What exactly is cash flow investing? (And some other definitions.)
The technique is simply defined as follows: Cash flow is essentially investing cash (or other assets) in order to receive recurring payments - typically monthly or quarterly. These recurring payments provide the cash flow investor with a return on investment. Cash flow investments generally include a cash flow return and an increase in value (appreciation).
Cash flow investing: could it be the right thing for you?
It’s pretty much a given that we’d all like to find the ideal investment route, the singularly perfect way and place to put our money and then sit back and look forward to a great life and rich retirement.
Could that solution be the concept known as cash flow investing? After all, as you’ll learn below, observing its techniques offers a good chance of consistent positive performance not subject to the volatility of the stock and bond market.
And can be managed by experts you pick while at the same staying in ultimate control. Considering all that, it seems like the perfect way to build assets and wealth.
Because the principles of cash flow investing can positively power retirement plans as well, we’ll also touch briefly on the simple steps you need to take to make funding these kinds of investments with your IRA and 401(k) possible . . . and even why exploring that route for your retirement fund doesn’t necessarily lock you in to anything if you change your mind, depending on the types of alternative investments that you choose.
Along the way of our cash flow discussion, we’ll also give you examples using real estate, just one of the investment types available to cash flow investors and recommended as a strong alternative to the traditional stock-market - to illustrate where the numbers come from - and why they can look so good.
Let’s provide an example of cash flow investing using a simple real estate purchase. (Again, real estate is only one of a number of possible investment asset classes, but an excellent one. We’ll have more on this later.) The principles remain the same whether the investment is in residential or commercial real estate.
In this example, someone puts up a lump sum of cash (or invests with other partners) to purchase a property in order to receive the monthly or quarterly income that the rent of the property produces.
The investment property is purchased for $50,000 and the rent is $800 a month.
The gross scheduled income is $9,600 (12 x $800).
We will assume a standard vacancy rate of 8%, thus reducing income by $768.
Assuming a fairly standard 45% expense ratio, we project annual expenses of $3,974.
This nets an annual income of $4,858.
This yields a monthly cash flow of $404.
This is a cash flow return on investment (ROI) of 9.7%.
(This, by the way, is an appropriate representative example, since a cash flow return of roughly 10% is a good rule of thumb for those just starting out in terms of what you might be able to expect from this type of investment. That does not include any appreciation or increase in the value of the property, which is often projected to increase 3-5% per year, on average, due to inflation.
So with this representative example in mind, let’s discuss the overall benefits of cash flow:
Cash flow investing allows you to stop speculating blindly on uncertain returns. It affords realistic protection against volatility associated with certain other asset classes (the best/worst example being the stock market). Nobody can predict where the stock market will be a year from now, but with cash flow investing, if you’re selective and invest only in low-risk opportunities - with real estate.
For example, highly occupied (85-100%) properties - it’s fairly easy to predict what your cash flow will be because you can estimate your income and expenses within a reasonably accurate range.
Cash flow investing allows you to build a more predictable future for you and your family. Through careful planning and, of course, prudent investment decisions, you can more reliably “set yourself free” by leaving your job (as Jeremy did) and fund both your ongoing existence and, if you choose, a retirement plan that allows you to maintain the wealth you build without ever encroaching on your “nest egg.”
Cash flow investing lets you invest like the rich for “wealth-adjusted returns, which often includes significant tax benefits.” The wealthy tend to have opportunities that others don’t have access to - and investing in cash flow is one of their elemental secrets.
Many of their investments include depreciation and other tax deductions that may defer most or all taxes into the future, letting them (and you) benefit by writing off some of the assets and depreciation - tax deferral that can amount to a huge benefit long-term in any wealth-building program as it opens up growth to the power of compounded returns.
Cash flow investing enables you to take control of your returns. You can invest in what you want (and know) or work with an operator (aka manager of an investment) in whom you’re confident, instead of, say, having to hope that the stock market will come through. Also, with some non-traditional investments, you have the power to add value to your investment.
For example, if you face a vacancy in a real estate property, you can increase your marketing or rehab the property to rectify that situation. Under the right circumstances, you may even choose to increase the rent. Some of these steps do amount to extra costs, of course, but they often can be planned for and they allow you to make improvements in your property (and thus protect or improve your return) by exercising your own free will.
If you own mutual funds or stocks, you’re just along for the ride and your return will be completely immune to any effort you would personally hope to make to improve the value of those assets.
Cash flow investing works for both taxable and non-taxable purposes. The reliable building of income and assets that results from following these principles can be applied to tax-advantaged environments and programs as well, with their benefits thus magnified (for instance, the tax-deferral aspect of IRAs and 401(k)s). Regardless of your priorities, cash flow investing helps you earn potentially higher and more predictable returns, short-term and long, than traditional investments.
What about “traditional” and “alternative” (non-traditional) investments?
We’ve given you our mantra that the solution to the risks with traditional stock market-related investments is changing your focus to non-traditional, alternative investments that generate cash flow, but what exactly are some of the risks inherent in traditional investing?
With traditional investments, there’s no guaranteed predictability, and therefore you can’t plan your future based on past market activity (a case in point being that, despite its ups and downs, the market ended up essentially flat between 2000 and 2012, which unfortunately set back the retirements plans of tens of millions of people in the U.S.).
Traditional investments are subject to stock market seasonality and cyclicality. There are emotional (some would call them irrational) decisions that drive the market up and down in spikes and create and burst bubbles. Prices are also vulnerable to the shock of world events (whether or not they reasonably relate to the value of stocks) and to high-frequency trading.
With traditional investments, you have no personal power to add value - your inability to do anything about, say, Apple introducing a bad iPad leading to possible negative effects on your Apple stock versus our example of being able to rehab rental property you may be holding.
We’ve pointed out that to date, knowledge, and use of this alternative, non-traditional investments have been held (if not intentionally) pretty close to the vest by the sophisticated investment community.
Here is Investopedia‘s the definition of an alternative investment:
An alternative investment is an investment that is not one of the three traditional asset types (stocks, bonds, and cash). Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, limited regulations and relative lack of liquidity. Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts.
That sounds both simple and pretty heavy, but we’re here to suggest that it’s time - and it’s easy - to start “investing like the wealthy” in non-traditional investments and gaining the long-term advantages of cash flow investing.
Alternative investments come in essentially two types:
Alternatives that deliver recurring, predictable cash flow with a high degree of probability. These alternative payments do serve the purpose of cash flow investing
o Monthly residential real estate rentals
o Quarterly commercial real estate payments
o Monthly ATM payments (from the ownership of non-bank ATMs)
o Monthly hard money real estate loan interest
o Monthly lease payments
o and others
Alternatives that do not deliver recurring payments over the life of ownership but speculate on the payment of lump sums after a period of time. With their unpredictability, these alternative payments do not serve the purpose of cash flow investing
o Small family home flips
o Land banking
o Residential real estate development
o Commercial real estate development
o Speculative oil drilling
o Precious metals (gold, silver, etc.)
o and a variety of others
There are compelling reasons to focus on the “right” kind of alternative investments in a cash flow portfolio.
With them, you have a greater hold on your investment activity - deciding whom to work or invest with, having the ability to add value to your investments and allowing you to invest in cash flow, not speculate on appreciation.
They offer you a choice of flexible structures (time horizon, amount of investment, amortization schedule and so on) to suit your needs, often providing the ability to align the investment manager’s incentives (when he/she gets compensated, etc.) with yours.
It is possible to find unique and hard-to-find opportunities, without increasing your risk, if you know where to look.
In the commercial real estate, as an example, the total annual returns you can expect can be impressive once you total the three possible ways to earn money with this type of vehicle - your cash flow, the increase in your equity if you’re paying down an annualized mortgage each year and some expected appreciation. Using even conservative projections, you could earn between 17% and 20% per year on a typical property.
That’s huge - more than double what you would achieve with the market if you assume 8% annualized growth (which actually might seem high if you examine the stock market average over the past decade, but we’ll give the market the benefit of the doubt by using the S&P’s long-term historic annual growth).
All that being said about the benefits of “investing with the wealthy,” successful cash flow investing still takes hard work - and you need to be very careful to avoid these potential threats to success:
To avoid years of sub-par or no cash flow, you need to be selective in your investment choices. Importantly, you need to center your selection of investments in the generation of cash flow (income), not appreciation.
This is a core rule for this type of investing.
You need to ensure that you are properly diversified across enough opportunities to avoid the risk of “having all of your eggs in one or too few baskets”. This can be avoided by paying particular attention to how much you invest in each opportunity. If you need advice on how to choose the right investment amounts for you then be sure to consult with your investment advisor.
You do not want to get to the point where you’re encroaching on your investment capital, having to withdraw from your nest egg for expenses, thereby reducing your investable funds, your future earning power and your wealth. The simple way to mitigate this is to carefully forecast your needs and plan ahead to generate the cash flow you’ll require before you leave your job or retire.
You need to constantly work on optimizing your investment decisions by staying current on the economy and economic data, networking, reading other materials like this, investigating investment courses - and being flexible and resilient enough to learn from your experience.
To avoid lack of liquidity - which is to say, finding yourself with the inability to take advantage of strong investment opportunities as they come along - plan ahead to avoid over-allocation of your total investment pool.
Finally, while cash is normally a great thing to have, for the cash flow investor, it isn’t. Having too much idle cash (other than what’s necessary, of course, for day-to-day operations and emergencies) instead of keeping it in working investments comes with an opportunity cost that can and should be avoided.
Why we like real estate.
As we’ve noted, there’s a world of choices once you’ve decided to focus on alternative investments that deliver recurring payments. With research and diligence, cash flow success can be achieved with investments of many types, both “niche” and normal. We certainly have investigated different asset classes.
. . but on balance we believe that, if it’s appropriate for your investing goals, consistent, predictable and positive results can flow from making real estate the primary asset class in which your cash flow assets are invested.
To begin with, a successful real estate investment by its nature can provide a number of ways to make money — from predictable monthly cash flow to appreciation in the property itself to the tax benefits that real estate provides.
In addition, real estate allows you to make money one more way, through debt buy-down. You can borrow money against your holdings, and long-term, if you’re paying off that loan with the cash-flow income you’re receiving from your tenants. You’re making money on your investment without anything having to come out of pocket.
Real estate, then, allows you to make money four ways.
Real estate is a proven method for building wealth, with more millionaires having been made through real estate than any other wealth-building medium in the world. Long-term real estate ownership historically has proven to be a strong vehicle yielding high appreciation, often far superior to other retirement asset choices. Further, modest real estate investments (i.e., $25,000 and up) can be “shared” via syndicated participation in larger real estate investments that would normally be out of the reach of smaller investors.
Careful selection of real estate investments affords realistic protection against volatility as compared to certain other asset classes (and certainly compared to stock-based holdings). For instance, if you are selective and invest only in low-risk real estate opportunities - let’s say 85- 100%-occupied residential properties - it becomes fairly easy to project what the year’s net cash flow from rentals will be, as you can usually predict expenses within a certain range - this in contrast to being at the call of the fluctuations and higher risk of other investment classes.
Real estate is a diverse asset class affording a variety of opportunities serving different investment objectives (dependable cash flow, property appreciation in the short or long-term, or both) and also allowing the possibility of anticipating and adapting your investment mix as the nature of the real estate market changes over time.
Unlike traditional market-based assets, real estate is a tangible holding. As we’ve seen, stock exchange-based holdings do not represent a hard asset, and can be subject to the pricing and whims of the market, sometimes emotional and often not predictable. Contrarily, the floor on a hard real estate asset doesn’t usually go to zero.
As we’ve demonstrated before in our discussion of non-traditional investments, with real estate in your portfolio, you have tangible power to add value to your investment.
What types of real estate investments can you include in your cash flow program?
The answer to that question is “almost anything” . . . but do keep in mind the imperative of tilting toward recurring cash flow over property appreciation.
Categories available for an interested investor to participate in real estate can be broadly defined as follows:
Residential real estate investing in single-family residences is a very classic real estate investment. The last few years, of course, have witnessed major decreases in the values of homes across the country along with a flood of foreclosures (now abating) and short-sale activity, and although a recovery is underway, the single family still represents an extremely attractive investment.
Continued tight lending standards, following the wave of foreclosures, should also help keep the rental market robust in the foreseeable future. A steady supply of renters combined with low home prices is an excellent formula that can make this type of investment in a self-directed account a success.
Multifamily (apartment) investments:
Multifamily is one of the best real estate investments you can make in today’s market. Historically, multi-family has low vacancy rates and unlike other commercial sectors such as retail or office, multifamily has shorter-term leases that help the owner quickly capitalize on changing market conditions. Multi-family is also well-known for providing stable cash flow as long as you invest in the right types of multi-family properties in the right locations.
Recent years have proven to be a great time to invest in multi-family. As the current economy, still in recovery, continues to take its toll, the impact on long-term multi-family investment properties is positive. Demand for multi-family housing is expected to double in the next few years as homeownership rates remain soft due to continued tight lending standards and poor credit scores.
Also, the next generation of renters, the Echo Boomers, are projected to increase the renter pool by nearly five million people over the next ten years. More renters in the market should help keep cash flow trending steadily upwards as property values continue their recovery climb.
Commercial Real Estate:
The commercial real estate also offers tremendous opportunity and diversity within this type of investment. The most critical factor in commercial real estate investing is the experience and expertise of the operator and his or her ability to either manage the property or oversee the property manager.
The commercial real estate is more akin to running a business, and understanding both the micro and macroeconomic factors that can make this type of investment success is crucial. For most of us passive investors, the real skill in analyzing these kinds of opportunities lies in the ability to determine if the operator is skilled enough to operate them successfully.
Some examples of commercial real estate investments include retail shopping centers, office buildings, mobile home parks, self-storage facilities, industrial buildings, and hotels. The commercial real estate can provide excellent diversification across asset types and location.
Some commercial real estate asset classes, including mobile-home parks and self-storage facilities, for example, are known for their strong performance during economic downturns and can, therefore, offer particularly good diversification to help reduce cyclical volatility for investors.
Trust deed investments:
Less known as a type of real estate investment, but under the right conditions an effective use of investment funds, you can lend other people money for their real estate transactions. In this case, the loan is secured by real property and you are loaning money on specific terms and conditions for a specific property.
Tax lien investments:
This type of investing involves purchasing “liens” on residential and commercial properties levied by counties for the failure of others to pay property taxes. Once the late bill is settled (and most are), the government will contact you and pay you back the amount you originally paid plus substantial double-digit interest. Investing in tax liens, however, is a labor-intensive process and can benefit from the help of an expert.
Real estate notes:
Real estate notes, or mortgage notes, are ideal for investors who want to own real estate without the hassles of traditional property ownership. Instead of buying an actual piece of property, investors buy the loans or notes, that is secured by a piece of residential or commercial property.
Notes have a wide range of entry points, making them accessible to a broad range of investors. Like every investment, what would make the most sense for you depends on what you’re trying to accomplish, how long you have to accomplish it and your own risk tolerance. This type of investing is specifically appropriate for those who want to invest using their retirement funds.
In real estate - and in cash flow investing generally - how do you find the best investments and whom should you choose as advisers and partners?
This, of course, is a huge question that we can’t answer in a short document like this. But we can sum up our thoughts in three broad words:
In our summary to this blog, we’ll mention again the importance of constant networking and learning as you develop and manage your investment program moving forward. There’s no better guide to success than education and learning from your own and others’ experiences - and there are many ways to do that.
However, it will be the quality of the people you run into and seek out and with whom you work as you move along your journey of cash flow investment that, bottom-line, will have the greatest impact on the success of your efforts.
It’s a general truism in business, and we would say most important in the selection of investments, that the deals you make aren’t as important as the people with whom you make them.
To narrow it down, for now, let’s again take real estate. We have made the case that real estate is something you should investigate and that in our own actions and through the advice and techniques we’ve given to others, the rewards have been substantial - but one lesson we have learned and that guides us in everything we do is that WHOM you invest with matters more than WHAT you invest in. It’s as simple as that.
Integrity and performance are that important - and this philosophy goes way beyond real estate, extending to every participant at every stage in the process of building and operating your program. Integrity is a characteristic hard to spot (and here’s where your networking and personal experience will eventually guide you to the right people), but a true comfort once identified.
Performance is identified and measured in a myriad of ways depending on the nature of your investments and what stage you’re in - but using real estate as an example once again, performance is evidenced in the process of selecting your investments from the many which will (eventually) be pitched to you.
In this case, the best-performing operators (those holding properties and proposing you participate in them) provide you or your real estate advisor in-depth, 360-degree reports and analyses of proposed properties and investments, exhaustive in their detailing of every aspect relevant to the purchase from the nature of the neighborhood, type of construction, history of occupancy to the quality of management and their support team.
Of course, the best operators include detailed, credible, and conservative income forecasts and projections. Our preferred operators are those who strive to “under-promise and over-deliver” to build long-term relationships with investors as opposed to those who “overpromise and under-deliver” just to make a quick buck at the expense of investors.
We can vouch from our years of experience that there will be many fine players along the path of creating and investing in your cash flow program, and we trust it won’t be hard for you to find individuals and firms with competence and integrity to serve as your partners, suppliers, and advisers. The search for these qualities is something you absolutely never should lose sight of.
We abide by an investment philosophy borne out of historical analysis and actual observed results - that cash flow investing can allow you to earn more predictable returns that significantly outperform the long-run average of the stock market. That, in turn, will lead to strikingly increased long-term wealth.
Let’s take a macro look at some simple representative returns from traditional and non-traditional investing and see what compounding over the years can do in each case with an initial investment:
Take $100,000 as a starting figure and use a conservative 11%-20% target return for cash flow (remember the 17%-20% rule of thumb above) vs. the historical S&P 500 figure of 8%.
If you assume 8% annual growth with the market, you’d be talking about almost $1.1 million in net worth after those 30 years:
$100,000 @ 8% 30 years = $1,076, 516
But if you took a look at investments that were on the lower end of the alternative investment return schedule and were generating about 11% for 30 years, then you’d have about $2.5 million in net worth - about two and a half times what you would have achieved with the market.
$100,000 @ 11% 30 years = $2,593,102
Impressive. But here is where it gets really powerful: if you were looking at what we honestly would consider to be more of a normal total return range for alternative investments, on the lower end you’re talking about maybe 15%, which would literally deliver you more than eight times the net worth than from the market over 30 years of investing.
$100,000 @ 15% 30 years = $8,290,345
And on the high end, you can get up to $34 million!
$100,000 @20% 30 years = $34,891,198
Now, that number may seem crazy, but we can say that we’ve personally earned annualized returns of more than 17% over the past 11 years through a whole slew of passive cash flow investments, so his number would be somewhere between 10 and 15 times what the stock market would be predicted to do.
An even crazier thing is that we’ve actually earned those returns between 2002 and today, and during those years, despite gyrations up and down, the stock market was flat, so in theory, we would be at even higher multiples compared to what we could have earned in the market during that period.
So now you get a sense of why these types of return are typically reserved for the wealthy. The point is; this is how the wealthy invest! You can, too. We’ve alluded to two types of investors - active and passive. What are they, and what’s right for you?
As with many decisions in life, once you’ve made the jump into cash flow investing, you have the choice of becoming an “active” or “passive” investor. The definitions of these two levels of involvement are intuitive, and based on your available time, past experience, your roll-up-your-sleeves-and-get-involved-in-all-decisions nature, and your self-confidence when it comes to real estate matters, the choice will probably be easy.
An active participant seeks out alternative investments where he/she has full control - for example, in buying a single-family home for the cash flow it offers, the active investor takes title to the property and assumes all management activities (or hires a property manager) as well as all decisions relating to financing and selling the property.
This takes time and attention, magnified for a multi-property portfolio. Active investment is thus best suited for people with the time, detailed knowledge about a specific type of investment and/or who wish to retain full control.
A passive participant invests in alternative investments that are managed by someone else, hiring experienced operators (syndicators) to handle the assets. In buying that same single-family home, he/she may do so using a buy-and-hold of a pool of homes that are managed by an experienced operator in exchange for management fees and a split of the profits. The operator/manager is given full control of budget, spending, and decisions on which properties to buy, on structuring the investment opportunity and on the financing and selling of the property.
The key to successful passive investing is to make sure the operator(s) hired are experienced in that type of asset or property. Passive investing is best suited for persons without the time or the expertise to get deeply involved (or who just choose not to take on that responsibility) and who are willing to invest in an opportunity managed by others with full day-to-day decision-making powers, thereby handing the control over to an experienced operator.
The decision on the depth of involvement is yours, though we tend to recommend that the starting real estate investor strongly consider a more passive entry into this new world. This can, of course, change over time . . . and the decision need not always be based on an investor’s industry knowledge or confidence level.
We are proponents of and committed to passive investing, as it has proven to be the best fit for us after years of investing.
While there are pros and cons to both approaches, definite factors often augur in favor of passive investment:
Passive investing allows for more diversification. Operators with specialized experience can be “hired” across various asset classes and geographies, allowing passive investors to be much more diversified than active investors. You gain diversification along with expertise by investing with experienced operators.
Passive investing obviously makes it easier to accommodate the schedule of part-time investors with jobs, as the operator is responsible for managing the investment.
Passive investing can generate significant cash flow results without doing as much work! Most of the work is upfront in evaluating the property and the operator. Once that’s done and the investment is in place, most of your work - metaphorically and with only a little exaggeration - is going to the bank and cashing your checks (with even less work if you receive electronic [ACH] payments)!
(Success can and should never be considered totally hands-free; it still revolves a lot around researching and evaluating investment opportunities, and constant and long-term planning is required to ensure that the resulting cash flow matches your personal and family needs looking forward, regardless of the degree of investment “involvement.”)
Passive investing allows you to leverage other people’s credit. This allows you to invest in multi-million-dollar properties where your credit doesn’t qualify you but someone else’s does, opportunities that you might otherwise never be made aware of. Getting involved on this basis has no effect on your credit rating. Most passive investments accept retirement accounts, with the creation of a “self-directed” account and then the transfer of funds from the existing retirement account, which is easy to do. More on that shortly.
It is vital that you define your cash flow priorities, your goals and your activities with a long-term plan.
By now we hope we’ve begun to convince you that focusing on a cash flow investment program, one that utilizes alternative investments and places you in an active a mode as you feel fits your time and predilections, is the beginning of a successful plan to help you escape the corporate world, to enjoy life and, if you wish, to build a comfortable retirement plan.
It is all that - but true success and a smoothly working investment program begins and continues with a long-term plan. Plans can be simple or they can be complex, but they all should involve defining your monthly cash flow goals for living expenses, for retirement and for any “extras” in life, and then evaluating and planning out a cash flow program that delivers the right amount of income ideally at the right time.
This is possible by choosing investments offering monthly or quarterly payments at the right times and with the right time horizon to match your budgeted expenses and also, ideally, delivering income over and above those foreseeable expenses for reinvestment purposes.
We believe cash flow is king and it can change your life with the right moves and the right effort to find the right investments . . . with the right plan. Now a few more words on retirement: the good news is that virtually all aspects of cash flow investing can be done using your retirement savings. The great news? The benefits of cash flow are leveraged immensely by your plan’s tax-deferred status.
IRAs, 401(k)s and other retirement plans can feel like they come burdened with rules that restrict investments to those offered by your company’s 401(k) custodian or the custodian you’ve been working with on your IRA, and in most cases that means you’re probably invested 100% in market-related equities or funds.
Just as non-retirement-related investing can be put on a vastly better growth track by shifting to cash flow investing, so too can your current retirement plan portfolio. Since tax-deferral continues to apply with your new retirement fund, all the benefits we’ve spoken about and the power of compounded returns become significantly upsized.
It’s legal and it is simple to make the transition. All you need do is create a “self-directed” retirement plan (say, an IRA) with the assistance of an IRA custodian firm familiar with this type of retirement account, which takes only about $50 and 24 to 48 hours to set up.
And then you’re ready to transfer all or a portion of your funds from your standard plan, easily and with no tax implications because you’re merely rolling your portfolio from one retirement custodian to another. Your IRA custodian then in effect becomes the trustee of all your future investments into your new fund.
The rules governing cash flow investing in a retirement plan differ a bit from non-retirement plans, but observing them amounts to little restriction in your ability to benefit in every way we’ve described so far.
There are three - only three - non-traditional, alternative investment categories excluded legally from investment in a self-directed retirement plan - collectibles, life insurance and stock in “S” corporations.
One more restriction: you, your IRA fiduciary and certain family members cannot do business with your IRA (sell services to or live in an investment property, etc.) - essentially all lineal relatives (parents and grandparents, children and grandchildren) and their spouses. (You may go sideways, though - to brothers and sisters and so on.)
As we note, there are few and mild restrictions compared with the immense benefits of “investing with the wealthy” in retirement plans.
Summing it all up.
We hope you’re intrigued by what you’ve begun to learn about “how the wealthy invest” and how many of them do so well in growing their assets and wealth by following the principles of cash flow investing. We’ve reviewed the basic tenets of the technique, and discussed why, although the range of acceptable investments is wide, we’re fans of real estate for both those starting out and experienced cash flow investors. We hope you understand that these types of investments are available in relatively reasonable minimum investment amounts (starting at $25,000).
We leave you with the reminder again that your success with cash flow investing never stops benefiting from education and networking to share in the experience of others and find new investment opportunities.
There are many fine investment clubs, classes, and other opportunities to do this around the country, and we encourage you to use them to your advantage. In addition, Jeremy and David each host monthly public meetings of “For Investors By Investors” (FIBI), an organization with over 10,000 members that was co-founded by Jeremy in 2007. FIBI hosts casual monthly meetings throughout Southern California and across several states focused on the subject of alternative investments.
Their purpose is purely networking and information exchange, with profit motives and sales pitches, strictly prohibited. FIBI has experienced strong interest and growth since it was founded in 2007 because investors know they will not be pitched blogs, tapes, or seminars at any FIBI meeting. You can find more information about FIBI at We are what we do | Meetup (We are what we do | Meetup) (search for “FIBI”.)
We hope you don’t wait long to take advantage of this impressive investing approach. Regardless of your chosen investment path, we wish you good luck and successful investing!
The wealth the Right Way
Investing starts with you. It starts with you knowing yourself and to be willing to do the homework to “trust and verify.” Most believe “trust” but don’t “verify.” It takes time to do this, but the time spent in verifying the details up front will ensure better results down the road. It’s the same thing we do with our properties.
Pay your time now or pay the penalty later. It starts with you knowing your objectives. It starts with you knowing your vulnerabilities and the details. It starts with you knowing how to ask questions - even ones that you may fear sound unintelligent or too basic. If an investment doesn’t or can’t make basic sense to you, run.
With all that in mind, here’s a list of key questions every investor should ask:
What’s my appetite for risk?
Am I young and easily able to recover if an opportunity doesn’t pan out? Am I nearing retirement and needing stability more than high yielding returns? This is the kind of question where there’s no right or wrong, just what’s right for you. The greater the risk, the greater the potential upside - and that’s what you need to deliberate.
What’s my timeline - short-term or long-term?
One year? Three years? Ten years or more? This makes an enormous difference in the types of investments that will be a good match.
What actually makes sense for me at this stage of my life?
Your appetite for risk may be telling you one thing, but your life stage/timeline may say another. When in doubt, we encourage you to err on the side of whichever voice is the more conservative one. The risk-taker in you may not be quite as thrilled, but you’re still apt to make a sounder financial decision by being sure to take your life stage into account.
DO I UNDERSTAND WHAT I’M INVESTING IN?
Kids these days tell us typing in upper case is the written equivalent of SCREAMING. So, we put this question in all caps because we’re screaming at you. Furthermore, we’re knocking you upside the head and capping it off with a facepalm to our own heads.
Of all the questions, this one is the most important. You’re infinitely more vulnerable - in every way - if you don’t understand what you’re investing in. You’re infinitely more apt to not understand risks and outcomes. You’re infinitely more likely to be caught off guard if it doesn’t yield the kind of results you were hoping for.
You’re infinitely more prone for some dishonest person to come along that portrays himself as more knowledgeable than you can ever hope to be in the investment vehicle and play you for a fool. Furthermore, if an offering gets too complicated, we tend to pass. Don’t leave your power with the experts. Use your gut and brain in listening carefully to the story and see if it seems to make sense in both gut and brain.
Quite frankly, it’s why we like real estate. It’s something tangible and easy to understand. Here’s the thing to remember: your money may make you three, eight, 12 or 24 percent - and it’s good to understand different vehicles that yield those different results. Not understanding the basics of what you’re investing in can not only yield you anything, it can cost you your nest egg.
Is the opportunity I’m evaluating sound too good to be true?
Any investment has inherent risks. You need to know what those risks are, and what that means in terms of what could happen if a deal doesn’t happen the way you hope. Parachutes aren’t the worst thing in the world, even if your investment firm needs to use it. A prime example of this is the foreclosure process; we’ll talk more about that later. For now, know the far greater risk is associated with convincing yourself your investment doesn’t need to pack the parachute at all. Turbulence happens; be aware it may happen while you’re on board.
Do I believe what I’m investing in?
You don’t have to confuse this bar with the kind you set for your charitable donations, but each of us as a responsibility and obligation to understand money is a powerful thing. You should want your investment to go into something that you think does some good or serves a useful purpose. If you can’t fathom why another person would want to pay money for what you’re investing in, it’s a signal that it’s not a good fit for you personally.
Do I trust the ethics of who I’m investing with?
There are two essential components to trusting who you do business with: trust in their ethics and trust in their abilities. In terms of ethics, what guides their moral compass? How do they behave when no one is looking?
Reality check: no one ever comes right out and says “I’m not a great person” - especially the slimiest people on the planet. They often work hardest to come across as ethical, making your job all the more difficult. That’s why assessing a person’s ethics is often better observed than discussed. How does the person treat others? Does the person move around a lot - whether it’s physical moves or burning through personal relationships? Have you noticed the person lie to someone else?
Let’s break these down. How a person treats others is an indication if they respect people they perceive to have less power than themselves. We all know the type - the people that behave one way to people that can do something for them, and quite another when they think the person can’t. Their actions tell you something about their perceptions of the worth of others. Those perceptions tell you something about their character.
Moving around a lot, whether it’s from city to city or person to person also likely says one of two things. We’re not talking about the type of moves associated with a career like being in the military - where there’s a clear, long-term commitment to an organization that just happens to necessitate moving.
We’re talking about the types that either get a bad rep and need to move or don’t know themselves well enough they just seem to bounce from one thing to the next. Either way, it’s not to whom you should hand over your money. Stability is the prized trait you’re looking for in this regard.
Lastly, there’s lying. If you know a person has lied to someone else, there’s one key takeaway: they will lie to you. There’s overt lying, lying by omission, white lies and the nuanced reactions people give when putting on the spot about something sensitive (does the dress make my butt look big?). No, all lies are not the same. But they are all pangs, shades or blatant forms of dishonesty. The takeaway is this: to the degree, the person is dishonest to another, they will be dishonest to you - and that’s the degree you need to feel comfortable about.
If you think life’s little observations don’t matter, think again. They’re clues. How a person treats others is a clear and relevant indication of how they’ll treat your money when you’re not looking.
Do I trust the abilities of who I’m investing with?
The next component of trust is in a person or firm’s abilities. Is the person an actual expert? Does the person know how to think and navigate any and all possible environments? Again, actions speak louder than words. You want to know everything you can about their experience, education, track record and results. Ask questions about how long the firm has been in business, the volume of business and for references. Take the time to read a person’s bio. If it doesn’t fully answer a key question, ask for the answer.
While we’ve established you want someone honest and ethical handling your funds, ability in the financial world also means someone with a backbone. Two types of people can win in business: nice guys and bullies. One type will lose pushovers. You can be nice and hold the line. You can be a good guy and command respect.
You can fire someone that isn’t right for a job and do so in a way that respects the other person’s dignity. You can be fair to others and put your foot down and insist others be fair to you and your investors. You can only be successful with other people’s money if you have enough self-respect to stand up for what’s yours. It’s not a matter of if someone will try to skate or come in under par with your money; it’s a matter of when.
The thing about a bully is he will certainly hold his own in the ring, but he’s also prone to bully you when you don’t even realize you’ve stepped into the arena. We’ll share an example later on.
Yet you still want someone that, when challenged, can step into the ring and hold his own. He’s likely fighting on behalf of your child’s college education or your personal retirement funds. When provoked, he needs to know when and how to throw however many strategic punches it takes for a threat to be averted, but after it is, you want the guy that gladly takes off the gloves.
What homework have I done to affirm that trust?
This may seem like a redundant question or a repeat of the one above. Too often, people want to skip the due diligence stage and jump in at the end of a one-hour presentation. You’re busy. We get that. Taking a few extra steps like running a background check and actually calling a reference (or two or three) can be worth it, as can spending a little time with a person outside the office.
References will yield you as useful information as the questions you ask. You want to know how the person communicates disappointing news as well as the good. Are they able to explain the status of an investment in a way you can understand? Are they forthcoming if something doesn’t go as hoped? Are they able to navigate challenging financial times as well as the good ones?
You also want to know what will be done to keep you informed as the investment process progresses. You want to ask how accounting is handled and what kind of reporting you can expect to see. You want to have access to the blogs at any time. The key trait you’re seeking here is transparency. Consider “homework” an ongoing responsibility.
Evaluating the Multi-Family Opportunity
Hopefully, you feel more empowered than ever, and have greater faith and confidence in your ability to make good financial decisions for yourself. The next step is to evaluate your options. Specifically, we’re out to help you determine if investing in the commercial real estate is right for you, and if so, which program best suits your objectives.
First, here’s why we like real estate over other investing options. For starters, it’s a tangible, hard asset - there’s no faking bricks and mortar. With as much funny business that goes on along Wall Street, many of our clients tell us they’ve come to the sad conclusion it’s a game they’d rather not play. Secondly, real estate assets perform for you.
The cash flow we receive is distributed quarterly to the Limited Partners. Another advantage has to do with taxes. As an owner of the property, the limited partners receive tax depreciation as long as cash is invested. Qualified plans or IRAs do not receive the tax benefit. Finally, when we do sell the properties, the profits are taxed at a capital gains tax rate as long as we hold the property for more than 12 months, which is the plan.
Thrive, FP offers two kinds of investment opportunities - our Debt Program and our Equity Program. These programs are designed for investors with different objectives and needs. Before we share the specifics of those programs, we want to zoom out and share with you the steps we go through when determining what properties or people in which to invest or to lend money.
What we invest in
Thrive, FP makes investments on real estate-backed assets or loans to people investing in real estate. This means for every cent we place, there’s a tangible asset on the ground. We happen to be big fans of real estate because it meets our criteria for believing in what we’re investing. People need places to work, sleep, eat and live. Most of those places are apartments and other commercial real estate assets.
Within the commercial real estate sector, there’s retail, office, industrial and multi-family property types - all relatively self-explanatory. Multi-family properties are perhaps the easiest to explain in perhaps painfully basic layman’s terms. The term refers to housing where multiple housing units are clustered together and rented to people. The most popular kind of multi-family property is apartments.
Why we invest in it
People need places to live, so in this sense, multi-family properties provide one of life’s most basic and universal necessities. In that sense, it’s a service we feel good about providing, particularly as we’ve evolved in the way we’ve gone about delivering that service. We see tenants as people, not commodities, and believe in running properties in a manner that respects the human spirit.
We like multi-family properties in particular because they tend to be a more stable asset type than other commercial real estate sectors. What we saw in the last downturn is that people flocked to rental properties. For many, changes in the home loan process meant that they couldn’t afford the down payment money required to purchase a home.
Yet, even as the economy improves, rental properties in growing areas continue to fare well. That’s because there’s a continuous supply of young people turning 18 and leaving the nest. The key is being sure to invest in areas with population growth.
Where and What
Population growth has been particularly strong in: Texas, California, and Arizona. As such, our firm focuses our investments in these three markets exclusively. We understand markets cycle; the economy will go up and down. So population growth tends to act as a hedge against the dips and lows.
Of course, simply investing in any multi-family property in one of these three states isn’t a winning formula in and of itself. That’s why we focus on urban areas, with particularly strong residential growth. In Texas, this has meant areas like Austin, San Antonio, Houston, and Dallas. In Arizona, it’s been Tempe. Within our target areas, we look for properties that are in areas where people have an established track record of wanting to live.
Often existing properties in established locations are considered Class B or C-level properties. Properties are grouped into levels and assigned a grade by the market - not too different than the grades you get in school. Class A refers to the shiny new properties built with modern touches and high-end finishes.
They tend to command the highest rental rates. Class B properties are often just older Class A properties, and still, have healthy rental rates and occupancy levels. Class C properties are generally more than 20 years old, and as such, are viewed as outdated by the market. As such, they tend to have the lowest rental rates.
Simply doing a drive-by, you may find yourself thinking the Class A properties look the most attractive. But it’s the Class C properties that tend to offer the greatest upside to investors when a new buyer comes in and makes strategic upgrades.
The thing about Class B and C properties is that a greater percentage of the population can afford them. This means we aren’t competing for the dollars associated with the top echelon of tenants. Class A dwellers are often on their way up the economic ladder. They’re the young professional straight out of college that will likely own a home within five years, or they’re a trendy jet-setter that will want to move to the even better, newer Class A property in a few years.
Tenants in Class B and C properties tend to stay longer - when they’re happy with how a property is maintained and managed. As we’ve found, through our years of experience, lower turn-over rates translate to greater profit margins.
From time to time, we have invested in a new property - but it’s been in an established location, otherwise known as infill development. It’s been in conjunction with partners that focus on creating affordable opportunities for a broader cross-section of the population.
The thing we like about established locations and affordable price points is that they’re proven. We can get the property and area’s history, otherwise known as market data, and analyze it backward and forward - and then determine its future potential. The analysis process is the next step, also known as underwriting.
The Microscope Treatment
Earlier in this blog, we advised you to know what you’re investing in and who you’re investing with. Remember that last question about homework?
First, we’ll provide a technical definition of the term underwriting, and then we will present ours. Underwriting refers to the process that a service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit).
Thrive, FP’s underwriting means doing tons and tons of homework. That’s about as laymen as it gets, and it’s the plain truth. We’re are as suspicious and meticulous as possible, and we couldn’t be more proud of it. Translation: we investigate every potential investment with the same tenacity a lawyer performs a discovery when going before the Supreme Court - ditto when we’re investigating a potential borrower.
Investopedia offers a historical perspective on the word ‘underwriting’, noting it comes from the practice of having each risk-taker write his or her name under the total amount of risk that he or she was willing to accept at a specified premium. The principle remains true to this day.
Another term for investor could be risk-taker. It’s just a less-appealing label. However, it gets to a point that’s crucial to understand: all investments involve risk. It’s a matter of how risky is right for you and your money. Certainly, nothing ventured, nothing gained. What proper underwriting means is we do our very best at is minimizing the venture and maximizing the gain.
In terms of homework, we study a property’s location in depth. We want to know the area’s demographics, nearby employers, transportation access, etc. We study a property’s occupancy rate. Not just current figures, but as far back as it takes to see how the property performed in the most recent economic dip. We study its age and condition, wanting a full understanding of what’s apt to break in the near future and a few years down the line. JP’s father has a great saying “if it works well in the rain, it will be great in the sunshine.”
We also determine its value and fire sale price. We define fire sale price as the amount the property is likely to sell for if we had to sell it in a big hurry. Every possible scenario is important to understand. Everyone is happy if everything goes well. Our goal is to make sure we don’t lose money if things don’t go as well as we all expect. It’s that whole parachute thing. We insist on packing one to go along with every venture.
Not only does this process help us determine if a property is worth buying, it helps us determine how to best utilize it in the future. If there’s a property with below-rate values because it offers sub-par conditions, it’s our job to determine what improvements to make and what new rates are appropriate to charge. You must know particular sub-markets norms to be strategic with every cent you invest.
Responding to Underwriting’s Results
Keep in mind, there’s doing the homework, and reacting appropriately to the results. Case in point: Thrive recently went through our due diligence process. Everything about what we were finding was leading us to believe a borrower and property would fit our criteria. As such, we had told some of our investors about the opportunity and had been raising funds for its purchase.
Near the very end, something surfaced on our radar screen about the property that gave us pause - pause enough to walk away from the transaction at the last minute. Specifically, we learned something about a potential borrower’s past history - how a situation was handled with a former associate - that we found troublesome.
We’ll be honest; we went to our investors with our tail somewhat between our legs. This wasn’t news we were hoping to share. While we weren’t wrong in thinking the property had potential, the borrower didn’t pan out to be as right as we require to meet our investment standards. We were concerned with how our investors would react to an unanticipated letdown.
Would they be mad? Would they think we wasted their time? Would they understand we were telling them as much as we knew and understood in real time, but that understanding changes with the more knowledge you gather?
Much to our relief, our investors handled the news well. They understood we were trying to ensure positive results. Some told us they trusted us more than ever - because they knew it wasn’t easy to walk away. Here’s the hard truth:
Thrive itself would have made money on that deal. Our fees would have carried us through just fine and made it worth it to us as individuals. The results to our investors were less clear. The perceived risk was just too high to feel good about.
To bring it back to a point made earlier, this scenario is why you don’t want to give your money to a bully. A bully would have turned a blind eye and placed his own self-interests above his clients’ best interests. Maybe it would have ended ok, maybe it wouldn’t. Our conscious wouldn’t allow us to continue knowing what we knew and shouldering that kind of risk. We wouldn’t have advised our friends and families to put their money in the deal, and that’s our standard.
More times than not, underwriting positions an investment firm to create appropriate terms for each deal.
Terms and Safeguards
Once we fully understand a property or a borrower and determine it fits our criteria, it’s time to create the terms. Specific amounts and terms are customized based on the specifics of the perceived strength/risk of a property or borrower.
The thing we’re vigilant in doing is building in safeguards. For the properties we invest in, this means:
We select “Best-of-Class” operators who specialize and excel at operations. Many firms try to do asset, property management, and operations. We think it is better to focus on our strengths and leave the operations to our “Jedi Master” partners. Thrive, FP makes less money, but our investors get a bigger and better team who specialize in their respective strengths.
We utilize our extensive broker network and local experience to obtain a detailed history on a property and its neighborhood before buying. We discussed this at length in the section above.
We pay close attention to our portfolio with a highly experienced asset manager, while watching closely for any important trends. We trust but always verify, with our property managers.
We underwrite with room for market fluctuations and unanticipated issues, not just “sunny day” scenarios.
In lending, examples of safeguards include:
Securing a promissory note that’s personally guaranteed by the borrowers.
Executing a deed of trust. This serves as legal notice to the world, and provides for an accelerated foreclosure should a borrower default.
Insist the borrower obtain fire, hazard, and lenders’ title insurance.
Receiving independent verification of a safety margin, and lend no more than 65 percent of loan-to-value, or less in most cases.
This also means we never put in more than the fire sale price. In this case, fire-sale price means what we could sell the property for if we had to sell it in a big hurry. In other words, if the borrower defaults and we had to foreclose on the property, our investors would still recoup the value of the property for their investment. It may not yield as much as if everything went smoothly, but it still means you’re apt to land on the ground in one piece. Thank you, parachute; thank you.
Next up, it’s time to proceed with the investment. We offer qualified investors an opportunity to participate in one of our two programs, our Equity Program or our Debt Program.
Our Equity Program
Accredited investors with a minimum of $100,000 to invest are eligible to participate in our Equity Program. It’s ideal for investors seeking greater returns over a longer time period, specifically anywhere from one to seven years. Between our two programs, this one has greater risk, greater rewards, and takes more patience.
Our investors are able to use cash, self-directed IRA funds or 401K savings to participate in this program. The IRS (Internal Revenue Service) qualified Real Estate Investing as acceptable investments. This means you can defer interest and take advantages of other tax benefits afforded to recognized retirement plans.
The concept lets you unite with other investors to jointly purchase multi-family real estate properties that you wouldn’t be able to purchase as an individual. As an owner, you receive monthly dividends based on how well the property is performing. Typical monthly dividends range from 16 to 24 percent of the amount you invested.
The bottom line is this program offers a hassle-free approach to real estate investing. Clients reap the benefits from high-interest returns without having to deal with issues like being a landlord, vacancies, tenants, repairs, evictions, etc.
Our Debt Program
Accredited investors with a minimum of $100,000 to invest are eligible to participate in our debt program. It’s ideal for investors seeking great returns in a relatively short amount of time. Loans in this category are typically short-term, specifically anywhere from six to 24 months. Our net annual yield to our lenders is currently garnering eight to 12 percent Annual Percentage Rate.*
Our investors are able to use cash, self-directed IRA funds or 401K savings to participate in this program. Like our equity program, the IRS qualified Trust Deed Investing as acceptable for IRA or other retirement account investments. This means you can defer interest and take advantages of other tax benefits afforded to recognized retirement plans.
The concept essentially turns everyday investors into a bank. It sounds lucrative, but banks aren’t known for taking risks. That’s why they tend to stay with secured loans such as mortgage loans or auto loans. Think about it...has your bank ever offered you a loan to purchase stocks, bonds or mutual funds? Yet, they will gladly offer you a loan to purchase real estate. Private lending is an excellent way for a private individual to act like a bank, enjoying high returns with a relatively low-risk.
Thrive, FP specializes in lending private funds to professional real estate developers and local home builders for both commercial and residential real estate transactions. These short-term bridge loans are fully collateralized by real estate. As a private lending company that represents a fairly large number of private individuals, we’re able to secure financing for these developers and builders in this tight credit market, while at a much faster pace than traditional mortgage lenders and banks.
The collateral for the loan is the specific piece of real estate for which the loan is funded. In other words, the borrower’s property is the security for the loan and the debt is evidenced and secured by a first deed of trust. The private lender’s name is reflected on the deed of trust and is recorded in the appropriate county to make the loan or debt a matter of public record. The connotation of “first” trust deed signifies that our lien has a first priority status, which means we maintain the premiere right to foreclose on a property if there’s a default on the loan.
It’s important to note that the maximum exposure we give is 75 cents on every dollar, otherwise known as a 75 percent loan-to-value ratio. This means that if a property’s value is worth $1 million, which we determine during our thorough underwriting process, then the max we loan is $750,000.
Another safeguard worth noting is states like Texas are called Deeds of Trusts states. This means they have a non-judicial foreclosure process, which significantly accelerates the timeline associated with a foreclosure, should it need to occur.
The bottom line is this program also offers a hassle-free approach to real estate investing. Clients reap the benefits from high-interest returns without having to deal with issues like being a landlord, vacancies, tenants, repairs, evictions, etc.
*Net of loan servicing fees, assuming a loan is paid as agreed. Past performance does not ensure future success. Money invested in trust deeds is not guaranteed to earn interest or insured or regulated by the FDIC.
How to Get Started
Standard Disclosure: Mortgage paper securities are not rated or insured against loss and may be subject to significant risks that are further described in the general and specific offering circulars. Past performance is not a guarantee of future results. Investors are urged to read the entire private placement memorandum before investing. We invite and welcome your questions.
Keeping you Informed
Above, Thrive, FP advises you to do your homework, and then keep doing it. We try and make that as easy on you as possible. Each investor receives quarterly reports on each asset they invest in and we are always reachable if you have questions. Also, each one of our investors is welcome to review our blogs at any time.
The Anti-Slum Lord
One thing we didn’t get into above is what happens after we close on a property. We do reference our alliances with top operators, and that’s key. At the end of the day, they answer to us - so it’s incumbent upon us to set a tone.
Some Class B, and in particular some Class C landlords have reputations as slum lords. Slum lords know they rent apartments to tenants with fewer options than people with more economic means. In other words, they don’t care about their tenants’ satisfaction because they don’t think they need to in order to make money. It’s just another form of bullying we discussed above, and quite frankly, it leads to a vicious cycle of perpetual disrespect that yields no winners in the long run.
What Thrive, FP has found is that a little investment goes a long way - investments in properties and investments in people. When you’re making strategic investments in areas with a dense population, people at all economic levels respond.
In terms of investments, this can mean anything from new carpet and countertops, the addition of a business center or energy-efficient appliances. More than that, we’ve found programming makes people feel “seen” and valued as the human beings they are. Class A-level properties often roll out the red carpet - incorporating all kinds of special events or little perks for being a customer. That’s not historically been the case in Class B, or certainly Class C properties.
We fundamentally want our tenants to succeed. We want them to get the job or get the raise, or have access to the goods and services they need. That’s why we offer events like job fairs or rides to the grocery store, which are so well-received.
We stated in the introduction that we want people at EVERY link in our economic chain to succeed. Our team has a long, successful track record of turning under-performing properties into ones where investors and tenants alike benefit. We serve people within our communities with far more than the walls they inhabit. We make environments safer, save money through energy efficiencies, and try to connect people as neighbors and friends creating flourishing communities.
Imagine knowing that your investment is out there improving the quality of life for others - while simultaneously generating healthy returns. While we’re just as conscientious and protective about the bottom line, we also genuinely care about the tenants in our communities. Our philosophy is that when they succeed, a property succeeds - and when a property succeeds, investors win.
Create and Protect Wealth with Real Estate
Over the next few pages, my intention is to share with you three items that will help you get in the real estate game or take your current real estate investments to the next level:
1. The Four Biggest Mistakes People Make When Investing in Real-Estate (do any of these and you’re likely sunk).
2. My Five-Pillar System to Create and Protect Wealth with Real Estate (we actually make more money when times are “tough”).
3. My Answers to the Two Questions I’m Most Frequently Asked - “How do I get started (even if I have limited funds at the moment - i.e. $50,000)?” and “How do I get better returns?”
Before we get into that, we should first discuss...
Why I Believe Real Estate Is the Single Best Wealth Builder and Wealth Protector Around
Growing up, I was on both the Dean’s lists... the good one and the bad one. I started college when I was 16 and was quickly recruited by a venture capital company that specialized in “profit maximization through business and asset optimization” (that’s a fancy way of saying they tweaked operations to make a business or property more profitable).
Through this work, I discovered that I was particularly talented at looking at the structure of a business deal and finding ways to increase revenues and decrease costs. This is a skill I use to this day in each of our deals (and we’ll talk more about how you can do this too, later).
They put me in their real estate division and it was there that I learned:
Why and How Wealthy People Use Real Estate as a Vehicle to Protect and Grow Their Wealth. First, landowners throughout the history of modern civilization have been power brokers. It has been a proven asset class for centuries.
Second, one of the most popular investment philosophies for the preservation of wealth in the world’s wealthiest families is to invest in companies that provide basic human needs. The need for shelter is primal. For centuries, wealthy families have utilized residential real estate to protect and grow wealth and enjoy passive returns.
Third, for someone with $5 million or more to invest, 10%, 20%, and even 30%+ annual return deals were easy to find (I was shocked when I first learned this). Those with under $5 million couldn’t get in on the game (this is something I would eventually make my mission to change).
Fourth, there are incredible diversification opportunities inside real estate to ensure you’re cash-flowing during both the good times and the tough times - there’s always a play in every market (this is really an incredible science).
Fifth, when purchased properly, real estate represents the most secure investment opportunity and best inflation hedge available. It turns out these wealthy families were playing “Lincoln Logs and Legos” on a much larger level.
My first project was negotiating the lease space for Camelot Music in the city of Houston. This is back before the digital age, a time when music stores actually existed and were thriving. I had no idea what I was doing with the negotiations, but I understood what the numbers should be to make the deal successful. My mentor at the time told me - “Jeff, most people will go out and just sign the contract. Most people listen when someone says, ‘Here’s the price, take it or leave it.’ The reality is there’s an art to negotiating a great deal.”
So, I started negotiating and fell in love with the process and opportunities. The Camelot deal went extremely well and I was a rising star in the firm. I Quickly Began to Understand the Role the Government Can Play in a Deal (both Good and Bad). You see, the overall economy is intimately tied to the success of the real estate industry.
I’ll never forget sitting in a room with President Bush (the first) and listening to him discuss how tax credits could be used in real estate to help stimulate the whole economy. Because politicians understand the driver that real estate is for the economy, there are often great opportunities with these tax credits (a discussion for another time).
The lessons I learned during my time in venture capital were priceless. I learned about value-add properties and the different classes of properties (A, B, C & D and when each one should be purchased, held, built, and sold). I discovered a new world of maximizing opportunities and took this time to learn the discipline required and wealth multipliers in the real estate game.
After Seven Years in the “Vulture Capital” Industry, I Was Burnt Out and Distanced from My Faith - It Was Time to Move On.
The 80-90 hour weeks had taken their toll. The selfishness in the Vulture Capital industry was toxic. I had really started falling away from my core beliefs as a Christian and I felt I had to break free while I still could. I remember the moment like it was yesterday. I was sitting in my apartment one day after work.
The System I Use - Step-By-Step
Here’s the simple formula to the success we have used:
First - you need to avoid big mistakes. Many people that work with us are in a position where they can’t afford to take losses or strike out, so avoiding the mistakes can help keep your investment safe and secure.
Second - you need to understand the core principles that allow you to spot the properties that’ll grow at 8%, 10% or 20%+ per year rates.
Third - you’ll need to plan your immediate next steps (if you’re taking things to the next level or just getting started). So let’s get going...
The Four Biggest Mistakes That Cause People to Fail with Real Estate
The Four Biggest Mistakes Are:
1. Lack of Discipline on the Purchase
2. Over-Leverage Due to Lack of Capital
3. Poor Asset Management
4. No Access to Great Deals
Let’s dig deeper into each one...
Mistake #1 - Lack of Discipline on the Purchase
Two of the most important lessons you need to understand about real estate are:
A. “You Make Your Money When You Buy”
B. “Buy When Everyone Is Selling, Sell When Everyone Is Buying”
I’m not sure where I originally heard those two quotes, but whoever first said those was a very intelligent individual.
The first lesson above is a crucial part of the real estate process. When you purchase an asset you should understand exactly how the deal is going to play out. What I mean by this is that before a single dollar is spent, you must take the time to analyze all the costs of acquiring, modifying, upgrading, managing, and selling the asset to ensure that your purchase is sound. Too often people buy an asset hoping for something to change instead of knowing they’ve made a great investment.
When we evaluate a property, we run a simulation that calculates exactly how much we expect every piece of the deal to cost. It calculates exactly how much we’ll have to outlay over the deal from the moment we take title to the moment we place it in one of our portfolios or sell the property.
Too many new investors purchase a piece of property without knowing exactly what they’re getting into. If you’re getting into this industry, you need to do it with expert guidance. You need to put in the time required to learn the industry. You need to understand the complexities and the disciplines of the real estate game.
Wealthy families have developed an extremely effective way to make sure that their children don’t lose the family’s money from one generation to another. Anytime the family makes an investment, they bring in a board of independent consultants to help them make the purchasing decision and ensure that it is a sound financial investment.
I recommend you do the same when you’re purchasing real estate. Convene your own board of experts who can help you crunch the numbers accurately and make the right purchases. These should be people who have the results you desire and the willingness to assist you in achieving the same success. Now does this mean that you’ll always get exactly what you projected? Unfortunately, no.
However I can tell you that because of the way we buy, we’ve never lost money on a deal. I’m going to say that again because it’s a key part of our system - we’ve never lost a dollar. Sure we’ve missed projections a few times and not ended up with the full projected profit, but the disciplined nature of the way we buy makes sure we’re getting deals with enough padding to support any bumps in the road.
The second lesson in Mistake #1 is...
Getting Caught Up In a Buying Frenzy
Unfortunately, human nature can sometimes get us into trouble when it comes to investing. This is why it’s important to have a process for taking emotion out of these decisions.
In 2004-2006 in Austin, Texas - where we’ve done a lot of work - the market was booming. Prices were skyrocketing, but our participant owners and I were off-loading our properties during this time... the returns were incredible. Some of my friends heard we were selling property in Austin and thought we were crazy. We weren’t crazy, we just understood the market! Everyone was buying which meant it was time to start selling.
We’d list something, and by the end of the day have multiple offers over asking price. As an expert in real estate, I can tell you that the real estate was building itself into a bubble. Anytime you hear of a situation like this and you’re considering investing, think BUYER BEWARE!
Many people even use these ‘frenzy’ opportunities to take advantage of people. One of the many unfortunate examples of this is a woman who thought she purchased seven duplexes. Unfortunately, they weren’t performing. She had heard of us through a friend and gave us a call to see if we could help out.
We went out and took a look at these “duplexes.” It turns out they were mobile homes. Never in my life have I seen a mobile home billed as a “duplex” until then. On top of that - they were in a terrible neighborhood. It was so bad that when one of our maintenance men was there checking out the property, he heard a “pop, pop, pop”, went out to his car, and saw a man shot dead in the street. This is clearly not the type of asset we want in our portfolio.
Unfortunately, she had purchased the property through a realtor without looking at it herself or having someone she trusts to look at it. She ended up in a position with an equity value that reflected a loss of over 80%.
I can’t even begin to tell the number of stories we hear like this; we could fill books with stories of people who just want out of the property because it’s such a nightmare. Don’t end up in this position. Don’t think there’s a way to shortcut the process and get rich quick. Real estate is an incredible vehicle to build and protect wealth, but like any investment, you must respect it and use it properly.
Be disciplined when you purchase, completely understand your numbers and exit strategy, and make sure you review your plan with someone who truly understands the industry and has your best interest at heart.
Mistake #2 - Over-Leverage Due To Lack of Capital
Leverage is one of the biggest multipliers available in the world - it makes a good decision better and a bad decision worse.
Here’s the golden rule for leverage: Leverage is great if and only if the asset is stable and performing.
Typically when we structure deals, we bring leverage in as the last piece, once the asset is already performing. Many think leverage is the best way to expand your buying power, but if you start off your project fully leveraged and one thing goes wrong, you’ll lose the entire property and your equity. It’s also possible to get so upside down on your first property that you never get a chance to invest in another.
This would be a good time to mention the “No Money Down” Get-Rich-Quick Real Estate Schemes out there. While this is cute marketing, I’d suggest you run in the other direction if someone is pitching you one of these “opportunities.”
In our expert opinion, you need a minimum of $50,000 to start doing real estate the right way. The right way to start is not to leverage your capital to buy a $200,000 or $500,000 property (more on this later).
Mistake #3 - Poor Asset Management
A good asset management company will not only pay for itself (they usually charge 8-10% of collected rent), but they’ll actually make you money and eliminate the stress from the situation. Just like with finding a great deal, finding a great asset management company takes some work.
Let’s face it - nobody wants to get the call in the middle of the night that the toilet has broken, the apartment is flooded, the AC is broken, or the heat is not coming on. Management companies are the ones that take that phone-call (24/7/365) and use their relationships in the industry to get your tenants taken care of quickly and cost-effectively.
When we first got started, I opened the yellow pages, called an asset management company, and turned over the keys. I was shocked when I saw the way they managed my properties... It was terrible. Expenses were up over 300% at times, renters were leaving properties, rent wasn’t being collected, equity value was decreasing due to poor maintenance, and the rents they were getting were below market value. They were calling me asking for a check instead of sending me one.
This was the opposite of a home run; it was a strike-out.
So, We Formed Our Own Management Company - One That Was Built for Protecting and Creating Wealth, One That Understood the Investor’s Mindset and Goals
Mistake #4 - No Access to Great Deals
Before coming to work with us, one of our participant owners (who’s a brilliant brain scientist) invested in two pieces of land priced at $1 million when he heard a large Fortune 500 company was considering moving to the area. He put 20% down and had a mortgage on the rest.
He figured that this influx of jobs and capital would make the land out west more valuable. If it had happened, it would’ve been a great play. Unfortunately, that Fortune 500 Company picked the other side of town and only moved half of the jobs expected.
Now, he’s had his money tied up in this property for years and has been in a negative cash-flow situation for years. On top of all that, he’s stuck with two pieces of land that likely won’t be built on until his kids or grandkids are his age!
When you don’t have access to a great deal, the best thing you can do is keep your cash in hand and wait for the next one. Do not try to manufacture or force a great deal.
The problem many people have is they can’t ever find a great deal because:
They’re not sure how to tell which ones are great deals.
The deals they’re seeing have already been sifted through by companies like ours.
We’re fortunate that our 15 years of over-delivering for our partners have built a track-record, Rolodex, and reputation that gives us access to extraordinary opportunities. Our office receives hundreds of opportunities each week in addition to my staff of six individuals trained to go out and find us deals. (We call that “bird-dogging” in the industry). Oftentimes, we see these opportunities months before they’d hit the typical online websites or MLS.
Out of 1000 potential deals, about ten will make it to my desk and we’ll execute on one or two, and that’s if it’s a great batch of opportunities. To make this easy for you - I’ve included the information about our brokerage that is built by investors, for investors below. If you’re looking for opportunities or help to find great properties, feel free to give us a call.
When you’re financial future is on the line, you should not be speculating. Be disciplined and wait until you find a great deal. At this point I hope the discussion on avoiding these four mistakes will keep you from making the most common mistakes I see people make. Now it’s time to get into the fun stuff...
My Five-Pillar System to Create and Protect Wealth with Real Estate
This system is something that’s taken over 20 years of experience in the industry to create and I hope you find it valuable.
The Five Pillars to My System Are:
1. Focus on the Fastest Growing Real Estate Markets in the World
2. Focus on Residential Real-Estate
3. Out-Hustle and Out-Research the Competition
4. Cut Out the Middle-Men
5. Understand Market Dynamics
Pillar #1 - Focus on the Fastest Growing Real Estate Markets in the World “A rising tide lifts all boats.”
Pillar #1 is extremely simple. Many people like to invest in their backyard - because that’s the area in which they are familiar.
I think it’s extremely important that you’re investing in the right areas. I believe in an investment philosophy that maximizes our probability of meeting and exceeding expected returns - that means focusing on the areas expecting to see population growth over the next decade. Once a city begins growing, it can really gain momentum and allow you to recognize extraordinary gains.
At the time of this writing, areas to look closely at are Austin, San Antonio, and Dallas, Texas, Oklahoma City, Oklahoma, and North Carolina. Because of these areas being widely known as growth areas - they’re the ones most likely to go through frenzies, so invest wisely. Make sure you take your time, study the trends, and know the right time to buy and sell.
Pillar #2 - Focus on Residential Real-Estate
As I mentioned above, one of the most popular investment philosophies for the preservation of wealth is to invest in companies that provide basic human needs. The need for shelter is primal. While many people like commercial real-estate (and I understand the allure of a triple-net lease), we’ve always seen more success and opportunity with the residential real estate.
Here are three cardinal rules for the residential real estate:
Usually, the types of properties you want to live in are not the best ones to invest in.
The people who often make the money on new construction are either the builder or the second owner (so be one of those positions unless you’re purchasing a primary residence).
Anything under four doors is a huge risk.
Let’s expand on that final point a bit, because it’s really important. A four-plex is an OK situation but duplexes are dangerous.
Let’s imagine if half of a duplex is vacant... guess what you get? Half the income, which means you’re now in a negative cash-flow situation each month. (Instead of cashing a check each month you’re now writing a check each month.) People buy single-family homes all the time because they’re perceived to be “safe,” but you’re suddenly in an all-or-nothing situation - a lack of diversification is never a good situation to be in.
Even if you’re just getting started, there are ways to avoid being in these bad situations. Investing in the residential real estate, done right, opens up the door to much higher returns.
3. Out-Hustle and Out-Research the Competition
Insiders know the majority of new investors fail because they underestimate the task at hand. While the concepts of investing in real-estate are simple, the execution is a full-time job requiring due-diligence every step of the way. It’s easy to make a mistake that puts a project upside-down. Experience is the best, and also the most expensive teacher.
Our team has over 100 years combined experience in the business and an impressive track-record so if you’re just getting started, reach out to us, or a company like us, to help you get started. I always have loved the idea of standing on the shoulders of giants.
With that said, when you begin your investment, whether alone or with an advisor, two of the most important metrics you need to be looking at are the CMA’s and the indexes. For anyone in the industry, the CMA’s are very standard. CMA stands for “Comparative Market Analysis” - basically it’s an analysis of what the other properties in the area are selling for.
It’s very important that you look closely at CMAs. Different states have different rules, and it’s easy for two properties to look the same but be very different (i.e. built in different years, different quality construction, or different neighborhoods even though they appear to be across the street).
The second major metric is indexed; these tell you how much real estate is renting for. These metrics are available and accurate since they are prepared by the government so they know where to funnel federal assistance programs. Indexes are usually provided on a $/square foot basis (i.e. if it’s $1/ sq. ft., a 900 square foot apartment would rent for $900 per month).
These are actually extremely well-prepared documents and are free for you to access! Whenever I’m considering investing in a new city, I start by studying the patterns in the indexes over the past decade and projections for the next decade.
In the process of reviewing a deal, I’ll typically go through 400 or so pages of data and information to get a good feel for the property. When you plan on investing in real estate, make sure you’re taking decisions seriously and properly researching the situations. Please do not jump into these investments without knowing exactly what you’re getting into.
4. Cut Out the Middle-Men
The world of investing is full of “fees.” I hate fees. Be very careful with fees when you’re investing in anything as it’s a way your profit is vultured out of the deal.
I recently saw a deal that came across my desk from a highly-recommended commercial real estate investment firm. On top of the 80/20 profit split in favor of the house, there was a 2% asset management fee, and a 1.5% financing fee. Ouch.
Fees don’t belong in real estate, so be careful when people start lining up their fees. Even 1% or 2% over the course of your investment can add up to a lot of money that should be in your pocket. To eliminate fees, optimize ROI, and maximize efficiency, we cover every critical area - from sourcing deals to planning and construction to manage in-house.
It’s a “no fees” model that allows the community to do more with their dollars. I recommend you look to build or invest in companies that have a similar model and take a very close look at any fees with your investments.
5. Understand What Type of Market We’re In...
As I mentioned above, there are incredible diversification opportunities inside real estate to ensure you’re cash-flowing during both the good times and the tough times. This is really where the magic happens.
By specializing in small fast-growing regions, we’re able to fully understand the pulse of the market months before the big-box investment funds. This ability to see market trends and act on them keeps our partners protected and enjoying healthy returns throughout every season. When you’re in the industry you can tell when one area is softening and one is becoming more robust. When areas change, you simply switch gears.
It’s taken 20 years to develop a system where we can easily shift from buying to selling to building to rehabbing. If you told me I just had to buy properties I’d be bored and disinterested. If you told me I just had to build or rehab, I’d be bored and disinterested. But seeing how the different areas of the game all work together is fun to me. It’s exciting and it opens up incredible investment opportunities.
Opportunity for more copy on the formula - buy when selling/sell when buying. This marks the end of the five pillars I have used to create financial freedom for myself and have taught hundreds of others to use as well. I hope that you’ve found this information valuable and it helps you take the right next step for you with your investments.
There is one final lesson I’d like to leave with:
“You Can Either Work For Money or Money Can Work For You. “
Very early in my career, a mentor shared with me the quote above. Investing in real estate is about putting your money to work for you. It’s about generating passive returns that are hands-off and tax-advantaged. It’s truly the vehicle that allows you to take your wealth-building to the next level.
The Two Big Questions and Next Steps
FAQ #1 - How Do I Get Started?
If you’re just getting started, whether it’s with $50,000, $500,000 or $5,000,000 I recommend you “Play the Bank” on your first few deals. What I mean by this is that you should put yourself in a position where you are the lender to a successful, trusted firm with a proven track record (in the first lien-holder position). This way, you don’t have to deal with the majority of the risks in real estate and don’t have to make any of the difficult decisions.
It allows you to see the transactions as they play out, and start to get a lay of the land while earning 8-12% on your money. Most importantly, it allows you to build your experience and expertise while avoiding the four big mistakes. There are a handful of companies out there that can put you in a position to do this - including ours.
One of the unique ways our company works is that we take the time to understand where you want to be long-term and educate you on exactly how the deals are done. The reason for this is to build a plan based on your goals and make sure you’re in the know and in control of your financial future.
For example, some people love playing the bank. They love the idea of 8-12% consistently without having to get involved in any decisions. Others eventually want to be involved on the real estate purchasing side and are interested in the higher risks and higher returns. Some even want to be a weekend warrior and do rehabs part-time when the market’s right.
You make the decision where you go after you’ve learned the industry. However, despite what you want to do long-term, “Playing the Bank” for at least a deal or two is really a smart way to go (and one you can do even if you’re starting with $50,000).
FAQ #2 - How Do I Take Things to the Next Level?
The people who ask me this question are usually those who have heard me discuss the 10%, 15% and 20%+ returns that we enjoy on our investments and want to know how they can get in on those projects.
Usually, there are at least two items that need to change if you’re not seeing these returns:
Better Asset Acquisition
Better Asset Management
“No Matter What it Takes” Strategy for Real Estate Success
Investment choices today are as varied as the people making them. Regardless of what flavor investment you’re looking for - and the level of risk you’re willing to accept - you have a number of choices to make that will determine the kinds of returns, you’ll see.
Real estate has been the consistent choice of people looking for tangible results from an investment that they can touch, see, and feel, as opposed to more volatile and subjective paper-based investments. But, if you’re considering investing in real estate, there are some distinct challenges to overcome and pitfalls to avoid if you want to make the experience a positive one - and reap rewards that will last.
The residential real estate market is ever-changing and recent events have made turning a profit a bit of a challenge for investors that aren’t ready to roll with the punches. In this report, I’m going to teach you some principles that will help you survive, thrive, and begin to turn the corner towards achieving your goals and your dreams.
Regardless of where you’re at in your investing career - a brand-new, starry-eyed investor or a seasoned veteran - you either have discovered or will soon discover that there’s one big reason that real estate investors lose money.
They make mistakes.
It doesn’t matter whether a mistake is large or small. Each has the potential to cost you money, and over the course of a real estate investing career, even the smallest of mistakes can cost you tens - even hundreds of thousands of dollars.
This blog is dedicated to helping you avoid mistakes that can cost you money. I want you to make as much money as you possibly can, but in order to do that, you need to avoid mistakes and also settle on a strategic investment plan that can be replicated for continued success.
You Aren’t Alone
Whatever you do at this point, I don’t want you to think I’m talking down to you or criticizing you in any way. Because when I first got started in real estate I made every mistake that someone could possibly make. Within a year or two I managed to lose about $500,000 in a series of bad moves. As a matter of fact, I probably invented a couple.
However, I didn’t rest on my laurels complaining about what I’d done wrong; I didn’t lick my wounds, and I didn’t quit. I learned from my mistakes, changed my strategies, and began to see positive results. Since that time I’ve made millions of dollars from real estate and I’m going to show you how you can, too.
What I did wrong, in the beginning, is probably where you’re going wrong - because almost everyone does it at some point in their career. It’s not what you may think, so I’ll save you the trouble of playing guessing games. The number one reason so many real estate investors lose money in real estate is because of the way they think about real estate. What I mean by this is that if you’re like most beginning real estate investors, you play little mind games with yourself and you hope to turn a profit.
Decisions are based on bad reasoning, questionable logic, and general assumptions. A lot of people like to fly by the seats of their pants in everything they do, but you can’t do that with real estate. If you pay too much for a stock, you can lose money, but it’s even more critical that you invest wisely in real estate. The stakes are high - and the potential profits can be awe-inspiring.
The “What if” Concept
Unsure how to go about real estate investing, the average investor adopts a business model that makes sense to them that is based entirely on assumptions - many of them flawed (although they don’t know it yet). When you do this you’re playing with fire. Instead of using sound logic you’re probably following what I’ll refer to as the “What if” concept. Be honest with yourself for just a minute and tell me if this sounds familiar: when you analyze a potential investment property, you’ll run the numbers, make a series of assumptions, and decide that it will work if (pick one):
the property will rent for the amount you’ve estimated
you can find a buyer immediately and convince them to pay the market price
you can rehab the property and find a buyer within a reasonable period of time
What if you find an investment property you like and the market rents will support a rental rate of $1,200 per month? If your monthly expenses are only $1,000 you’ll be able to slip $200 into your pocket every month and begin to smugly think that real estate investing is one of the easiest games in town.
What if you locate a property for 60%-70% of the market price? If you can buy this property, you could flip it faster than your local IHOP restaurant could flip a pancake. Surely somebody would jump at the chance to save 30%-40% off retail prices. Real estate is really simple - and anybody can make it work.
What if you take out a mortgage on a property that you can gut and fix within 90 days? If you can get it fixed quickly and get it back on the market, you could sell it, make money - and repeat the process. Could there possibly be a quicker, easier way of making fast money?
There’s a problem with approaching real estate investing with these thought processes. They’re flawed and will lead to almost-certain failure. It doesn’t matter how militantly you’ve followed your strategy, if you play the game like a rookie, you’re going to get rookie results. Rookie results will kick you to the curb as a real estate investing failure in no time flat.
These “What if...” situations are common real estate investing scenarios. Thousands of novice investors try these strategies every year. A lot of investors make a whole lot of money using one or more of these strategies. These strategies may work...for a while.
Then...”What if...” turns into “What now?” When you base your ability to turn a profit on a singular investing approach you can still make money as long as all the trains are running on time. You know as well as I do that eventually the best-laid plans can be turned on their ears. “What if...” really can become “What now?” because you’re overlooking a universal truth about real estate investing - actually several.
Three Fundamental Truths
The reason that this strategy is flawed is that you’re overlooking a few fundamental truths about real estate investing. Here they are as I see them:
The real estate market is just as susceptible to changing conditions as any other investment opportunity. Generally speaking, real estate gains in value year after year. However, just like the broader economy or the stock market, real estate runs in cycles. It’s not unusual for a real estate to enter periods of appreciation or depreciation. If you assume that an investment will always gain in value, you can and will lose money.
You might purchase a property expecting that you’ll always be eligible for specific tax credits. By the same token, you may expect to be able to participate in the federal Section 8 housing program. If you purchase a property with the expectation that you can supplement your rental income from tenants based upon receiving federal rental assistance checks on behalf of tenants and the eligibility rules change, you might find yourself shut out of an income stream that you depend upon for a fair amount of real income.
Failing to be cognizant of changing laws can cause the profitability of a property to evaporate.
One out of two marriages ends in divorce. If you purchase an investment property with the expectation that your marriage is on solid ground and for some reason “Happily Ever After” fades into “Have Your Lawyer Call My Lawyer”, you might find yourself in a situation where you absolutely have to sell to in order to satisfy a divorce decree. What will you do if your marriage falls apart and you have to sell while the market is down and your property has negative equity when it’s time to sell?
What will you do if your spouse sours on the idea of investing in real estate or one of your children require specialized medical care for some dreaded disease? The circumstances in existence when you initially purchased a property can change in the blink of an eye. Failure to be aware of the possibility that circumstances can and do change on a daily basis can be financially devastating.
I’m going to give you three examples of how real estate investing mistakes can derail your plans and destroy your dreams very quickly. Imagine yourself in the following three “What if...” situations. These situations will give you an idea of just how quickly you can go from being in charge of your destiny to hanging on for dear life.
Plan A: Bubble Investing
Until the real estate bubble burst in 2007, it was almost impossible to not make money in just about any market. For instance, in Florida, the market was expanding so dramatically that you could buy a property based almost entirely on a fairly accurate verbal description and - even if you had negative equity to start - could hold it for a few months and still turn a profit.
More than one real estate investor who didn’t know any better would jump into the market, take a call from somebody describing their property, and decide whether to move forward. So how did some of these investors make a decision if they couldn’t see the property?
They would ask for a description of it.
As long as the market was skyrocketing northward at breakneck speed, the ability to analyze a deal was optional. It made millionaires out of novices who were clueless about how to make money and who were simply the beneficiaries of favorable market conditions. So what happened?
As you know, the market fell apart and the guaranteed profits went the way of the dinosaur. When that happened, all these “What if...” investors became “What now?” investors and their existence was jeopardized. Not knowing what to do, they began falling one by one like little dominoes.
These investors weren’t bad people - nor were they stupid. They just didn’t know what they were doing. Instead of being able to roll with the current market conditions they were rocked by conditions beyond their control. Why did this happen to them?
In short, they were well-positioned to continue making money as long as the sun kept rising every day as it had since they jumped into the market. The market, like the sun, kept going higher and higher. In their experience, there was no such thing as a rainy day. Plan “A” was making them so rich that as long as the market continued to rise the need for having a Plan “B” never occurred to them. Do you know what else never occurred to these investors? It never occurred to them that their Plan “A” was also flawed.
When the rains came, as they inevitably will, the only option they had was to fall to the wayside as real estate failures.
Real estate investors can make tactical errors for a variety of reasons. Unfortunately, they frequently don’t realize they’ve made a tactical error until it’s too late to change course. By then the train has left the tracks in a massive financial derailment that could take years to clean up.
When real estate investors are first starting out, many of them will rely on the guidance received from a real estate investing course, a blog they’ve read, or a series of articles that they’ve seen on the Internet for advice about how to succeed as a real estate investor.
If you’ve ever bought one of these resources, you’re very aware that they almost always universally recommend that you have or develop a working knowledge of your local real estate market. As a result, a lot of brand-new real estate investors will purchase property very close to where they live with the erroneous thinking that because it’s in their local real estate market that it is a good investment.
That’s not always the case.
Just because a property happens to be in your neighborhood doesn’t necessarily make it a good investment. However, partially out of laziness and partly because of an honest misapplication of the above principle, far too many real estate investors purchase property just down the street or around the corner from their own residence.
Take it From John
Take John for example. Because he knows his own neighborhood and the property values much better than areas farther away from his home, he decided to get started with a property just a stone’s throw from his front door step.
The good news is that it’s a very attractive property - and he can point it out to his friends as tangible evidence that real estate investing is a great idea. The truth is, he paid retail for the property, but he rationalizes it in his mind because of its proximity to his house. It is, after all, one of the best-looking places on the block.
Plus, he ran the numbers himself so he knows he will realize a small positive cash flow every month as long as he can handle his own property maintenance. The property management is simple enough. All he has to do is swing by the property once a month and pick up a rent check from the tenant. Anyway, it won’t hurt to learn a little bit about how to effectively deal with tenants and tenant issues. He actually enjoys this aspect of property ownership and, anyway, it’s fun and even a little invigorating.
Maintenance is no trouble because he’s always been the type to strap on a tool belt on the weekend and he enjoys putting together those cheap pressed sawdust furniture items his wife insists on buying at Wal-Mart. It’s also really easy to rationalize his decision because while he is learning more about the up-keep of his property, it allows him to keep up-to-date on the overall condition of the property and is helping him to become a better landlord and real estate, investor.
His “What if...” investment is working out much better than he had hoped, and now he’s living his life’s dream - in miniature. He is a real estate investor. Although he isn’t experiencing the level of success he had initially hoped, he realizes that it’s still early in his career. Overall, he has no complaints.
Then everything changes with a simple phone call from his boss. He’s been transferred to Portland, Oregon. What now?
Left with no choice but to go, his “What if...” real estate dream is about to become the poster child for “What now?” real estate regret. When he lived just down the street from his investment, it seemed like a good idea. Although he had to handle his own maintenance and management, John did have positive cash flow every month, which is more than he could say for some of the other investment opportunities he had looked at.
Once his move was complete he went from being a part-time real estate investor to full-time worrier. Even though John’s property was in outstanding condition with no deferred maintenance (thanks to his regular handyman efforts) he was concerned about the possibility that something major could go wrong. Things were looking good for now, but a lot could change in a hurry. As long as nothing broke, he’d be OK.
Then the bottom dropped out of John’s “perfect” plan: John’s too-good-to-be-true tenant proved that he was - and promptly stopped paying his rent as soon as John was too far away to physically do anything about it. Adhering to the concept that “The mice will play while the cat’s away,” his positive cash flow evaporated as soon as the steady flow of rent payments stopped.
Unfortunately, begging, pleading, and threatening to put a curse on his first-born did nothing to get John’s tenant to pay his rent. He has stuck hundreds of miles away from a tenant who steadfastly refused to pay his rent, so John had no choice but to dip into his dwindling savings account to pay the mortgage payment on his property.
John decided to give his tenant a call to reason with him. Surely he would start paying the rent once he understood the importance of on-time rental payments. Claiming poverty, he promised to pay within a few weeks.
Unfortunately, John didn’t have a few weeks for his tenant to get his financial house in order. The mortgage company needed to be paid today - not next month or when the urge struck him. Losing his composure, John told his tenant to either pay his rent or get out. So his tenant opted to leave - after filling the pipes with cement and remodeling with a baseball bat. The damages - several thousand dollars’ worths - would have to be fixed before another tenant could move in.
After six or seven months he’s at his financial breaking point. John’s budget could hardly handle one payment - and two was almost enough to put him in the poorhouse. Before he can re-rent the property to another tenant, he’ll have to scrape up the cash to repair the place, and finding a contractor he could trust was going to be next to impossible.
Never in a million years did John consider the possibility that he would be transferred to another part of the country not long after pulling the trigger on a real estate investing career. Because John thought he had done such a good job of vetting his rental candidates - and because of his payment history - he didn’t even consider the possibility that his tenant would become a conscientious rent objector.
Unfortunately, these situations are rarely foreseeable. Furthermore, most times they won’t even appear on your long distance radar screen as distinct possibilities. When you do your “What if...” projections you feel good about the numbers you come up with if the result is a positive number. When you don’t know your numbers are flawed and things take a turn for the worse, you have an important question to answer: “What now?”
Here’s a third situation that can throw your nice, finite “What if” projections into a tailspin of real estate investing uncertainty. Not only is it an unknown situation, but it’s a situation you simply can’t plan for unless you have a crystal ball.
A Quick Fix and Flop
You’ve found the perfect fix and flip property. After running the numbers through your mind countless times you’re convinced it’s a winner. After rehab expenses, which you’ve figured no fewer than 100 times, you think you’ll be able to turn a profit of about $35,000 if you can sell the property at current market value.
The first stage of your renovation goes a little better than expected. You’re just under budget and your project is progressing as expected. The contractor you’ve hired for the job is doing good work and is showing up as promised. Keeping an eye on your calendar, you’re impressed when he completes the job a few days ahead of schedule and right on budget.
You decide the renovation is in the bag and there’s nothing else that can possibly go wrong.
You call a real estate broker on the phone to come to look at your house. She’s impressed by the condition of the property and by how much curb appeal you’ve managed to give the place on a shoestring budget. She even said your property has character. Asking her opinion, you’re gratified to see that she agrees with your assessment of what your property is worth. You settle on your asking price and happily sink a metal sign into the front lawn and wait for the inevitable calls to come.
And then the inconceivable happens.
In one of the unexpected and seemingly random acts of violence that plagues your city, a young woman innocently walking her dog is gunned down just down the street from your property. The property isn’t in a seedy part of town, but it’s not in one of the best neighborhoods of your city, either.
However, one death has marred the neighborhood’s reputation in the eyes of local real estate agents. Not wanting to promote the area because of its newfound notoriety, your property has become damaged goods in the eyes of the public and the real estate agents you were counting on to sell your property.
Once again, your “What if...” concept has become “What now?”
When you invest in real estate with a wing, a prayer and a “What if...” scenario, you don’t know what to expect. If everything goes exactly the way you have it mapped out you will make money, and in many cases - a lot of it. By the same token, if there’s a single variable that you’ve failed to consider, you’re in deep trouble.
You never expect that things won’t go the way you have them mapped out because doing that would call into doubt your ability to look carefully into a situation and know with a degree of certainty what will happen in the future.
A Certain Future?
The reality of life is that we don’t know what the future holds. If we did, we’d all be professional athletes, ballerinas, police officers, or princesses, and these decisions would have been made by the time we were five years old. Since we know this isn’t true we have no choice but to conclude that accurately guessing the future is as difficult as solving a Rubik’s cube in the dark.
“What now?” is a scary place to be because it forces you to acknowledge that you don’t know the answer and that you will likely be losing money - a lot of money - on what you had thought was a foolproof transaction.
If you want to move beyond the uncertainty of not knowing if, when, or how much money you’re going to make in a real estate transaction, and you also want to avoid the mistakes inherent to thinking about real estate in terms of “What if...” it’s absolutely essential that you set yourself up so you’re never left asking the “What now?” question in the first place.
In order to avoid being left with the money-losing question of “What now?” you must redefine the way, you look at real estate investing. Instead of entering a real estate transaction with a single strategy, you go in with your eyes wide open to the reality that life very seldom goes the way we have it planned. As a result, it’s of paramount importance that you have a real estate investing strategy built around always having another move up your sleeve that will allow you to make money on a deal.
No Matter What
I call this the “No matter what” strategy. It truly is a comprehensive strategy because if you buy a property with the intention of renting it out and you find that you can’t make money despite your best intentions, you move on to “Plan B”. If your alternative falls apart, you go to “Plan C”.
The “No matter what” concept doesn’t say that you don’t have a preferred strategy or method of attack. What it does say, however, is that no matter what you do, there are a dozen different ways you can make money on a real estate investment. If each plan falls apart despite your best efforts, you don’t miss a step because you always have another move you can make.
Because you have so many effective strategies available to you, you’re never going to get caught in public with your pants around your ankles looking for a graceful way of exiting stage left. If every single strategy turns out being a loser, you can smile, shrug your shoulders, and sell your property. Even then, you’ll make money because it is a contingency for which you have planned - even if the specific situation is a surprise.
That’s the raw real estate power of being a “No matter what” investor.
Because you go into every investment with a solid game plan and an exit strategy you’ll never have to worry about where your blood pressure pills are. You’ll have the flexibility of knowing that sleep will come easily to you each night because the question of what you’ll do if a specific strategy fails will have already been answered.
The No Matter What Strategy Defined
If you want to avoid making mistakes you need to have more than one option available to you. One specific strategy will help you make money no matter what you do. The way you make it happen is by redefining what you think of as a good deal.
If you pay retail or near-retail prices for property, you limit your options. For instance, if you pay 90%-95% of retail for a property you intend to rent out, you limit your options. You may have every intention of putting a renter in the property and holding it for 5-10 years. “What if...” real estate investing strategies say that it will work if all the trains are running on schedule.
There’s no room for error, deviation, or any of the other life situations that can derail your ideal investment opportunity. However, when you buy property with the “No matter what” mindset, you’ll make money regardless of what happens. You can still make money when every possible investing strategy fails. While highly unlikely, you should plan for every possible contingency to cover your assets and guarantee that making money is still in the cards.
If you recall the example I gave you of John, the novice investor who bought a property near his home, he was able to turn a small profit by doing his own property management and handling all of his own maintenance. While he made more than one mistake along the way, the biggest mistake he made was in the price he paid for the property.
If he had been able to pay less for the property he would have opened up a world of opportunity for himself. When he made the initial discovery that he couldn’t turn a profit on his investment without doing his own maintenance and management, he could have implemented another strategy that would have allowed him to make money.
Then, later on, when he was notified by his employer that he would have to pull up his roots and relocate to Portland, Oregon, he wouldn’t have been left with the terrible choice between staying with a property that was just barely profitable or transferring out of state. He could have just switched gears and moved on to another strategy that would still keep him in the black.
Finally, when the mother of all financial insults took place and he discovered that his too-good-to-be-true tenant had badly damaged the property, he had no good alternatives available to him. All he could do at that point was trying to scrape together a monthly payment and tread water financially on a month-to-month basis with a property that was generating no income.
Had he had more options he could have done something about it.
The “No matter what” strategy would have covered his backside. He could have quickly sold the property for what he could on the open market, put the property behind him, and still put money in his pocket when it sold.
The way he could have done that is by controlling how much he paid for the property when he bought it. If you can buy a property cheap enough, you’ll make money regardless of what happens. You have the peace of mind of knowing that a hundred different things can simultaneously go wrong with your property, your tenant, or your strategy, and there will always be another weapon in your arsenal that will make it possible for you to make money.
The real estate market has fallen apart in many parts of the country. Strategies that worked well when values were rapidly rising are no longer possible. Instead of lamenting what might have been, you could simply move on to something that will work given the current market conditions.
Buy your property cheaply enough to make money and you can use whatever strategy that will work in order to make money instead of playing “What if...” and hoping for the best. It’s a huge mistake to do otherwise.
Keeping Your Emotions in Check
The key to avoiding the mistakes and pitfalls inherent to novice real estate investing is to give emotion its proper place at the table when purchasing real estate. Allowing emotion to control your investing decisions is to real estate what allowing a five-year-old child to make all discipline-related decisions in your household is to domestic tranquility.
Neither one should have a position of authority or you’ll experience disaster every time. Emotional considerations are the root causes of any number of bad decisions. A lot of them can’t be avoided, but when you’re buying real estate for investment purposes you can’t afford to give emotion a place at the table.
When you’re buying real estate that you intend to live in, emotion can and will sneak in the side door and command a prominent place in your thought processes. That’s only natural. Your primary residence is in many cases an extension of you and your personality. We decorate our homes to be pleasing to us. We like it when people praise our home and tell us how much character it has. In these cases, emotional considerations are a good thing.
But investment property is radically different. You’re not planning on living in an investment property for thirty or forty years. You won’t be raising your children in your investment property, debating important family issues, or doing any of the other things that make a house a home.
Emotion tugs at our heartstrings and can cause us to do things we normally wouldn’t. Emotion can lead you to pay more for a property than you should or to pay more for a property than it is worth. So you’ll be doing yourself a favor if you can keep emotion out of the decision-making process of your real estate investments.
The question you have to answer, though, is: how do you keep emotion out of the real estate investment decision-making process? The answer to this question is important, but there’s an even more important issue I need to address first.
What if...John Was a No Matter What Investor?
In the three examples, I told you about, including the example of John, “What if...” investors formed a real estate investing strategy, but I would almost bet every dollar I have that they let emotional considerations enter into the equation. Let’s take a close look at John’s ill-fated investment property just down the street from his house.
What do you think his primary reason was for buying so close to home? It was familiarity with the area closest to his home and the fact that he could point his investment property out to his friends. That’s an emotional consideration.
He could have bought something that would have made a better investment if he had taken the time to really analyze the investment, but instead, he fell in love with the property. He liked the property so much that he set aside logic and bought a property that would only be profitable under tightly controlled circumstances. In other words, he let emotion take over. By letting emotions take over the abandoned logic and ultimately lost his shirt by making a bad investment.
There is a better way of thinking about real estate that can help you to avoid the mistakes and pitfalls facing real estate investors of all experience levels. This strategy will work every time you even consider an investment property.
The reason it will work is that it strictly limits the access that emotion has in the way you go about the process of deciding the relative merits of any investment you’re considering making. We’ve already established that excess emotions can suck the life - and the profits - out of your investments. Do you know what one component will help you make an unemotional decision?
Good Numbers Tell No Lies
This one-word answer has huge implications for the future success of your real estate investing career. Numbers. That’s it, nothing more. By taking emotions out of the investment property equation and inserting numbers in their place you can eliminate many of the mistakes that imperil your future. You can use specific mathematic equations that can tell you in very simple language whether or not an investment makes sense. If the numbers are there, you proceed - if they’re not you simply walk away.
Effectively limiting your exposure to mistakes begins when you’re considering making a purchase. Numbers don’t lie. They tell a story about whether or not you’ll make money with a particular property. The ingenious thing about this strategy is that you don’t have to pull the trigger and put your financial security on the line in order to decipher whether or not you’ll make money.
There are 24 hours available to you today. There are thousands of properties out there that you could conceivably invest in and possibly make money. You have several options you can utilize in deciding whether a property is possibly worth pursuing.
With the first model, you go look at each property to ensure that it meets quality standards, you do your due diligence, and you meet with each property owner before making a decision. That’s a daunting, time-consuming process that can fill your days with an unproductive activity that won’t get you any closer to buying a single property.
This method involves doing a cash flow analysis and working up a sample budget and determining whether you’ll have a positive cash flow if you buy the property at a specific price. While you always need to know if a property will make money, you only need to know if certain properties will make money. The only property you care about is one you will buy. None of the other properties matter.
A better way is for you to find out in advance what the numbers are and quickly make a decision. By putting my strategies to work with mathematical formulas you can analyze a property within minutes. You’ll know right away whether you can make money with a property. Instead of wasting time on a senseless activity that bleeds all the energy out of you, you could be doing things that will build real sustainable wealth.
There are a whole host of mistakes you can make as a real estate investor that will take the wind out of your sails and will cause you to doubt your commitment to pursuing real estate investing as a wealth-building mechanism for your future. Numbers - good numbers - are the only mistake-neutralizing tonic that will save your time, your sanity, and your investing future.
You can choose to follow the low road and still reach real estate investing success. It will require that you make a series of mistakes and commit some costly blunders. You’ll take longer to get where you’re going, but you can still get there.