Get Rich Education 302: Five Ways Real Estate Pays You, Offensive vs. Defensive Investing
Learn how real estate pays you up to five ways simultaneously.
Should you be playing offense or defense as an investor now?
Learn how a return of less than 20 to 25% is disappointing.
We’ll add up all five ways you’re paid and see what your Year One return is from: Appreciation, Cash Flow, Return On Amortization, Tax Benefits, Inflation-Profiting.
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Central Florida rent-to-price ratios are about 0.8%. Interest rates are at historic lows.
What does late rapper Notorious B.I.G. have to do with real estate investing? You’ll see today. Kind of.
**Complete episode transcript below. Read along as you listen.**
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Welcome to Get Rich Education. I’m your host, Keith Weinhold. There are seasons in your investor life where you either play offense or defense. What should you be doing now? … as we refresh the “Up To 5 Ways That Real Estate Simultaneously Pays You.”
Anything less than a 20 to 25% rate of return in buy-and-hold real estate investing is disappointing. How can that be? Today, on Get Rich Education.
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Welcome to GRE! From Asmara, (Air-UH-tree-UH) Eritrea to Ashtabula, OH and across 188 nations worldwide. I’m Keith Weinhold. This is Get Rich Education.
Thanks for being here, but you’re not here for me. You’re here for you.
In your investor life, are you playing offense? Or are you playing defense right now?
Or, in general, longer-term, are you a more offensively-oriented investor, which correlates with more risk-taking for higher returns.
Or are you more defensively-minded - where you’d rather have less risk and lower return?
Are your mindset and actions aligned toward offense or defense?
Well, I’ve got an answer for you here, and you’re going to have a really valuable takeaway.
Anything less than a 20 to 25% annual rate of return in real estate is really … actually … disappointing.
“What choo talkin’ ‘about, Willis?”
What I’m talking about … Will - is ...
Really, this all comes back to how - when you buy income property the right way - you are paid up to five ways simultaneously.
A stock typically only pays you one way, perhaps two.
I think that the easiest way for you to understand the five ways you’re paid - and even celebrate these five ways you’re paid - because … this ... is ... pretty compelling - is to use an example.
I’ve discussed this before. So if you’re a longtime listener, I’m going to put “The 5 Ways” through a new filter for you.
And if you’re a newer listener, say in the last year, this could completely change your investing thought paradigm for the rest of your entire life.
In fact, compound interest is lame and rarely, if ever builds real wealth in real life. I’ll tell ya what does here.
And yes, I know that this is abject heresy. It is replete blasphemy to criticize “compound interest” in the finance world.
I am surely guilty of committing financial profanity right there.
This is really fundamental stuff I’m about to share with you here - and yet the real paradox is that most real estate investors don’t even understand this.
This is pretty fun to do. We’re going to add up the five ways you’re paid and determine your total rate of return here.
Let’s say that you purchase a $100,000 property - $100K. And, no worries, if that’s too “small time for you”, this is all based on ratios, so it scales up to a $1M or $10M property.
(Ha!) And sometimes I wonder how much longer a $100K property will even be a feasible example as inflation makes $100K properties less common all the time.
But with your newly-bought $100K rental single-family home, you buy it with a tenant already residing there, where the monthly rent income exceeds the monthly expenses - that’s a big part of “buying right”.
With your 20% down payment, you have $20K out of pocket then, and an $80K loan.
The first of five ways you’re often paid is ...
1 - Appreciation Let’s just say that your property appreciates from $100,000 to $106,000. That is just commensurate with real estate’s historic appreciation rate of 6%. But here’s the big “a-ha” moment.
Your $6,000 gain is based on only your $20,000 down payment.
Well, that’s your ROI formula - your gain divided by how much you have invested. Well, your $6K divided by $20K is a 30% return to you. Really? How did that happen exactly?
How do you have a 30% return from just this first of five ways you’re paid?
This is because you achieved a 6% return on both your $20K of skin-in-the-game and the $80K borrowed from the bank. This is what is known as financial leverage. Financial leverage means that your return is 30%.
No wonder that I’m known for saying that compound interest is lame and leverage builds real wealth. More on that soon.
2 - The second way you’re simultaneously paid is with Cash Flow It’s your monthly rent income minus all the expenses (like mortgage, vacancy, insurance, maintenance, taxes, utilities, management). We’ll be conservative and say that leaves you with only $100 of residual income in this case.
Annually, that’s $1,200 more for you, divided by your $20,000 down payment.
Yes, it’s $1,200 still divided by that same $20K of skin you have in the game.
This another 6% return for you. This portion is what is known as the Cash-On-Cash Return.
So, so far you’ve got a 30% return from leveraged appreciation PLUS a 6% cash-on-cash return from that monthly cash flow & we’re still going.
3 - Loan Paydown Unlike your own home where you pay down your principal mortgage balance with money that you had to earn, well, here, your tenant pays the monthly principal portion of your $80,000 loan on this property!
At a 6% interest rate (and you know you can do better than that today, but we’re being conservative here) on a 30-year mortgage, that’s about $1,000 that the tenant pays down your loan for you annually.
Divided by your (still the same) $20K of “skin-in-the-game” means that’s ANOTHER return for you of: 5%. This portion is known as your ROA - your return on amortization. We are still going - still adding up all the ways you're often paid in real estate.
4 - Tax Benefit You can have a mortgage interest deduction, an ability to pay zero capital gains tax with a 1031 Exchange, and tax depreciation - which can tax-shelter part of your rent income.
This is hard to measure. We’ll conservatively call your investment tailwind another 5%. There’s something else called “bonus depreciation” that can certainly make this 5% tax tailwind higher, but let’s just leave it there.
And the fifth and final way is what I call Inflation-Profiting. Few people understand this.
Like inflation erodes the value of your lump of savings, it also degrades your mortgage debt balance.
How is that? It’s because your $80,000 loan today gets easier to “pay back” as wages and prices escalate over time. Your bank only asks to be repaid in nominal dollars (while your tenant pays the interest), not real, inflation-adjusted dollars.
So just say that over a few years, you had 10% cumulative inflation. Well, then rather than paying back the bank $80K, you really only need to pay them back $72K in inflation-adjusted terms.
Inflation has been low lately. We’ll call this benefit a return of another … just 2% to you.
Well, there were all five ways. Let’s add them up to see what your total rate of return is. You got a return of:
30% from leveraged appreciation, then…
6% from cash flow - which is that portion known as your cash-on-cash return, plus another
5% from your ROA - that Return On Amortization, where you tenant pays down your loan for you. Then another …
5% from tax benefits …
2% from inflation-profiting ...
And your first year total Return On Investment from this income property is 48%
You just achieved a 48% return - and without taking any INORDINATE risk. Now, your real-life return probably won’t be exactly that - it’ll be higher or lower.
A few other caveats here. I think you probably realize this example is simplified.
If we had 18 spreadsheets, then we could probably get an exact number, like rather than a 48% total rate of return for you - then it might be 46.16% or something like that. …
… but eighteen spreadsheets doesn’t work in audio format as we’ve just broken it down here on Get Rich Education Episode 302.
1) Note that in the example, we did not factor in your buyer mortgage loan closing costs (the seller can often help you pay these).
Of course, risk still exists. If you buy property in a losing job market, or hire a disreputable property manager, for example, your return can erode.
3) You will still have SOME inevitable problems along the way. It just happens in real estate.
Also, note that your property insurance premium WAS considered in the example. That hedges you from a lot of major loss types.
And that your management cost was considered here, meaning your income is largely passive.
Also, be mindful that after your 48% return in Year One of this hypothetical example, your return typically DROPS in future years.
Maybe it’s down to 38% in the second year and 29% in the third year.
Why is this? Well, primarily due to the fact that equity accumulates in the property, and equity has zero rate of return.
Compound interest? Well, you’re typically not leveraging other people’s money with compound interest.
In the example we used - you’re not just growing from the return on your own money.
You achieved that return because you got to use BOTH your own money plus three other parties’ money at the same time:
the bank’s for the leverage
the tenants for the income and the return on amortization … and
… the govt’s for the tax incentives - plus, really the government’s policies for the inflation-profiting benefit too … if ya think about it.
With just a 20% down payment, you got access to getting the return on OTHER people’s money all over the place.
Another risk is to be mindful of overleveraging. Overleveraging means that you’ve borrowed so aggressively that, say you get in a situation where the tenants rent income no longer meets or exceeds the monthly property expenses.
That’s negative cash flow from overleveraging.
With these five ways ...
Now you understand how real estate makes ordinary people wealthy!
Now you know how to actually “keep score” with real estate investing.
Now you understand how less than a 20-25% Total Rate Of Return is disappointing.
This is LEVERAGE rather than compound interest.
Long-term, one’s hopes for compound interest get eroded and worn down to nothing after applying - something that longtime listeners can almost repeat after me - applying those deleterious effects of inflation and emotion and taxes and fees and volatility.
If you understand what I just described, you understand something that Billionaire RE investors do NOT understand.
Billionaire real estate investors don’t understand what you now know.
So, when it comes down to, are you playing offense or defense as the theme for your own investing strategy?
The answer is, when you’re paid five ways, you have the ability to constantly do BOTH - you’re playing both offense and defense - at the same time, all the time.
By the way, they say that offense wins games but defense wins championships. It was legendary Alabama football coach Paul “Bear” Bryant that’s credited with saying some version of that.
I don’t know whether that’s so true or not, but here you have multiple offenses and defenses.
But what I’m talking about here, is, with the 5 ways you’re paid:
Appreciation - That’s playing offense
Cash Flow - That’s more predictable than appreciation, and that’s playing offense too
Return On Amortization - That’s defense. It’s slow, predictable, and it builds illiquid equity
The fourth way, taxes - that’s defense too. It’s kind of built-in, predictable, and really just recurs when you do your annual taxes.
And the fifth way, inflation-profiting - That’s defense too.
So, there you go, with one single-family rental home or apartment building, you’ve played offense two ways and defense three ways … all at the same time.
And when you’re paid five ways, if one or two stop providing you with yield, well, then you’ve still got three or four ways that are.
But, yeah, these return sources aren’t apparent to a lot of people.
You know, I was recently doing a review of one of my larger apartment buildings with an experienced investor, because the cash flow basically dried up.
And, for example, this apartment building has $2,100 of tenant-made mortgage principal paydown every month. That’s $25K per year in equity buildup.
$25K divided by my $475K in equity is a Return On Amortization of about 5% on this particular apartment building.
So I think that the real takeaway here is - invest in something where you’re paid multiple ways, where you can invest in offense & defense at the same time, and it pays you income so that you can begin enjoying your life now, not “maybe someday” - which correlates with more of a compound interest approach.
If you think about it, a central theme of this show is how to optimize the 5 Ways You’re Paid - and avoid mistakes.
This is really a huge part of the compelling “why” for real estate that is so often missed.
You want to own the real property yourself to make sure all five of these benefits aren’t diluted.
You also want to be sure to have a good loan on your property to amplify your ROI over the long-term.
As you know, I am “pro-good debt”. I have no interest in paying down low interest rate debt, that the tenant pays down for me and inflation even further debases.
Instead of using that dollar to pay down debt, you could use that dollar as a down payment on another property - expanding your empire.
Gosh, with interest rates this low, it puts an exclamation point on the fact that you don’t want to be paying down your debt … here in the early 2020s decade.
Paying down good debt is one of the last things that I would do with my money. You lose leverage every time you do that.
Turning a liquid dollar into equity just transferred cash into equity.
Financial freedom achieved when you do the opposite - when you transfer equity into cash flow.
The probability that I’m going to wake up tomorrow and start accelerating paydown on low-rate, fixed mortgage debt tied to this cash-flowing property - is about nothing.
It’s about the same as the chance is that my Dad wakes up tomorrow and starts listening to the Notorious BIG with Junior MAFIA.
“I chill … “ to “ … you know”.
Haha! Yeah, not happening!
Not for my Dad, anyway. Not his style. Sounds alright to me. I might drop that in during a workout or something.
You’re listening to a more detailed discussion about the Five Ways That Real Estate Pays You and we’re talking about it through a fresh lens of “offense vs. defensive” investing here on Get Rich Education Episode 302.
I strongly believe: It is very difficult to get wealthy without debt. Often won’t achieve freedom without debt. It’s going to be alright ... when your debt is reliably outsourced to others.
You know, at one point in my life, when I still worked for an employer. (The last day job I ever had was working in the QA section for a state DOT, by the way).
At one point, I realized that every dollar I lock in a stock or 401(k) is a dollar that I can’t use to leverage OPM. That epiphany was a real turning point.
Checking the RobinHood app every 15 minutes isn’t going to build real, durable wealth for you.
And, sometime before that, it was the realization that for me - and for you - to get more out of life, you can’t live below your means, you’ve got to expand your means.
To achieve financial freedom, it sure isn’t going to happen by cancelling Netflix $10 for month.
That’s not going to happen if you save $80 on air tickets by adding an extra layover on your trip itinerary. You just added three hours of low-quality time to your life - and you’ll never get that time back.
That’s cheesy. That’s unattractive.
It’s not about saving money on your Butterball turkeys or car gasoline.
I’m not saying you can NEVER do those things. Sometimes you gotta do what you gotta do.
But people need to stop being congratulated for being cheap or even focusing on frugality. Gosh, that stuff can make people miserable.
People that say, “I want to live frugally.”, they don’t REALLY want to live frugally. They actually want to say, “I want to live well.”
But they don’t know how to do that. They don’t have a vehicle to move forward with.
It’s kind of like, when we had T. Harv Eker here on the show here a few years ago - it’s about setting your mental thermostat higher, so that you can get greater wealth & freedom for yourself …
And with the “five ways you’re paid” like I described earlier, hopefully, I’ve charted a substantially clearer path forward for you so that you can do that.
Well, with “The Up To 5 Way That Real Estate Often Pays You”, that’s something that I first started talking about more than five years ago. I’ve never heard anyone else talk about it before. So, as far as I know, I guess I’ve “coined this” or whatever.
But since I began talking about it, I hear other people talking about it too - even other educational platforms.
Now, I do own three real estate trademarks, so what do I think about OTHERS now teaching the “5 Ways You’re Paid”. I’ll discuss that in just a few minutes here.
I’m also going to discuss who influenced ME - and give them some credit. And this includes a couple people that you’ve surely never heard about before.
If you would like to see the “5 Ways You’re Paid” in one easy-to-read infographic - that all fits on one sheet - so that it’s REALLY cear to understand - I’ll send you a colorful electronic “5 Ways Infographic” all you’ve got to do is go to GetRichEducation.com/Book.
That’s got to be one of the greatest deals anywhere. That’s where you can opt-in to get the electronic version of my int’l bestselling book, free, emailed right to you.
Then a few weeks later, the “5 Ways You’re Paid Infographic” is automatically sent to you too.
That’s at GetRichEducation.com/Book
More next. I’m Keith Weinhold. This is Get Rich Education.
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Welcome back to Get Rich Education. I’m Keith Weinhold.
Hope you like our humorous moments to lighten up the show here. Hey, you run a little math on audio and … it begs for some embellishment to spice things up.
When it comes to the up to five ways you’re paid in real estate investing. Yeah, since I first discussed this more than five years ago, I’ve noticed that other REI educators now teach the same thing.
I don’t know whether they credit that to me or not - and you know what - I don’t really care whether they do or not. I mean, it’s cool if they do, but …
… the more important thing to me is that conscientious people get the information. Share it. That is so much more important than anyone getting the credit.
So just … share it.
“Helping the people” is more important than “getting the credit”.
I think that the world would be a better place - imagine if everyone put “helping the people” before “getting the credit”.
I don’t own trademarks so that I can go after people that say the same stuff that I do. That’s just not in my nature. I’d rather do productive things with my time.
The trademarks are thre just because I wouldn’t want someone else to swoop in and tell me that I can’t use something that I might have come up with in the first place.
When it comes to “helping the people” and “getting the credit”, now, everyone has influences - things they learn from others. You & I are no different that way.
Even those that influence you were influenced by someone else before them.
Well, I DO like to give credit to those that I learned from, so ...
Though I know he’s a polarizing figure to some people, credit is due to Robert Kiyosaki and the Rich Dad Company. Learn more about them at RichDad.com
The most important lesson that I learned there is “Don’t live below means. Expand your means.”
It’s more important to increase your income than cut your expenses.
Don’t make a budget. You’re just tearing things down.
Instead, build a cash flow statement. Now you’re constructing. Now you’re making more of yourself, not less. These are really Rich Dad principles and helped develop my mindset.
Now, as for who helped turn this mindset into something actionable? I’ve got to give props to “The Real Estate Guys” - Robert Helms and Russell Gray. Learn more about them at RealEstateGuysRadio.com
That’s the first place that I learned, for example, that in real estate, the market is more important than the property.
Look, you can’t very well be in your crib with your trading app and just order up real estate - even though people are building online marketplaces.
But one mistake people make is that they buy property because the numbers look good based on some YT video they watched on how to crunch the numbers - but they know nothing about the market or the team.
Then they buy it. Then only after they go buy it, NEXT they go looking for a PM and hope there’s a good one that can handle it.
Then next, they try to figure out the market that they already bought in.
That does not work. They’ve got it backwards. If the market and your property manager check out, then & only then do you get the property in that market.
It’s sad when people get that wrong. That’s why people walk away from RE & they say that RE doesn’t work.
Well, no, that investor wasn’t very strategic. But you CAN understand how that happens to people.
And it was great to have both authors of the “Rich Dad, Poor Dad” book Robert Kiyosaki and Sharon Lechter - and The Real Estate Guys all here on Get Rich Education with us multiple times.
Another set of influencers are two guys that you’ve never heard of before.
Their names are Chris and Raj. They are simply two longtime friends of mine that bought four-plex buildings.
That got me to make my first-ever property that seminal four-plex building where, with a 3.5% down payment I lived in one unit, rented out the other three, and that started it all for me.
These otherwise “regular guys” reinforce the quote from the late Jim Rohn, “You Are The Average Of The Five People That You Spend The Most Time With”.
Today, I’m a collector of real estate - most of it in the United States. Being the geography guy that I am, did you know that I have a world map on the wall of our garage …
… and I have a little red sticker - little red dots on top of those areas where I own property. Yeah, it makes this real estate collecting kind of visual. Maybe you want to try that too.
Well, one part of the world that I’ve been adding more red dots to lately is where I’ve been buying - across Florida.
Areas around Tampa, Orlando, and Jacksonville all make sense from a cash yield perspective.
A lot of BRAND NEW construction properties have numbers that work there, especially where our Orlando provider - that’s Greater Central Florida really - have been actively sourcing brand new construction property in Sebring, Florida, among other nearby places.
Sebring is pretty much smack dab in the center of peninsular Florida, south of Orlando.
These single-family homes that make great rentals have a metal roof, they’re 3 bed, 2 bath, and the prices really are remarkable - $179,900 and $159,900.
Yes, that’s for new construction in Sebring, Florida.
The rent-to-price ratios are a very attractive eight-tenths of one percent or so. Quite good for new construction, plus you’ve got the tailwind of extremely low interest rates as well.
And when it’s new construction, the PROPERTY INSURANCE premiums are so reasonable too.
If you’d like to learn more about those, you can do so at GetRichEducation.com/Orlando
It isn’t just single-family rental homes. New construction duplexes are available too.
That’s GetRichEducation.com/Orlando
You know that I often like to leave you with something actionable like this at the end of an episode.
And knowing and doing are two very different things.
How do we already know that? Well ...
Many people aren’t at their ideal body weight … and it isn’t because they don’t know what to do, they just aren’t doing it.
You also need time to figure out what you want to do. I like eating pizza, for example, but it took me eating different foods in order to find that out. I had to try and do.
Learning is best done by trial-and-error but it doesn’t have to be YOUR trial-and-error.
Learn from me. I’ll even eat your pizza for you!
I help give you the information you need to make an informed decision.
I connect you with property teams with proven track records - many of whom I invest with myself.
You ultimately choose your investments.
There’s risk with anything … anything in life.
You either take the risk or lose the chance.
I think it’s helpful too, that you follow someone that’s been through a recession.
I’ve been investing for … nearly 18 years … it’ll be 18 years next month … since I bought that landmark four-plex building.
Teach you how to fish or GIVE you a fish? Well, why not do both? You can get the fish at GetRichEducation.com/Orlando
Have you ever wondered where your money is? Well, the world already has your money. You just need to go out and claim it.
I’m Keith Weinhold - grateful, as always for your listenership. I look forward to chatting with you again next week.
Don’t Quit Your Daydream!