Real Estate As A Business And Real Estate As An Investment

By 2019-02-20Radio Show

RPRE Tom | Real Estate

 

Oftentimes people don’t make the distinction between what we’re investing in versus what we’re doing as a business. One of the things that we teach at Right Path is we teach real estate as a business and real estate as an investment because there’s a difference between those. When you’re looking at real estate as an investment, that implies that your money is at work, but you’re not. If you’re flipping, for example, that’s real estate as a business. Single-family investor Daniel Gollinger joins us as we get into the ways you can do real estate as a business and as an investment.

Watch the episode here:

Real Estate As A Business And Real Estate As An Investment

I want to welcome, Daniel.

I’m glad you’re all joining us. I’ve been getting a lot of comments, a lot of compliments about the content. Our message has started to shift. We’re seeing some new things from some new points of view. Our eyes are opening. We’re trying to open other people’s eyes. I’ve been getting a lot of positive feedback about where we’re headed. It’s exciting.

I’ve been hearing the same thing. I’m excited about that as well. One of the things that I want to talk about is I met with what I’ll call an insider in financial money management.

Think about it like this, have you ever wished that you could sit down with these people and know they would tell you the truth when you ask them a question? You had the opportunity to do that. Nothing was held back. It was completely honest. It’s completely raw.

I call it unfiltered.

Most people never have that opportunity.

Imagine if you could sit down with a leader like a governor, a politician, an economist or something and say, “What’s going on behind the curtains? Let’s be transparent.” I got that. I was blown away. One of the things that I want to talk about is oftentimes people don’t make the distinction between what we’re investing in versus what we’re doing as a business. One of the examples that I’ve always given is if I’m a chef, which I’m not. Full disclaimer, I’m not a chef. You’ve met those people that have a passion for cooking. I know you’ve worked with some people. They live for creating. There’s like chemistry to food. It’s not like putting out a Betty Crocker cake.

RPRE Tom | Real Estate

Real Estate: A real chef is going after not your palate, but your nose, your eyes, and all the things that go along with it.

 

It’s so much more than taste. It’s all the senses combined. A real chef is going after not just your palate, but your nose, your eyes, your sense of touch and all the things that go along with it.

Imagine that you’ve got a chef that’s passionate about that. He says, “I want to open a restaurant.” He wants to work in the restaurant as the chef, as he probably should or could. A great chef like that could go work for a top-notch restaurant, make about $150,000 a year with rough hours, all that stuff. That’s the marketplace. Imagine he opens his restaurant and he makes $180,000 in profit off of his restaurant. The question you have to ask is, was he working in the business? Was he drawing a salary? If you made $180,000 owning the restaurant and he paid himself a $150,000 salary, he truly made $180,000 in the restaurant. If he didn’t pay himself the salary, then he only made $30,000 on the investment.

Because you have to offset the salary.

For example, this money man, which is not stocks because they put people’s money in a lot of different things. All of them, what I’ll call traditional, either funds or derivatives or bonds or REITs or things that are traded openly. They’re being mentored by someone who wants to help them with their own personal investments. This person essentially sold a company for $15 million, made a bunch of money. He’s decided that he wants to manage his own money instead of handing it over to a professional money manager. He trades a lot. What he does is he sells covered calls. He does some puts and things like that. One of the things that this lady does that I was meeting with shared with me that he’s making a 45% rate of return on his money. I said, “No, he’s not.”

Why would he lie?

She looked at me like, “You don’t know what you’re talking about.” I’m like, “No, you don’t understand.” First off, I agree that based on the metric that he’s using, this is how much money and I’m growing it by this much. What I would say is how is he accounting for his time?

He’s earning an hourly wage.

In the grand scheme of things, we're trying to create wealth. Click To Tweet

We could argue that attorneys charge $500 an hour, also making an hourly wage. We’re not saying that he was making minimum wage, but we’re saying that if he’s making half of $15 million, $7.5 million, half of that is $3.75 million. If he’s making 45% on $3.75 million, he’s making about $1 million a year. I’m not knocking $1 million a year. That’s different than saying, “I’m going to turn over and put my money in an investment.” When you’re using a metric like a return, that’s meaning that your money is at work, not you’re at work. You have to say, “Is his time worth $250,000 a year? Is his time worth $100,000 a year? What’s his time worth when he’s working 50 hours a week, 50 weeks out of the year?”

Obviously, it’s worth $1 million.

Because what happens is when he’s not working, he’s not earning the income. His money is not at work, he’s at work increasing the value. What he’s doing is he’s day trading. What I’ll say is if you know anything about how an exchange works especially in the old days with their pits and somebody was the market maker. I want to compare that to real estate because one of the things that we teach at Right Path is we teach real estate as a business. We also teach real estate as an investment. There’s a difference between those.

I started Houston House Buyers back in July of 2013, I started that like you would start a mechanic shop or you would start a restaurant or any other business. You’ve got to start with some capital. We started the business with $50,000 in capital. I didn’t need it to make any money out of the business right off the bat because I was the Founder of Fast Track. I own 100% of Fast Track. I was drawing an income from Fast Track. That meant that we could use that money strictly for marketing. That’s where most businesses start is they need to market the business. It’s either guerrilla marketing or you can pay for marketing. We were spending $5,000 a month on marketing. What we built was Houston House Buyers. We did seven houses in 2013. We did 67 houses in 2014. It continued to grow from there. That’s different from real estate as an investment. I’ve taken some real estate classes in college. I’d considered as a summer job becoming a real estate agent because everybody knows a lot of people buy houses in the summertime and all that.

You knew some stuff on the retail side.

I understood the principles of buy low, sell high and all that stuff. I had read a couple of Carleton Sheets’ No Down Payment, those kinds of real estate books, that stuff. I had an interest in it even all the way back in college. I also spent a lot of time studying the stock market back then as well. When you’re looking at real estate as an investment, that implies that your money is at work but you’re not. There are two ways that you can do real estate as an investment. You can do single-family buy and hold. The other one is that you can be a lender. You can be the bank.

If you’re doing real estate and you’ve been going to another group, you’ve been going to a local REIA anywhere in the country. You’re going to some guru or you’re trying to learn how to do real estate, most people are trying to learn how to do real estate as a business. There are some a-ha moments in life that you have some epiphanies. One of the things I was teaching was that when you’re doing something, that leads to a result. We have what we have in life because of the things that we have done. We do what we do based on how we decide and we decide based on how we think. Oftentimes what will happen is we will experience something in life that will shift our thinking. Some people go kicking and screaming into changing their thinking because they accept how they think or how they believe is fact. Once you believe that that’s truth for you, then you continue thinking the same way, which leads to similar decisions, which leads to similar actions, which leads to similar results. When people get stuck, they cannot get themselves unstuck. If they could, they would never get stuck in the first place.

RPRE Tom | Real Estate

Real Estate: A couple of thousands of dollars on a flip is not how you create wealth. It’s how you create profit.

 

We were talking about real estate as an investment versus real estate as a business. One of the epiphanies that we had in Houston House Buyers, there was a particular house, I remember. We bought it for $65,000. I’ll tell you the story. I remember I walked in. I got to the appointment at the appropriate time, knocked on the door. A lady answers the door. Her husband is there in the kitchen with two other investors that were measuring the countertops, measuring the breakfast room with a traditional tape measure. I’ve done Fast Track for a while. I would always measure things with a laser tape measure. These guys were measuring with a tape measure. I walked in and I said, “Nice to meet you. How are you doing? Would you mind showing me around the house?” She takes me through a tour. I’m like, “How long did you raise your family here?” I’m making small talk. I asked the question, I said, “I don’t suppose you and your husband have talked about the number that you all won’t go below.” She says, “Yeah.” I said, “I don’t know about you. Do you know that car buying experience that everybody hates?

The dealership, they want you to make an offer on their car.” Obviously most people low ball, “I don’t know. We can go that low,” back and forth. Most people hate that experience. That haggling back and forth. I described that story, “Don’t you hate that? Here’s the deal. I hate that. Wouldn’t it be a whole lot easier if I can stretch to get to that number? We’re done.” She goes, “That would be great.” I’m like, “Could you share that number?” She goes, “We won’t go below $65,000.” The $65,000 for this house was a great price. It needed some updating on flooring, some paint. It was not in bad shape at all. In our level of deferred maintenance that we talk about the Wealth Through Real Estate Academy, that’s a two-day event that we do. It’s one of the things that we teach. It was stage five, like Grandma’s house. Everything that’s ever broken has been fixed and all the residuals. It’s in great condition. I said, “If I can stretch to that number, what would happen next?” Then she’d go, “We’d sign an agreement.” I’m like, “Not now.” She goes, “We’d do it.”

There are guys in there measuring.

That’s what I said. I was like, “Surely you’d have to get an offer from these other guys?” She said, “Forget about them. We don’t know them. If we get our number, we’re done.” I was like, “Let me call my business partner and see if we can do that.” I said, “Do you mind if I step away? You’re not going to sell the next two minutes while I step away on the call?” She goes, “No.” I was like, “Fine.” I stepped away and basically called my business partner. I already knew the number was good. I was like, “What do you want to have for lunch?” I go back and said, “We talked it over. We can do $65,000.” We do $65,000. It needs about $18,000 in repairs. It’s $83,000 probably worth $120,000, $118,000, $119,000. We sold it for $119,500.

If you do the math on that, that’s not bad. That’s $36,000 minus some closing costs. It’s $16,000, so about $27,000. That was in 2014. Fast forward three years, that’s a $180,000 house. We were like, “If we had done no work whatsoever except for collect rent through a property management company, we would’ve made an extra $60,000 in three years.” Imagine if we did that with ten houses. I don’t know about you, but if you can add an extra $600,000, ten houses could get you $200,000 a year. Talking about real estate as an investment versus real estate as a business, we’re not doing any other work. That’s real estate as an investment. If you’re flipping, that’s real estate as a business. When you’re doing buy and hold, that’s real estate as an investment.

I was sitting at the back of the room as you went over this example and it was the first time I’d seen you do it. I was obviously paying attention as well. When you finished the scenario of what you guys sold it for and what you made it and it was like, “What’s wrong with this picture?” Everybody in the room was like, “Nothing is wrong with that picture. That’s great.” When you brought up the fact that, “This is what we could have made.” Even one guy in the room was like, “You must be jaded because $27,000, $28,000 in a month is great.” In the grand scheme of things, we’re trying to create wealth. $28,000 on a flip is not how you create wealth. It’s how you create profit.

That was 2014 that we made that $20,000 after selling costs and all that. In order to make that another $20,000, we have two choices. Either we can do another house in 2015 and then another one in 2016 and another in 2017 or we hold on to that house and let it earn $20,000 in 2015, and then $20,000 in 2016. It’s flipping itself three more times in the next three years. I would compare that as an investment versus annuities. In fact, one of the things we’re going to start marketing is people who are looking at buying annuities. One of my goals is to get out a video that’s going to compare annuities versus real estate.

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It’s not that they’re choosing the annuities, they’re choosing the 401(k)s or choosing the stock market because they think it’s the best vehicle. It’s because they don’t know any better. It’s our job to show them the difference.

I also said something a little bit controversial. A single-family, in my opinion, is a real estate. I know commercial real estate guys. They’re going to disagree with me on this. They’ve got their real estate license. They buy and sell buildings or they lease buildings or things like that. I asked a group, “Anybody in here knows a business owner?” “Yes.” “What kind of business do they own?” They said, “I know a guy that owns, an optometrist. He is an optometrist and owns his own store.” I said, “Let’s imagine that he wants to retire and he wants to sell his business. How is that business evaluated?” They said, “It’s based on its profit.” Normally you add back in what the owner makes because the owner is working. You also have to recognize, is it going to be passive or is it going to be active? Apparently, TSO still exists. I imagine whoever owns TSO is not actively working, for sure not in all the stores.

It’s a passive thing obviously.

It’s a business. If somebody wanted to come in and buy TSO, they’re buying it based on it being a business. In other words, it’s revenue minus expenses is profit. It’s going to be some multiple of that profit.

At no point would you refer to that as a real estate deal?

We know that every single TSO or every single optometry store is in a piece of real estate, whether it’s leased or owned, the fact that there’s real estate involved is secondary to the business. I would argue that everything except for single-family, everything else that we consider real estate is not real estate. It’s a business. In other words, when you buy an apartment complex, it’s not real estate. People are going to push back on this. They can call me an idiot or whatever. What you’re buying is a business because the valuation on it is how much profit does it make? In other words, it’s not like a single-family house. I can go look at appraise value based on comps that have sold to retail buyers. That’s the difference is single-family houses are a piece of real estate that an end-user owner-occupant could buy.

They’re the only asset in real estate that you’re selling to a retail buyer that you can base value off of.

RPRE Tom | Real Estate

Real Estate: As we continue to move forward, the industries that we’re involved in are constantly changing.

 

You’re never going to sell an apartment complex to someone that wants to live there, put his whole family. It’s always going to be to an investor. It’s a business being sold to a person who wants to buy the business. It’s evaluated like an optometry store, like a machine shop would be, like a flower shop would be. It’s like any business. I would argue that hotels are sold that way. Even an Airbnb is not real estate. You’re in the hospitality business. I’ve talked to the path about machine shops, but some people don’t know what a machine shop is. Picture oil and gas, sometimes you have pumps or pipes or things like that. You’ve got to custom make a part. It’s normally machined out of a block of aluminum or steel or whatever.

You machine it to make this. It’s CNC machines. It’s benders. It’s all that kind of stuff. If a machine shop were going to be sold, it’s based on the profit. They don’t do machine shops. They don’t do flower shops up in the clouds. You normally have a piece of real estate, especially retail flower shops. The fact that there are dirt, foundation, building and all that stuff, it’s secondary to the fact that it’s a business. I would say that multifamily is the same way. First off, you’ve got to run it like a business. That’s number one. It’s got to be run like a business. Number two, you’re in the business of housing people. The fact that it’s got wood framing. It’s got bricks or siding or roofs, that’s secondary to the fact that you’re analyzing it as a business. Your exit strategy is always only to sell to another business buyer.

The value of that property is typically not going to go up without the income of the property going up.

You’ve got to reduce expenses or increase income.

Either one of those is related to the net profit. That’s how you assess the value of that property.

There are three things on multifamily that people evaluate other than deferred maintenance or capital expenses that have to be done. The way you evaluate multifamily is what are the rental rates and compare it to the marketplace. Are they lower? Are they higher? Are they right on the money? What are the expenses? What are the occupancy rates? Last but not least, it’s the cap rate. I was talking with a guy. They say that you’re the average of the five people you hang around with the most. I choose to hang around with this guy. I love him like a brother. We were talking about cap rates. He goes, “I’ve heard the term. What is it?” I said essentially think of cap rate like the percentage rate of return on your investment. It assumes passivity. If you’re going to go buy 400-unit multifamily, for example. Let’s say it’s Class A, just built, brand spanking new. That’s what a Class A is. It’s got to be newly constructed. They can stay Class A for a year or two, or something like that. Right now, those are trading on a four cap. Let’s say it’s 400-doors. Let’s say that expenses are $300 a door. Rents are $1,500 a door. You’ve got $1,200 a door profit. I’ll say $1,200 a door times 400 doors. You’re bringing in a $480,000 a month times twelve. It will be like $5.6 million and a four cap means that you’re paying 25 times that. You’d be paying $144 million. That’s low on the expense side and all that. Understand that means you’d be getting a 4% rate of return in your money, which if you have a 1% cost of capital, then that makes sense.

I had a person ask me, “Should I pay off my mortgage?” I said, “Here’s the way I analyze what you should be doing in terms of paying things off. What’s the interest rate on your mortgage for your own personal residence?” That’s what they were asking me. They said, “It’s about 4.3%.” I said, “Your investments, are they earning more or less than that 4.3%?” The reality is when you have a 4.3% interest rate and you get to deduct the interest from your taxes, then that lowers your effective cost of money. It becomes even harder. Who can’t make 5%, 6%, 7% on their money? This person can. They’re making right now 2.8%. I said, “You take money out of your 2.8% bucket and put it into your 4.3% bucket.”

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Because not paying 4.3% is almost the same as earning 4.3%.

What we want to teach is how do you leverage appreciation and how do you systematize that process to where you can do it duplicatably and repeatably? That’s what we teach here is how do you run the systems so that you can repeat a process over and over and over, but also make adjustments. One of the things I know in life is nothing ever stays the same forever. It’s constantly changing. The marketplace now is different than it was a year ago.

The lending rules are different. Lending products are different. I would say the information available to the consumer in the marketplace is different. Especially with technology and things like that, as we continue to move forward, the industries that we’re involved in are constantly changing. The more information that’s available, it causes them to change even faster.

We were talking about this one house that we bought and then we sold it. To me, that’s a little bit like selling the goose that lays the golden egg. Every year that goose is going to lay $20,000 golden egg. When you sell the goose, you stop getting it. If I surveyed a thousand people, “How much money do you want to have when you retire? What’s the minimum amount?” What’s the number one answer we get? The audience knew it $1 million. Through 401(k)s, how many people get there?

It’s less than 1%.

The average retirement balance of 65-year-olds is $209,000 according to Fidelity.

Not 1% of the population, 1% of account holders. I think it’s only around 30% or 35% of United States citizens have a 401(k). If you went by the percentage of people reaching $1 million versus population, it’s a quarter of a percent, which is very scary.

RPRE Tom | Real Estate

Real Estate: Your net worth is directly related to the size and quality of your network.

 

By comparison, if we’d done ten houses that are growing at $20,000 a year in value, then that’s $600,000 in three years. For people who are getting close to retirement age, there’s hope that there’s light at the end of the tunnel. It’s not an oncoming train getting ready to smack you in the face. There is another way. I would love anybody to have the conversation. If they’re an annuity salesperson or if they’re a financial planner. What I know is the rates of returns that are available through real estate, I believe are unparalleled and unequaled. One of the things that you want to look at is what’s the risk of this outsize return versus what’s the reward? Many people are able to evaluate, “This investment is better because it gets 13% than this other investment that gets 11%.” Not necessarily. What’s the risk of the extra 2% that you get?

If the risk is equal for both of those then yes, you could say 13% is better.

What if the risk on the 13% investment is a 50/50 chance you lose your entire investment?

It will probably go through 11%.

One of the things that we talked about is when you analyze it, there are five ways to make money in single-family real estate versus in the stock market or in a 401(k). There are only two ways to make money in real estate. One is the value has got to go up. That’s number one. To me, it’s as likely that it goes down as it goes up. It’s a little bit like building your financial plan on going to the roulette wheel and you’ve got red or black. If I get good, if I studied the roulette wheel, then I can retire with $1 million. Anyone that’s ever built $1 million net worth on a roulette wheel? It doesn’t work. I know of someone. It’s through casinos.

We can sub out for a financial planner.

The question is, is it Fidelity, the casino?

Absolutely. That happened right here live. We made that.

What I’ll tell you is ignorance is not bliss. If you’re not afraid to swallow the red pill and wake up to all the cards that are stacked against you, it’s math. What I’ll tell you is, it’s sad to me that in our educational system, in elementary school, junior high, high school, even college, they don’t teach this. I think it’s by design that they don’t teach it.

I’ve felt this way for a long time. There’s a reason that we’re wasting our time learning classic literature and thinking. I’m not saying those things are bad to learn because they open your mind and things like that, but there’s a reason that they’re bogging you down with these things because the system is built for you not to see the truth. It’s built that way from every stage of your life, all the way through to your retirement.

People oftentimes ask, “Tom, why do you do the teaching that you do?” What I can tell you is it’s about growing your network. Your net worth is directly related to the size and quality of your network. What I can tell you is there’s a crash coming in the marketplace, I believe. It’s time to build relationships. Imagine that I hope you make $1 million over the next year or two. We’re going to develop a relationship doing that together. You’re going to build a trust relationship with me. When the crash comes, everybody seems to panic. If the market crashed, 25%, 30%, 40%, the sky would be falling. People would be selling en masse. A lot of it happens automatically. Sell orders get triggered. All that stuff happens. The reality is that if it crashed, that’s a great time to be buying. The problem is that so many people have deployed all their capital into investments, that they don’t have enough cash. You got to have some cash on the sideline to take advantage of opportunities like that.

When the real estate market crashes for multifamily, for commercial, retail, those kinds of things. When it crashes, that’s what I’m going to reach out to the network that we’ve grown and say, “We’ve been talking about this, time to call all your families and friends,” because lenders won’t lend. Banks will not lend on an office building that’s vacant. The office building we used to be in, I know the guy that’s the owner. It’s about 2006 stories. It’s about 130,000 square foot building. He bought the building in a crash when it was vacant for $30 a foot. You can’t buy a house for $30 a foot. It’s not Class A because it’s not new construction, but it’s a good solid beam on I-10 on the feeder road. I believe that’s coming back. It’s going to happen in the next three to four years cycle. It is a cycle. That’s why Right Path exists to help people build wealth and income now so that then we have a network. Imagine if we had 1,000 people that were millionaires. We put that to work. That gets pretty exciting. You’re talking about could you deploy that capital? Imagine if you have 1,000 millionaires and the borrowing capacity of that, not based on the asset because that’s how we teach now. Lenders don’t want to lend on those broken assets.

They’ll lend to quality people with the right credentials.

If you want to be a part of that, that’s where it gets exciting because I can teach you how to make $1 million a year. You’ll do well doing that. You’ll have a good life. If you want to take it to the next level, that’s when it gets amazing to be able to say, “That’s how you make $10 million, $15 million, $20 million, $25 million.” That’s what Right Path is about. I also want to talk about one of our students lives in Corpus Christi. He invested in Corpus Christi. What we do, although we invest in Houston, we’ve done outside in other areas like Wichita Falls, in Orange, in Dallas and Point Comfort. We’ve done the greater Houston area, but we’ve got students in San Francisco, Seattle, Tennessee, Kansas City in Florida, all over the country. People come flying in from around the country, come to our two-day class. They take what we teach back home. One of our students, Mike, said, “My wife would like us to move, go a little bit further west. Does this work?” I was like, “Absolutely. You could uproot me, place me anywhere in the country. Within a few short weeks, I would have my network built because I know how to build a network.” It’s about building relationships. It’s about building win-win relationships.

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About Daniel Gollinger

RPRE Tom | Real EstateDaniel has been with Right Path Real Estate since January of 2017. He assists with live events and the application process for new members. Daniel is the proud father of four and loves real estate and helping people find their way to the right kind of education and mentorship in order to find success in this business.

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