Warren Buffett

Many stock market investors look up to Warren Buffet as their “guru”, but if you listen to him closely, he’s basically telling you not to invest in stocks.

Warren Buffett’s rule #1 of investing is “Don’t Lose Money.”

Rule #2 is “Don’t forget rule #1.”

Retail Stocks Don’t Qualify

What he means by that is: don’t invest in anything that can go down in value.

By that definition, almost all stocks are ruled out. By contrast, Warren Buffett wants you to buy assets at wholesale, not at retail prices. That means picking up property or companies at 50 cents on the dollar.

When you buy stocks online, you are, by definition, paying market value for the stocks. The only way to get a company at wholesale is to buy the whole thing like Warren Buffett.

Wholesale Real Estate

Since most people can’t afford an entire company, the next best thing is a piece of real estate.

We buy $100k properties for $50k and fix them up. We are never in to a property for more than 70% of the after repair value. That way, we are protected against a downturn in the market.

Don’t Lose Money!

The hardest thing in investing is recovering from a loss. It takes a 100% gain to recover from a 50% loss. So don’t lose money!

Last week I did something that I never before imagined was possible. I made more money with a few phone calls than I did in my entire first year as a blogger.

$7,500 Just Like That

My real estate partner, Shauwn, and I started an investment company called Passive Equity, LLC. Last week, we were given a $7,500 check for assigning a contract on a house from one investor to another.

The crazy thing is that we didn’t spend time looking for the house, we didn’t need to look at the house (I drove by just to prove to myself it was real)… We didn’t do anything except make a few phone calls.

Entrepreneur 3.0

Ever since I found a whole new gear of making money, It amazes me how much easier and faster it has become than in my early days as an entrepreneur. I used to work my tail off for what ended up being a minimal result. Now it’s just the opposite. At each step along the way, I learned something revolutionary that made my life easier.

E 1.0 was back in the 90′s when I was in high school and college. I started a lawn mowing businesses, a t-shirt design company, an online poster website, and on and on…

I thought that working for myself was the way to go, no matter how hard I worked. It turned out that owning your own job was harder, more stress, and sometimes less profitable than working for someone else!

E 2.0 started when I read Rich Dad, Poor Dad. I got smart about passive income and learned how to create businesses that didn’t require me to be there. I got into bulk candy vending, blogging, an automated eBay business, etc.

That was pretty cool, but it soon dawned on me that passive income was great, but only after my bills were taken care of. I was trying to live on passive income alone and it wasn’t enough.

The problem was speed. I wasn’t building it fast enough.

E 3.0 Over the last year, I started seeking out people who had made lots of money at the rate that I wanted to make it for myself. I let go of trying to reinvent the wheel and just listened to the guys who knew how to do it.

The $7,500

As I was networking, I ran into a guy who assigned contracts for a living. Commonly known as a wholesaler, he specialized in finding property a deep discounts and assigning the contracts to investors for an assignment fee.

He was expanding his business to include Central Texas, so he asked if I could help him find buyers for his contracts in exchange for half of the assignment fee.

No problem, I said, but it really seemed to good to be true.

The Call

A week later, he called me with a property that he had under contract. It was a large home with a pool on the outskirts of San Antonio.

Comparable homes in the neighborhood had been selling for $220k – $250k. He had it under contract for $105k.

I first thought about buying the house to flip. I talked it over with Shauwn and we agreed that it was a little bit too “outside the box” for our comfort because it was out of town in a slow-moving real estate market.

But, at that price, I was sure someone would want it!

The Plan

My plan was to get an estimate on the repairs and then start working my real estate investor contacts. I sent over my rehab guy and he discovered that it was pretty clean except for some plumbing issues and a little updating. His estimate was around $20k, mainly because it was a big house in an upper-end neighborhood.

To my surprise, he told me that he wanted to buy it!

Sweet, I thought. That meant I didn’t even have to touch my contact list!

We went into price negotiations and settled on $120k.

That’s $15k more than we had it under contract for.

An Amazing Way to Make Money

The closing date was set for a few weeks after the deal was signed… and to be honest, I wasn’t going to believe it until we got a check.

Would you know… We got the check!

At closing, the investor bought the property for $120k with a $7,500 assignment fee for us and a $7,500 assignment fee for my wholesaling friend.

Unbelievable…

It was truly a win-win deal. The investor got a great deal that he will rehab and make a ton of money on. We made some quick cash for showing him a deal that he couldn’t find elsewhere. The owner got rid of a plumbing headache and moved on with her life.

When I look back on how hard I’ve worked over the years for varying degrees of pay, making money like this simply blows my mind. All I did, literally, was make a few phone calls. I drove by the thing just so I could see that it was real, but I didn’t have to. My wholesaling friend never even saw the thing.

Well, you better believe that Shauwn and I will be doing a lot more of this kind of thing in the future. I’ll be sure to keep you updated.

Six Ways to Make Money is Better Than One

I’ve made several comments over the years recommending real estate investing as the most powerful form of passive income.

The reason it’s so powerful compared to other passive income sources such as stocks, blogging, or bulk candy vending is: there are six ways it makes you money.

Stocks, by contrast, only share one of these sources (two if you’re getting dividends).

Income Sources of Different Passive Income-Producing Assets

Once you understand how all six of these income sources work, you will begin to see the tremendous wealth-building power of real estate bought and managed correctly.

I Said Correctly

Quick Disclaimer: These six income sources only apply to real estate bought and managed the way my mentors taught me:

A) with equity,
B) with cash flow,
C) in “bread and butter” neighborhoods,
and D) managed with best practices.

If your knee-jerk reaction is that real estate investing is too risky, you have not yet been taught how to minimize the risk. The way I was taught to invest in real estate is not the same way that many of the “gurus” teach. Most of those programs are far to risky for my taste.

Multiple Streams of Income

One neat thing about having so many different income streams is that real estate can be forgiving. Many people I know (including myself) screwed up on their first deal, but still made money. That’s because one income stream can make up for a lack of another.

Now, I don’t recommend screwing it up. You might as well do it right as long as you’re getting in the business. That way you won’t ruin your taste for the most powerful wealth-building tool available to the average person.

Let’s run down the list of the six ways:

1. Cash Flow

Cashflow is the reason we seek passive income-producing assets. Without cash flow, you don’t have income… meaning: you can’t quit your job without cash flow.

All of the assets on my comparison chart have cash flow (I’m assuming your stocks have dividends). If it doesn’t cash flow, I don’t consider it.

We don’t buy a piece of real estate unless the rental income is greater than the monthly expenses by a decent margin. For example: when your tenant pays you $1,000 a month and your monthly expenses including principal, interest, taxes, insurance, and maintenance/occupancy reserve are $800 a month. The $200 difference is now income in your pocket.

2. Equity Capture

Equity capture is when you buy an asset for less than it’s worth. In real estate, it’s when you buy a house in a $100k neighborhood for $50k, fix it up for $20k and you’re “all in” for $70k.

You just captured $30k in equity which goes directly towards your net worth. Few other investment vehicles can create wealth so quickly

In fact, of the six assets on my comparison chart, real estate investing is the only one that allows you to capture equity. Stocks are sold to the average person “at market” which, by definition, means there is no captured equity.

Without equity, you are exposing yourself to the risk of a falling market. We always buy assets with equity so that we are never hurt by a down market.

Online businesses, network marketing, and vending can be good sources of cash flow; but they don’t offer an opportunity to buy an asset for less than it’s worth.

3. Forced Appreciation

The ability to change the value of an asset by your own efforts is a very attractive reason for choosing an asset for self-determinists like me. Most of the businesses that I have ever started relied heavily on my creativity and work ethic to gain in value.

In real estate, you have the opportunity to physically change the value of an asset. In single-family investing, we take a distressed asset and raise the value back up to where it supposed to be with a proper rehab.

Multi-family investing lets us take this concept to a new level. While the value of a single-family house is constrained by the comparable sales in the neighborhood, the value of an apartment complex is based on the profits. That means you are only limited by your ability to increase the income and decrease the expenses.

The value of a vending or online business is also based on the profit margin that you can personally control.

Unfortunately, stocks do not allow you to control the value (that’s in the hands of the execs), and network marketing businesses typically can not be sold (so they don’t have a market value).

4. Market Appreciation

Real estate doubles in value every twenty years. It might fluctuate in the short term, but it is forced to rise over the long term with inflation of building materials, labor, and scarcity of land.

The main reason most people buy stocks today is for market appreciation while it’s only the 4th most important reason we buy real estate. Do you see the difference?

While stock investors live and die by market appreciation, real estate investors see it as a nice bonus to pile on top of the other five ways we make money.

5. Principal Pay Down

Here’s a neat way we make money in real estate that most people don’t even think of. We naturally accumulate equity in our houses as the notes get paid down.

Even if you weren’t making money any other way, your tenants would be paying down your mortgage a little bit each month. It starts out small, like fifty or a hundred dollars a month, but it grows over time and adds to your equity in the house.

The other asset classes typically don’t have mortgages, so this wouldn’t apply.

6. Tax Advantage

Real estate investors pay the lowest takes of any for-profit group in the United States. The IRS allows us to reduce our earned income tax on cash flow by taking a depreciation deduction against the house. We can avoid capital gains tax when we sell by using a 1031 tax exchange.

How long can you avoid taxes with a 1031? If you pass the property to your children, they will take over at the new cost basis, which wipes out all of the capital gains over the life of that asset.

None of the other assets can claim such a huge tax advantage.

Does it Make Sense?

Are you starting to understand why I talk up real estate investing so much? It’s the only asset class that I know of that can create rapid wealth. All the others make money in one or two ways, but not six.

One of the greatest things about real estate investing is that anyone can do it. People think they need money or credit to become a real estate investor, but that is simply not the case.

No matter where you are financially: broke or bulging pocketbook, there is a place in the real estate investing world for you.

The Ladder

I like to think of it like a ladder. We are all want to make it out of the rat race, and each of us is on a rung on the ladder. Whether you have a lot of money and are near the top of the ladder, or are just taking your first step; it is as simple as a series of steps.

It’s obviously easier at the top of the ladder because you have the most options. Cash is king and buying real estate with cash will get you the best deals and terms.

Because you have the most options at the top, it’s logical to choose the highest returns with the least amount of work. The top rung should be on the passive side of the passive income continuum.

At the bottom of the ladder, your options are limited, but not as much as you might think. You will need to find ways to invest in real estate with little or no money. You will have to give up some long-term gains for some short-term money to get you on the next rung of the ladder.

Let’s start at the top of the ladder and work our way down to the bottom.

5th Rung: High Net Worth, Wants Low-Risk Cashflow

People on the 5th rung have enough money to retire and are looking for low-risk, cashflowing assets that will give them a steady stream of passive income in their retirement without digging into their principle.

At this level, you could theoretically just dump your money in Treasury Bonds and live off the 1-2% return, but you can do better than that in real estate while keeping your risk to a minimum.

Multi-Family Yield Play

As real estate investors, we are all heading in the direction of the multi-family yield play. That’s where you buy an apartment complex that is in good condition and already stabilized; and enjoy a steady 10-20% return on your investment through monthly cashflow.

If you have a high net worth and are close to or in retirement, you want an investment that will give you a high rate of return without much hassle. Those that want the least amount of hassle should look for an opportunity to be a passive investor in a multi-family deal put together by an experienced lead investor.

Many lead investors will accept passives with as little as $100,000 to bring to the table. Your commitment might be as little as the optional quarterly meeting to vote on distributions. If you have placed your money with a solid lead, all you have to do is go to the mailbox and deposit your check.

Before entering in any deal with a lead investor, make sure they have a solid track record of safe, steady returns.

If you are willing to put more time and energy into a deal, and have the skill-sets to manage large projects, you might consider learning to be a multi-family lead investor. As a lead, you would earn extra compensation for putting the deal together and managing the asset.

Private Lending

Finding a great multi-family value play might take a little time, so in the mean time you can make a steady 6-10% return by lending money to real estate investors to buy property. Your investment would be secured by the piece of real estate at no higher than a 70% loan to value (LTV).

If you hold a 1st lean position on a piece of real estate at 70% LTV, the worst thing that could happen is you would have to foreclose on the borrower and take over a property with a 30% equity position.

You could sell the property and probably walk away with more money than you would have made if you had not foreclosed. Some people consider this the BEST case scenario.

(For more information on private lending, please visit PassiveEquity.com)

4th Rung: Medium-High Net Worth, Wants Big Gains

People on the 4th rung are either still building their nest egg, or are wanting to get more aggressive with their investments. They are looking for opportunities to make a 50-100% gain on a deal in a 1-5 year period.

Multi-Family Value Play

A Multi-Family value play is where you buy an apartment complex that is beat up with low occupancy, and rehab the asset until it is in good condition and performing at a high level.

There is more risk involved with such an undertaking, but the rewards can be massive. Think about it: If you by a apartment complex that was selling for $30k a door five years ago for $10k a door in foreclosure; imagine the possibilities if you could run that asset properly.

Before you embark on such an undertaking, get as much information from experts in this sort of deal. Find a local investor group with multi-family investors to learn from. Go to NationalREIA.com to find a local investor group.

3rd Rung: Medium Net Worth, Wants to Move Up

People on the 3rd rung have a good foundation, but not enough to get into multi-family investing. Their main concern is building their nest egg as quickly as possible while adding to their passive monthly cashflow.

Single-Family Buy & Refi

If you have $20-$100k to invest, you should be mainly concerned with preserving your liquidity. The object is to buy as much real estate with as little out of pocket as possible.

One way to do that is to buy rental real estate and then refinance your money back out in order to buy the next piece.

The first step is to buy the property with either cash or a hard money loan. In order to make this work, you will need to find a property that you can buy and rehab for 75% or less of it’s after repair value (ARV).

Once you have rehabbed the property, most commercial lenders will give you up to 75% of the value of the house in a refinance mortgage. Take your money back out of the property and do it again.

Rinse and repeat.

When you have built up enough equity to move into multi-family, sell your properties to liquidate your equity and move up.

2nd Rung: Low Net Worth, Good Credit

If you have somewhere between $5k and $20k with good credit, you are still in good shape! Your real estate investing plan should be to buy as many properties as you can with hard money loans.

Hard money lenders are non-traditional banks that will usually lend up to 70% of the after repair value of a property. This differs from traditional lenders who lend based on the current value.

If you can find a house that will be worth $100k when it is fixed up for $50k with $10k in rehab and $10k in closing costs, you will be all in at the end of the day for $70k. Since 70% of the ARV is $70k, the hard money lender will lend you everything you need to buy and rehab the property. In this case, you will have nothing in the deal.

If you are all in for $75k, you would only need to come out of pocket $5k.

Hard money allows you to stretch your minimal capital as far as possible.

1st Rung: No Net Worth, No Credit

If you have no money and no credit, you can still be in the game. Since you won’t be able to qualify for a loan, your strategy will be to find deals for other investors and make a short-term gain.

Wholesaling

Wholesalers are sometimes known as “bird-doggers” because they spend their time hitting the pavement to find deals for other investors. If you don’t have money or credit, you will have to bring value to the deal with sweat-equity.

You will set up a marketing campaign to find motivated sellers by putting up signs, sending out mailers, walking the streets, plastering your car with ads, networking, etc. If you can find a $100k for $45k that needs $10k in rehab, you could easily sell it to an investor for $50k, giving you a quick windfall of $5k.

(Remember that most investors are looking to be “All-in” for around 70% of ARV.)

Conclusion

I know people who make a living at every one of these rungs of the ladder. The reality is that it can be done no matter where you are financially.

After hanging out with a bunch of millionaire real estate investors for the last few years, it’s amazing to me how much most people DONT know about creating wealth. The average reaction to this article will probably be skepticism because most people have never even imagined creating wealth this quickly.

The investors who run in my circle are doing this every day.

Is $200 a month a lot of money?

How you answer this question speaks to your level of financial sophistication.

How Far Would You Go for $200?

Most people would not go very far out of their way to make an extra $200 a month. When compared to a monthly salary of $3,000 or $4,000; $200 sounds pretty insignificant.

A person might pick up an extra shift on a Saturday for a little vacation money; but the uncomfort from losing a weekend day keeps them from making a habit of it. Someone might sell an outdated computer or game system for a few hundred bucks, but that money’s usually gone by the end of the weekend.

As a way to create wealth, $200 doesn’t even cross most people’s minds. The average person spends more time buying lottery tickets and gambling in casinos than looking for ways to add another $200 to their monthly cashflow.

Successful Real Estate Investors

I happen to have the best job in the world. I get to produce videos about real estate investors, which allows me to meet many successful people and pick their brains in the process.

I’ve found that all the successful real estate investors I meet are excited about $200 a month in cashflow from one of their rental properties.

In most cases, that $200 a month is the main reason they pursued the property.

The Definition of Wealth

How you feel about $200 a month has a lot to do with how you define wealth. Most people associate wealth with a large dollar amount: Alex Rodriguez signed a $80 million dollar contract, or Bill Gates is worth $80 billion.

Throughout most of my childhood and early adult years, my definition of wealth was 1 million dollars. The day I opened up my bank statement and it said “$1,000,000″ was the day I was going to be wealthy.

Rich Dad, Poor Dad

My definition of wealth changed the day I read the book “Rich Dad, Poor Dad,” by Robert Kiyosaki. If you have never read the book before, your next click should be Amazon.com to order yourself a copy. This book changed the way the world looked at investing.

One of the most important concepts in “Rich Dad, Poor Dad” is the definition of wealth. While most people look at wealth in terms of a large, one-time amounts of money; Kiyosaki says that this has nothing to do with wealth.

Wealth is determined by this simple test:

Quit your job today; and without touching the principle on any of your investments, how long can you live on your passive income?

Passive Income

A few forms of qualified passive income are:

• Interest from Checking and Savings accounts
• Dividends on Stocks (not capital appreciation)
• Cashflow from Real Estate

All of these things A) give you cash on a consistent basis, and B) once set up, are relatively easy to maintain.

How Long Can You Live on Your Passive Income?

To figure out how long you can live on your passive income, you first need to know how much your personal bills are each month. Add up all of your expenses: everything from the house note and car note, to toothpaste and tuna. If you’re married, just do it for your half of the bills.

Let’s say that the average American needs $3,000 a month (after taxes). Since a month is about 30 days, that’s $100 a day.

So how long can you live on your passive income?

I would suggest that most Americans can only live a few hours… maybe a few minutes on their passive income. Most people don’t have anywhere near $100 a month in qualified passive income. They might be getting a few cents in interest from their savings account, but that would only cover a few seconds.

One Single-Family Rent House

Let’s say, in the next three months, you go out and buy one single-family rent house that cashflows $200 a month. Can you see how you may have done more to retire yourself in 3 months than you had in your entire working career?

That one house, and it’s $200 a month cashflow, pays for 2 days out of your month. If you don’t have more than $200 a month right now in passive income, this one house did more to retire you than you had done for yourself in your entire working career.

Now, go buy another one… that pays for 2 more days…

Buy another and you’ve now paid for 6…

By the time you have 15 rent houses, you’ve now paid for all 30 days in the month… and the month starts over again.

Theoretically, you can now live forever on your passive income.

Side Note on Kiyosaki

After seeing Kiyosaki live, buying his board game, and reading many of his books; I’ve come to realize that he is BIG on ideas, but small on details. When you finish reading his books, you’ll be so jazzed on creating wealth that you won’t know where to start… (that’s because he didn’t give you any details.)

Make sure you are part of a local investor group to fill in all the little details that Kiyosaki doesn’t tell you. My favorite is Lifestyles Unlimited Real Estate Investing, Education, and Mentoring where I am both a member and mentor; but you should shop around until you find a group or groups that you are comfortable with. Go to NationalREIA.com for a list of investor groups in your area.

$1,000,000 401k

Now, let’s compare our 15 rent houses to a million dollar 401k. Let’s assume you were the worlds greatest at-home stock trader in the early 2000′s.

You listened to Jim Cramer every day and managed to act on his good advice and avoid the bad advice that lost everyone else 40% of their portfolio in 2008. You sold everything before the market crashed and now you’re ready to retire.

The challenge you now face is how much money to take out of your 401k in your retirement so that it lasts the rest of your life

Or.. as Real Estate Investor Del Walmsley likes to put it: so you can hurry up and die before you run out of money.

The Conventional Wisdom Plan

You seek the advice of a financial planner and they give you the conventional wisdom on retirement:

1. Conservative Investments

You’re told to put your money in conservative investments that will only yield 2-4%, but at least you can have some peace of mind in retirement. Sounds reasonable.

2. 4% Drawdown

You’re allowed to draw down your 401k at the rate of 4% per year to live on: $40,000 per year.

Before the crash of ’08, 4% was generally accepted to be the right amount to draw down in retirement. The book “The Number” lays out research from William Bengen showing that those who drawdown at 5% have a 30% chance of running out of money.

3. A Little Interest

Won’t I be getting some interest, too?

Yes, but it will be at a very low interest rate and getting smaller each year as you eat into your principle. Let’s say, another $10,000 per year.

$50,000 a year doesn’t sound as great as you had always imagined, but at least you don’t have as many expenses as you used to (you did pay off your house, didn’t you?).

4. Pay Taxes

Wait, I thought we were done!

Sorry, here comes the worst part… Now you have to pay taxes. You were sold on the 401k as a way to defer taxes, but you didn’t realize that defer was not the same as avoid. You pay roughly $14,000 in taxes which leaves you with $36,000.

$36,000 a year just happens to be $3,000 a month or $100 a day.

15 Rent Houses Did the Same Thing Faster

15 rent houses did the same thing as your million dollar 401k, but did it take you your whole working career and a huge chunk of your paycheck to build?

No. You can buy 15 rent houses in 5 years or less.

The Five Year Plan

Here’s how to buy 15 rent houses in 5 years:

Year 1: Save $5k from employment to buy 1 house with a hard money loan. (1)
Year 2: Save $5k and refinance $5k out of the 1st house to buy 2 houses. (3)
Year 3: Save $5k, refinance $10k out of last year’s 2 houses, to buy 3. (6)
Year 4: Save $5k, refinance $15k out of last year’s 3 houses, to buy 4. (10)
Year 5: Save $5k, refinance $20k out of last year’s 4 houses, to buy 5. (15)

This example only took $25,000 out of pocket over a 5 year period… much less than a million dollar 401k …and much faster.

But Wait… There’s More

The story doesn’t stop there, with 15 rent houses and $3,000 a month in cashflow. The beauty of real estate is that there are so many different ways it makes you money.

While a 401k gets smaller and smaller in your retirement, rent houses continue to increase in value and cashflow year after year.

1. Equity Capture

If you bought those houses correctly, you should have captured equity in each house. Let’s say you captured $20k in each house. That’s $300,000 added to your net worth.

2. Market Appreciation

Real estate doubles in value every 20 years. That means: by the end of your retirement, your real estate holdings would have exploded in value.

If each house was worth $100,000 when you bought it, then all 15 were worth $1.5 million. You could potentially add another $1.5 million to your net worth over the next 20 years.

3. Cashflow

Rents rise over the long run, adding to your cashflow year after year.

4. Principle Paydown

Your tenants will be paying down the notes on all of your houses. If you had 20 year notes on each house, you would have them all paid off in 20 years, adding another $1.5 million to your net worth.

5. Tax Advantages

Real estate investors pay the lowest taxes of any for-profit group in the United States. The cashflow is virtually tax-free when you account for the depreciation deduction the IRS allows you to take.

If you decide to sell and capture your equity, you can roll the profits into a 1031 tax exchange to defer the capital gains tax. When you pass the properties down to your children, they take over the property at the new cost-basis, wiping out all the capital gains tax.

Conclusion

Now, do you see why I stopped playing around with small-ball investments and focused on real estate? Real estate is the most powerful wealth-building tool that is available to everyone in the United States.

Stop playing small-ball and start investing in real estate.

The two most basic real estate strategies are:

1. Appreciation – Buying property you think will appreciate in value in order to sell it for a profit.

2. Cashflow – Buying property that will rent for more than the cost of holding the property.

Appreciation Strategies

Appreciation strategies are the more glamorous of the two, and the only thing anyone seems to talk about when real estate comes up around the water cooler. The idea of making 10, 25, 50, or even $100,000 in a year just by owning a piece of property is very appealing to most people.

Here’s how a typical appreciation strategy works:

Purchase price: $300,000
20% appreciation: +$60,000
Sales Price: =$360,000
Gross Profit: $60,000
Expenses: -$30,000

Net Profit: $30,000

These were the types of deals we often saw during the real estate boom of the early 2000′s. People were making money hand over fist by simply owning property. With the stock market in a slump, people thought that real estate was the next great money-making opportunity.

Appreciation strategies are typically short-term in focus, with investors holding the property anywhere from a few days to a few years before they cash out. Short-term holds are known as “flips,” where the investor only holds the property long enough to fix it up and sell it again. A slightly longer-term strategy is to find a tenant for a year and then sell it. Transactions tend to be larger in size, where bigger margins mean bigger profits to cover transaction expenses.

Supply and Demand

Appreciating properties tend to be closer to the center of a metro area. As more and more people move to a city, competition for limited urban property intensifies, and prices go up.

The ultimate example is New York City, which is a city on an island. Since the supply of land is limited by water on all sides, and demand is extremely high, the resulting property values are astronomical.

In more rural areas, like the midwest; the supply of land is much greater. As demand increases, cities spread out to absorb it, and prices remain more reasonable.

Speculation

Financing for appreciation-focused investors has been increasingly creative in the last few years, with investors taking on riskier mortgages such as variable interest and even interest-only loans. Since short-term home buyers plan to get rid of their property quickly, they tend to choose the loan that allows them the greatest purchasing power with the lowest holding costs.

The national average for annual real estate appreciation over the last 100 years is somewhere around 5%, so the 20, 30, and even 50% gains that we saw in the early 2000′s were somewhat of an anomaly. Speculators with short-term mindsets and highly-leveraged financing were a major driving force behind the bubble that has now burst.

If you were an unlucky appreciation-minded investor who bought at the height of the bubble, your investment might have looked something like this:

Purchase price: $300,000
10% depreciation: -$30,000
Expenses: -$30,000

Net Loss: -$60,000 & $2,000 per month until it sells

Appreciation strategies carry enormous risk for those who can’t afford to hold a property if it doesn’t sell for what you need to make a profit. If a market turns upside down (like it has in many areas of the country), you might have to wait 5-10 years to make your initial money back. Unfortunately, the cost of holding onto a property that long can be immense.

Cashflow Strategies

Cashflow strategies are the less talked-about sister of the two; but tend to represent a more stable, long-term strategy. A typical cashflow strategy looks something like this:

Purchase price: $100,000
Monthly Expenses: $900
Monthly Rent: $1000

Monthly Profit: $100

$100 a month is a lot less sexy than $100,000 profit, but here’s where it gets more attractive:

1. The cashflow lasts as long as you can keep the property rented, which could be the rest of your life.

2. Rents tend to go up over time, increasing your cashflow.

3. If you get a 15 year fixed mortgage, your mortgage payment will drop out after 15 years, increasing your cashflow by around $600.

4. You could realistically end up turning a $100-a-month cashflow property into a $1000-a-month property over the course of 15 years.

5. As long as your rents cover your expenses, you don’t have to worry about property value, even if it goes down.

6. Any appreciation you get along the way is icing on the cake.

Cashflow investors tend to be long-term oriented, intending to hold their properties for 10, 15, 20 years; or even forever. The transaction sizes tend to be smaller, where rent levels can match expenses.

Casflow-type properties tend to be located on the outskirts of a metro area; where prices are lower, but rents are still strong. These areas tend to have more families and people with more consistent lifestyles; both desirable qualities in a tenant.

Downside

A sure-fire way to become a millionaire is to buy a cashflowing property every year for fifteen years. The accumulation of increasing cashflow, mortgage reduction, and capital appreciation will provide enough money to get most people out of the rat-race.

The problem with this strategy is that it’s expensive. An investor usually needs a 10% down payment in order to buy a property. If each house is 100 to $200,000, you’ll need 10 – $20,000 a year for down payments. In addition to that, you’ll need another 2-$5,000 for repairs and holding costs.

The average Joe doesn’t have this kind of money laying around each year. That’s when he starts thinking about flipping.

Hybrid Strategies

If you’re looking for long-term wealth, but need short-term cash to get the ball rolling; a hybrid strategy might be a smart way to go. Combining short-term and long-term property acquisitions is a way to benefit from both strategies while minimizing risk.

Here’s one example:

1. Starting Cash: $15,000

2. Flip a $150,000 property, making a 10% return on the purchase price after expenses: $15,000 profit

3. Take your $15,000 profit, plus the $15,000 initial investment and buy two $150,000 properties.

4. Put a tenant in one property, and flip the other.

5. Continue the process of buying two properties and flipping one until you have as many properties as you want.

The advantage of the strategy described above is that you don’t need to add any more capital than your starting amount. This, of course, is in a perfect world where every one of your deals goes as planned. It rarely works this way, but here are a few ways to limit your risk:

Never Lose

One-time richest man in the world and fellow Nebraskan Warren Buffet knows how to make money. He famously champions value investing, which goes in and out of fashion depending on whether it’s a bull or bear market. In great bull markets (like the tech boom of the late 1990′s), so-called experts tend to discount Buffet’s strategy as old-fasihioned; but he always gets the last laugh.

His most famous advice to investors is “never lose,” meaning to protect your downside at all costs. Using this strategy in the stock market, you would never risk your money on an overpriced stock (with a high P/E ratio). The idea is that underpriced stocks have much of the risk already taken out of them.

Buffet looks at a company and figures out what it would be worth in a worst-case scenario. If it went out of business and stopped making money, what would the assets themselves be worth if sold on free market?

This price represents a theoretical basement for risk. The closer he can get his purchase price to the basement price, the more risk he has taken out of the investment.

This is an obviously over-simplified description of his decision-making process, but it illustrates the principle of protecting your downside. In real estate, it makes a lot of sense to protect your downside as well.

Worst-Case Scenario

What is the worst-case scenario if you buy a piece of investment property? There are a million things that could go wrong, but here’s the short list:

Appreciation Strategies

1. Real estate market goes south and your asset loses value.

2. Can’t find a buyer for extended amount of time, forcing unexpected holding costs.

3. Home needs more repairs than budgeted

Cashflow Strategies

1. Can’t find tenant for extended amount of time, forcing unexpected holding costs.

2. Can’t get expected rent, forcing negative cashflow.

3. Tenant damages property, forcing unexpected repairs.

Limiting Risk

To limit your risk, you must do your due diligence to know exactly what you are getting.

Purchase Price

Never pay too much for a property. Don’t just look at comparable sales in the neighborhood, ask yourself what the bricks and mortar are worth. If it only costs $100,000 to build a comparable home in the middle of nowhere; don’t pay $600,000 for that property just because it’s in a great location. Overpriced properties like these are the first to get hit in a real estate downturn.

Cashflow

Cashflow is the ultimate downside-protector. If a property cashflows, you can hold it as long as you need to. The perfect flip is one that will cashflow in case of an emergency.

That being said, it takes due diligence to make sure a property will cashflow. How is the rental market? Are rents going up or down? What are the occupancy rates? What is the average time on market for a rental property?

Over-Budget

The biggest mistake people make in calculating cashflow is under-budgeting. It’s not as simple as subtracting the mortgage payment from expected rent. The problem is that there are several other expenses you need to account for in order to insure positive cashflow.

1. Holding costs. -It’s next to impossible to have a 100% occupancy rate for your rental property. Therefore, you need to budget a month or two between tenants where you will have to make the mortgage payment. Start with a 10% re-letting expense, meaning if you’re rent is $1000, you should budget $100 a month for this expense.

2. Maintenance. -Your property is going to need maintenance, guaranteed. If you don’t budget it in, you’ll be left with the bill. Budget another 10% maintenance expense.

3. Insurance, PMI, Taxes, Homeowner’s Association, and any other expense you can think of.

Complementary Properties

One way to limit risk on a flip is to find a complementary cashflow property to support it. If you’re making $200 a month cashflow on one property, it’s easier to buy a speculative property with -$200 cashflow. This way, if your flip doesn’t work out the way you expected, the worst that can happen is zero cashflow.

Make Your Money Upfront

Profits in real estate are made at the purchase, not the sale. If you can find a deal on a property that is already below market value, then you’re starting out ahead. Don’t rely on appreciation to carry you. It might not be there.

Sweat Equity

Real estate, like any market, is fiercely competitive. It’s not easy to find deals that will automatically make you money. You have to find an advantage somehow.

One way is to creatively see the potential in a property that other people can’t see. Then, do as much work as you can professionally do on your own to fix it up, and hire out the rest. Using “sweat equity” can yield excellent returns in the value of your property.

Don’t Settle

Your most powerful tool against risk is your ability to control your emotions and stick to your plan. Don’t fall in love with properties, and don’t get soft when it comes to your numbers. Make sure the property cashflows by your conservative estimates.

It takes patience to find a good deal. If it didn’t, everyone would be real estate investors.

Bottom Line

If there’s one thing we learned from the recent real estate boom and bust, it’s that you have to be smart about investing in real estate. It’s not as easy as just buying any property and watching it grow in value.

Do your due diligence, protect your downside, and be smart about your real estate strategy.

I picked up my copy of Buy Low, Rent Smart, Sell High by Scott Frank and Andy Heller at The Real Estate Wealth Expo in New York City a few years ago. It was the biggest convention I had ever been to and it was packed with over a hundred real estate gurus pitching every get-rich quick scheme imaginable.

For the most part, I was unimpressed. Gurus teaching slick sales tactics and questionable techniques for taking advantage of people while they’re down didn’t sit well with me. That being said, I did meet a few people with ideas that justified my ticket price.

The first was Mike Summey, the author of Weekend Millionaire’s Secrets to Investing in Real Estate; and the second was Andy Keller. Both of these men immediately struck me to have a strong sense of integrity, ethics, and sincerity about them. I could tell that money wasn’t their only motivator.

The Plan

The innovative plan that Andy and Scott describe in their book is well thought-out. It combines the benefits of a long term buy & hold strategy with the capital benefits of a shorter term strategy. Ethics is at the forefront, with fairness at every level: buy, rent, and sell.

I like the fact that the book is very analytical. Being a “numbers person” I enjoy the level of detail in the descriptions. Most books on real estate are long on concepts but short on specific examples. This book is just the opposite.

Buy Low

The cornerstone of the plan is consistently buying homes at a 10-20% discount. The authors’ preferred method is forming a relationship with a bank and getting access to foreclosed homes before they get to a courthouse auction.

They identified this stage in the process as the best for their needs for three reasons:

1. The home is already out of the previous owner’s possession. This avoids the undesirable work of tracking down and negotiating with distressed sellers.
2. A relationship with a banker often gives them first looks on new homes to the market.
3. It avoids the risks associated with blindly buying a foreclosure on the courthouse steps.

At this stage in a a foreclosure, banks want to get rid of homes quickly and are often willing to let them go for a 10-20% discount.

To Hold, or to Flip?

In developing my own real estate strategy, I’ve often found myself uncertain whether to pursue a long term buy-and-hold strategy or a short term “flipping” strategy. Being a long-term thinker, my preference is to buy and hold. The long term benefits of holding a rental property far outweigh any short-term gains that can be made by flipping.

The problem with buy-and-hold strategies is investment capital. If you are going to buy a house every year with a 10% down payment, you are going to have to come up with a lot of extra cash every year. That can be a big problem for the investor without a lot of money.

Flipping can provide you with an influx of cash to reinvest, but it tends to be risky. When considering all the fees that go into buying and selling a home, much is lost in the process; not to mention the fact that you are foregoing the long-term benefits of holding.

Scott and Andy’s plan seems to blend these two strategies nicely, while reducing risk at the same time.

Rent Smart

Scott and Andy have developed a unique type of lease-purchase contract that gives a mutually beneficial relationship with their tenants. They have eliminated all of the strong-arm tactics of traditional lease-purchase contracts and structured it on fairness.

A lease-purchase contract is different from a traditional rental agreement because it gives the tenant the ability to buy the home at the end of the contract. Scott and Andy’s contract is different from a traditional lease-purchase and has several advantages for both the tenant and landlord:

Tenant
1. A tenant with bad credit is offered the opportunity to build equity to be used for a down-payment while fixing their credit situation.
2. The tenant locks in a fair-market value for the home at the signing of the contract, meaning that they could potentially execute it years down the road profiting from any appreciation.
3. The upfront option money is reasonable and can be applied to their down payment if they decide to execute the sale portion of the contract.
4. The rent is set a fair-market rate.

Landlord
1. Tenants tend to take better care of a home that they might potentially buy, reducing maintenance costs.
2. It eliminates the holding costs of waiting possibly months for a buyer. Landlord maximizes profits by collecting rent while tenants prepare to buy.
3. Most tenants decide not to execute the sales portion of the contract, allowing the landlord to keep their option money.

Sell High

The fact that most tenants decide not to buy creates a unique blend between selling and holding properties.

The holding and selling decisions are made naturally. A certain portion of homes sell, adding an influx of cash needed to buy more homes, while the rest are held, locking in the benefits of long-term capital gains.

I love the simplicity of this approach compared to agonizing over which properties to buy and which to sell.

Six Profit Centers

This program gives investors access to six different profit centers:

1. Equity gained by acquiring homes at a 10-20% discount
2. Cashflow from monthly rental payments
3. Tax write-offs
4. Equity gained from tenant paying down the mortgage
5. Home appreciation if tenant extends the lease-purchase agreement
6. Option money obtained if tenant does not execute the sales portion of the agreement.

Buy this Book

If you are interested in real estate investing, I would definitely recommend this book. I love the creativity that was put into forming an investment strategy that blends short term and long term benefits while keeping honesty and ethics at the forefront.

Buy Low, Rent Smart, Sell High by Scott Frank and Andy Heller

You’ve read a lot on this blog about how to create passive income with little or no money, and I’ve suggested several ways to start the trickle of multiple streams of income into your pocket; but where is all of this headed? In our quest to create passive cashflow inexpensively, we’ve been forced to make certain tradeoffs for a lack of capital investment.

In the case of bulk candy vending, the tradeoff is labor and potential. Bulk candy requires at least a day or two’s hard labor a month to maintain the flow of money. Also, earning potential is limited by the number of locations you can find and maintain.

Monetizing creative online content is a great way to create an income stream with almost no upfront investment, but the tradeoff (once again) is time. It takes a tremendous amount of time to create the amount of content that will eventually produce a decent stream of passive income.

Network marketing is probably the easiest way to create wealth out of nothing because you can use regular expenses as your investment, so it’s no new money. The power of leverage can mean serious income for those who excel, but the tradeoff is: you still have to manage your income stream. If you pick the right company with a high retention rate, you can keep your management time to a minimum, but you can’t completely let it go like you can with real estate.

Real Estate

The foundation of any long-term generational wealth is real estate. Businesses and fortunes rise and fall, but smart investors stash their profits in real estate to preserve their wealth.

Done correctly, real estate investing offers a stream of cashflow with the least amount of maintenance and highest long term potential of any stream discussed on this blog.

The tradeoff is money. Real estate costs lots of money to get into. While there have been many books and seminars devoted to acquiring real estate with no money down, the deals tend to be risky and hard to find. I personally have acquired property with nothing down, but prefer a strategy of putting 10 – 20% down on properties to reduce the risk of leverage and increase cashflow.

Movin’ on Up!

My passive income philosophy is to acquire multiple streams of passive income inexpensively with the purpose of eventually rolling the profits into real estate. If you can build up to about $1000 a month in passive income from inexpensive sources, you can then roll $12,000 a year into real estate. This means that you could purchase one $120,000 house with 10% down per year.

Buying one piece of cashflowing rental property per year will make you a multi-millionaire within 10 or 15 years.

The Power of Real Estate

Explaining the entire topic of real estate investing would take volumes, but I’d like to highlight a few of my perspectives on why real estate is such a great investment.

Limited and Lasting Resource

If you paid attention in macro-economics 101, you know that the value of a resource is based on the factors of supply and demand. To get high prices, you need one of two things: low supply or high demand.

iPods, for example, make a lot of money because everyone wants one (high demand), so Apple can charge a premium. Gasoline prices are higher than ever because refining capacity is low (low supply) and oil is a limited resource (low supply).

Real estate is unique because the amount of land available on the earth will basically always remain the same. New York City is my favorite example because it’s an island. More and more people want to live in New York every year , but the expansion of the city is limited on all sides by the water.

Since they couldn’t expand outward, city developers expanded upward; and since that still didn’t provide enough supply for the demand, the price per square foot of real estate in Manhattan is astronomically high.

Demand in the real estate market as a whole will continue to increase as long as the economy expands, and history has shown that over the long run, our economy grows steadily. There may be markets within our economy (such as rural areas) that see real estate downturns, but smart investors will always be able to find good markets.

Tangible Asset

Real Estate is much more than a monetary asset like a stock certificate. You can touch, feel, breath, and experience a piece of land. Land can be a part of a family’s history and a part of who you are.

Like I said before, fortunes will be made and lost, your house might even burn down; but the land beneath it will almost certainly always be there.

Solid Stream of Income

A point of clarification: when I talk about passive income streams from real estate, I’m talking about a long-term buy and hold strategy, not flipping. I think there’s a time a place for making a quick buck on property, but over the long-run, your fortune will be made with solid streams of income.

Let me give you an example: Let’s say you buy one house worth $120,000 with a 10% down payment and a 15 year fixed rate mortgage. Let’s be pessimistic and say that when all expenses are said and done, including an allowance for vacancy, maintenance, and management fees; you just break even on the rent.

While this isn’t a very sexy situation to a flipper, watch what happens over the long run: Let’s say you are getting $1,200 a month in rent, which just covers your expenses, but you intend to raise the rent 3% per year. Here is what your monthly cashflow will look like for the next 15 years of that mortgage:

Year Rent Cashflow
1. $1,200 $0
2. $1,236 $36
3. $1,273 $73
4. $1,311 $111
5. $1,350 $150
6. $1,391 $191
7. $1,432 $232
8. $1,475 $275
9. $1,520 $320
10. $1,565 $365
11. $1,612 $412
12. $1,661 $461
13. $1,710 $510
14. $1,762 $562
15. $1,815 $615

$615 a month cashflow isn’t bad, but the best part comes in the 16th year! Since your mortgage will be paid off (by your tenant), you’ll have an instant jump in cashflow. If your mortgage was $800, cashflow in the 16th year would be $1,469!

Starting in your 16th year, you’ll have a steady, increasing stream of income of about $1,500 a month, or $18,000 a year; all from a $12,000 initial investment! It would only take a few deals like this for you to be set for life.

Patience

The secret to real estate is patience. You can’t get greedy or you’ll end up hurt. Wait for the right deal and make sure the numbers work.

By the numbers working, I mean rental income exceeds all expenses including an allowance for maintenance, vacancy, and management. You have to establish enough discipline to resist the temptation to veer from this path.

A lot of people are sour on the real estate market now that areas of the country are seeing a downturn, but rest assured that the deals are still out there. Look in the suburbs, or in another state. The midwest and south might present some good opportunities.

Get Started

If you are just getting started in real estate, I would highly recommend Weekend Millionaire’s Secrets to Investing in Real Estate by Mike Summey and Roger Dawson.

Of all the approaches to real estate investing that I have been exposed to (books, seminars, CD’s, and networking), the one presented by Mike Summey and Roger Dawson is the one that I have adapted as my own. I like their approach for many of the same reasons that their book is not a best seller: it’s not about getting rich quickly, it requires due diligence, and it’s based on honesty.

Mike Summey

I met Mike Summey at a Real Estate Wealth Expo in New York. I listened to about fifty different real estate gurus that weekend including Robert Kiyosaki, Donald Trump, and more; and I have to say that Mike Summey was my favorite.

After hearing guru after guru preach slick sales tactics or how to take advantage of people in distress; Mike’s down-to-earth demeaner was a breath of fresh air. He even emphasized how close he was with his tenants, having them over for get-togethers and holidays.

I also found him to be genuinely interested in helping other people. While most gurus were selling their tape sets for thousands of dollars, his was less than a hundred.

Farming

The Summey/Dawson technique focuses upon “farming” a neighborhood one day a week on foot until you are an expert. A “farm” is a real estate term for a neighborhood of just a few thousand homes. By narrowing your search to a farm, you can be in a better position to spot deals than most real estate agents and investors who keep track of an entire city.

Long Term Focus

This book is not about flipping. The Weekend Millionaire approach focuses on finding properties that cashflow and holding on to them for the long haul. Most people that I talk to want to learn how to flip. They hear stories about tens of thousands of dollars being made in a matter of weeks, and want a piece. While flipping has its place, holding properties for long term cashflow and appreciation tends to be a better technique for building long term wealth.

Negotiating

Roger Dawson is a world-renowned negotiating expert and shares some of his advice in this book on how to get the best deal possible. I like his approach because it is very professional and respectful. While many people use negotiating techniques to take advantage of other people, Roger Dawson emphasizes coming up with win-win deals.

Emphasis on the Numbers

The book places a specific emphasis on only entering deals that meet the strictest cashflow standards. There is a very detailed list of expenses that they suggest to consider when running the numbers on a deal. Many real estate investors make the mistake of buying a property that doesn’t conform to strict cashflow standards hoping that they will make up for it in capital appreciation. The Weekend Millionaire approach teaches caution and patience.

This is the first book I would recommend to anyone interested in learning more about real estate investing. Like all legitimate paths to wealth, this one requires hard work and intelligent strategy. Roger Dawson and Mike Summey hit the nail on the head with this one.