I'm going to share with you is why real estate is such an ideal investment vehicle for building your net worth. We're going to talk about what net worth is, why it's important to you, why real estate is so great in building that and everything in between. Real estate is an ideal investment for building your net worth no matter where you're starting from, where you are right now.
Building Your Net Worth Using Real Estate
What is Net Worth?
Net worth is your balance sheet, how much assets you own. There's a great book that I recommended called "The Millionaire Mind" by Thomas J. Stanley. He talks about BAs or balance sheet affluent people. The balance sheet net worth, that is going to be your assets. Real estate is an ideal investment for building your net worth no matter where you're starting from, where you are right now. When I say ideal, I mean ideal. We're going to break this down.
Specifically using real estate for building a net worth, that means that you are going to be buying and owning the property for at least a year. Ideally, we'll talk about this throughout this acronym here, you're going to be bringing in income because you're going to be renting it out while you own the property.
I is for Income
Is it possible to buy raw land or to buy a piece of property and just flat sit on it? Yes but that's typically a bad idea because when it comes to building your net worth. You want the property to consistently be able to sustain itself. I oftentimes hear where people will buy real estate on say a 15-year mortgage so they can pay it off faster but they're actually losing money, they're not making any income. That's a bad idea. The property has to stand on its own two feet.
With real estate that you own and you have it rented out to somebody, you're hopefully bringing in income. I am going to argue that you need to be bringing in good income or what we call cash flow or else it's not worth it. It's very easy to buy properties that don't cash flow. There's lot of them out there or they'd cash flow very little. You got to keep in mind, if this house here, this drawing, there's a lot of expenses. You got taxes, you may have a mortgage payment, that's probably going to be pretty big. Say a loan, but it's not just those, you've got insurance and then you've also potentially, you may have HOA dues, those things, you're certainly going to have maintenance. You've got a lot of expenses that all go against your income. Hopefully, at the end of all these expenses, there's still a little bit of green at the top. You're still bringing in some money because you also want to save, not only for the maintenance but the catastrophes, things that could go wrong.
D is for Depreciation
Depreciation is, by the way, this is United States tax law right here, the IRS says that a single-family home can be depreciated over 27 1/2 years. That means that the structure, not the land but the structure, is deteriorating at an even amount over 27 1/2.
We know that most houses if maintained correctly will last well longer than 27 1/2 years. The beauty of that is, it allows you to have a phantom expense. You're not actually paying out of pocket but there's an expense that goes against your income which means that the income is tax-advantaged. I'm going to suggest that for net worth purposes, the goal is not going to be money today. The goal is going to be building a net worth or what you look like on paper. Depreciation is a nice thing that you can take against that income.
Hopefully, you're buying your properties wisely so that when you buy the property, when you first begin, maybe you're paying $150,000 but it's actually worth $180,000. That happens a lot. You can find great deals. You got lots of other videos that talk about that kind of stuff.
You could walk in to instant equity as soon as you purchase. I'm going to give you an example that's quite a bit different, what would be stocks. When you buy publicly-traded company, pieces of publicly-traded companies also know as stocks, they're called equities as well. Typically, you're buying the stock at whatever the market price is. Unless you have an inside track such as you have stock options, if you're buying the stock at the market price, you're not instantly walking into equity. You may know something that other people don't know, some new thing that's coming out in the company and so the market was not pricing it correctly, but in most cases, stock market's priced, the equities or the publicly-traded companies correctly.
With real estate though, you can buy properties with instant equity. That's so wonderful. If the goal is to build net worth, boom, you've already started to build your net worth just for the fact you had instant equity.
A is for Appreciation
Be careful here because over the long haul, single family homes specifically as an asset class do not appreciate. They usually just keep pace with inflation studies have proven that. Properties can appreciate. They can go up in value. Here's the thing, they're not going to appreciate the way, say, a stock would. But, let's just say it did appreciate by 2%-3%, hold on with me here as I go to L on ideal, that is leverage.
L is for Leverage
Here's when things get real cool. In real estate, you don't have to have the entire amount of cash to purchase the property. You only need $150,000 the example I brought earlier. What if you just 10% down or 20% down? Now, all of a sudden, you're leveraging borrowed money to, let's say, put $10,000 into a property, let's say, worth $100,000. We'll do that here. We're going to say the value is $100K, that's the value. But if you're only putting $10k into it, if that's how much you got into it, the other $90k is coming from somebody else, but watch.
Your controlling a $100K property with $10K. If it appreciates 3%, then that means after year one it's worth $103,000. That's a $3,000 difference when you only put up $10K. What percentage gain on your $10K, if you got a three more thousand dollars? 30%. Pretty cool.
If the property just appreciated by 3%, you just grew your net worth from $10K up to $13K here, or a 30% jump. Let's say for example the house is actually worth $120,000. Well then, you added an extra $20K in instant equity there.
It's got to bring in money and stand on its own two feet.. It's got to because if the property does not cash flow, you have a real problem on your hands. You have to bring money from somewhere else. That's an issue because the whole point of net worth is to grow your wealth and not to be 5 years down the road and look good on paper but be so cash poor, you can't even feed yourself.
I have made the mistake of owning real estate unwisely and five years later looking back going, "What a waste of my time?" Because real estate, especially when you own a rental property, whether it's a duplex, triplex, quad, apartment building, single-family home, there is work involved. What are some of the drawbacks of this thing?
We talked about the fact that it can't take money out of your pocket. It's got to always cash flow positive. It's got to cash flow positive, that's the first thing. But number 2, it's going to require management. Even if you hire a manager, you got to manage the managers. We have a great video on whatever a real estate investor needs to know about property management.
If it's going to require management, that requires some of your time. If it's going to require some of your time, it needs to make some darn money.
As long as the property cash flows strong, you have to prepared be for disasters, this stuff happens in the real world y'all. When disasters occur, hurricanes, floods and all those others, you better pay the right amount of insurance and you better have things in gear, financially have a vault, a fortress of extra money that be able to handle when problems occur. Disasters may also be evictions. It might be just problems that occur on the property, busted water heater, hot water heater.
The key here is it all boils right back down to this thing called cash flow. So long as the only properties that you purchase for long-term haul to build your net worth cash flow strong, all will be good. It's not about how many doors you own, it's not about how many properties you own, it's how productive and how profitable and how net worth growing the properties you don't own are. This is not a contest of the number of properties to own. I went through that phase in my investing career early on where I was, "I had 25 properties, oh yeah!"
That's not fancy. It is certainly not cool. What's cool is if you just own one or two that you own free and clear that are cash flowing like a freight train as opposed to 25 that are encumbered to the hilt. The key here is it's not about how many you own, it's about the ones you do will cash flow in extremely positive.
One of the hard money lenders that I've worked with over the years, his attitude has always been that... for the most part, single-family homes you flip. You flip three and then you hold one. That's been his ratio. In other words, the majority of deals, he always believes that you just flip most of them but every so often a good one comes along and that cash flow is very well that you hold on to. If you are a full-time investor watching this video, what you may end up doing is you flip, flip, flip and then hold the winner. Flip, flip, flip or flip, hold the winner, two more flips so that its' slow and steady. You're building that net worth along with flipping some of the deals.
For some of you that are many in part time and you have no interest in flipping houses you just want to own properties long term, what that means is you have to kiss a lot a of frogs. I'll write that down. That was a phrase that my mentor used to always say, kiss a lot of frogs to find a prince.
If you are going to be a part-time investor and you just want to build your net worth one property at a time, you have no interest in flipping. You need to look at a lot of deals to see which ones cash flow. If you spend some time, energy and money on generating or marketing for the best deals, that's also a great way to do it. That way, you can go direct to the sellers and work out the best deals.
How to Turn a Little Into A Lot
I want to encourage you to watch a video that I just put together called, "How To Turn A Little Into A Lot". This video introduce you to the net worth properties and principles of real estate investing. This video right here gives you the practical knowledge. There's actually two parts of, exactly how you do that. How do you invest in real estate most wisely to build either your net worth or do it as you want to do. That's what this video will clarify.
I also want to say this as well. If your goal as a net worth building, that's where you want to go, then you probably can have your cake and eat it too. Meaning, along the way, if you suck out all the income from the property as opposed to re-investing it, maybe, let's say for example you've got a quad. As the cash flow comes in, let's say, when a property goes vacant, lets say you took all the cash flow that you had saved up and then, you read in the kitchen, read in the bathrooms before you re-rented it. Now, you can rent it for more money than before.
If you can hold on to it you can use whatever extra cash flow you've created from that investment and plow it right back in, that's going to grow your net worth even more. A perfect example of that , not in real estate but just in life, would be Warren Buffet.
Warren Buffet, known as one of therapy most successful investors in world history, he has always kept a really small salary, really small salary. It's not until recently that his salary went from over $100,000 to now it's like $400,000 where most of that money goes to pay for security guards. He had the goal to build his net worth which meant that he had delayed gratification.
If you really want to build your net worth with real estate, then you have to have delayed gratification with the properties that you own and that is taking that income and plowing it back into the property. Saving up the money, saving up the money and then maybe you put in new roof, you re-paint, you do the things to, not only maintain, but improve the property which allows you to increase the rents but also allows you to hold on to that asset longer and for it to be a better and better asset for you years and years down the road.
I have been doing a weekend marathon of Phil’s investing in real estate! I heard in this video where you left out condos and townhomes and in another one wher you state not to invest in these types of properties, can you elaborate on this? Why do do see these as poor investments?
Love your enthusiasm!
Phil Pustejovsky says
In most situations, townhomes are hard to lease and sell for top dollar. Buyers want single family homes with no attached neighbors and the white picket fence. Renters are happy renting an apartment and don’t see much benefit in moving into a townhome rental unless you drop the rent below market rent. Again, in most cases. Condos can be a nightmare because of Condo Associations. They can impose huge bills that all condo owners must pitch in to pay for a new roof, or whatever. Plus, Condo Association monthly fees can remove all the cashflow. Condos can be tough to resell too. And what I have just shared is just the beginning.