Episode 5: What is the Ideal Investment?
In this episode, Lance and Randy discuss different viewpoints in finding the ideal investment. For Lance, the acronym I.D.E.A.L. works for real estate investing. Is the property: Income Generating? Does it have depreciation? Is there built-in equity? Does it have potential for appreciation? Is there leverage?
What you’ll learn in this episode:
- Lance’s first mentor in real estate taught him a formula for the ideal investment in the form of the acronym IDEAL – Income, Depreciation, Equity, Appreciation and Leverage. Whether it’s real estate, buying a business or investing in the stock market, you can apply the details of the potential investment against this IDEAL attribute.
- Income means the passive income an investment generates, otherwise known as “mailbox money.” Depreciation is the benefit given by the IRS, a loss we can claim on our tax return that offsets our active income. It’s a paper loss.
- Lance defines Equity in real estate: “When you have a mortgage on the real estate, every month you’re paying it down – or more precisely, your tenants are paying it down for you. Over time, that becomes equity that you get as a bonus for owning the property.” Appreciation means the values go up. The market can drive it up, or it can happen through “forced depreciation” where you can force the value up by raising the rent and raising the occupancy. The final attribute is Leverage – buying the investment using leverage and OPM (Other People’s Money) and leveraging your own know how and other people’s resources.
- Lance measures buying stocks and a business against the IDEAL attributes. Each has some of them, but the only investment that meets all five criteria is real estate. Randy measures IDEAL against putting money into a checking account, and only one element matches. Lance adds that the 401k he had during his corporate days fell short as well.
- Lance can easily show that anyone can, using the IDEAL formula, buy pretty real estate in pretty areas and make a 15% annual return on their money. He says, “Buy retail price stuff, 15% APR on your money, because you’ve got all the attributes coming in, taking into account your depreciation, mortgage pay down, appreciation and cash flow.”
- Lance goes into more detail on leverage. When you’re borrowing money, depending on how you approach it, and what type of asset class the property is, you can have recourse, or non-recourse loans. Non-recourse means we don’t personally guarantee anything. In recourse, if the property owner can’t make the mortgage payments, the lender can take the property back or come after you personally. Non-recourse, the world Lance plays in, allows him to not personally guarantee anything. If the property owner can’t make the payments, the lender gets the property back but they can’t come after you. Lance has insulated himself from that exposure.
- Lance talks more about income. When you’re buying income producing real estate, you have to make sure you’ve got cash flow. You want the value to go up, but if something happens and there’s a downturn in the market that causes the value to go down, there’s still cash flow and you can ride it out.
- Lance offers insightful investment advice: 1) “Why don’t you go take whatever cash you put into your home, go buy an apartment building and use that cash flow to pay the mortgage on your house? Now you’ve got an asset helping you.” 2) “Instead of paying cash for your next car like you planned, take that cash and use it with leverage to buy an apartment or other income producing real estate, and use the cash flow off that apartment building and use that to get a car loan or pay the debt service on the car.”
- Lance offers more detail on the concept of leverage. It’s a big part of real estate because you can buy property using none of your own money or personal assets. You can buy rental houses, apartment buildings, even strip malls with 100% leverage, getting cash flow off that and using it to buy or pay the mortgage on your house. He learned early on that real estate is something we take money out of, not something we put our money into. He knows of no other investment vehicle with as many tax benefits as real estate.
- Randy then shares the essence of his investment approach, which he breaks down to five bullet points – It’s 100% liquid, 100% safe, gives you a 100% rate of return, is 100% tax efficient and 100% passive. The kind of properties he invests in are those where “I don’t have to do a darn thing.” As he and Lance did with the IDEAL formula, Randy measures his criteria against a checking account and real estate. Neither fulfills all of his bullet points.
- Randy agrees with Lance that the more passive and liquid the investment is, the lower the return will be.
- Randy makes the point that when you’re making an investment, you should run it through the filter of five elements of the perfect investment and realize most likely you won’t fulfill all five. Ask yourself what you’re willing to give up. That way, for instance, you won’t be disappointed because you can’t buy into a liquid, passive, safe investment and expect huge rates of return.
Resources:
Grab a FREE Copy of Lance’s Best Selling Book, How to Make Big Money in Small Apartments here.
Get Access to Lance’s Best-selling Small Apartment Wholesaling Course here.
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