6/1/14: Getting to Critical Mass – Rebalancing Your Real Estate

As any real estate investor knows, properties may generate passive income, but owning them is far from passive.

Because even if you have great property managers and you never see your tenants, you still have important decisions to make about markets, debt and equity.

And while most real estate investors focus on doing deals and managing cash flow (both VERY important activities), the smartest ones also pay attention to asset allocation models.

Yes, it’s true.  Asset allocation modeling isn’t just for Wall Street financial planners and paper asset advisors.

Balancing on their chairs in the studio to build on this critical topic:

  • Your massively popular host, Robert Helms
  • His unbalanced co-host, Russell Gray

All businesses have jargon.  So to make sure we’re all in the same page, let’s clarify some terms:

Critical Mass – that’s how much equity you need to invest for cash flow to generate enough spendable cash flow to support yourself in the manner to which you’re accustomed…or would really like to be accustomed!

Asset Allocation – In traditional financial planning, you’d have a pie chart divided into slices for stocks, bonds, cash, precious metals and maybe one or two other things like annuities, fine art, etc.  We’ll talk about what that looks like for real estate investors in a moment.

It's important to rebalance regularly as you build towards critical mass

It’s important to re-balance regularly as you build towards Critical Mass

Re-balancing – this is simply adjusting your asset allocations (how much of each component) to bring the ratios into alignment with your predetermined plan or model (which of course presupposes you have a plan or model!).

Make sense so far?

Most people’s investing lives can be divided into two broad categories:  Accumulation and Consumption (sometimes called Annuity, not to be confused with insurance products of the same name).

Accumulation is just what it sounds like.  You’re accumulating wealth on your quest to reach Critical Mass.

At Critical Mass, you have enough wealth (equity) to deploy for enough Passive Income (money you don’t have to work for) to achieve escape velocity from the gravitational pull of the daily grind.  Or as our good friend Robert Kiyosaki would call it, Getting Out of the Rat Race.

Critical Mass provides the thrust to propel you out of the Rat RaceObviously, the FASTER you can build wealth, the sooner you can get to Critical Mass so you can achieve escape velocity.

In our temporarily out-of-print book, Equity Happens, we spend quite a bit of time talking about equity growth strategies and the important role of leverage.

Now that equity is happening again (did you have any doubt?), we thought it was time to revisit some of the important themes inside the topic of getting to critical mass.

First, you have to be on the OWNERSHIP side of the equation.  That is, you don’t want to be the lender.  You want to be the owner (or part owner).  This is called EQUITY.  That’s why they call stocks “equities”.  In real estate, it’s called being the landlord.

Next, it’s important to pick the RIGHT MARKETS.  The old adage about the 3 most important things in real estate being Location, Location and Location is true.  Because it’s all about Supply & Demand.

When you pick properties in popular areas (demand), where there is some limiting factor in supply, you have a chance of getting APPRECIATION.  That’s people bidding up the value of the property FASTER than the pace of simple inflation.

Of course, what’s “popular” depends a lot on the property type.  If you’re depending on rental income to pay for the property, mansions in Beverly Hills might be low in supply and high in demand among Hollywood elite, but no one’s renting them from you.  And if they did, the rent probably wouldn’t provide enough cash flow to make the use of leverage appealing.

So “popular” might be affordable houses or apartments in B class neighborhoods in areas with a strong, geographically-linked, regional economy.  Or it might be resort properties in a popular area with limited supply and lots of people paying top dollar for overnight stays.

One way to re-balance your real estate during your Accumulation Phase is to REPOSITION EQUITY into hotter markets.  You can use a cash out re-finance (those are coming back!) to move equity out of a property you want to keep; or you can sell the property and use a 1031 Tax Deferred Exchange to transfer the equity without paying tax on any gains.

Now, if you were in the Consumption or Annuity Phase, you might move your equity from a highly appreciated, low cash flow market to a market and product types that cash flow like crazy (but maybe don’t appreciate as well).  So the idea of re-balancing applies within each phase or in transition from one phase to the other.

Does your brain hurt now?  Sorry.  Let’s just do a couple of more concepts and then you can get a snack.

LEVERAGE (i.e., debt) can be one of our best friends…especially during the Accumulation Phase.  Debt allows you to control MORE property with LESS purchase equity (down payment).

Of course, the down side of leverage is you’ll get less cash flow.  But that can be okay, as long as you have enough (with a safety margin) to make the mortgage payments (and you don’t need any cash flow to live on).

And at today’s stupid low interest rates, it’s hard to make the argument that the best use of cash or equity is to reduce mortgage debt.  But that’s a different discussion.

The main benefit of leverage is that it MAGNIFIES GROWTH.

For example, if you own a $100,000 property for cash and a year later its value increases 10%, your wealth (equity) has grown by $10,000.

If you paid CASH, then your return on your $100,000 invested is 10%.  Super.

Now, if you put only 10% down ($10,000) and got a 90% loan, then you grew $10,000 on $10,000 invested, which is a 100% gain. WOW!

Of course, a paid for property will have more positive cash flow than a 90% leveraged property.  That’s the trade-off.  Maybe for you something in between is “optimal”.  That’s where BALANCING comes in.  YOU have to do the math and decide what’s the optimal balance for your situation.

Lastly (at least for this blog)…

You don’t have to wait to build equity.  That is, you might be able to proactively do something to the property or its operation to FORCE equity rather than wait for the market to appreciate.

So, in the previous example, if you put $10,000 down on on a $100,000 property, then fix it up, you might not have to wait a year for the value to increase.  Because you forced it to happen sooner!

Then you can decide if you want to leave the equity there, or reposition it for more property or higher yield (investing extracted equity for higher interest than the cost of the loan).

See?  Real estate asset allocation, rebalancing and equity optimization can be FUN!

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4/8/12: Choosing the Right Market – An Engineer’s Perspective

Is there a scientific way to approach market selection?  Something the average real estate investor can do – or at least understand?

To find out we went deep into the heart of Silicon Valley where we rustled up a left-brained engineer turned real estate investor.

In the laboratory for this electric episode  of The Real Estate Guys™ radio show:

  • Your right-brained host, Robert Helms
  • Your hair-brained co-host, Russell Gray
  • Special guest, our mad scientist of market methodology, Tom Wilson

What you do when you’re an “A” student with a 30 year career as an engineer and corporate manager, and you take a critical look at your financial future and see a nuclear meltdown?

For Tom Wilson, he called upon his engineering background and managerial experience to design a better outcome.

Now we talk a lot about how a market “feels”, and going with your gut, and using the Force to guide you in your investing.  But guys like Tom just sit there with their arms crossed over their lab coat and slide-rule waiting for the formula.  In Tom’s case, he actually did a thorough analysis and designed a formula to real estate fortune.

But did it work?

Well, Tom’s no Donald Trump or even a Ken McElroy, but in the 10 years since he walked away from the corporate life of Silicon Valley, Tom’s done multi-millions of dollars in deals and has managed to accumulate 230 rental units.  Not too shabby for a propeller head.

So we sit Tom down and interrogate, er…interview him.  How did he do it?  What did he learn along the way?  Will he loan us some money?

Tom introduces us to the concept of a “sensitivity analysis” (and you thought engineers were all cold, clinical and calculating).  So we reach for our Kleenex and are all set to get in touch with our inner investor. Then Tom explains what a “sensitivity analysis” is and it isn’t what we think.

We find out that there are a number of factors (“variables”) which all affect outcomes in any experiment. In this case, we’re talking the financial performance and risk of real estate investing.

Now some of those factors are more important than others.   Some are WAY more important.  And wouldn’t you just like to know exactly what those super important factors are?  Of course you would.  But you’ll have to listen to Tom, because we wouldn’t do the topic justice – and goodness knows, you deserve justice.

But enough about Tom’s engineering background.  You’ll learn all about that when you listen to the episode.  And when you order his free report (details at the end of the episode), which is replete with charts and graphs, you’ll really get into the deepest recesses of his analytical mind.  Ooh Ahh.

For now, let’s talk about Tom’s managerial experience.  After all, to build a portfolio this big, you need to have a team.   This is where Tom’s success as a high tech manager kicks in.

He tells us about the character qualities he values most in himself and what he looks for in others.  He says he makes it a point to surround himself with people smarter than himself.  So both of those people work with him now. 😉  He shares some valuable tidbits of managerial wisdom and a dose of real world reality.  Let’s face it.  If people are involved, there’s going to be some brain damage.

Tom says he believes having patience and tenacity are essential to success.  It reminds us of a concept from Midas Touch by Robert Kiyosaki and Donald Trump: FOCUS – Follow One Course Until Successful.  We agree.  For guys like Tom, he’s smart enough to plan his work and work his plan.  Other guys (like us) are just too dumb to quit.

One thing’s for sure:  it’s very cool being radio talk show hosts because we get to hang out with lots of people smarter than us…like Tom Wilson.  And it’s our privilege to go find these big brains and bring the interviews back to you.  You’ll enjoy this one!

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The Real Estate Guys™ radio show and podcast provides real estate investing news, education, training and resources that help real estate investors succeed.

 

 

5/2/10: The State of the Fractional Interest Real Estate Market with Dr. Dick Ragatz

Unless you’ve been living off planet, you know that the real estate world has changed dramatically in the last few years.  Why?  Because financing as we came to know and love it has all but disappeared.  But does that mean people have stopped wanting to buy real estate?  Of course not!

The idea of fractional (not “fractured”, though many underwater property owners may feel that way) ownership isn’t new.  It’s a proven structure which is often used to allow people the opportunity to enjoy the use and ownership of resort properties.  But it’s also a great technique for building a diverse portfolio of investment property.  And of course, you can combine resort property and your investment goals in what we call Lifestyle Investing.  That’s one of our FAVORITE ways to invest!

We think market conditions are ripe for more people to consider fractional structures. So we decided it would be a good idea to talk to one of the biggest brains on the subject, Dr. Dick Ragatz.  Anytime you call someone “doctor”, you know they’re pretty smart.

Dr. Ragatz has a Master’s degree from the University of California at Berkeley and a Ph.D. in City and Regional Planning from Cornell.  He taught Housing Market Analysis at Cornell and also at the University of Oregon.  He’s been an active participant and leader in many industry trade groups including the American Society of Planning Officials, the American Institute of Planner, the American Institute of Certified Planners, and our personal favorite, the American Resort Development Association (ARDA).  He won awards for outstanding contributions from ARDA in 1989, 1995 and 2006.

We could go on and on, but you get the point.  He’s a really smart and accomplished guy, the kind you would want to sit down and talk real estate with.  So, since you couldn’t do that yourself, we did it for you!

Check out this very informative interview with this highly intelligent industry leader.  Get the inside scoop on what’s happening in one of the most interesting segments of the ever-changing real estate industry, courtesy of The Real Estate Guys Radio Show!  You’re welcome.   😉

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Squish Happens

Most people believe bubbles “burst”.  When people talk about the decline of tech stock values at the turn of the century, they say “the tech bubble burst”.  Of course, lately it’s all about the “real estate bubble” bursting.  Over the last two years, The Real Estate Guys™ have taken some criticism over one of our TV shows where we said, “Real estate bubbles don’t burst”.

But we’ll stand by that.  Bubbles don’t burst – at least not as long as whatever is underneath them is real.  And there isn’t much that’s more real than real estate.

So we say bubbles are squishy.  In fact, the term “bubble” (in the context of referring to a rapid run up of prices) is really a misnomer.  Better to say “balloon”.

When you squeeze a balloon, it squishes.  It comes out the sides or goes between your fingers; it just finds someplace else to go.

So you’ve heard that real estate prices have dropped.  There’s deflation.  Equity is gone.  Everyone’s underwater.  Life as we know it is over.  It’s real estate Armageddon.

Then you see (like we did) today’s Wall Street Journal article, “Hong Kong Land Sale Raises Worry of a Bubble”.

A bubble?  Didn’t it burst?

Well, no.  Actually, it squished.

According to the Wall Street Journal:

“Government officials here (Hong Kong) grapple with how to cool off overheating property prices”.

When’s the last time you heard “overheating” and “property prices” in the same sentence?  It almost seems like an oxymoron, like “reliable copier”.

Here’s another excerpt:

“The big (land purchase) came after (the real estate developer) sold 900 apartment units in a major new residential complex over the weekend for a total of  US$541 million.”

If you do the math, that’s over $600K per unit!  In ONE weekend.  We haven’t seen THAT in the US for awhile.

More…

“In China…home prices have risen as much as 25% in the past year and land values have doubled.”

That’s this past year, as in 2009.  You know, when US prices were in their third year of decline.

Now, consider where much of the money that fueled the US real estate bubble came from.  Get it?

The bubble squished.  But if your perspective is too narrow, you might think it burst.  Especially because that’s what everyone says.  And if you think bubbles burst, then you will quit the game and hide in your FDIC insured bank account.  Meanwhile, as the dollar crashes, you’re savings become worth less and less.

We have two main points:

First, real estate is an asset class unlike any other.  It’s real (permanent).  Gold and other commodities can also make this claim so, in and of itself, being real doesn’t make real estate utterly unique as an investment.

But, unlike virtually every other investment, real estate’s value is not universal.  Real estate values vary by markets and sub-markets, and those markets are global as we can clearly see.

Compare that to gold, which is also real.  If an ounce of gold is selling for $1200, it’s the same price all over the world.  There’s no squish, except to another asset class.

To really look at it right, you can’t think of real estate as an asset class.  You almost have to think of each property, or at least each market or sub-market, as an asset class.  So when one is down, another is up.  Squish.  Like stocks and bonds, gold and the dollar, etc.

But the big thing (our FAVORITE) that makes real estate unique, is that it can be financed with bank or private funding and debt serviced by tenants.  This makes it VERY conservative when structured properly.  Why?  Because even if the property declines in value, as long as it produces enough net operating income to amortize the loan (meaning the tenants are paying down your loan) some day it will be paid off.  Then it just generates cash flow forever.  That’s a beautiful thing.  Form that perspective, squish doesn’t matter that much.

Our second main point is that right now many people are forming new financial paradigms as a result of what they’re seeing and experiencing.  The people who lived through the Great Depression came out of it with very powerful convictions about how they viewed and handled money.  There were many great attitudes such as frugality, saving; and loyalty and appreciation for the opportunity to work.  We would all be better off by adopting these attitudes.

However, many of those same people missed out on some of the greatest opportunities in modern history because they brought a lot of fear and rigidity out of the trauma of the Depression.  Many people were hyper-conservative.

To be clear, we aren’t suggesting anyone should take risks they aren’t comfortable with.  And we aren’t criticizing anyone’s personal investment philosophy – no matter how conservative it might be.  We’re certainly more cautious about the risks we take these days.

We are merely suggesting to be mindful of the temptation to be hyper-conservative in terms of your willingness to be an investor.  If you won’t invest in your education or take time to investigate opportunity, you’ve probably decided “investing is too risky” and have effectively quit.  You think the bubble burst, the game is over, and there is no opportunity.  Or it’s so far off or you’re so out of position that you’re on investing sabbatical.   This is probably not you, or you wouldn’t be reading a blog like this.  But, there are lots of people who have quit – or are in various stages of quitting.  Make sure you know who you are and that you’re honest about it.

Now is a great time to be getting started (or re-started).  Talk to the people you know about real estate investing and see what they say – and watch what they do.  How are their attitudes changing as a result of the last three years?  What’s their game plan going forward?  Ask yourself those same questions.

Remember, squish happens.  As an investor, you want to pay attention to the flow of capital and try to be on the right side of squish.  And since you know squish happens, be sure to structure your deals to survive if you’re on the wrong end of it.   We’ll be talking more about this in the future.

Most of all, make sure you take the right lessons out of this Great Recession.  The right lessons are those that make you a better investor, not those that push you back to being merely a saver or a non-participating observer.  Invest in your education.  Investigate and evaluate opportunities.  Keep your head in the game, even if you’re on the sideline temporarily.

We’d love to hear from you!  Use our feedback page to tell us how this recession has affected your investing philosophy and strategy.  What are the people around you saying and doing?  Where do you see opportunity and why?  What are you doing to broaden your horizon, increase your education and increase your network?

12/13/09: Ask The Guys – What’s On Your Mind?

What is the meaning of life?  Why did God create flies?  How many little styrofoam balls in a bean bag chair?  These are just some of the many questions that The Real Estate Guys will never answer.  Fortunately, our listeners have sent in much better questions!  To provide irrefutable answers to our listeners’ real estate questions, we decided to the gather together the world’s most brilliant minds.  But since they weren’t available, we decided to take a stab at it ourselves.

The professional pontificators in studio for today’s show:

  • Your illustrious host, Robert Helms
  • Financial philosopher, Russell Gray
  • The Godfather of Real Estate, Bob Helms

Answering your questions is one of our favorite things to do.  But because we want to keep our broadcasts topical and focused, we typically don’t take calls.  Instead, we gather up questions during the week(s) and look for common themes.  Then, we dedicate a show to sharing our ideas and opinions on a few select questions.  For this broadcast we addressed the following topics:

  • Is it dangerous and dumb to buy an out of area property without seeing it first?  Is there a way to do it safely?
  • What should I so with my negative equity / negative cash flow rental property?
  • What do you think about the investment opportunities in Southern California real estate?
  • I’ve been studying real estate for two years, but haven’t bought anything because I’m afraid of making a mistake. What should I do?

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