Direct investment in single family income properties has strong demand from both investors and renters. Single-family home (SFH) income property advantages include: they trade independent of market cap rates, stronger appreciation than apartments, inflation protection, amortization, tax depreciation, lower cost, easier financing, more understandable, no shared walls, divisibility, less tenant turnover, and better locations than apartments. Today’s guest, HassleFreeCashFlowInvesting.com’s David Campbell helps Keith break down single-family investing advantages. Grab Get Rich Education’s new book at GetRichEducation.com/Book
Want more wealth? Listen to this week’s show and learn:
01:15 Ken McElroy in 2017: “It’s a terrible time to buy multifamily in most metros.”
06:23 SFHs trade independent of cap rates.
09:57 Appreciation vs. Inflation.
11:03 SFHs are approachable because they’re lower cost and financing can be easier.
14:52 No shared walls: pests, fires, noise.
15:48 Arbitrage.
18:00 Keep a low equity position for asset protection.
20:17 Divisibility.
20:53 The fallacy of “buying cash flow”.
25:08 Prepaying the mortgage is a huge mistake.
27:55 SFH: no or low utility payments.
29:00 Neighborhood quality.
32:00 Cash flow.
33:51 Income tax-free states.
34:57 Tenant psychology in SFHs. It “feels like their own”. Exit strategy.
36:50 GREturnkey.com has many of the best income property SFHs.
38:25 Ask: “Mr. Manager, what would like to manage?”
40:40 SFHs have less tenant turnover than apartments.
43:10 SFHs is where you typically start.
45:46 “Leaving a trail behind” with 3.5% down payment FHA loans.
48:30 David’s free e-book at www.HassleFreeCashFlowInvesting.com
Investing in Real Estate and Cashflow Producing Notes Using These Eight Hidden Sources of Capital by Professional Real Estate Investor David Campbell
It is amazing how fast time goes. 2014 marks my fifteenth year investing in real estate and my tenth year as a real estate developer and syndicator. Long time readers of my blog will know that I started investing in real estate while I was a high school band director with no business training and no net worth. Over the past 15 years investing in real estate I’ve been fortunate to have had more real estate wins than losses (losses are an inevitable part of investing in real estate) and I am grateful for the amazing mentors and life experiences that have helped me get to where I am today. Growing a successful real estate investment, brokerage, and development company out of humble beginnings has taught me a lot of lessons that I would like to share with you.
Here is a question I get asked all the time: “How did you become so successful investing in real estate when you started with no money?” What the asker is usually thinking is: “How do I become successful investing in real estate with a limited amount money?” Whether you have $100 to invest or $100 million to invest, everyone’s personal financial resources are limited. Don’t feel intimidated by investing in real estate just because you don’t have a large bank account. A great mentor once told me “Never let lack of capital get in your way of doing a good deal. If the deal is good and you know how to tell the story of a good deal someone will fund it.” As an innovating investor I took those words of encouragement one step further and looked for creative ways to fund my real estate growth. Below are a handful of creative ideas to help you improve your wealth and passive income investing in real estate regardless of how much capital you are currently starting with.
Disclaimer: Ideas can be powerful tools. Please remember in the hands of an untrained user, any tool can also be dangerous. Please digest these ideas with a air of caution and if you decide to implement any of these strategies I encourage you to reach out to an experienced financial mentor to discuss your plans. A good mentor may help you identify pitfalls you may not have thought of. For example, some of the ideas listed below are legitimate strategies when working with private financing and commercial lenders, but these creative financing techniques may not work or worse could get you into legal trouble when working with conventional “Fannie Mae” style residential lenders. I am not a tax advisor or a legal advisor; check with your team of professionals before committing to any financial decisions!
Hidden Capital Source #1: Self-directed IRA – If you are self-employed or have IRA funds saved from when you worked at a previous employer, you can roll those funds into a self-directed IRA and use those funds for investing in real estate and notes. If you earn $1 and put it into a tax deferred IRA you will have $1 to invest. If you are in a 40% tax bracket and don’t defer the tax, you earn $1 and have $0.60 to invest. That means you need a 67% profit just to break even ($0.60 x 167% = $1)! If you would like to learn more about self-directed IRA investing here are some great free training videos for you: http://www.hasslefreecashflowinvesting.com/video/ira-tax-videos/
Hidden Capital Source #2: 401(k) loan – If you have a 401(k) plan you may be able to borrow against your 401(k) to create a pool of cash to invest for investing in real estate. (Check with your plan administrator and tax advisor to make sure this would work for you!) If you use the proceeds of your 401(k) loan for investing in real estate you may be able to pay interest to your 401(k) that is tax-deferred income to your 401(k) (A GOOD THING) and take a present day interest expense tax deduction on your personal tax return (A GOOD THING). Let’s say you borrowed $50,000 from your 401(k) for investing in real estate and then paid 4% interest per year to your 401(k), your 401(k) would be earning a 4% return ($2000), tax deferred, while you would have a $2000 deduction on your personal return. Let’s say you then invested the $50,000 from your 401(k) into a note and trust deed that paid 10% ($5000 profit per year). You would have $5000 of interest income less $2000 of interest expense (to your 401(k) which means $2000 of your note income would be tax deferred as earnings to your 401(k) and $3000 would be taxable to you personally in the current year. While it might be better tax planning to own the note directly in your 401(k) it might be logistically impossible to do so. For example if your 401(k) is invested in your current employer’s plan and you are unable to roll it over into a self-directed plan, most employer sponsored IRA plans will not let you self-direct your IRA into notes and real estate, but they may let you take out a loan against your own 401(k) and pay yourself interest.
Here’s a potentially better tax plan for investing in real estate with your 401(k) funds. Let’s say you borrowed $50,000 from your 401(k) and purchased a $250,000 rental house with 80% financing and 20% down. Let’s say the rental house was a 6 CAP rate
($250,000 purchase price x 6 CAP rate = $15,000 Net Operating Income)
and you borrowed 80% of the money from the bank at 5%
($200,000 bank loan x 5% bank interest rate = $10,000 interest expense to bank)
and you pay back your 401(k) loan at 4% interest
($50,000 401(k) loan x 4% interest = $2,000 interest expense to 401(k))
Your gross real estate profit from rental activities would be $3,000
$15,000 NOI – $10,000 interest to bank – $2,000 interest to 401(k) = $3,000 profit
However, this $3,000 profit is before we add in the tax loss from depreciation. Assuming a $250,000 rental property is $30,000 land and $220,000 structure and we depreciate the structure over 27.5 years we get an $8,000 tax loss from depreciation.
$3,000 profit less $8,000 in depreciation results in a $5,000 tax loss
***Check with your tax advisor about all income tax related issues. Nothing on this website should be considered tax advice.***
So let’s recap this strategy…
EXAMPLE 1: By borrowing $50,000 from your 401(k) and purchasing a note you create profit and positive cashflow inside and outside of your 401(k). You would be creating tax deferral on the funds going into the 401(k) but you would have a taxable event in the current year on the profit that is in excess of the interest charged by your 401(k). Talk with your 401(k) plan administrator and tax advisor to see if you have control over the interest rate charged to yourself by your 401(k) and also confirm with your plan administrator that the interest you pay to your 401(k) accrues to your benefit rather than to the benefit of the plan administrator.
EXAMPLE 2: By borrowing $50,000 from your 401(k) and purchasing a $250,000 rental property you are creating tax deferred interest income and cashflow inside of your 401(k) as well as a “phantom loss” on your personal tax return in the current year. This “phantom loss” may or may not be able to offset other income you’ve earned depending on your personal tax situation. Although the property is showing a paper loss (aka phantom loss) the property itself is profitable because you borrowed all of the money at an interest rate lower than the earning rate of the property. Investing in real estate at a CAP rate higher than the cost of borrowing is called positive arbitrage and this is a key component of the Hassle-Free Cashflow Investing philosophy. CAVEAT: even though the property in this example is profitable and creating a phantom loss (which are both good things) it could result in negative cashflow because the amortization on the bank loan in addition to the shorter term amortization on the loan to your 401(k). Remember, not all profitable investments are positive cashflow and not all negative cashflow investments are bad.
Hidden Capital Source #3: Cash value life insurance. I got the downpayment for my first rental property by taking a loan against a cash value life insurance policy my dad purchased for me when I was a kid. You can learn more about investing in real estate using cash value / permanent life insurance and the “infinite banking concept” by watching this great video webinar with myself and Patrick Donohoe from Paradigm Life. http://www.hasslefreecashflowinvesting.com/video/cash-management-strategies-for-real-estate-investors/
Hidden Capital Source #4: Deploying existing real estate equity owned by you or your friend. This is a potentially obvious investment strategy that I am going to put a creative twist on for you. Investing in real estate or notes using a cash out mortgage or line of credit against real estate you already own can have very powerful results and can often improve your cashflow and LOWER your risk. Here’s how: My client owned a primary residence valued at $500,000 and had a $300,000 first mortgage and $200,000 of equity. The client refinanced the property with a new $400,000 first mortgage and pulled out $100,000 of investment capital. His net worth was the same before and after the refinance; he just moved half of his equity into cash. He then took the cash and purchased two $50,000 notes totaling $100,000, secured by $140,000 worth of real estate. The client borrowed the money from his primary residence at 4% and invested it into notes paying 10%.
$100,000 borrowed capital x 4% = $4,000 interest expense $100,000 invested capital x 10% = $10,000 interest income $10,000 interest income – $4,000 interest expense = $6,000 annual profit
On a simplistic basis, we can see this was a profitable move because the fixed cost of funds was lower than the fixed earning rate. Let’s look a little deeper at the cashflow on this deal.
The $100,000 of extra mortgage expense at 4% on a 30 year fully amortized loan is a cashflow outgo of $477/month.
The $100,000 investment notes at 10% interest on a 15 year fully amortized loan is a cashflow income of $1,075/ month.
$1,075 cash in less $477 cash out = $598 positive cashflow
(Albeit, not all of the $598 is profit because we are dealing with principal and interest payments using two different amortization schedules (expense is 30 year and the income is 15 year).
The above is a great example of how being a borrower and using the concept of positive arbitrage can improve cashflow. The investor client is happy because he improved his cashflow position by $598 per month simply by signing his name a few times, but he is also happy because this situation LOWERED his risk. Here’s how:
When your monthly cashflow improves, your risk goes down because you have more liquidity to service your debts and build up cash reserves.
When the investor moved $100,000 of equity from his home into first position debt secured by other real estate, he moved the asset from higher risk “equity” to lower risk “senior debt”. Let me go deeper into this concept. If the investor loses his job or credit in the future, he would be unable to tap the equity in his home without selling his primary residence. However, by moving the equity from his home into first position liens on other property, he has the peace of mind that if he ever loses his job and wants to tap the equity in his home, he can always liquidate the notes for cash.
The investor has also insulated his assets from the potential of real estate price declines. If the investor had not moved his equity from his primary residence and real estate prices decline 40%, his $500,000 property would be worth $300,000, less the $300,000 of original debt, so his net equity would have gone from $200,000 to $0. If he sold his house at this point in the market, he would have zero cash from the sale and he certainly wouldn’t be able to refinance any equity out of her home because there would be no equity.
By moving his equity into first position notes, his liquidity is more insulated from loss. His $500,000 property declines to $300,000. Less $400,000 of debt, that means he has a $100,000 negative equity in his primary residence but he doesn’t have to sell his primary residence until the market recovers. Remember, when investing in real estate the value of a property only matters when you are selling or refinancing. The main concern the investor is insulating against is not a change in profitability but a change in access to liquidity. Even if the notes go bad (always a risk), the investor will end up owning the underlying real estate. Ideally, the foreclosed houses would make great rental properties and would produce more rental income than what he was originally receiving in interest income from the previous owner. However, if he decided to sell the foreclosed real estate, even if that real estate had gone down in value, it would not have declined to zero as the equity in his home did. Moving your at risk “junior” equity into positively arbitraged “senior” notes while you have the equity and credit available to you would be the lesser of two evils in the event of large price declines.
Here is another risk mitigating bonus for my investor client: The investor owned a home in a high priced state and was concerned that the state’s economy and home prices might be fragile and unaffordable in the future. He moved his at risk “junior” equity from his high priced state into “senior debt” secured by entry level real estate in Dallas, Texas, which is a more vibrant and diverse economy. The investor felt that moving the equity out of his primary residence into a senior debt allowed him to (1) improve his immediate cashflow, (2) allow him to have access to this equity in the future regardless of his employment or credit position, (3) gave him options for liquidity in the future even if there are massive price declines, and (4) it gave his investments geographic diversity by moving a portion of her equity to Texas.
Hidden Capital Source #5: Cash advance credit cards – Here is a practical application on the idea of positive arbitrage that has merit but comes with some powerful caveats. I have a client with the ability to borrow from his credit cards at a teaser rate of 0% for 12 months. The client borrowed $10,000 from his credit card for 18 months and invested in a $10,000 note and deed of trust paying 10% that had a due date in 12 months. The client borrowed the money at 0% and invested at 10% which generated a 10% yield spread.
$10,000 trust deed x 10% interest rate – $10,000 credit card loan x 0% teaser rate = $1,000 profit
The client used the $1,000 interest income generated from this “arbitrage play” to pay down some of his longer term student loan debt. It’s another example of borrowing for profit. There is a risk that the credit card teaser rate would expire and reset to 18% before the note and trust deed were paid off so the investor made sure that if the note and deed of trust were not paid by the 12 month due date the note would have a default interest rate of 18%, which is the same as his credit card interest rate. A big consideration for this type of arbitrage play is that your FICO score will be negatively impacted for the period of time your credit cards are drawn more than 50% of their available credit line. However, when you pay off the credit card at the end of the borrowing period your FICO should improve. You probably don’t want to use this strategy if you are about to apply for financing on a new real estate purchase. And while this strategy could work well in investing in shorter term notes, you probably don’t want to use this strategy for investing in real estate as a long term investment unless you are confident you have another way to repay the credit card before the interest rate increases.
Hidden Capital Source #6: Barter your services or personal property – I once had one of our company’s vendors express interest in investing in real estate by purchasing a home built by my home building company. The vendor could qualify for the loan but didn’t have the down payment. We signed a seven year service contract with the vendor and paid the vendor for all seven years in advance. The vendor gave us a slight discount for pre-paying for his service. The vendor then used the lump sum of cash we paid to him as the downpayment on a property we built and sold to him. This was a win for the vendor because he got a seven year contract out of us when we previously had a month to month relationship and the vendor got to purchase a house he could not previous afford to because he didn’t have the down payment. This was a win for our home building company because the profit on the sale of the house exceeded the amount we advanced to the vendor and we got the added bonus of a slight discount on a vendor’s services we were going to purchase anyway. In the past, I’ve offered to accept vehicles or musical instruments or jewelry or land as the downpayment on houses. If you’re looking investing in real estate or a trust deed and you have personal property or land that you’d like to use as your downpayment, give me a call. I would love to work with you. Often times I have taken my real estate equity or real estate broker commission in a promissory note or co-ownership in a property. If you would like help investing in real estate or an income producing note and you want a broker to co-invest their commission with you give me a call at 866-931-9149 x1 and we’ll see what we can put together.
Hidden Capital Source #7: Investment partners / syndication – When I find a good investment larger than what I can purchase with my own capital I go to my investor clients to form a partnership or real estate syndication. Investing in real estate using partners can be a very complex subject but it is something I have gained a lot of experience with. Here is a great video with myself and real estate attorney Jeff Lerman teaching a free one-hour course called “Partnering for Profit” http://www.hasslefreecashflowinvesting.com/video/partnering-for-profit/
Hidden Capital Source #8: the seller’s bank – Here is a great strategy for investing in real estate that works especially well with commercial properties: On multiple occasions, I have met commercial real estate sellers who owe slightly more money on their property than it is worth as a cash sale. A great investing formula is to get the property in contract with the seller for the best price you can (usually what they owe on the property) and then go to the seller’s bank and say, “Mr. Banker, you currently have a loan on such and such property for $1m and the property is really only worth $975,000. I know you typically require a 25% downpayment on commercial real estate, but I am only interested in buying this property (for more than its worth) if you will give me special financing terms to buy this property. I would like to reduce your loan from $975,000 to $900,000 and I will give you a personal guarantee that is worth more than the seller’s personal guarantee. Will you do this?” Usually the bank will say no. However, you can explain to the banker that if the seller pursues a cash sale it will probably result in a short sale for the bank. If the bank will cooperate with you by offering a higher than normal LTV loan you will lower the bank’s debt / risk position in the property by slightly paying down the existing loan, provide superior management to the asset, and provide a superior personal guarantee on the loan. It doesn’t happen often, but I have been successful acquiring high LTV property using this strategy. There are an infinite number of variations on this strategy, but the key points to remember are: how do you make the situation into a win for a bank who has a problem (loan overexposure and risk), a win for the seller (who has a loan/property they think will be a short sale), and a win for the buyer (who is willing to slightly overpay for a property to get superior financing terms from the seller’s bank).
If you would like help formulating your personal investment strategy or if you would like to learn about current Hassle-Free Cashflow investment opportunities please give me a call at 866-931-9149 ext 1 or schedule our phone call using this link to my calendar. https://my.timedriver.com/WBYTQ
To your success!
David Campbell Real Estate Investing Strategist Office: (866) 931-9149 Ext. 1 Cell: (707) 373-9966
If you are considering buying investment property now or in the future, then this article is for you!
Read this article to discover if buying investment property is right 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.
