How to Make Money for Your Own Account
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How do we make money for our own account? By consistent planning we call “Estate Planning.” It’s amazing that when you mention estate planning the majority of people think that it in terms of death. They consider its sole function to be the passing of their estate to their heirs with a minimum of shrinkage. Yet the connotation of the work estate is the degree, nature and extent of use of property. Our concern is to build an estate and what other vehicle lends itself better to accomplishing almost all objectives, than REAL ESTATE. So are we any different from thousands of people who are seeking to build fortunes or increase their income through profitable investments and good management? OR are we using good business sense and sound economic concepts only for the benefit of our clients forgetting that we are entitled to the same valuable services for ourselves.
I submit to you that when making a transaction on our own behalf, many of us throw caution to the wind and are later surprised when we fall flat on our faces; not because the property acquired was necessarily bad, but because the ownership became bad.
Some go to the other extreme and tip the scale the other way. By being overly cautious and using tunnel vision they never make a move because the property is just not good enough and there is not enough value as an investment. A property however is inanimate and therefore of no value, except for its ability to provide amenities. In the past, the approach used to evaluate a real estate investment was based solely on the numbers game. The current or potential yield on the money invested was the deciding factor of the quality of the investment whether it was a good or a bad property.
Today we realize that this is not sufficient and that there is no such thing as a bad property. What we may have is bad ownership. What other factors do we have? We all know that when you have a small property with a high equity and loan constant, and possibly some cash flow and you need tax shelter, the answer is exchange up. The problem is that everyone else knows it too, and there is a great scarcity of people who are willing to exchange down. This introduces the factor of scarcity which by its very existence influences value. As we all know, the law of supply and demand controls the market. When the supply decreases, the demand heightens and with that, the price of the commodity increases.
The same applies to exchanging. The investor going up is not in a position where be can be too concerned with the $ sign. He should rather evaluate the benefits he will be receiving in comparison with the ones he is getting now. Is he getting more tax shelter? Won’t he have a faster equity growth because the loan is larger? Has he not reduced the percentage risk of his vacancy factor by having more tenants? He should then realize that if someone is willing to assume his problems, that willingness must be compensated by sometimes paying the premium price.
Excellent financing is another factor worth paying the premium for. Therefore, when analyzing a property and when making the decision to move or not move, rather than losing a transaction because the pencil was too sharp and the price is too high, think in terms of positions. Where are you now and where will you be in a few years down the road if you acquire the property.
Then, based upon your opinion of value plus the benefits to be derived, determine the actual value. The “BENEVALUE.”
A few years ago, I started a client on an estate building program. His motivations were high but his assets were low. To accomplish our goal, we chose to acquire fast equity growth property on good terms; there was no choice but to overpay. In two years we doubled his equity and again based upon “Benevalue” we made an exchange on the same formula. The move was repeated with the client consistently paying more money than other people were willing to, but always getting his benefits. During the years, with his ability, he increased the values of what seemed high a few years ago, and was now a bargain. Because this client saw the entire picture and not only the frame, his equity was worth $300,000 in only a few years. Had he been price conscious rather than benefit oriented he may have never overpaid and would still have his $6,000 equity. When talking about value, let’s truly think in terms of value to whom and when making a decision, be willing to pay for benefits received.
Investments to build an estate are not to be made as a guessing game. To achieve results you must plan. Sometimes people think that once they have made a good investment, it remains one forever more. They will not face the fact that investments like everything else in life, are subject to constant change for better or worse but never maintaining the status quo.
Also what was right a few years ago may not be economically sound in today’s marketplace. Therefore the investment is always subject to adjustments. An example is the use of high leverage which can be so profitable in the beginning and may have adverse effects later. A building was bought with a minimum down and due to the tax shelter some cash was generated. Now a few years later, the income tax shows a high profit. The depreciation is gone, and the equity is growing. The income has not increased enough to show spendable and pay the taxes. Things have been lucky and over the years there was a low vacancy factor so why do any work if you don’t have to? A little deferred maintenance has crept in. The neighborhood has new buildings with lobbies and other modern features, which brings in functional obsolescence. You now have reduced income, no benefits, and the high leverage is not as attractive as it was at conception.
Sure all the problems may be corrected but where is the cash coming from to do it with? Is this the type of an investment you should have in your portfolio? Unless you have other properties to offset your taxes with, and a way to fund the building when cash is needed, it probably should not be in your portfolio because you could not weather an emergency.
When evaluating income property you have to be concerned with the financial stability factor, which is determined by income and expense factors. You have to be realistic. Maintenance and replacements do exist. They are not merely a figment of your imagination. Roofs do have to be replaced and yesterday’s estimates will be doubled tomorrow. Unless you can provide for the needs of the property, you will not only not receive the benefits expected, but it will cut down on your ability to obtain benefits in your business.
It is a poor risk investment and we cannot and should never gamble. We don’t have to. Though the property may offer great benefits to someone else, it has ceased to do it for you and should be disposed of. This is why it is so important to reevaluate your investment portfolio regularly. A good time to do it is after you have filed your income tax return and have the entire picture.
A well balanced portfolio should definitely have diversification, for that purpose you need certain elements. You should have at least one property which you could categorize as a Blue Chip investment. This is the type of property that will give you security, and it may well be your home. You need long term investment properties to provide for stability.
The short term investments are your speculative ones. They are the properties you may go in and out for a fast profit. Then, last but not least, you should have the growth and appreciation vehicle which in most cases if offered by land ownership. To back them all you need liquidity, be it in the form of cash, a line of credit at the bank, cash value in life insurance, or saleable paper.
When reviewing your estate, concentrate primarily on your long term investments. They within their own category are also of different classifications and should be evaluated in the perspective of your needs. What are they? At different times they may vary. For the maximum return on your investment, LEVERAGE is a powerful tool (controlling the most real estate with the least amount of money). The magic formula is OPM, other people’s money. To illustrate its magic, let’s compare two investments made with the same amount of money, $100,000.
One will buy a $100,000 building and receive $8,000 spendable. An 8% return on the investment. The other will buy with the $100,000 initial investment. As an additional bonus he received his cash flow tax free due to his depreciation and possibly shelters other income too. Contrast the 44% with the 8% yield of the 1st investor and you have a dramatized version of the difference between the conservative philosophy and the high voltage leverage concept. However as the formula goes, it is only as good as the material put in it. If the ingredients that go into it are poor, the leverage principle accentuates them and it can become dangerous. As a rule of thumb, be sure that the lean payment never exceeds 50% of the income and preferably it is only 40-45%. Otherwise, sooner or later you will definitely be in trouble. As a beginner, you may not have another choice and the leverage formula maybe an excellent starter.
As a safeguard, immediately start finding ways to improve the property and increase the income to provide an adequate cash flow. This brings us to another classification. THE CASH FLOW PROPERTIES. Your goal should be to develop enough cash flow properties in your portfolio to provide an adequate income should you need it. That does not mean that you should use the cash flow if you have it. If cash flow is available, in no matter how small of a stream, you should treat it as income in trust. Pay it to yourself regularly as any other fixed expense and put it in a savings account, for emergencies only. If major repairs are needed you can easily borrow the money from the bank, especially when your statement shows cash in savings. This method will help increase your estate by building a liquid fund which will allow you to take advantage of opportunities when they are offered.
The third type of property which should be found at the end of the rainbow is that illusive pot of gold. The FREE and CLEAR property. You should have some properties earmarked for this purpose and the decision has to be made when you acquire a property. Those that have a high amortization factor will accomplish this, but never take one in this category at the sacrifice of safety.
If you have confidence in your own talent and ability to solve problems, you may speed up the process of making money by using the option. Exchange some land or lots as an option on units with a problem contingent upon your obtaining the management of the building until you exercise the option. When optioning a property you negotiate the price and terms at that time, and usually due to the problem the negotiated price will be well below the market. If you are knowledgeable in management you can increase your future equity by upgrading the property. This means also an increase in rent and on the 30 unit building a monthly increase of $20.00 rent per apartment may mean $60-80,000 increase in equity. When the project is completed you exercise your option and pick up your profit.
MANAGEMENT is the KEY TO SUCCESS in all your investments regardless of category. Your personal relationship with your resident manager is of utmost importance. Be thoughtful and generous to them. This does not mean an exorbitant salary, but it means that you don’t take them for granted and that you show appreciation for their efforts, always assuming that they are worth it. Otherwise change them, and do it quickly. Don’t hope that they will change. They will not and unless they prove to be good within the first months, they will never be better. Let them understand the problems you face and the necessity of good housekeeping. If you establish a good rapport, they will be on your side and bend over backwards to protect and increase your investment.
To establish control, you should be aware of all the details. This can be accomplished by weekly and monthly reports. Let the manager know that you support them and their decision, but first train them to make the right ones. By delegating a certain amount of authority you free your precious time for more productive efforts. This is why I recommend having a manager in all your properties no matter how small they may be. You will find in all buildings one tenant who is more interested than the others and is willing to take some responsibilities. You don’t even have to pay them on a monthly basis. You can make arrangements to pay them if they clean an apartment and if and when they rent one. The tenants can mail their checks in to you on smaller buildings, but they all know that the person who rented them the apartment is their manager. You can even have mangers on single family residences. Who is more interested in your rental homes than the neighbors? They have their investments as well. You can make arrangements with them for showing the vacancies and pay them a small fee or give them a gift. You will learn to appreciate each other. Good management is not necessarily doing all the work yourself or hiring it done. Since some of the goals will take years to accomplish, proper utilization of your time will pay dividends. Use it where it will benefit you the most.
HAVE A PLAN AND BE SURE TO FOLLOW IT. NOTHING WILL HAPPEN BY ACCIDENT SO IT’S UP TO YOU TO “MAKE IT HAPPEN.”
