer up there. He goes, huh, you know, places a dump. But you got a, you got a 15 year roof on there. Yeah, you got a 15 year roof on there. It's been on there two years. And I go, you know, right to the roof line item. I'm like, yeah, never mind, we're good. No, no expense shock test on that one. Right. And then they go in. Then I've got the electrician, he's like, well, you know, the panel, the panel's fine, but it really should be upgraded. And then I'm like, okay, whoa, hang on. I know what's going to happen. I'm making the place look cool. I'm getting younger people in there. Guess what? They've got that microwave, they've got every. They're plugging in 14 things at once. Just like I do at my house.

[B]

Yeah.

[A]

You know, I've got all the air purifiers, computers. Yeah. I've got the. I forget what it's called. You know, I had the like super upgraded panel. They put the, they put. I can't remember what's called the arc. The arc light breakers on. You know, it's a super safe breakers, which means if I run three things at once in the kitchen, I got to run outside and flip the breaker again.

[B]

That's hilarious.

[A]

Yeah. So, you know, I just know. So, so I'm doing a line item by line item. Expense shock stress test. And, and, and if it's, if it's, if it's marginal, I'm building it in.

[B]

It helps you negate future stress. Stress, expense stress.

[A]

So what I do when that electrician. So we're just gonna say, we're just gonna say instead of going up there, the roofer goes, ah, you know, you got two to two to five years. I'm like, what's a 15 year roof cost? You know, and then I'm, then I'm taking that cost of the 15 year roof and I may be spreading that out over two or three years. I'm building that in to the cost. I'm expecting in the next three years to have to put that new 15 year roof on. When he goes up, he goes, well, actually the building is a dump, but you got, you know, your roof is solid now. I talked to the electrician, he's like, well, you know, the panel really should be upgraded. It's not an emergency right now. You know, I'm like, upgrade, like, okay, great. So if we wanted to right now, I'm not saying we're doing it if we wanted to right now. What's the new panel? What's the new upgraded panel cost? What are we gonna have to change wiring? What, what are we gonna have to do? What's the full deal? And then again, I'm taking that and I'm putting it. If he says, you know, it's not an emergency, it's, you know, eventually you'll need it. I'm, I'm putting it into the 2, 3, 4 year category.

[B]

Absolutely.

[A]

Yeah. Yeah.

[B]

So especially if you're investing in the property, you know. Yeah. Oh, a third of the pro, A third of the property's vacant. I'm gonna renovate those units. While you're renovating those units, you're upgrading the electricity at some point or another.

[A]

And I'll tell you that, you know, the last stress test is the rate and refinance stress test, which people did not take. They did not think about it. So five years ago, when rates were half, if somebody asked me, hey, should I take a 30 year fixed mortgage, I, I gotta tell you, the smart part of my brain says don't do it. Do a 15 year, you know, you'll save money. Not a, it's still a 30 year. It's still a 30 year loan. It's going to adjust in 15 years. But the reason why I say take a 15 year instead of a 30 is because most people I know don't stay more than 15 years.

[B]

Especially in a, in him. Well, I was going to say especially in a single family, but in an investment too.

[A]

And what I do is I look at the spread and so how much are you really going to save? And if it, you. My, my numbers, you know, if my numbers are tight, I don't buy the deal just to begin with. And so, you know, usually I'm paying a bit more and I'm taking the longer term. And I got to tell you, I, I, I say it a thousand times on this podcast. I do not have a crystal ball. And I will tell you, five years ago when rates were 3%, I was getting 30 year. Oh, I could have gotten 2.75 on the 15. And I, and I will tell you, I'm not staying anywhere for 15 years. Usually I'm not keeping a rental property for 15 years. Usually when I saw that spread of 0.25 to get an extra 15 years, I'm like, I'll take it, period. I went 30 years on, on all the stuff that I bought that people were doing the 5 and 7 and 10 years short term lending.

[B]

Yeah. They were just thought it would never change.

[A]

Yeah. Right. And I, I knew people that were doing I, geez, I forget there was tied to like some kind of. I should remember the Libor. Golly. Right. I can't even remember the Libor.

[B]

Yeah.

[A]

They're like, oh, it's Libor plus, you know, 0.25 or whatever. It' you know, 2.6.

[B]

Yeah.

[A]

And that rate changes. You don't even have, forget five years. That rate was changing like monthly. Monthly. Yeah. I'm like, no way, I can't sleep at night with that. Yeah. You know, because then it starts going up. You're chasing and chasing and she's like, well, when am I gonna. Oh, now if I go the 15, it's really expensive, you know, but then it keeps going up, it's getting more expensive. I'm not doing it.

[B]

That would have been a bad equation if you entered into the market that we entered into three years ago.

[A]

Yeah.

[B]

And have been in.

[A]

So okay, so I've talked about the vacancy stress test. I've talked about the expense shock test and how to avoid those. Vacancy stress test is just use a decent vacancy rate. Expense shock stress test is just go line item by line item. And if it's got the 15 year roof and you're two years in. Not a, not a shock test item for me. If they're like, well, you know, next couple of years, two, three years, you'll need it. I'm, I'm treating it like it's happening now or certainly budgeted into the next three years. Like future expenses. Yeah, that's right. I'm taking the total expense of full rewiring and I'm dividing it by three. I'm hoping it lasts five or six or seven years, but when it comes, I've got it and that avoids that. And then the rate and refinance stress. It's like I'm not doing the short term loan.

[B]

Perfect.

[A]

All right, I think we got it. All right, we promised 20 minutes. It's probably been 60 minutes. But, you know, hey, we covered it.

[B]

I think you hit all of the, the points that really move the needle for any possible investor.

[A]

I love it. Excellent. Thanks for asking the question. Thank you, sir.

[B]

My pleasure.

[A]

It.