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.