Americans used to work up to 80 hours a week back in the day. Now most of us are used to working a 40-hour work week. Are we aware of the cost of not? Instead of asking what would happen if we started working for more hours again, we can find more meaning when we ask what would happen if we do not start working beyond 40 hours a week. The thing is, people will change only when the price of change is smaller than the price of staying the same. Learn the cost of not investing in single family real estate.
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The Cost of “NOT”
I’ve been getting a lot of tax questions. I am not a CPA. I’m not an attorney. I’m not even Michael Placks. I am a guy who pays too much in taxes. If you’re looking at both the Senate and the House Bill, both bills conflict and they conflict in major ways. I posted that article in my Facebook page. It’s a fantastic article. I highly recommend you read it. It could go one of two ways. It could be really great for real estate investors or could go horribly wrong. One thing I do know is that Congress has a whole bunch of real estate investors in it. There happens to be a guy in the White House that’s bought a couple of deals, so I can’t imagine it would end up being detrimental for investors. If that Senate bill passes, you’re going to see a reckoning in commercial real estate like we saw in the ‘80s. It’s going to be ugly, especially for the folks that have bought these six, seven, eight Cap Class C assets. If you want to go read that article, you can go to Facebook.com/Jason Bible.
On the show, we’re going to talk about the cost of not. What’s it cost not to do something? Everyone always asks the question, “What’s it cost to go to the weekend retreat? What’s it cost to go to college? What’s it cost to invest? What’s it cost to do these things?” One of the things I always like to say is, “What does it cost not to do those things? What’s the cost of not going to college? What’s the cost of not investing in yourself to build a real estate business, to build a real estate investment portfolio?” What is the cost of not? That’s the theme of the show.
A lot of people can calculate what their return is potentially. They can’t calculate the risk as accurately oftentimes, but there is always a choice, an A and B choice. Most of the time people think that the status quo is really what the cost of not doing it. Things will stay the same, things just won’t get better. For some people, that’s okay. It’s one of the questions that people used to ask. I used to be involved in a direct sales company. In fact, I still am. That’s a nutrition vitamin company. People used to ask, “What’s the cost of the vitamins?” It was meant to get them to think a little bit deeper than what the price is because that’s what they’re asking. “What’s the price?” I said, “The costs if you take them or if you don’t take them?”
There are some health costs when people don’t swallow good nutrition. Doctors will tell you,” If you eat a typical American diet, you’re going to get all the nutrition that you need from the food that you eat.” Most people don’t eat well-balanced, the right grains, the right fruits and vegetables. They eat a high-sugar diet essentially. It’s pounds of sugar on an annual basis. It leads to all the major health issues that you have in your 50s, 60s, 70s, and beyond. Heart attack, stroke, cancer. That has serious consequences. Most people spend more time planning their annual family vacation. If they can afford to go on that, then they spend planning out their financial future. It’s one thing to sit down and plan out long term, but it’s another thing if you had to come up with an extra $500 a month. Could you do that consistently and predictably over the long haul? Most people don’t even have, short of going and getting a greeter job at Walmart, which sounds easy on the surface until you go and try and do it and realize there’s actually competition for that spot.
Have you been applying for greeter jobs at Walmart?
I haven’t. Have you ever seen a young person as a greeter? You’re competing against gramps or grandma. That’s not as easy as it sounds. Tom Brokaw wrote The Greatest Generation book. It’s about the World War II generation that came back and created the lifestyle in the country that we have thanks to their work ethic. Back in the day, people used to work 40, 50, 60, 70, 80 hours a week. Nowadays, people are whining about a 40-hour work week. There are all different paths to get out of situations that you are in. I was talking with somebody about how much of a difference the mindset makes.
Most people won’t change until the pain of changing is smaller than the pain of staying the same. The pain of staying the same has to be greater than the pain of change. They’re stuck in a place in their life. They’re not happy with where they are and they’re asking, “I can’t figure out why I can’t make this change.” I’m like, “The pain of staying the same is less than the pain of changing.”There are plenty of stories in our society about people that grew up in an impoverished household. The pain of staying in that environment was so great that they had to change, do whatever it took to get out of that. There are also other families that generation after generation, they’ve become comfortable with their lot in life. One of the great things about the American society is there’s not a caste system like there is in India where you’re born in a particular station. Everybody realizes this is the land of opportunities. People sacrifice so much to get here. The number one thing that gets in the way of a great life is a good one.
I had that conversation with a guy up in Dallas and he was struggling with what to do next. I said, “Your biggest problem is you’ve got a really good life. You’re not going to be willing to make the changes necessary to make your life great.”It’s not small changes to go from good to great because all the things that you’re doing on a daily basis have gotten you too good. It’s like a doctor deciding that in order to have a great life, he has to become an attorney. That’s not a small change to go from being a doctor to being an attorney. That is a massive change, especially while he’s practicing medicine. There are not many people that go to law school while they’re practicing medicine. It would take giving up medicine or vice versa. It’s that monumental for most people to go from good to great.
What I see in the real estate space is you’ll get folks that say, “I like to get in real estate” and they don’t have a plan B and they get laid off. “I want to be in real estate,” and it’s like, ”You have to make it.” As opposed to, ”Start investing now, start investing in you, start investing in your future now, before all that bad stuff happens.” Have a backup plan. Have a plan B and a plan C if those things don’t work out. That’s one of the big things I see is that, “I’ll get to it sometime,” and then the problem is sometimes it’s too late. We’re looking at opportunities now that we think this is the time to get into single family real estate. It’s going to go down as one of those times like 2007 and 2008 is. These things are easy to finance. They’re easy to manage. You’ve got a whole team up here at Right Path. Now is the time to really go all in on real estate.
That’s the number one thing that I see. The other thing is there are ways that you can get started with no money, no job, and no credit in building a business. It’s hard to start real estate as a business with no money, no job, and no credit. Can it be done? Yes. Are there stories of gurus, even local gurus that have done it? Yes, there are. However, they haven’t done it recently. The environment may be a little bit tougher today than it was ten or twelve years ago when some of these guys were getting started. It’s a more competitive marketplace now. There are more people, as a result of the HDTV shows. It’s slightly more competitive. Is it impossible? No, I don’t think it is. There are people out there that don’t feel safe and secure in the job that they have right now long-term. They have some time where they can make some decisions now. There are people that can start making some decisions now to put a better plan for 2018 in place. You don’t even have to set a huge goal. Imagine if somebody bought four houses a year, one every 90 days. You find the house, the first month. You close on it, the second month. You rehab it, the third month. You get a tenant in there, then we’ll repeat the same thing the second quarter. Imagine you did that for ten years. Where you would be ten years from now would be a monumental difference in terms of trajectory.
We’re talking about the cost of “not today” and that is not taking action. I’m trying to think if there’s any time in your life where it’s detrimental to take too much action. I can’t really think of one where you just go all in. Granted, you got to know what you’re doing. Anytime I look at regrets that I’ve had is because I didn’t take action soon enough.
There are some people that take too much action. They’re not physically prepared to climb Everest, and they die up there. They’re not really well enough trained, they take too much action. There are some dead bodies up there. There are some casualties. They took too much action. I don’t know of anybody that’s died doing real estate, not directly from doing real estate. Could you die from doing too much real estate? Probably not. Not from doing too many deals.
Drew Whittaker said, “Tom, you’re right. Four rentals a year for ten years would definitely be life changing.”We bought 67 houses, not all for rentals, but we’ve bought 67 houses our first full year in business. To do 40 over ten years, that’s not monumental. You could set up almost like a drip 401k plan for doing that. You realize where the average American retires. If I started at 40 buying one rental house a quarter and in ten years at 50, if you had $300 a month positive cash flow times 40 houses, you have $12,000 a month passive coming in. That’s astonishing. Imagine if you could take all your excess rent on a monthly basis for the next ten years, for example, and you take that extra $12,000 a month passive income and you put it all towards that first house. You would have been paying on the mortgage on that first house, the second house, the third house, the fourth house for nine years already. You don’t have a whole lot left. Take that $12,000 a month extra, put it towards that first house mortgage, get the first house paid off, then the second and the third and the fourth. Imagine having 40 paid-off houses in twenty years and you’ve got $40,000 a month passive coming in. It’s like 99% of seniors live on less than $40,000 a month.
If they bought $100,000-house, year ten, which would be payment 120, they would owe $81,000 left on the mortgage.
If you had $12,000 a month coming in, $81,000 will take you seven months.
Nine months if you do it starting at $100,000, put $12,000 a month towards it, you pay it off in nine months.
If you didn’t start that process until you got all 40 houses.
Seven months at $80,000. It’s the old Dave Ramsey debt snowball. It’s the same thing. These folks that go out and re- leverage and re-leverage, it doesn’t make any sense. We’ve met so many people that when the market changes, have gotten just absolutely clobbered because they leverage and leverage. They refinance and refinance, got into multi-family, refinance, and then the market changed. Their margins are too thin, like what may happen with this tax thing. I’m predicting if it swings towards the Senate bill, you’re going to see some commercial real estate just go right back to the bank. There’s just not enough margin in these things.
What’s the greatest hedge against changes in the market? It’s not having debt. You’ve got to acquire these things with debt in the beginning. Put your cash for good times against the house. One of the wisest things I’d ever heard from a coach I had early on, we had a lot of excess cash just sitting in our checking account, she said, “Why don’t you just use the houses as a savings account?” I thought, “That’s brilliant.”Cash flowing houses, not a flip property. Let’s talk about ROI. Your ROI should be infinite. That’s true for single family flips. For rentals, you can have some money in the deals because the cash flow is every month.
Let’s say you have an extra $40,000 sitting in your checking account. What if instead you put that in a savings account, let’s say you locked it up in a CD for five years. In an emergency you could get it out, but you’re going to pay a penalty, you’re going to want to fight not to do that for giggles and grins. You might get less than 1% on that. $40,000 is going to earn you $400a year in terms of interests. If instead, with $10,000 out of pocket, you could have four rental properties with $10,000 out of pocket relatively easy. That wouldn’t be a stretch to do that. If you had $300 a month of positive cash flow coming per house, you’d have $1,200 a month coming in on that same $40,000 of leverage. That’s $1,200 a month versus $400 a year in interest. Would you be willing to park that for five years for $1,200 a month, which is $14,400 a year.
You get some huge tax advantages because you get depreciation on the property you get to write off against. Part of that payment that’s going to be made by your tenant every month, you’re going to be paying your mortgage, which is going to cover your PITI, Principle, Interest, Taxes and Insurance. You get to deduct your insurance as an expense against that income. You get to deduct the interest. You get to deduct the taxes that you pay on the property. The leftover is that $400 or $300 a month cash flow is typically wiped out by the depreciation because you get to write off 28.5 years on the entire property.
It depends on your income. There’s a whole bunch of other caveats there. At the end of the day, you’ve got to have a plan B, even folks who are high income earners at some point. What happens when that job disappears? What do you do next? If you look at most of us that are high-income earners were specialized in certain areas. What if the field doesn’t exist anymore? A lot of people think, “I got a college degree and I’m such and such this special certification.” They’re pumping those people out in places like India. If you don’t think your company’s going to outsource all of your high-speed programming overseas, that’s exactly what’s going to happen. Companies are rewarded based on their profit. The cost of people is one of those big expenses. You’ve got to have a plan B just in case.
A right path didn’t exist when you and I first got started. I’m not disappointed with where we are, but we would be much further along if we have taken a shortcut. How would you recommend a brand-new person get started if they were starting today? Knowing what you know now, if you were starting over, what would you do?
What I would do is I would buy rentals like they were going out of style. Buy as many rental properties as you can get your hands on. If there’s anything you can do in real estate that’s really easy to do, rental properties are the easiest. Wholesaling from a transaction standpoint is easy, but from a part-time investor, building wealth and income, rental properties are super easy. People have been through other coaching programs, spent bukus of dollars with other real estate coaches, and they’ve gotten more out of the weekend retreat that they have spending hundreds of thousands of dollars somewhere else.
Farrah asked a question, “If we don’t have W2 income, should we look at hard money to finance rentals?”Most people, what they’re doing is they’re buying the property at a discount because it needs work, and rolling in the purchase and the rehab into the hard money loan on the front end. They’re refinancing out of that hard money loan. There’s at least one lender that’s on our vendor list that has a two-year hard money loan that is strictly an asset-based loan that gives you some time. Anderson Consulting, that was one of the things that we talked about. It’s important that you have your financial house in order because there’s a three-legged stool that you’re trying to make stable. The more you get out of balance in one area, you’re sacrificing some other areas.
People obviously want to minimize their tax burden. A lot of self-employed people do that at the expense of being bankable. You can write off so much in terms of expenses by having your own business. You pay almost zero taxes because it looks like you have no income, but when you have no income, then you’re not bankable. There’s this line that you want to pay enough taxes, show enough income that you become bankable. There’s also this liability issue as well. There’s liability, bankability, and then your tax burden. That’s the three-legged stool.
Every situation is a little bit different, it depends on what state you’re in. The underwriting that banks go through in order to underwrite loans, that pendulum after the crash of 2008 which resulted in all of the rules and regulations changing in what we have now, it went ultra conservative. We had loose underwriting where no job, no income, no credit, you could state that you were a gazillionaire and nobody needed to check on it. One of the advantages that you have with real estate is that it’s a self-collateralizing asset. It’s not like you’re trying to open up a flower shop or something like that, which the collateral itself can be dead in two weeks. It’s not like you’re trying to do that, but you’re able to use the real estate as collateral itself. Your bankability is a portion of it, but it’s becoming less and less of an issue as the underwriting constraints are being lightened.
You’ve got to have a loan to purchase and rehab the property. It’s not a traditional Fannie Mae loan, like once you bought your house with. There are hard money lenders out there that will lend you the purchase price and the rehab. At some point in the future, once that house has been rehabbed, you are going to re-finance that property into permanent financing. For most people, that’s a 30-year fixed rate mortgage. If you don’t have any W2 income, that creates some challenges. Everybody’s situation is different when it comes to the financing side of things.
It’s not necessarily a deal killer.
You can always partner with somebody who’s going to bring that credit and the cash to do it. It just made it a lot harder.
There are some products that go two years. There are some products that are asset-based only, they go 25 years. They have a big upfront in terms of points, but the rates are relatively reasonable. They’re not the most competitive, but if you don’t have another long-term financing source, it’s a great alternative. There are products out there that are strictly asset-based only.
Here’s the problem when we get into lending. When I sit down and think “asset-based lending,” what I really think is you will never sign a personal guarantee. Otherwise, you’re then guaranteeing the performance of that asset. There’s no 100% asset-based lenders out there because they want to make sure you can still write a check. If you’ve got folks that don’t have any money, their credit is not great, there’s really not a product out there for that person. You’ve got to have some money, got to have what they call reserves, and your credit has got to be decent. If you’re acquiring rental properties, the only other way to do it is in partnerships. There are some asset-based lenders, but if you are unemployed, don’t have income, don’t have any assets to really speak up, and then you don’t have great credit, rental properties is not for you.
Rental properties, although they can grow your wealth, they’re really a store of wealth. That’s really what they are. Because they’re a store of wealth, you have to have wealth to begin with or somebody else’s wealth. Let’s say, I’m the guy that brings a deal and Tom’s the guy that brings the money and the credit and the financing. We’re going to put Tom’s money and credit into the deal and I’m going to go find the deals. That starts making a lot of sense because there’s got to be some wealth somewhere. Acquiring that wealth and putting it into a deal is how you generate a return. That is probably the easiest way I can explain it for somebody who doesn’t fit the traditional W2 mold, like, “I’ve got a job that had been at for 25 years and a bank will give me all the money they want.”If you are outside of that box, it starts to get a little more challenging.
It’s not like it was a few years ago where that person was like DOA. They couldn’t do anything as it relates to a long-term buy and holds unless they were wholesaling or flipping those properties. That’s the challenge in rental properties. I’m slowly changing my tune on this one. Rental properties are not really real estate. Rental properties are finance and operations. Your financing dictates how you’re going to do that deal. The operation side is really picking the right tenant and ensuring that you are operating the assets according to the lease. A lot of people think it’s finding a good deal.
Finding a good deal is important, but you’re back-end financing is what determines your cash flow on the deal, your exit strategy. It determines a lot of stuff. If you’ve got a really great lender and if you’ve got a great property management company, it makes rental properties real easy to do. For example, there are landlords that can only get 70%financing. If the house is all fixed up worth $100,000, the max they can get is $70,000. Every dollar above $70,000, the investor has to come out of pocket. Conversely, if you’ve got somebody on your team that can lend at 85%, they will lend you $85,000 instead of $70,000, how many more houses can you buy with that extra $15,000 that you don’t have to come out of pocket?
If you start with $100,000 in savings, you could buy seven properties worth $105,000. If you only had to come out of pocket $5,000, you could buy twenty if you could finance more money.
That’s why that whole 70% less repairs rule doesn’t really work in rental properties. I do want to buy them as inexpensively as possible. The 70% rule is derived from a banking formula. If you’ve got a bank that’s backing you at 85%, and let’s say the house’s cashflow is $300 a month, why wouldn’t you buy the house? “I’m buying it at 85%.” You have no money in the deal. It’s all the bank’s money and its cash flow is$300 a month.
Sometimes people get caught up in the formulas and they lose track of the big picture. An 85% deal on a $300,000 house, for example, where rents are less than 1% of the ARV of the house, would not make as much sense as an 85% deal on a property where the rents were at 1.3% or 1.4 % of the ARV. In other words, you have $100,000 house that’s renting for $1,300 or $1,400 a month. That makes more sense to do at 85% as opposed to the $300,000 house because the $300,000 house can mean a negative cashflow.
It could, but we’re also looking at properties right now that are $350,000, $400,000 all in. They were worth before the storm $600,000, $800,000 and they cash flow $100, $200 a month.
Those aren’t 85% deals. That’s the caveat. That’s the reason why they’re able to be done. Brent says, “No credit or income. Ask the sellers to finance or sub, too. Offer them a little interest on their money.” Yes, that’s definitely an arrow to have in your quiver. That situation will fit in certain time. It’s hard to build a scalable marketing plan on that one strategy. You need to be able to do it when it fits. If I wanted to go and buy 100 houses in the next two years, I wouldn’t want to makes sure that that was my only strategy for being able to exit or get into the house.