How to Eliminate Virtually All of Your Risk in Real Estate
Hello, and welcome to the Creating Epic Wealth show, the revolutionary new money show disguised as a real estate show. Real estate is the final frontier where the average person has a legitimate shot at creating epic wealth. You really just don’t have a chance at any sort of financial freedom unless you incorporate real estate into your financial plan. If you just don’t have the time to do it, nor the desire to take on all of that heavy-lifting then this is just the show for you. So glad you found us.
Last week, you made two important decisions: you decided to shift your focus and efforts from building piles of money to creating streams of money, and you decided to use real estate as your passive income vehicle. Great decisions by the way. As you start putting action behind these decisions, you’re reading and learning about real estate investments, you’re hunting for properties, you’re analyzing deals, you’ve liquidated some of your under-performing assets, you’ve now got the capital to pick up that first investment property. You start negotiating, you start and closing deal, and you’re renovating and you’re repairing properties, you’re building your team, you’re hiring property managers, contractors, and other support staff. After a few months of front loading all that work, you rent the property, and bam! The hard work pays off, you get your first rental deposit. Cha-ching…or not.
See, after a few weeks this is what happens. You get a call from a tenant, they’ve lost their job, they need some time to make up the rent. Then the following week they call about the water damage that has happened due to the leaky pipe under the sink, so you dispatch your handyman, he needs to call a specialist to dry the place out. Then a handyman sends you a bill larger than you expected of course, you then do the math and realize it’s going to take an entire year of rent to cover that bill. It’s going to take a year of no more mishaps, God willing, just to get back to even.
All you really want is a responsible tenant in a quality property that pays the rent on time, but instead you’re wondering, ‘What have I gotten myself into?’ If you get this part wrong, that’s pretty much what happens. Tenants have endless excuses as to why their rent’s going to be late. Properties break down, contractors overcharge, and in your interest to move forward financially, you realize you’re actually moving backwards.
But, when you get this part right, you find responsible tenants that pay their rent on time every month. You find low maintenance properties and you work with competent licensed contractors that care for your business as much as they do their own. Your dreams of passive income start to become a reality. As I mentioned previously, the key to getting passive income and overall wealth creation to materialize is leverage. Leverage is the rocket fuel that’s going to make your journey to financial freedom, not only exponentially faster but significantly easier.
When most people hear the word ‘leverage’, the first thing that they think of is the leveraging of someone else’s money. In most instances, a mortgage via a bank. In typical scenarios, you invest 20% of your own money and the bank provides the other 80%. There’s a 5:1 ratio of other people’s money to your money. I’ll show you how this works and how rocket fuels reboost your wealth creation, how it is rocket fuel for your wealth creation.
I’ll use my client Jerry’s investment from a few years ago in Birmingham, Alabama. He paid $126,000 for a really nice 3 bed, 2 bath property. $126,000 in, he put 20% down, the bank brought in the rest. Since his purchase, the property has appreciated 19%. Birmingham has had a booming market over the last few years, and it’s appreciated in 19% and is now valued right at $150,000 grand, giving him a gain of $24,000 in equity. He gained $24,000 in equity. Jerry put 20% down on that property right? He earned $24,000 of equity, producing a 95% return. The property appreciated in 19%, but Jerry’s investment appreciated 95%. That’s how leverage works. There’s your rocket fuel.
I’ll share with you how this fuel boosts your real estate investments in ways that it can’t with your other investment options. For example, after hours of research I found an article in the Wall Street journal, dated back September 30, 1996. It’s comparing the average annual rate of return of stocks versus other investments. There are countless other articles and studies out there that you could refer to, but I chose this particular one because it represents the longest period of time that I could find of any other study. It’s from 1926 to 1992. The study spans 66 years. The headline reads, ‘Dowell Industrials Have Been a Wise Investment Decision’. In the article, it slanted toward leading the reader to believe that had they just invested in the small stocks of the Dowell Industrials, and just left their money there, over that period they would have received an average annual rate of return of 12.5%. 12.5%, more than any other option in the article. The chart actually shows a respectable 11.1% for real estate, so that 12.5% for the small stocks, 11.1% for real estate, 5.2% for intermediate term bonds, and 3.7% for treasury bills.
What the study doesn’t show though is that most people, when investing in real estate use leverage, don’t have access to leverage for the other investment options, but for real estate they do. The bank is not going to loan you money to buy a stock. Even if Bill Gates gave you a personal guarantee on that Microsoft stock, the bank would still not make that loan, but they’ll do it every day on real estate. Given the typical 5:1 ratio we just talked about, real estate’s returns in that article jumped up to 55%, absolutely crushing the Dowell Industrials. That doesn’t include the passive income received while holding the real estate, which is really incalculable but indeed significant. What’s more, the tax deductions that a company real estate of which are not available with stocks, bonds, or treasury bills increase your profit margin even further by mitigating your biggest expense in life, taxes. This is how the leverage of money serves as rocket fuel for your real estate investing. Well, that’s all fine and dandy but what about the time required to find, fund, fix, and manage the deal?
That’s where the second type of leverage comes into play, the leverage of other people’s expertise. That creates your wealth faster and the leverage of other people’s expertise creates your wealth easier. This is the most important piece of the puzzle. The most important piece of the passive income puzzle if you want to scale. You don’t want to interview endless people to find just the right tenant, you’ve got people for that. You don’t want to receive calls about leaky faucets, no, you’ve got people for that. You don’t want to fix the air conditioner when it breaks down, no, you’ve got people for that. If you bought a McDonald’s franchise, you wouldn’t clean the grill, salt the fries, and man the cash register, would you? If you did, well, your income wouldn’t be passive. The same goes for real estate.
Most people think if they want passive income from real estate they’re going to have the manage the real estate. Most people sadly and tragically are deterred from real estate investments because they don’t want the headaches of being a landlord. It’s nonsense. That’s not how it’s done. You don’t manage real estate, you manage managers to manage real estate. Depending on the size of your real estate portfolio, that’s the difference between 4 hours a day and 4 hours a month. Big difference. But leveraging money, that’s risky. Leveraging others to watch your money only compounds that risk. True, to some degree, if you do it wrong. Absolutely false, if you do it right. This is going to be a step-by-step process here. I’m going to share with you to virtually eliminate your risk in real estate.
Risk management begins with your strategy. You must have an income-based strategy, meaning, you do not invest a single dime into a single property unless it pays you more each month than it cost you to own it. When a property pays you more than what it cost, what’s left is called cash flow, that’s your passive income. You don’t wait for appreciation to buy real estate, buy for cash flow and wait. Do not gamble on appreciation, do not try to time the market, do not speculate, period. Appreciation that’s great, and it’s going to happen, but it’s the icing on the cake. Invest for cash flow. That right there, that’s the cake. That’s where risk management begins.
Risk management resumes and strengthens through diversification. You’re going to want to diversify your portfolio, specifically the locations of your properties. You may have heard that real estate is local; indeed true. By diversifying your real estate investments geographically, you protect yourself from natural and economic risk. We’ve got more to eliminating risk. I’m going to show you what there is to do next to minimize risk even further. This risk management tip cost me $300,000 to learn, and I am going to give it to you for free.
Step one in risk management is to invest for cash flow. Forget appreciation, meaning it’s great. Appreciation, it’s going to happen for you, just don’t factor into your decision process. If a property doesn’t produce positive cash flow, then you don’t buy it, period. Step number two in risk management is to diversify the geography of your portfolio. Don’t have all of your portfolio in one market. By doing this, by diversifying the geography, you protect yourself from natural and economic risks, stuff that’s local. Those local risks, so you don’t want to diversify the geography.
Now step three, you won’t hear anywhere. This tip I’m about to share with you cost me $300,000 to learn. I’d likely to have paid a coach $100,000 for this tip. That would have been a bargain. Instead I went to the school of hard knocks and paid $300,000 for this lesson. Step number three is to diversify your teams. Step two is diversify the geography of your real estate, step two is to diversify the teams that run your real estate. You need at least two property management relationships in each market, you need two realtor relationships in each market, and you need two licensed contractor relationships in each market.
Here’s the secret to managing your risk by diversifying your teams: make sure that they all know about each other. By keeping no secrets about who you’re working with, you’re quickly going to notice how operating costs tend to drop. What happened to all the repairs? Property performance tends to rise. All the rents start showing up on time, and my tenants are staying longer. It’s a big one. Keep no secrets about who you’re working with. I wish someone had told me that when I got started. I had to learn this one the hard way, like I said, this was a $300,000 lesson. It’s a very expensive story, and very painful at the time but it does make for a good story.
Step four is diversify your property types. If you start with single family properties like most people do, after you’ve got several of those under your belt, start looking at duplexes. Start looking at fourplexes, and start with the intent or the mindset of it. You’re going to be working your way up to larger multifamily properties, and then potentially, to commercial properties and better developments. Diversifying your property types is going to strengthen your equity and your cash flow positions. It’s going to preserve your wealth a lot better.
Here’s how my business is set up. I’m working currently in 12 different markets, and in each market, I have a project manager that manages my teams. I have one project manager that manages my teams and each team consist of a property manager, a contractor, and a realtor. Like I mentioned, each team is aware of the others’ existence and I do this intentionally, because that this inherent element of competition. It increases performance and it decreases expenses. My clients and I benefit significantly from this.
In many of my markets, the combined portfolios of my clients and my personal holdings, a lot of my properties are right next door to my clients’ properties, that makes up a significant portion of each team’s business. What I found this to result in is preferential treatment. Simply put, my clients and I are able to leverage each other’s portfolio for stellar management of our assets. I have the same setup in each market. The people that work with us benefit from our relationships and the sheer volume of business that we represent to each team member. If they upset one of us then they lose our business, they lose a good portion of their business. If gone up, it’s going to be painful for them.
But wait…there’s more?!
This post has been adapted from the Epic Wealth podcast. Click here to listen to and see the full show notes page for this episode.
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Hi! My name is Matt and I’m the guy behind EpicRealEstate.com. I am a fifth-generation California native and Desert Storm Veteran (USMC) and have worked as a full-time real estate professional since 2003. After building a small real estate empire with hardly using one dime of my own money or one point of my own credit (mostly because I was lacking in both), I have discovered that I have a knack for simplifying the complicated, implementing systems and producing desirable results for myself and others.