The 4 Methods People Use to Get Rich with Real Estate

Andrew Carnegie once said that 90% of all self-made millionaires made their wealth through real estate. There's no question that real estate is still one of the most used ways to build wealth, but navigating the world of real estate can seem overwhelming and expensive, especially if you don't know what to do. So today, let's go over the book Rental Property Investing by Brandon Turner. And let's get started. Lesson number 1 The Four Wealth Generators In the early 1990s, the average home price in the U.S. was $122,000. Today, the average home price is over $467,000. This is what is called appreciation, an increase of value of an asset over time. Now, in real estate, there are two types of appreciation. If your grandparents bought a house in 1955 for $18,000 and sold it today for half a million, that increase in value would be considered natural appreciation because this type of appreciation is the normal tendency for real estate to grow over time. Natural appreciation happens due to a few factors, like inflation, scarcity, supply and demand, and well, good old American greed. If you bought a two-bedroom house and worked on it to turn it into a three-bedroom house, it would immediately increase the value of the property. This is called forced appreciation, which is an increase in value as a result of improving an asset. Once you buy and start renting a property, you will have income and you will have expenses. The income comes from your tenant paying your rent, and your expenses come from your mortgage, taxes, insurance, and repairs, among others. The difference between your rental income and your expenses is your positive cash flow. Cash flow is one of the most important wealth generators for rental property investors. Appreciation is nice, but most investors are looking for a stable long-term return on investment. Now, one of the main reasons why people like Donald Trump or Robert Kiyosaki pay little to no taxes is due to the tax advantages that one can get from real estate. For example, as a rental property investor, you can write off the operating expenses to rent your properties, like you would any other business, like your maintenance and repairs. But you can also write off owner expenses, like a car if you drive around to manage your properties, or even your home office where you do your paperwork. If you sell a property, you pay less taxes since your profits are likely to qualify as capital gains income, where the tax is capped at 20%. Or you could even defer your tax bill if you reinvest your money to buy more property, which allows you to expand your net worth without paying any tax. Imagine a rental property as a giant and very expensive piggy bank. This piggy bank costs $400,000. You put $80,000 or in many cases less as a down payment and you borrow the other $320,000. Now, you own this giant piggy bank. So, this piggy bank has $80,000 of real value inside which you invested. This is called equity. It also has $320,000 of debt inside. The best part is that you don't have to pay for this debt. Your tenant is putting money into this piggy bank for you every single month, paying off your debt, increasing your equity and making you wealthier. Lesson number two, buying your first rental property. As you look for your first rental property, there are a few guidelines Brandon recommends to keep in mind. Number one, find a multifamily property if possible. Buying a multifamily property allows you to have multiple tenants at once. This has a few benefits. First, you get to collect multiple rents, which can mean a higher cash flow. And second, the more units you have, the less volatility you have with vacancies. If you only have one unit, a vacancy can be costly. But with multiple units, the cost of a vacancy can be reduced by the income of another unit. Number two, each unit must provide you with at least $200 a month in positive cash flow. This is after you use the property's income to pay all of the expenses, including calculating for potential vacancies and future property management. Now, we'll analyze a property later in the video. Number three, the property must be purchasable for at least 80% of its value. Your goal is to create a margin of safety. If you buy a property and the market drops 20 or 25%, you'll end up owing more than the property is worth, which is never a good idea. Now, these properties are not common, but you'll be surprised how many motivated sellers there are out there. Number four, the property must be able to be improved and appreciated by 10% during the first year through forced appreciation while spending the minimum amount of money on improvements. In other words, if you can fix it and bump the value by 10%, you got a deal. And number five, the property must have the potential to continue appreciating an average of 3% per year after the first year. This shouldn't be too difficult since that is the average natural appreciation of real estate, but it could be a good idea to take a look at the quality of the property and the neighborhood. Lesson number three, the three rental strategies. Out of the many ways people can make money with real estate, Brandon shows us the three best strategies to create wealth with rental properties. First is the traditional method. This is where you focus on saving 20% of the total price of the property or less if you have good credit and find a property that fits with the previous guidelines. A multifamily property that you can get for below market value that only needs minimal work that you can create good value with forced appreciation. And after you find a great tenant that will respect your property and pay their rent on time, use the positive cashflow to save in order to invest in the next property. You can eventually have your property buy you another property with the cashflow and not have to put any money out of pocket. The second method is the house hacking method. This method is all about getting creative to leverage all the different available tools you have. One of the most common examples of house hacking is to buy yourself a home to live in and use part of this property to rent out to other people in order to reduce or eliminate your own mortgage payment, essentially living for free. Many people do this in two different ways. One, they get roommates to split the cost of the house or they use their home as a short-term rental property using platforms like Airbnb, Booking.com, or Couchsurfing. Another popular method is to either buy a duplex, which is a property with two units, a triplex, which is a property with three units, or a fourplex, which is a property with four units in it. The investor can live in one of the units and rent out the rest, the tenants pay the mortgage, and the investor can live there for very cheap or even for free. Now, these types of properties can still be bought with a personal mortgage. Anything over four units has to be bought with a commercial loan, which tends to be more expensive. Many people get what is called an FHA loan, which is a Federal Housing Administration loan. This is a home mortgage that is insured by the government to help low to moderate income families attain home ownership. This type of loan requires a lower minimum down payment on a property, as low as 3.5% instead of 20, and it can help those with lower credit scores. This can allow people to put a much lower down payment on a property, helping them acquire their homes or small multi-families that then can be house hacked for a much lower investment. Now, there are a few caveats for this type of loan. Like, for example, those who use this type of loan need to pay an additional insurance on their mortgage, since a lower down payment means more risk for the bank. The third method is called the BRRRR method. This stands for Buy, Rehab, Rent, Refinance, and Repeat. With this method, you buy a property that needs work, then you repair the property to create forced depreciation, then you rent a property to great tenants to start creating cash flow. Then, since you forced depreciation, you refinance the property to get your original investment back, then repeat the process again on a new property. If done properly, this can be a powerful strategy, because you can acquire many properties without running out of capital to invest, or having to wait to accumulate the capital. With this method, Brandon recommends to look for deals where you can purchase the property for 70% of the after-repair value of the property minus the cost of the repair. For example, let's find your ideal purchase price for a fixer-upper property that will be worth $300,000 after repairs and will cost you $25,000 to fix it. First, you take your ARV of $300,000 and you multiply it by 0.7, which will give you 70% of the value of the property. Then, you subtract the cost of the repair, which gives you your target purchase price of $185,000. Lesson 4 Analyzing Your First Rental As you get ready to invest in your first rental property, you must understand how to financially analyze the property to determine if it's a good investment or not. So, let's analyze this property together. 1. Calculate Total Project Cost The first step is to analyze the property to figure out total project cost. In other words, we want to find out how much this property is going to cost to buy, fix, and get rented out. There are four major expenses to consider here. 1. Purchase Price This is how much you will pay for the property. In this case, the property costs $75,000 to buy. 2. Closing Cost These are the charges associated with the transaction. These are things like loan fees, title fees, prepaid insurance, attorney charges, among others. In this case, our closing costs are $2,500. 3. Pre-Rent Holding Cost It is likely that you won't have a tenant on day one of owning this property, especially if you need to do repairs. Which means, you will likely need to pay the monthly expenses out of pocket until you are able to rent it out. In this case, our pre-rent holding cost is $1,200. 4. Estimated Repairs This is how much work the property needs to be rented. In this case, our estimated repair cost is $17,250. Then, we add all of these expenses together and get our total project cost of $95,950. Next, you find out how much cash you need to complete this project. First, we need to figure out our financing. Let's say that for this project, you will put down 20% of the value of the property. So, to get our down payment, we multiply our purchase price by 0.2 to get how much our 20% is. Then, we do the same for our loan amount. We multiply our purchase price by 0.8 to get our 80%, which is how much we are financing. So, we will need $15,000 in cash for the down payment and we will finance the other $60,000. But, we are not done just yet. We need to take out the total project cost of $95,950 and subtract our loan amount of $60,000 to get our total out-of-pocket cost of $35,950. Now, of course, there are many methods that can reduce the out-of-pocket cost. Like I mentioned before, there are federal housing administration loans where down payment requirements are lower and if you are a handyman, you might be able to Third, you calculate your mortgage payment. This is one of the easiest steps because we can get this number from either the bank we are financing with or a mortgage calculator. We only need 3 pieces of information to get this number. Our loan amount, the loan period and our interest rate. We already have our loan amount of $60,000. This will be a 30-year mortgage and we have a 5% interest rate. This gives us a total mortgage payment of $322.09. The fourth step is to determine the property's income. In other words, how much can we get in rent every month? By checking online, we find out that in that area, rents for this type of house go anywhere from $975 to $1,300. So, since this is a newly renovated house, we can comfortably price our rent at $1,200 a month. The fifth step is to figure out how much owning and running this property is going to cost us every month. Here, we must make a list of all possible expenses and even potential future expenses. These include your mortgage, insurance, taxes, vacancies, maintenance, potential future repairs, property management, among others. All added together, we have a total monthly expense of $902.27. Now that we have all of this information, we can evaluate whether this property is a good deal or not. We start by calculating the cash flow this property is likely to produce by taking the total income of $1,200 and subtract the total expenses of $902. This gives us a potential cash flow of $297 a month or $3,572 a year. Now, we want to figure out what kind of return on investment this property will produce us. So, we take our total invested amount of $35,950 and divide it by our yearly positive cash flow of $3,572. This gives us a $9.95 cash return on investment or cash on cash return. Keep in mind that this return on investment does not include the fact that your tenant is paying down your loan and your property is likely to increase in value over time, which makes your overall ROI much higher. Lesson number 4 Location, Location, Location As you begin investing in real estate, you quickly find out the importance of the location of where the properties are located. Brandon recommends to consider a few things when looking for the location of a property. First is crime. An area with a high level of crime can make it difficult to find and keep good tenants. Therefore, it is important to get a sense of the criminal activity of the location of the property. Schools Proximity to schools is an important factor that impacts both the level of vacancy and the price A property in a good school district can have a much lower vacancy rate and much higher rents. Population growth A growth in population should allow you to continue to raise rents over time and increase the value of the property due to supply and demand. The more people there are, the more demand there is for a place to live. Proximity to local businesses We want to invest in good economic markets. Think about this. If Starbucks decides to open up a new store, would they open in a place that is close to economic activity or in a place with low economic traffic? Businesses like these spend millions of dollars doing research to find the best places to do business in. Therefore, it would make sense that if businesses are investing in a particular area, it might be a good area to consider. Lesson number 5 Your real estate team Just like in any other business, you want to have a team of experts that will keep you informed, protected, and productive as you invest in real estate. Brandon says that one of the most important people in your team will be your spouse or partner. A partner that is opposed to your goals can be a big hindrance to your goals, so getting your partner to be on your team will make a huge difference in your long-term success. The next member of your team will be a good real estate agent, to help you understand the locations, the state of the market, and give you additional information about specific properties and markets. Having a lender on your team will help you fund your ventures. Unless you plan to pay for properties in cash, you will need a lender. Contractors and handymen are a must to have on your team, especially with rental properties. If anything breaks, you have someone you can depend on to fix it right away. Having a bookkeeper will make your job as an investor much easier. You already have enough to do as it is, so having someone keep track of your income and expenses and have your files ready for tax season will be a huge help. Having a CPA, a certified public accountant, can help you take advantage of the different tax benefits and give you recommendations for your overall business. Having a good insurance agent on your team can help you understand insurance and the process of insuring your property, especially as you get multiple properties. And lastly, having a property manager will make owning rental properties much easier and make it feel much more passive, since a good property manager puts tenants in your property, manages the paperwork, takes maintenance phone calls, makes the appointments, manages any tenant problems, and keeps you in the loop on the state of the property. A good property manager can turn you from a busy investor managing everything to a more passive investor collecting paychecks. Let me know your thoughts on this book. And make sure to check out this video on the book Tax-Free Wealth by Tom Wheelwright where you'll learn how many investors use real estate to pay less in taxes.