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January 19, 2012 / paulio10

My Thoughts on Real Estate Investing

My goal right now is to learn how to make money in this world, to become free of the Rat Race, under the current rules of how money and wealth works. I’ve already learned I’m pretty bad at a lot of the ways people make money, many of the ways don’t feel right to me. Real Estate investing seems to be fairly most compatible with my values and goals. It works for me. Someday the rules of how money works in our world will change dramatically – when that happens, I will learn how to do it all over again. Because money is a potentially unlimited kind of energy in our world, which can be used to do great things. It’s a man-made energy. It has man-made limitations and side-effects, compared to real energy like electricity or magnetism or light or love or will-power. But it can still do great things.

The Rat Race

Anybody working a job, taking a paycheck, and living off that money is in the Rat Race.

You’re out of the Rat Race when you’ve invested enough that the cash flow from those investments (Passive Income) is all you need to live!
You no longer have to work for your money because your money is working for you with the investments.

Yes it takes a lot of money. But not quite as much as you think. And, making money is easier the better you get at it. I’ll explain that in a bit.

Getting Out of the Rat Race

You’re out of the Rat Race when your Passive Income meets or exceeds your total expenses (cost of living). How much money do you need to live each month? That’s a specific number. Record all your expenses for 1 month and figure it out. Take into consideration any annual expenses or quarterly expenses you have, too; divide annuals by 12, divide quarterly’s by 3 to get the amount per month you generally have to come up with, so you can pay all your bills, year round. Yes, surprise expenses come up too; you should set aside a reasonable amount for those as well. What total did you come up with?

Now imagine that you have enough Real Estate that all of the rents you collect, combined, exceeds that number. Well, there are expenses with Real Estate too, like property taxes, HOA fees, advertising to get new renters, paying utility costs between renters, loss of income when you don’t have a renter; etc. That might sound scary, but really it’s a small cost in my experience. As long as you buy a property in such a way that the rents you’re receiving are more than all the expenses combined (including the mortgage, if there is one), then you’re cashflowing that property – you’re getting free money every month for simply owning that property. Very little work on your part (near zero) once you have a steady renter.

Let’s say a single property can cashflow $250 per month for you – that’s your money free and clear, after all the property’s expenses are paid for. Now, you already calculated what your personal living expenses are. How many $250’s go into your personal expenses total? That’s how many of those properties you need to own to be completely out of the Rat Race!

Suppose you can get by on $4000 per month (total personal expenses). Well, $4000 / $250 = 16, so you’d need to purchase 16 of those properties. Man, if you only had 16 of them, all that cash flow would pay all of your living expenses – no need to work! Or, you could continue working, and have LOTS of extra money for truly awesome vacations, or you can actually spend your time helping the world in the best way you know how, which you never could do before! You’re not trapped by the Rat Race – not locked into a career path or job you hate but keep going to day after day because it seems to work for you; and because you need the money. You don’t need the money now!

But I know it seems a long way – from where you are today until that future point where you own 16 properties. There are many questions. Will a bank even give me 16 mortgages to buy 16 properties? (answer: they’ll loan up to the first 10; by then you’ll know 3 or more alternate methods of financing those last 6). Is this even legal? (yes; I know more than one person in the Phoenix area who own over 100 properties themselves). The thing is, just focus on acquiring that first property.

More Money Each Month Makes it Easier to Invest

Here’s an interesting thing to think about – once you own your first cash flowing property, you have that extra amount of money every month coming in. That will help you save up money for the next property! Just getting that first one is the hardest. Now think about when you have 1 property, and it seems to be working, $250 extra cash in your pocket month after month. All right. Then you get a second one. And it seems to work, month after month too, $500 in your pocket now each month (in the above example). Hmm this gets interesting! With $500 cashflow above and beyond what you make at your job, you can put it aside for investing, in addition to whatever else you can save from your paycheck, if anything. I know it’s hard. But now you have an emergency source of income if you need it upon occasion; and, if you can just save up again, you can buy a third property. More cashflow! And so on.

Of course obstacles come up – you’re hosting Thanksgiving at your house, have to buy a lot of supplies and food, then Christmas arrives and you have to buy presents and decorations. November-December is the hardest time for my family in terms of saving money. But don’t let it get you down; some months are easier than others.

Getting Started

Getting started in Real Estate investing, there’s so many unknowns, you have to trust many people who might be strange to you (real estate agent, property inspector, contractor for repairs, etc.) But like everything else, as you get to know these people over time and see how they help you, that obstacle will go away. Then there’s the psychological side of the problem! We are not trained in the public school system (or most colleges and universities) about investing. It doesn’t feel right or normal to receive money for something you own.

Psychology of Investing

I want to talk about the psychological side of investing, because it’s extremely important. If your mindset is not right, you will sabotage yourself and not be a successful investor.
I don’t know what it is, but most people have emotional resistance to buying “extra properties” that they are not going to live in. Or about handling large sums of money. Or they’re overly suspicious of the people in the industry when they don’t have to be. There are many mistaken ways we think about things related to investing. We’ve watched so many movies that show horrible stereotypes of the money-grubbing evil rich man; Hollywood has done a great disservice with this. Example: Other People’s Money from 1991. Movies like this cause people to be unable to imagine themselves as being Good and Rich at the same time. Do you really think additional money will change your psyche all that much? It won’t. You’ll always be you. Besides, when you have more money, you can still choose to live the same way you always do – you just have more money to donate to a soup kitchen, women’s shelter or school; or do good work with around the neighborhood, your city, state, the church, your country, or elsewhere in the world.

If you find yourself facing irrational fears or anger about property investing as you learn about it, or if you catch yourself sabotaging your hard work in some way, you can help yourself get out of that rut with exercises you can do yourself. I recommend trying either EFT (Emotional Freedom Technique) or TAT (Tapas Acupuncture Technique).  There is a lot of emotion around money for a lot of people.  These exercises can help you escape past emotional-damage, even if it was given to you by your parents or others in your life. The instructions on both sites cost you nothing, it’s a free download. And both of them really work, for a lot of things, not just money issues.   Why not try them?

Consequences of Losing Your Job

Think about Real Estate investing this way:
When you own NO properties, all of your income comes from the job you work at. If you quit or get fired, you just lost 100% of your income. Period.

But, if you have 2 properties each bringing in $250/month, that’s $500/month you get every month even if you lose your job. That’s kind of a nice thing to think about! 4 properties would be $1000/month. A little elbow room to find that next job, a little cushion.

Not all properties cash flow $250/month. I’m just giving an example. If you buy wrong, it might break even ($0/month); or even cost you money every month. You have to do your math, add up all the expenses and incomes, to know whether it is going to work for you or not, before you buy it. But I also know people with single family rental homes cashflowing $300, $500, or even $700/month that they acquired at a good price.

What’s a Good Deal? Measure by ROI

The way you evaluate a good property investment is to look at the ROI (Return on Investment). In other words, how much money are you getting back each year, in comparison to the amount of money you spent buying the place? Because think about it: If you had to spend $100,000 to get a property that cash flows $500, is that better or worse than buying 5 properties ($20,000 each) that cashflow $200 each? $200 x 5 = $1000 a month, so obviously the 5 smaller properties is a better deal.

ROI is the percentage of your initial investment that you get back every year in cashflow.
You can calculate it like this:

ROI = (cashflow per month) x 12 / (investment initial cost) x 100%

In the above example, $100,000 property that pays $500/month has an ROI of 6%
(500 x 12 / 100000) x 100%

Each of the $20,000 properties paying $200/month have an ROI of 12%
(200 x 5 x 12 / 100000) x 100%

So, even though $200 sounds like less than $500, the ROI is better, so you might as well buy the better ROI property!

Another way of looking at it is: how many years before you got back ALL THE MONEY YOU INVESTED?

Yes that’s right, there is a number of years after which you’ve received ALL your original money back. You still own the property, you’re still making money from it every month; it still has most of its value left. You just paid yourself back the whole investment! Now that is a deal!

A 6% ROI property has paid for itself in 17 years. (100 / 6, then round up)
A 12% ROI property has paid for itself in 9 years! (100 / 12, then round up)

Can you believe that? You can have a chunk of money that you do something with (buy property), such that it pays you nearly every month for 8 years, until it’s all paid back to you. And when you’re done, you still own a valuable property and the cash flow is still coming in. Then, at the 16-year point it’s re-paid for itself again. And again at the 24 year point. And 32 year point. And so on.

The money can keep coming in until the day you die, even if you live to be 132 years old. And, when that happens, your children can inherit the property and continue receiving cash flow from it, for ever and ever. As long as they don’t sell the property 🙂

(And they can inherit it tax-free if you set up a Trust before you passed on; but that’s a topic for another day.)

ROI is very much like APR (annual percentage rate). Except APR is what you pay your credit card company for your rotating credit. It’s good for them. What APR do your credit cards have, 10%? 12%? 19%? Very likely.

Now, you also have a bank account, and it probably earns you interest too. That’s passive income – cash flow! You did nothing but leave money in your bank account, and the bank thankfully pays you some returns on it, month after month.

But how much are you earning that way? Right now my bank’s interest rate on savings and money market accounts is 0.1% per year. How much money do I have to deposit with my bank to make the interest they pay cover that $5000 per month expenses in the example above? Let’s do the math:

(deposit amount) * (0.001 / 12) = (monthly interest)

(monthly interest) / (0.001 / 12) = (deposit amount)

5000 / .000083333 = $60,000,000

You’d have to invest SIXTY MILLION DOLLARS in order to cover your expenses!
That’s totally unreasonable. Bad ROI. That’s never going to work.

You can do similar math for other financial instruments like CDs (Certificates of Deposit) and other things.  The “totally safe” investments like that don’t look good.

So, as you might imagine, it’s not worth dealing with properties that are going to net you only a few percentage points of cash flow per month. I shoot for 5% to 10% as a conservative ROI. Once you have a few properties of this type, you can choose whether to invest in more risky properties that can net you 20% or even 30% ROI.

Sometimes You Get an Amazing Deal

And there’s always stories. A friend of mine lives in a condo which was recently bought by an investor for the amazing low price of $17,000. The investor spent a little money on paint and kitchen items like a new oven, stove, microwave, etc. Let’s say he spent $22,000 total. Well my friend is living there, so he knows what the rent is: $750/month. I will assume there’s no mortgage, and taxes are around $70/month, HOA fee probably around $80/month, I’m just guessing now; I bet the investor is cashflowing at least $500/month on the place! The ROI on that is 27% – he gets it all back every 4 years!

Learning More

If you aren’t familiar with Real Estate, all the terms and concepts; what order to do things in; how to calculate whether a property is worth buy ing or not; well, there’s a lot to learn I know. But, there is a finite amount of stuff to learn – you can learn it, and then you’re done. And, this knowledge by and large hasn’t changed in 100 years. If you learn it today, the basic ideas will work the rest of your life. It’s not like computer technology that’s changing dramatically every 5 years. And you can teach the concepts to your kids.

How can you learn more about property investing? There’s many ways:
1. go to a realestate investing group in your town – there’s probably more than one. Search for them on the Meetup web site.
2. buy and read books on the topic. Learn to think right with Rich Dad, Poor Dad and Rich Dad’s Cashflow Quadrant to get motivated.
3. buy the board game “Cashflow” from Rich Dad, and play it: Rich Dad Cashflow 101 board game (with CD’s)

The Cashflow game sets your brain up to think properly about investing. Play it with your kids – I was surprised how quickly my 17 year old daughter picked it up when we first got it 2 years ago. She makes it out of the Rat Race faster than I do more times that not!

Investing in Real Estate is a friendly sport. Investors aren’t battling against each other – they encourage each other and work together many times to be successful. If I help you, I didn’t subtract anything from myself. I can still invest my money regardless of what you’re doing. Cooperation – it’s the way business ought to be! That’s another thing I like about Real Estate investing.

Other Advantages

There are many other advantages to owning Real Estate investments which I haven’t mentioned yet. You get a tax break for all the interest you pay on mortgages – with a lot of properties, you might pay very little income tax. You have an emergency resource you can sell if you ever need a large influx of cash. When inflation rises, you can raise your rents when everybody else is raising the rents on their properties. And, if property values ever start going back up, you can make money on selling the place someday, too.

You Were Born At A Disadvantage

Look – you’ve been trained since birth to be OK with carrying heavy DEBT – a mortgage on your house, car loans, school loans. Credit cards. Why weren’t you also trained about the symmetric opposite: ASSETS? Debts cost you money every month. Assets make you money every month. Why didn’t anyone encourage you to learn about Assets? This should make you mad.

The deck has been stacked against you. What are you going to do about it? It’s time to learn about assets, about investments, which you can do in your spare time. Learn what the “rich people” were taught from birth. You can learn how to harness debt to acquire assets that make you money. You can learn this yourself, and the proof of your success will be the cash flow coming to your wallet month after month. Then it won’t matter that you never learned it when you were young. And, you can fix the future – teach your children now, while it’s easy for them to learn it. And thus you’ve improved the world.


ADDENDUM – Investing With an IRA

A lot of my money is locked up in my IRA, which loses money most of the time if I just leave it with a money manager. All aspects of the stock market are way too risky for the past few years, and the next few years, to be investing money reserved for retirement. It’s just wrong. Don’t do it.

There is a way to invest IRA money in nearly any kind of investment, by moving it to a different kind of manager. I moved mine to Vantage Retirement Plans (formerly Entrust Arizona). They’re a popular one here in Arizona when you want to invest your IRA funds in Real Estate. Basically, that company holds the funds in trust for you, to be distributed at your retirement – and they will “invest” it in anything you tell them to. What you do is create an LLC that you are the manager of, they are the member – and you ask them to “invest” it all in the LLC. This is a completely legal way that gives you the ability to control your retirement funds, to invest any way you want, without having to get approvals constantly from the management company. There are numerous stipulations, you can’t spend the money on your self or your family members; and other rules. It has to be investments that don’t benefit you or your family in any way. For example, if you buy a rental house, you can’t move into it, neither can your family members.

It’s complex to set up the accounts and LLCs, but I trudged through it. The income on realestate in an IRA is all tax free – because you aren’t taxed in a Traditional IRA until you withdraw the funds at retirement. To withdraw funds with this system, I would have to (1) have funds to withdraw (i.e. cash; maybe sell a property if I have to), (2) pay the funds through the management company (Vantage/Entrust or whoever you use); (3) they take some percentage as their fee (often 2%). In addition to all the regular IRA requirements (you must be 59.5 years old or older; a limited amount each year can be withdrawn; after a certain age you’re forced to withdraw a certain amount or lose it; etc). Luckily I don’t have to worry about all that for many years to come. My job right now is to make the money grow through investing in Real Estate.

I’m just now realizing that IRA’s and 401K’s are really sucky investment vehicles. All the good parts of investing have been stripped out of these entities, in the name of “conservative investing” – “to protect you, the inexperienced investor”. Really, all it does is pay large interest, fees, and dividends to the stockmarket participants who know more than you do. You have very little control in your IRA, and even less control in your 401K to make enough money for you to actually retire on. The IRA I built up for 11 years at my previous company, staying invested for 6 more years after that, currently has less than 1.5 years worth of income at my current rate – there’s no way I can retire on that. It’s a travesty.

You need a way to set up your retirement money to make a consistent, reliable income for you, at a good interest rate, every single year between now and when you retire. But it’s such a pain in the butt to have to work with money in an IRA, I almost think it’s easier to pull it out, take the tax hit on it now, and do the investing directly as personal funds from now on. The accounting and bookkeeping would surely be easier in my life if I did that. I currently am not planning on doing that, but I seriously considered it.



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