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Is Buying Investment Property Right for You?
By David Campbell On 12/05/2012 · 2 Comments · In Cashflow Investing
If you are considering buying investment property now or in the future, then this article is for you!
You’ll learn how to become a more profitable investor, using passive real estate investment opportunities and group investment opportunities to increase your wealth and to make your life BETTER. That’s really the whole point behind real estate: building a brighter, better, happier future through how we control and use our resources.
Eight Essential Resources
So let’s talk about your eight essential resources. If you are like most investors, the resources you’re working with are what I call the “above-the-line” resources: your cash, cash flow, credit, and equity. The “below-the-line” resources are your time, your talent, your relationships, and your control of opportunities.
If you have a very high-paying job – you’re a software engineer, a doctor or lawyer, oftentimes, you are best off buying investment property with your above-the-line resources and getting a professional or someone who is an active real estate investor to leverage their below-the-line resources. For an investment to work, you need all eight resources, but YOU don’t have to provide them all. For an investment to be passive, your primary contribution must be an above-the-line resource. If you’re contributing below-the-line resources, by definition, you are now actively involved in that process, and it’s no longer passive.
Why to Buy an Investment Property
One of the reasons that we’re attracted to real estate is retiring earlier than we thought possible, achieving our financial goals sooner, and otherwise compressing time frames. Real estate gives us higher yields, and it allows us to take distribution, or cash flow, without depleting principal. This is a really, really powerful idea. That’s why my whole brand is “Hassle-Free Cash Flow Investing.” If you buy gold, or silver, or stocks, you have equity. But, in order for that equity to make you a profit that you can spend, you have to sell the equity. So you sell the gold, the silver, the stocks, and then you have cash, and once you spend the cash, you have nothing left.
But with cash flowing real estate assets, you have an asset that produces a dividend for you on a regular basis, and dividend-producing income property is an incredibly powerful investment vehicle.
How and When to Buy an Investment Property
One of the cardinal rules behind hassle-free cash flow investing is: there is no such thing as a good or bad property, or a good or bad investment; There’s only appropriate and inappropriate ownership and timing.
You have to make sure that what you’re buying is appropriate for YOU. You might have a buddy who says, “Hey, I’ve got the investment tip of the year. This is the absolute best thing. This is going to go through the roof.” And it might be great for them, and you say, “Congratulations! Go do it!” And they say, “You should do it!” But should you?
An investment that’s appropriate brings you closer to your personal investment objectives – your personal goals. If it does, then it’s appropriate. If it takes you farther away from your personal goals and your lifestyle objectives, then it’s not necessarily an appropriate investment, even if it’s profitable.
You also need to consider emotional costs of investing. I’ve had clients buy very profitable investments, but lose sleep at night over the deal. That is not what you want. So you’ve got to know yourself and know something that might be a great investment for your buddy, and even a profitable deal, still might not be appropriate for you. As someone who works with passive investors in my projects, the last thing I want is someone to get excited about a high return on investment, write a check, and then lose sleep for the next ten years because they’re worried about loss of principal, or they’re worried about something in the investment that is really just not suited to them, or they’re looking for something that’s unrealistic to achieve.
Challenges of Individual Properties
Individual properties are always active investments. If you buy an investment property, and you hold it in your name or the name of your entity, and you’re the manager of that entity, and the buck stops with you, you’re never totally passive because you’re putting in your resource of TIME. You can find hassle-free properties – properties that are really easy to manage, and which don’t take a lot of your emotional resources to deal with – but they still take time. How passive is your income then? You might be making thousands of dollars a month from your real estate portfolio, but if you’re still managing your manager, I say it’s not passive – you just have a really well-paying job. You get a high return on your time investment. Other investments, like group investments, are completely passive.
Both are good – I’m not knocking one or the other. But ask yourself, when you’re looking at your time, which is more appropriate for you. If you’re a high income earner, it probably makes more sense for you to be passive, so you don’t take time away from your high-paying job. If you’re a low income earner, and your skills and resources and relationships are more valuable than your salary, then you might consider leveraging your below-the-line resources, and using your time to produce revenue through real estate.
Buying Investment Property with Group Investing
Group investing is when several individuals come together to pool their financial resources, managed by a group of professional investors. I have a team behind me. I get to lead my team, and I get to be the face of the company, but I have a lot of really smart people behind me. Having a team is a really important part of the process, and if you want to leverage a team, group investing is the way to go. When you invest in a group investment, it’s limited liability to you, as the investor. You’re purchasing membership units or shares in a company, and you did not sign personal recourse on that debt, so even if the property eventually is sold at a loss, your total loss is whatever you wrote a check for. That is a very powerful thing, especially if you’re a high net worth person and you’re looking at buying investment properties and diversifying your assets. You might pick up maybe ten different assets – you have ten percent of your net worth in ten different deals, but if you had signed personal liability on all of those deals, you might have nine deals profitable and one deal turns so upside down that it wipes you out because of that personal recourse on the loan. When you’re in a group investment, you don’t have personal liability. Your liability is only what you write a check to the deal. If there is negative cash flow in the future, you can always choose to meet your negative cash flow or not. When you have whole ownership of a property, and you own it, you either make your cash flow contribution, or the bank takes it back. That’s pretty much it. In a group investment, that’s not so. You have more options.
Group investments are a way to force equity without (your) effort. You can do developments, and you can get the benefits of changing a property’s use or finding the needle in the haystack deal, but you don’t have to put the time in to do it yourself. You can leverage MY time and MY team and MY resources and MY brain. Group investments involve very little time for you – almost none. You make your investment decision, and then, when the project has a milestone, participate in an investment update or video or a webinar or a phone call to voice your opinion – what would you like to do? Maybe you have to vote on something, but there’s almost no time involved for you, as a passive investor in a group investment. That’s the whole idea behind the management team. There’s no hassle. You never have to deal with a tenant phone call or the bank calling or meeting the repair guy.
Also, in group investments, you can get access to deals none of us could get on our own. I like to say, “Deals attract dollars, and dollars attract deals.” Instead of me just investing my money, I can go to the marketplace and say, “Look, I have a great pool of investors that have been with me for years and they like what I do. They would like to invest in a passive way, so we could syndicate capital to do this deal.” I can go to the marketplace and do much bigger deals. Because of my track record of syndicating and doing larger commercial projects, that puts me – and you! – in deal flow that the average person is not in.
Group investments allow you to do bigger and better opportunities, and they also help you build credibility if you’re a young investor. I remember one of my first syndications – I wrote a $75,000 check to participate in someone else’s medical office building. At that time, I had never developed a medical office building, ever in my life. But I wrote a check to that deal because I liked it, and from then on, I could say, “My partners and I are developing a medical office building in Texas.” I was just the above-the-line resource guy. I put in the cash. My partner did all of the work. He was the below-the-line resource guy. But that gave me credibility so that when I wanted to develop my own properties, the banks and the sellers and my team took me more seriously. It was also a great way to do what I call “earn while I learn” so that, while that medical office project was going on, I was entitled to be a part of a lot of those conversations and get access to a lot of information that was going on because it was my property. I had someone who was managing it, but they were managing MY money – I’m an owner, and I want to know what’s going on. That’s a great way to learn – earn while you learn.
Who should consider doing group investments? Busy people. People who want to earn while they learn. Retirement funds. If you like doing bigger deals; if you want to get into more active projects. Oftentimes, the bigger the project, the higher the margin is. In a small, single family house, there are a lot of people competing to buy that investment. When you get to a bigger project – a multi-million dollar project, there are fewer people who have the skills and the resources to take on that project, so the margins get bigger. If you are a small fish – small investor – but you want to tap into those higher margins, the way to do it is by leveraging other people’s resources.
Investment Property Diversification
You must understand the concept of active versus passive diversification. You might keep buying investment properties to create your own big portfolio of houses, and do that with your own cash while putting your IRA into group investments so you have passive diversification.
Marketplace diversification is powerful, too. You might feel very comfortable buying investment property in certain markets. You might know your hometown or where you went to college or certain other places where you went on an investor field trip and you feel very comfortable. But if you wanted to go to markets where you might not ordinarily choose to be, but because there’s a great opportunity and a great story, and the marketplace is strong, and you have a team there – you get to inherit my team – and that gives you an opportunity to be invested in multiple marketplaces without having to spend all of the resources to build your own team in those marketplaces. Also, product type diversification – you might say, “Housing is great, David, but in this recession, I’d really like to own a medical office because medical offices are very insulated from recession in a lot of ways. I also want to own a discount retailer. I want to own the bottom of the market – I want to own the 99 cent store type of businesses because those businesses do very well in recessionary times. And I also want to own apartments because people are renting.” Whatever you want to own, whatever your resources are, you can create more diversification by being in a group investment, by having a small piece of multiple pies in different markets, in different product types, and in different deal types.
Making Money With Group Investments
The way that we make money with group investments is through passive equity and passive cash flow. Passive equity is just the market smiled on you, and the property went up in value. That seems like kind of a silly thing at this point in the market, but cap rates are very high right now, so we’re talking about commercial property today. Commercial property is valued by its income, and the income might stay the same, and the property value could go up simply because investors are willing to take a lower rate of return. Right now, investors expect a very high rate of return, so even three years ago, investors might have bought a property at a seven cap, but today, they’re expecting an eight and a half cap for that same property, just in a three-year time frame. What that means is that, even though the cash flow is the same, the properties have come down in value, so today is a great opportunity to buy those properties at a high cap rate, and when investor confidence returns, cap rates will go down, and people will pay more for the same income stream. That’s a windfall, so you want to be buying investment property when cap rates are high – they are – and you want to sell when cap rates are low. Right now, cap rates are at the highest they’ve been in a long, long time. So it’s reasonable to expect that, if history repeats itself, the future will bring us lower cap rates. This is great for people who are buying now.
Found equity means you found someone who just got caught in an awkward situation, and the timing was not right for them, so they’re willing to give you their equity because you solved their problem in some way.
Phase equity is, for example, you could buy a retail property that’s leased for the next 30 years, and every five years, the rent goes up. Every time the rent goes up, the property value goes up because commercial property is valued on the income. Rent increases on commercial property are a really big deal. If you can predict what those rent increases are going to be, you can also predict what your future value is going to be. That’s what we call “phase equity.”
Forced equity is when you take something and change its use. You added value to construction or rehab or subdivision or some way you’re forcing the equity in the property, and I like to do all of these in different ways.
Investing objectives vary in each project. I would say we’re looking at creating blended returns. “Blended” means we’re going to take the equity growth – or what I often call an “equity kicker,” and add that to the cash flow. That gets us our blended rate of return. For example, an investment property might pay you eight percent cash flow. You might say, “Do I really want to buy something if it’s only eight percent yield?” At some point in the future, you’re going to get an additional twelve percent per year in terms of equity because as the mortgage gets paid down, that equity is your equity – it’s just not liquid yet.
Why Buying Investment Property Makes Sense
Cash flow is liquid money that comes out to you on a monthly or quarterly basis or annual basis – that you can spend. Right now, mainstream sources of passive income are not an option. The people who were investing for passive income for the last generation – the vehicles that they used to generate that passive income don’t work right now. Bonds and CDs are not outpacing inflation. You can even get federal government-backed bonds that are below the rate of inflation. The interest rate on bonds are at an all-time low, and when interest rates go up, it’s kind of like cap rates. So if you were buying a bond at a low cap rate – maybe a one and a half or a two cap – and suddenly investors are expecting four percent return on their money for bonds, then the value of your bond is discounted substantially. You might lose a very large portion of the value of that bond simply by interest rates going up in value. Bonds are not necessarily the safe investment that people think they are, especially when interest rates are at all-time lows.
The stock market is risky and unpredictable. It’s manipulated by governments; it’s manipulated by currency; it’s manipulated by ERISA laws that require baby boomers to take money out. Robert Kiyosaki wrote about it in one of his books, where the baby boomers are being forced to take money out of their stock portfolio, but the GenY – the people who are between 20 and 28 years old – they don’t believe in the stock market. They are not investing in the stock market. They’re occupying Wall Street; they’re not buying Wall Street. So you have a whole generation that’s selling, and there’s no one buying. It’s the ultimate Ponzi scheme. The buyers have gone away, and so what happens to values? They’re very fragile. I’m very nervous about buying in equity on the stock market.
When you’re buying investment property in a group investment, you’re buying something tangible. You’re buying a piece of real estate. You’re buying something that is dividend-producing. That’s why, again, hassle-free cash flow investing. We want things that produce dividends for you on a regular basis. We also have a high risk of hyper-inflation. All of the seeds for inflation have already been sown; they just haven’t arrived yet in consumer pricing. The money supply is there; the banks have the money; it’s just not in circulation yet. When that money goes into general circulation, we’re going to see inflation happen. When that does happen, you want to be well-positioned in real estate, which benefits from inflation, and leveraged real estate. You want to have good debt against your property – so positively arbitraged debt with a cap rate that’s higher than your interest rate so you can pay that mortgage off with cheaper dollars. You might borrow $100,000, which is five Toyotas. If a Toyota is $20,000, then that makes sense. Five Toyotas is $100,000. You could potentially pay off that $100,000 loan with two Toyotas, when a Toyota costs $50,000, and the only thing that happened is our currency devalued. I’ve written a lot about inflation on my blog, and I’ve got some great webinars about inflation, if you want to know more about that.
Why now? We’re at an unprecedented time in history to take advantage of the real estate market, and for those of you who see the opportunity, but you don’t quite have the skills and knowledge or the time inclination to dive in headfirst, being a passive investor is a great way to get involved. Prices are low, interest rates are low, sellers are flexible, inflation is looming, and there’s nowhere else to go. I don’t know of any other options that can produce dividends for you that are as safe as the real estate investments that we’re talking about.
Here is a typical market cycle, where values go up and values go down over time. A lot of people say, “I want to buy an investment property at the bottom of the market. You tell me when it’s at the bottom, and I’ll buy.” There are a couple of flaws with that logic. The first is, the bottom is one nanosecond in time. When we hit that bottom – that nanosecond – you’d better deploy all of your assets into real estate as quickly as you can. But that’s not possible. I’ve been working on deals that have taken eight months to get to the place that they are where I can present them to you today. In that eight months, the market is moving and changing. The way that most recreational investors shop is, they say, “If everyone’s buying, I want to buy. When everyone’s selling, I want to sell.” That’s the opposite of the way that you make money. When everyone’s selling, you want to buy, and when everyone’s buying, you consider selling. Whether we’re on the left side of that trough or the right side of that trough, or somewhere at the bottom, nobody knows. Nobody has a crystal ball that can predict where we are in the market cycle. All that we can say with fair confidence is that we are a long way off that peak. We’re somewhere in that trough, and if you look at market cycles, it doesn’t really matter whether you buy at the left side of the trough, and you go down before you come up, or if you buy it on the right side of the trough, and you think, “Really?” the only difference may be a little bit of time. But if you’re buying cash flow producing, dividend producing, income producing property, then the income is there, regardless of what happens to value. Value only matters two times: when you’re refinancing, and when you’re selling. If you’re not refinancing or selling, who cares what the value is, as long as the dividend is coming in on a regular basis.
That concludes this educational article on buying investment property. If you think there is a place in your personal investment portfolio for group investing, a great way to get started is to send an email to David@HassleFreeCashFlowInvesting.com, and we can schedule a personalized investment strategy consultation to get you going. I look forward to hearing from you.
Tagged with: buying investment property • cashflow investing • group investing
Thanks for the great article. Loved reading it.
Yeah great advice right from the top – it’s a lot of work and you might benefit from working with someone else. Well said with the 8 Essential Resources, you really do need and will use them all, but yeah, you really don’t have to do it alone. Especially if you have the above-the-line, work with someone who will really get some miles out of your resources.