Real Estate Christmas Story

Last year I was at a friend’s home for a Christmas party.  As I was mingling through crowds of festive party goers, I was surprised to meet my friend’s landlord.  The party was at his rental house and my friend invited to be a guest of the party. I’ve been a landlord to over 100 properties and I’ve never once been invited to my tenant’s Christmas party!

The landlord, Mike, was a friendly man of about 68 years. We had a great time talking about real estate. In 1965, Mike took a job as a school janitor and he worked at the same job his entire career. Mike bought four single family homes over a period of 45 years and is now a multimillionaire with a $75,000 / year passive income from real estate. His passive real estate income is more than double what he earns from his janitor’s pension and social security.
What astounds me is the simplicity of Mike’s success. Mike purchased four “bread and butter” single family homes over 45 years. He always bought new properties, he always paid retail, and his cash flow was break even with 20% down and 30 year fixed fully amortized mortgages.  Mike never refinanced, never prepaid his mortgage, and he never sold. While this plan may not have yielded the highest return, it was powerful none the less. The fact that the plan was so simple is one of the reasons Mike was successful with it.

Mike purchased his first house in 1965. He paid $18,000 using 20% down ($3,600) and an 80% mortgage ($14,400). His mortgage payment was $86/month. That was a lot of money when Mike was a 23 year old school janitor earning $350/month. Today, this Northern California house is worth $575,000 and rents for $2,200/month.
Mike's home price
Mike purchased this $18,000 house with only $3,600 down and his mortgage was paid off by his tenant 15 years ago. His $3,600 investment is now worth $575,000. Mike’s annualized non-compounded return on investment has averaged 350% per year for each of the past 45 years. What investment vehicle other than real estate can do that?

mikes ROI with 20% down

In 1970, Mike bought a second house. In 1975 he bought a third house and, in 1980, Mike bought his fourth and final house. All four houses are now owned free and clear with $2.3 million of equity and positive cash flow of $75,000 year. Mike spent his career as a janitor and retired a multi-millionaire because he had the foresight to acquire four pieces of real estate over 45 years.

Inflation seems small because it is reported as a year over year number. However, inflation (and real estate prices) actually move as a compounding force.  Below is a chart of a basket of goods with prices from 1965 and 2010. I created a chart to illustrate the annualized compounding rate of increase for this basket of goods. Mike’s houses increased in price just slightly faster than the overall rate of inflation over the same period.
inflation basket of goods

Mike was the happiest guy at the party. He has the most abundant retirement plan of any of his peers, and he spent his entire career as a janitor not worrying about money or inflation.  He always knew that when he retired he would have four houses that were completely paid for by his tenants, and these houses would take care of him and his children forever.

It is nice when real estate investing has had such a positive impact on someone’s life. I asked Mike what he would have done differently 45 years ago and he said, “I wish I would have bought more houses.”

Merry Christmas and Happy New Year,

David Campbell
Professional Investor / Developer / Financial Mentor
Founder of Hassle-Free Cash Flow Investing
707-373-9966
David@hasslefreecashflowinvesting.com

Please leave a comment on this article.

How to Profit from QE2 (Quantitative Easing) – PART 2

By: David Campbell, professional investor, developer, and founder of Hassle-free Cashflow Investing

This article is a sequel to my last newsletter, but can easily stand on its own.  You are invited to read and comment on part 1 and 2 of this article on my blog.

I am absolutely certain we will (continue to) see high rates of inflation for the foreseeable future.  Inflation doesn’t mean commodities will increase in value, it just means commodities will increase in price because of a devaluation of our currency.  If you understand what inflation is, and you believe it will continue, you can either be a victim or a beneficiary of the phenomena.  I went to the grocery store recently and was amazed (but not surprised) at how much food prices have increased.  Rising prices is confusing and frustrating to most Americans, but it is a fact of life we must come to accept and financially prepare for.  Inflation has a winner and a loser.  Unfortunately, most people come out losers because they cannot out-earn or out-save inflation.  When I observe signs of inflation (rising prices) around me it does not affect me emotionally, because I have prepared to WIN from inflation. When inflation happens, savvy investors like me get richer while workers and savers get poorer.  This doesn’t make me feel good about the situation, but it is the economic reality we live in.

I spend a lot of time talking about inflation and taxes because these are the most important and misunderstood concepts in your financial life.  Inflation is a hidden federal tax upon every dollar in circulation worldwide.  If you are the US government, inflation is an ingenious invisible tax; if you are anyone else, inflation is taxation without consent (and, for most people, without knowledge).  I am about to show you ways to profit from inflation, but in no way do I believe inflation is a good thing for society. If I could stop inflation, I would. Since I can’t stop inflation, the best I can do is make a profit from it.

Here are four ways to profit from inflation:

1) STEP ONE: purchase durable commodities today when the supply of dollars is less than the supply of dollars will be in the future.  The durable commodities you purchase become assets on your balance sheet that maintain constant value while inflation drives prices up.  When the supply of dollars increases and the supply of commodities remains the same, prices rise because more dollars are chasing the same basket of goods. Inflation as a result of increased money supply assumes demand for commodities has remained constant. If demand for commodities increases or decreases, there is a change in VALUE which may or may not result in a change in price. Value and demand are synonymous price is a metric of demand, money supply, and the velocity of money.  We will talk about the velocity of money another day. Commodities may increase or decrease in value/desirability/demand, but inflation will make the PRICE of the commodity go up because of a looser money supply.  For example, let’s say you bought a hammer in 1960 and it cost you $2.72. Over the past 50 years, the design and demand for hammers hasn’t really changed and therefore the value of a hammer in 1960 and in 2010 is exactly the same.  Because the US currency has devalued (inflated), the price of the hammer is now $20.  Over 50 years, the hammer has increased in price by 15% per year.  RECAP: the value of the hammer didn’t change, but the price increased 15% per year because of inflation (15% per year is  simple interest, but it can also be expressed as 4% annualized compounding rate of increase which is how inflation is usually described). If you had purchased a truckload of hammers in 1960 (for $2.72) and resold them at today’s inflated prices ($20), you would have a healthy paper profit that outpaced most investments even though the VALUE of the hammer DIDN’T CHANGE.  While it is nice to find commodities that will increase in VALUE because of increased desirability or demand, it is easier to find commodities that will increase in PRICE because of inflation.  Because of increases in the money supply (or increases in the velocity of money), it is possible to have a commodity drop substantially in value but resell at a higher price / profit.

2) STEP TWO: purchase durable commodities using as much debt as can be paid for by leasing out the durable commodity.  Cash-flowing real estate is the perfect example of this.  Real estate and hammers are examples of durable commodities, while oil or soybeans are examples of consumable commodities.  No one will rent soybeans from you because they must be consumed to have value.  Many people will rent real estate from you because it produces utilitarian value without consuming it.  A bank will loan you most (sometimes all) of the money you need to buy an asset and the income from leasing the asset will pay off the loan. FREE MONEY! Now, let’s add inflation to the mix.  Let’s pretend you bought a house in 1960 and the value of your house is 6,250 hammers and the price of a hammer was $2.72.  (6,250 hammers x $2.72 per hammer = $17,000 house).  Over the 50 years between 1960 and 2010 we know the money supply went through the roof and the price of things followed suit.  Let’s assume the value of the house you bought in 1960 didn’t change over 50 years due to deterioration or increased demand and neither did the value of a hammer.  In 2010, the value of your house would still be 6,250 hammers. However, as the supply of currency increased, the price of everything increased. Hammers went up in price and so did houses.  If hammers now cost $20 ($20 per hammer x 6,250 hammers) your house must cost $125,000 even though the value didn’t change.  What happened to the value and price of the debt?  Let’s assume you had a 50 year interest-only loan on the property and you purchased it with 100% financing (eg. $17,000 of debt in 1960 and $17,000 of debt in 2010).  This assumption is highly unlikely, but it makes our illustration easier to understand.  Over 50 years, the price of the debt stayed the same while the value of the debt decreased.  When you purchased the property, your debt was equal to 6,250 hammers or 100% of a house or $17,000.  Sixty years later, $17,000 is only worth 850 hammers or 14% of a house.  Inflation made the VALUE of debt decrease.  If you know inflation is coming, you want to be a borrower of good debt (good debt is debt serviced by your tenants) and hold the debt as long as you can while the supply of currency increases.  Thirty year fixed interest rate mortgages are on sale right now. Get as many of these mortgages as you can while the government is still subsidizing low interest rates.

3) STEP THREE: Protect your profits from income taxation. As the price of real estate goes up with inflation, there is no income tax on the gain until the property is sold for a profit.  It is also possible for an investor to “borrow the profit” out of a property  and reinvest it without paying a single penny of income tax.  Many types of investments (interest income, business income, mutual funds, oil and gas, etc.) must pay income taxes on their profits every single year.  Annual taxation of your profits radically erodes your return (earning power) because you lose the ability to generate compound earnings on the portion you paid in taxes.  If you could double your money every year ($1 : $2 : $4), one dollar would equal one million dollars in twenty-one years.  Apply a 30% income tax rate before each year’s doubling and twenty-one years results in only $41,000.  Can you see how ESSENTIAL it is to have income tax deferral as a central component of your wealth building strategy?   The equity growth in real estate is automatically tax deferred (like an  IRA) while also creating a tax shelter for the ordinary income through depreciation of the real estate structures.  Depreciation is a topic for another day.

4) STEP FOUR:  Acquire income streams whose value will be enhanced by rising prices.  Let’s assume rent has a fixed value of 60 hammers per month. In 1960 rent would be $163 per month (60 hammers x $2.72) and in 2010 rent would be $1200 per month (60 hammers x $20). The value of rent didn’t change, but the price changed because of increases in the supply of dollars (fiat currency).  Let’s assume our rental house in 1960 had operating expenses of 28 hammers per month (taxes, insurance, maintenance, management) and mortgage payments of 30 hammers per month. There would be 2 hammers per month left over as the investor’s profit (60 hammers of income – 28 hammers of expenses – 30 hammers for mortgage). Over time, the PRICE of operating expenses will increase in direct proportion to the rate of inflation. However, the VALUE of operating expenses is not going up, the increase in the currency supply is making the PRICE of everything go up.  Over time, the PRICE of your fixed interest rate mortgage will stay the same thus reducing its VALUE. In 1960, your mortgage is 30 hammers x $2.72 = $81.60/month.  In 2010, your mortgage is still $81.60, but the price of a hammer has gone up with the money supply.  Your mortgage in 2010 is $81.60 divided by $20 per hammer = 4 hammers.  In 2010, you collect 60 hammers of income less 28 hammers of expenses (income and expenses didn’t change) less 4 hammers for mortgage = 28 hammers of investor profit (28 hammers x $20 = $560).  The value of rent and expenses stayed the same, while inflation caused the VALUE of the mortgage to decrease therefore increasing the investor’s profit.  Real estate is powerful because it allows you to control a very large amount of debt whose value is eroded by inflation.  As the value of debt is eroded, the borrower of the debt wins. An investor doesn’t need the PRICE of his debt to decrease, to make a profit, he just needs the VALUE of his debt to decrease. If the cost of debt is 5% simple interest, but the rate of inflation was 15% simple growth between 1960-2010 it is obviously profitable to be a borrower of good debt during inflationary times (eg. borrow at 5% and earn 15% = 10% profit on the funds borrowed).  Government inflation numbers are reported as compound rates of growth and that confuses people into thinking inflation is less of a factor than it really is.  4% inflation compounded annually over 50 years is the same as 15% simple interest.  Here is an easy to use inflation calculator if you want to see how much the price of things have changed over the past 100 years.

In my next newsletter, I will prove the Federal Reserve  must inflate the price of real estate by 50% or banks will continue to fail in huge numbers.  There were 140 bank failures in 2009 and 149 bank failures in 2010.  Here is an interesting interactive map showing where bank failures are occurring.  What is worse for our economy, widespread bank failure or rapid inflation? The Fed has been explicit in its public commentary on this issue; aggressive  inflation is preferable to continued bank failure, therefore  heavy inflation must be targeted at the real estate sector to pull the banking industry out of its nose dive. The Fed has made its decree public knowledge.  What are you going to do about it?

If you are like me and believe inflation is inevitable, how will you prepare yourself for it?  Doing nothing means your savings and wages will be eaten up through increased consumer prices. Acquiring positive cash flow real estate with 100% financing makes you the ultimate winner during inflationary times.

Don’t become a victim of inflation! Acquiring Hassle-free Cashflow Real Estate is a very simple step towards prosperity in the coming years.  If you would like help building a successful real estate portfolio, please call me right away while prices are low, long term interest rates are low, and banks are still lending to qualified buyers.  Inflation is coming, and this beautiful buyer’s market will not last forever.

Best regards,

David Campbell
Real Estate Investor / Developer / Financial Mentor
Founder of Hassle-Free Cash Flow Investing
707-373-9966
David@hasslefreecashflowinvesting.com

Investing Versus Trading

INVESTOR = mostly passive + dividends + long term capital gains

TRADER = mostly active + short term capital gains

As a Hassle-Free Cash Flow Investor, you must clearly understand the difference between an investor and a trader.  This is an important distinction in your investment style / investment philosophy.   Many people call themselves real estate investors when they are really traders.  While you can make a lot of money as a real estate trader, it is not the same thing as being an investor.

Hassle-Free Cash Flow Definition of INVESTOR:  An investor converts a lump of cash into an asset that has the probability of paying an income stream over a long period of time.   An investor is primarily concerned with cash flow and security of his principal over a long period of time.   To an investor, the increase in the equity value of an asset is a secondary benefit.  An investor is generally passive and expects his money to earn more money without the contribution of a lot of personal time and skill.

Hassle-Free Cash Flow Definition of TRADER:  A trader converts a lump of cash into an asset that has the probability of being resold for a larger amount of cash in the future.  A trader is primarily concerned about velocity and security of his principal usually over a shorter period of time.  A trader must buy and sell quickly or carrying costs and time will quickly erode his annualized return.  A trader is generally active and expects to contribute substantial amounts of management time and skill, as well as money.  A trader makes money ONLY if the value of his asset increases in value.

Being a trader is a job.  If you are like most people, you already have a job and don’t want a second one. Being a trader is NOT Hassle-Free.  As an investor, your money works so you don’t have to!  A good investor enjoys freedom of time and money.  Begin with the end in mind.   Focus on making good investments that will take care of you in the future while not eroding your quality of life in the present.

People looking to make money in real estate often call themselves investors, but their idea of investing is negotiating short sales, going to foreclosure auctions, scouring the world finding a needle in the hay stack deals, or doing rehabs and “flips”.  All of these are active forms of real estate trading that involve controlling a distressed property, improving its value, and reselling the property for a short term profit.   Admittedly there is a lot of money to be made being a real estate trader, but it is a JOB.  I have done over forty real estate flips in my life and I have made a lot of money doing them.  But doing flips is VERY hard and VERY time consuming.  It took me five years of study and practice before I successfully completed my first flip.   If the trader doesn’t show up to work, nothing happens.   Unless you want to quit your day job and become a full time real estate professional, stay away from being a real estate trader and focus on being a real estate investor.   A Hassle-Free Cash Flow investor should never have to do anything but monitor his cash flow and management team.

It is possible to build a real estate investment portfolio that takes less than one hour per month to manage.  With the right deal structure, leverage (financing), and cash flow it is very possible to achieve investment results well over 100% per year as a semi-passive investor.  If you can double your money every year as an investor working less than one hour a month, why take on the worries and time hassle of being an active trader?

TAKE AWAYS:  Being an active real estate trader takes time, skill and tenacity; it is a job.  However, being an investor in Hassle-Free Cash Flow real estate can be semi-passive, simple, and highly profitable.  The goal of Hassle-Free Cash Flow Investing is to enjoy your quality of life now, while creating financial abundance for the future.