It’s your questions and our answers.
That’s right. It’s time for another segment of Ask The Guys … when we hear about the real-world challenges investors like YOU face every day.
We have another great collection of questions from our loyal listeners … covering everything from infinite returns to gold, proper reserves, compressed cap rates, and cash flow.
Remember … we aren’t tax advisors or legal professionals.
We give ideas and information … NOT advice.
In this episode of The Real Estate Guys™ show, hear from:
- Your in-the-know host, Robert Helms
- His go-with-the-flow co-host, Russell Gray
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The ins and outs of infinite returns
Our first question comes from Sean in Durango, Colorado, who wants to know more about the ins and outs of infinite returns.
This is a topic we are pretty passionate about … it was even the theme of this year’s Investors Summit at Sea.
The idea of an infinite return is pretty simple. It means that you’re investing on the house’s money.
In other words, you put up some money for a deal … to buy a property or be in syndication or grow crops … and at some point the deal has paid you back … and you’re still making money.
Maybe that takes a year or five years … but once you get all of your initial capital off the table, everything else that comes in is an infinite return.
Infinite returns are easy to do in real estate … but it DOES take time.
There are lots of different ways to chase an infinite return, like getting creative with financing and syndication … but the core concept remains the same.
You’re earning a return on no money at risk.
Purchasing real estate with other people’s money
Teresa in Claremont, California, wants to know more about using other people’s money to leverage the purchase of real estate.
Does it only work with people who have lots of money for a downpayment? Are there any lenders willing to finance 100 percent of a deal for a buy and hold?
Using someone else’s money doesn’t mean breaking into their house in the middle of the night or stealing from their bank account.
It means showing them the opportunity.
One of the primary sources of other people’s money are lenders. They’re in the business of putting capital to work for their depositors, for their shareholders, and sometimes for themselves.
Lenders put up some of the money for a deal in exchange for some portion of the return or a predictable income stream, like an interest payment.
You can also leverage other people’s money through syndication. If you need $1 million to do a deal, you can raise $100,000 from 10 different people.
There are lots of legal and ethical implications to a syndicated route like this … but it can be a great way to get started passively or if you’re interested in being a full-time real estate practitioner.
A lot of people think they have to have some sort of money to start with to do a deal. It helps … but you don’t have to.
What you do have to have is a deal that makes sense … because it’s going to end up being the collateral or the investment that your equity partners come to.
No matter what, you’re going to have debt … and you’re going to have equity.
The key is to look at how much profit is in the deal and figure out how much of that you can give away to different people for their participation.
And when all of that is done … is there enough leftover for you?
Finding a lender who will cover 100 percent of deal through a loan is tough … and the ones that do will usually be for a primary residence.
Protect your cash flow with reserves
Gary in Scottsdale, Arizona, owns four single-family rental properties.
The question on Gary’s mind is how to deal with the reality of net cash flow … one major expense can wipe out your entire annual cash flow.
It’s real and it happens. It has even happened to us.
We always … always … put contingencies and reserves in our pro formas.
A pro forma is your plan for the property … what you think the income and expenses are going to be.
There are two major places where you will need reserves.
When you buy the property, you can’t put 100 percent of your cash into the down payment and the property. You need to have some in reserve.
Most lenders require this. When you close escrow, they’ll want to make sure that you still have money in your bank account.
We also recommend that you take some reserve capital out of every month’s payment as the rent comes in.
Perform your vital functions … and then put a little bit aside. That amount depends on your projected plan for your property and what needs you anticipate.
The cause and effect of cap rates and interest rates
With cap rates compressing across the country, it has been said that investors should be careful to still maintain a good spread between the cap rate and the interest rate.
Drew in Chicago, Illinois, wants to know if there is a direct correlation between these two factors or if it’s just a general rule of thumb to indicate when a market might be overpriced.
We think this is a great question.
Capitalization rate … or cap rate … is determined using net operating income.
Cap rate doesn’t include anything to do with leverage or your loan … so there is zero correlation between cap rate and the interest rate.
But there CAN be cause and effect.
If interest rates are low and you can borrow money for cheap … you want to borrow more.
And if you want to go out and find a property, you’re going to find a lot of competition because rates are low.
So, you’ll bid up the price for the same amount of income … making the cap rate go down.
Leveraging from gold and real estate
Debra in Alpharetta, Georgia, wants some further insight into leveraging from gold and real estate combined.
Assets like gold and oil are basically proxies for the dollar.
We borrow in dollars. We lend in dollars. We invest in dollars.
When you start looking at the dollar, you see a long-term trend in loss of purchasing power … it’s called inflation.
Real estate investors use inflation to get rich by borrowing money from the future and bringing it into the present when it’s worth more.
So when you borrow … you have effectively shorted the dollar.
You can accelerate that process with gold.
If you look at the history of gold relative to the dollar, it basically stays the same as the purchasing power of the dollar declines.
Gold gives you the opportunity to hold some liquid wealth outside of the banking system and hedge against the falling currency.
More Ask The Guys
Listen to the full episode for more questions and answers.
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