Category Archives: Investing

Economics of Cataan

Welcome my friends back to the musings of my mind.  Last week I was talking about compounding resources and specifically interest.  This week I want to continue my thoughts about compounding though looking at it through the lens of a game.  As I have mentioned a couple of times, I enjoy games.  I think most games that exist have lessons that are applicable in business and life.  Please hang with me and we can roll some dice together.

The game I would like to discuss today is Settler’s of Cataan.  In this game players obtain resources from placing settlements on tiles and using the resources to build more settlements.  Each new settlement generates new resources, and there is the possibility of upgrading  a settlement to a city which generates even more resources.  Each city or settlement gives the player points and the game ends when a player reaches a pre-determined amount of points.  The players can also choose to use the resources to buy cards which do various things, including giving points.  On a side note I very much recommend this game for families or for anyone who likes games.  There is strategy and community building and socialization.  Even for people that do not like typical strategy games there is enjoyment to be had in this game.

So the way I typically play this game is just to build up as many settlements/cities as I can and get as many resources as possible each turn.  That is where the compounding effect comes in. The more settlements you have, the more resources you make off each toss of the dice.  Sadly this is just a board game, so there is no interest to utilize.  My theory on this route of playing is that the more resources you have, the easier it is to either build or trade for something you need, ultimately leading to a feeling of satisfaction as new resources are added to your cache every turn, possibly even winning the game.

That is all well and good for a game, but why am I telling you about it?  I feel like this can directly apply to rental real estate as well.  The more properties you own, the more resources (or in this case cash…) comes in.  Granting satisfaction and freedom and control over your life.  Will owning rental real estate make you win the game?  Depends on the game and what you want out of life.  If the game you are playing is to give affordable safe clean housing to people, then yes real estate will help you win that game. If your game is to live comfortably and work only several hours a month maintaining your properties (or even better and not work at all because your apartment complex is big enough to have onsite staff), well that is what real estate is all about.  So yes, rental real estate and increasing your monthly cashflow can indeed help you win the game.

There is another benefit to real estate as opposed to Settler’s.  Like I said earlier, there is no interest in Settler’s, but there is in real life.  So collect your rent checks from your tenants, then put the money someplace where it will grow some interest for a while until it is large enough to purchase another investment.  In Settler’s once you buy something it is a permanent fixture on the board and the only wealth it holds is the future resources that is generated by having that settlement. In real estate, once you buy something it is still worth money that you put into it.  You can leverage that value to accelerate buying another investment or even sell the property if you need a pile of money for something else.  That is on top of the cashflow generated and that is the power of real estate.  You buy something that still has value and provides cashflow.  Using all of the benefits of owning real estate is a very good way to obtain personal financial freedom.

I believe games can teach as well as being enjoyable past times.  Here is what I think Settler’s of Cataan can teach us.  First that there is no competition in real estate.  Work with the other people in the business and everyone will prosper.  Next that it is best to create win-win scenarios whenever dealing with people.  This makes both the game more enjoyable and makes life more prosperous and fulfilling.  Last increasing the number of properties you own will increase your wealth and your options in what you can do.  In all I think that there are opportunities to grow everywhere in your life, you just have to embrace them and apply those lessons.

Until next time, feel the fear and do it anyway.

Compounding Resources

Welcome back to my little corner of the internet.  Today I want to talk about compounding interest, and actually compounding in general.  First to set the theme I have some insight from Randall Munroe of XKCD:

http://xkcd.com/947/

 

The numbers in this comic are low, but the math is sound.  The idea behind it is worth looking into deeper though.  Instead of relying on compound interest, the girls are going to go figure out a way to make more money.  Why not do both?  Make more money and have your money make you money.  That is one of the keys to wealth, having your money make more money for you.  Some people call that passive income and it will show up in many forms depending on what track your business is on.  Where my mind is focused, we call that income from rental properties.

First lets look at the math from the comic above.  2% interest annually is quite a bit more than most people are making from their savings right now!  Even their investments.  So I believe the 2% to be a bit of a tongue-in-cheek moment in itself.  So what is up with the numbers?  Why does that seem so underwhelming?  That is because the starting principal is so low.  With only $1,000 to start with, 2% only gets you a couple bucks a month in interest.  If you started with 1000 and ended with 1200, then you get your 2% return (1200-1000/1000 = 200/1000 = 2/10), but in this scenario we end up with an additional $20.  That is the power of compounding interest, extra money was just generated without any effort.  So the strength of the interest comes in that every month the principal earns a little more interest than the month before.  I am going to simplify this a little, but I do have a spreadsheet where you can see these numbers for you to download.  In the first 30 days, the principal will earn about $1.64.  In the 5th 30 days (not exactly 5 months, this is where I am simplifying) the principal will earn $1.65.  So with the $1,000 investment it will earn $1.64 each 30 days for 4 months ($6.56 in earnings) and then suddenly on the fifth month it is earning $1.65.  Then three months later it is now earning $1.66!  The time between each one cent a month increase shortens with every increase.  With enough time the interest earned every month will increase by more than a cent.

In the spreadsheet you can see a chart that takes this example out about 85 years, and you can see that the line changes from a line into a curve.  And in that 85 years the principal increases from $1000 to $5,437.  Without the compounding the principal would be 2700 over 85 years.  So just compounding the interest more than doubled the earnings over that time.

Like I said before, the reason that the comic is underwhelming is because the initial principal is only $1,000, and nothing more was added to it other than the interest.  The biggest secret to wealth is to keep adding to your savings, as well as leveraging the compounding effect on your money.  If we instead of using $1,000 as the base, what do the numbers look like if $10,000 is the base?  Since the base is 10 times as much, the earnings are 10 times as much, and the ratio doesn’t change.

Let’s instead focus on the rate of return.  2% is pretty good in terms of savings accounts or CDs right now.  But it is a pretty lackluster return on an investment.  In real estate it is not uncommon to have 12-20% cash on cash returns.  And that is just from the cashflow part of the investment.  As I have noted previously there are 5 ways to make money from real estate.  If just one of the 5 is already giving you a 20% return, then the others are just icing.  That is the power of wealth building through real estate.  So with a 12% return, and using $1,000 as the base investment, what does it look like in 10 years?  Then the balance is $3,303, or just over 300% returns.  Without the compounding, the balance would have been just $1,200.  So compounding in this case was almost 3 times as much earnings.  At 20% then the total principal after 10 years is over $7,000.  That doesn’t even take into account re-investing the returns.  So at 20% return, you should have your initial investment back in 5 years.  If you make the exact same investment at that point then you are effectively making a 40% return for the second 5 years.  Do that a few times and suddenly you are making 100% or 500% return every year.  That is where true wealth is grown.  Re-investing the returns and letting those compound as well as the original investments.   Compound Interest is a very powerful tool for building wealth, you just can’t totally depend on it like the girls above were contemplating.  Do both, make more money and utilize compound interest to grow your wealth.

Until next time,
Feel the fear, and do it anyway.

Link

Partnering for cash flow

Last time I said that I would tell you how I plan to buy houses on a large-scale despite having no money to do it. It is an incredibly simple concept. I am going to use someone else’s money. Easier said than done? Perhaps it is. I haven’t actually done this yet, but I certainly plan to. I will keep you posted on how it goes.

One of the major disadvantages of flipping compared to holding rentals is that the property only makes money one way. You sell it, you collect a check. Holding a rental can make money in 5 different ways. Equity capture or buying the house for less than market value; equity buildup or having the principal on the mortgage decrease; appreciation or having the property increase in value after you buy it; depreciation or having a paper loss that is allowed by the IRS; and finally cash flow or recurring rental income. One of the awesome things about real estate is that any of these five ways can be used in partner agreements.

Given that I don’t have any money I really need a property that cash flows. So that gives me four other things to use for negotiation with a partner. I plan on buying properties that have reliable cash flow and while appreciation is nice, I don’t plan to buy properties just for the appreciation. So down to 3 bargaining chips. I am going to aim at keeping the equity buildup as well since that equity is one of the key things to becoming rich, though this is a point where I can be flexible. I can keep it all or share it. The last two methods are my main giveaways so to speak. I would like to utilize real estate to decrease my taxable income, but I think for now that might have to wait. The cash flow is more important to me right now since there are other ways to decrease taxes just by owning a business.

I’m going to focus on the paper depreciation for a second before I detail out the last profit center. In order to give away the depreciation of the property my partner and I will have to form a legal entity together. I believe a Limited Liability Company (LLC) makes the most sense and is the entity I will likely be using, but I can see the argument for a Limited Partnership (LP) or an S-Corp. I won’t go into the differences on those now. LLCs are a passthrough entity as far as the IRS is concerned, so whoever owns the LLC gets all the taxes, both the good and the bad.

Since the taxes flow through an LLC, it is fairly easy to hand over the depreciation to one of the partners. LLCs are also taxed based off of profits, not income. So here is the wiggle room that I will have to decrease my taxable income. Have the LLC utilize the cash flow from the property to pay for things for me such as eating out or providing my cell phone. If all the cash flow is spent by the end of the year there is no income that passes through to me and nothing to be taxed.

The last profit center on a piece of property is the equity capture. I leave this to last because I think it might be a sticky point. What I will be proposing to my partners is that they bring the money for the down payment on the property. In exchange they get the paper depreciation for as long as they wish to receive it. I fully believe that most people will say they want their taxes reduced forever. But in the circumstance where they do want to stop receiving a tax deduction, then I have the equity capture to give back to them as well. If I buy the property right, the equity capture should be pretty close to, if not more than, the down payment they provided to get into the partnership.

There are a few other details in the partnership I am not going to go into here. They are things like property turn over and management and tenant management. The important part of what I am going to try to do is to utilize the different profit centers to create a win win situation. I get some much needed cash flow, they get much needed tax breaks, and we provide safe, affordable, clean housing to those who need it.

I hope this gives you some ideas on how to form a real estate partnership. Decide what you need to keep and what you can live with letting go and use that as the basic structure.

Until next time, take some action. Feel the fear and do it anyway.

Streams vs. Piles

Streams vs Piles

I think that maybe one of the things that keep people in jobs is the recurring income. Obvious right? Everyone has recurring bills so they meed recurring income to handle those bills. But even with the recurring nature of bills a lot of people are looking for a big payday. They think that once I have a large amount of cash, I will be set. Though what happens to that large amount of cash? It shrinks as the bills are paid or the toys are bought. I have heard that even if someone amasses 1 million dollars by the time they retire, that person has an 80% chance of out living that money. I don’t know the source on that, so take it as just another meaningless statistic if you wish, but given human nature to spend more to match their means it makes complete sense to me. So in order to not deplete the pile of money one must go make another pile of money. And then go make another pile.

Counter to piles of money are streams of money. Now I think that in the beginning that streams of money are not nearly as sexy as piles of money. Lets look at a scenario involving real estate. Buying a house and fixing it up and then selling it for a profit is called flipping. With flipping it is not unreasonable to easily make tens of thousands, possibly even hundreds of thousands of dollars in one transaction. 90 days to fix up a house you just bought and then have it on the market with a realtor for a couple weeks to make $75,000 is extremely sexy. In addition to sexy, one should be able to live fairly well on $75,000. That is higher than the median income of the US I believe. So with that methodology one could flip one house a year, work 4 months of the year, and otherwise be comfortable. There is certainly a lot of appeal to that.

Now with streams of money, called cashflow in most business including real estate, and more specifically to real estate rental income, that money comes in month after month with little to no effort to make it appear. So instead of working 4 months of the year to get one paycheck, you might have to work a couple of weeks to get one paycheck a month. For ever, effectively. However opposed to the $75,000 in one fell swoop, that rental you just picked up is going to be making you $300-$500 a month. That is a lot of months of rent checks to equal one flipping check. Yet even though the amount is much lower, it is recurring and steady. Just like your bills. So pretty easy to slot the incoming cash to match the outgoing cash.

Note that I said piles of cash are sexier at the beginning than streams. When does that change? Well it is going to change and be sexier with streams when compounded. It takes 3-4 months to do a flip, and if you hire out and are skilled in managing you can even have several going at once. It takes several weeks to buy a rental, but that time is mainly spent waiting. Waiting for the rehab to finish, waiting for the escrow agents to close, waiting to find a property that meets your criteria. So it is pretty easy to scale that and be waiting for 3 different properties to close at the same time. You have the same issue on the rehab in both cases, but otherwise waiting on multiple rentals is a pretty simple affair. So arrange to buy one rental a month. Or maybe two. Even go for 3 if your financials allow it.

So lets look at the situation of working 4 months a year and buying one rental a month that cash flows $300. The first month you make $300. Not terribly sexy, but that covers your car note. A little bit of mental easement there I would say. The second month you make $600. That looks a bit better. The third month you have $900, and the fourth month you have $1200 coming in. Now $1200 every month is starting to look pretty attractive. By the end of the year you will have amassed almost $12,000. Still not as amazing as the one $75,000 payout we talked about earlier, but still an attractive sum.

But instead of one house a month for 4 months, what if it was one house a month for 12 months? Or 3 houses a month for 12 months? Then the recurring income numbers are way sexier than the numbers for the piles. Especially given the amount of work needed to match those goals. I can hear some of you muttering that someone would need to have a pretty big bankroll to be able to buy 4 houses a month for a year. I agree, there is a pretty hefty sum of money needed to make those purchases. But it doesn’t need to be your money. Next time I will cover my plans to buy properties on that scale and not have funds on that scale.

Until next time, take action. Feel the fear and do it anyway.

Other Peoples Money

I figured out fairly young that the best way to make a lot of money was to have someone else give it to you. Ideally, lots of other people. I know that sounds simple and possibly even intuitive, but in reality I think it can all be boiled down to that.

Here I am going to show two ways of having people give you money. The basic premise is to provide more value than the money they give you. One way to provide value is to provide something for sale, the other is to provide a service. Finding some way to provide those things that is repeatable is the path to wealth.

The first way I want to discuss is selling something. One of the things I am passionate about is a card game called Magic: The Gathering. Now, I won’t go in depth on what Magic is, but here is a quick summary; Magic is a collectible card game and like most things collectible there is a secondary market for the cards. The cards are printed and sold to dealers and the dealers then sell the cards to players, and the players can sell their cards to each other and back to dealers as the the market and value of the cards fluctuates. So here is where my epiphany came from in regards to the cards. When the cards are first printed they are sold for a profit of about a dollar. So there isn’t a ton of profit in the cards with a single transaction, but when you have a thousand transactions the profit can add up quickly.

So all of that turns into having a lot of people give you a little bit of money in profit, and thus you have profits and wealth. As card dealers are a business they know that the should invest some of their money back into the business and repurchase stock and repeat the cycle. Again, this is not an article about Magic, so I won’t explore this any further.

In the realm of providing a service I want to talk about renting ou houses. People need a place to sleep, to have family dinners, and to hang their nick-nacks on the wall. Not everyone can own, or wants to own, property so real estate investors and landlords provide value in that regard. Make sure that the properties you own are safe and sound and people will pay you for the privelege of occupying and maintaining your property.

People will pay for the things they either need (in the case of housing) or that will entertain them (Magic, among other things). Figure out what people want or need and provide it to them. They will give you money. This works out in all aspects of business. Find a way to get other people to give you money and build a process where that is repeatable, reinvest some of your profits back into that process and you will do fine.

Until next time, take some action. Feel the fear and do it anyway.

Podcasts

My remote mentors

I am currently driving a desk while I work on trying to get my real estate business running and profitable. I ultimately drive two hours every day to get to that desk. Because of that I am a student in Windshield University. I listen to various podcasts hither and yon, and today I want to share some of those with you. These are ranked in no particular order.

First up is Epic Real Estate with Matt Theriault (sounds like Terrio). The podcast can be found here: https://itunes.apple.com/us/podcast/epic-real-estate-investing/id446611090?mt=2&ign-mpt=uo%3D4
and his website is here: http://epicrealestate.com/

Matt’s show is typically just him, though he does do interviews as well. He made his millions in music and then when digital downloads became the thing, he lost it all. He has rebuilt with real estate and he has the podcast to share his journey and bring everyone else along with him. Listening to just this show should give you more than enough tools to become a successful real estate investor. Matt gives away a ton of value and information in each cast and is very approachable with questions.

Next up is the Bigger Pockets podcast. https://itunes.apple.com/us/podcast/biggerpockets-podcast-real/id594419649
Website: BiggerPockets.com

Bigger Pockets is a social website for real estate investors. There are forums where you can ask questions and people who are active in the business will answer those questions. There is a lot of free information there about every aspect of the business, wholesaling, flipping, direct mail, tenant screening, etc. With the podcast the two hosts (Brandon Turner and Josh Dorkin) interview someone from the Bigger Pockets community that is active on the forums or blog. They have had people just starting out to 20 year veterans. The have a slightly regimented interview format that lends easily to casual conversation.

Next we have another show with 2 hosts, The Real Estate Guys! http://itunes.apple.com/us/podcast/the-real-estate-guys-radio/id194167775
Website: http://realestateguysradio.com/
The Guys are Robert Helms and Russel Grey. Robert has been an investor all his life and works with his father, Bob Helms – who is a regular guest on the show. While Russel was a financial planner for years before moving into real estate. This is a weekly radio show that is translated into a podcast. They talk about all aspects of the business even though they only do buy and holds. They typically have a guest on the show, but they also fly solo (duo?) sometimes. They organize trips and educational seminars and believe in location independent investing. “Live where you want to live, and invest where the numbers make sense.” – Robert Helms.

The next show is more about online business and information products, but it is good to learn from multiple avenues and be well rounded. This is the Solopreneur Hour with Michael O’Neal. https://itunes.apple.com/us/podcast/solopreneur-hour-podcast-michael/id692594227
website: Solopreneurhour.com

Michael has been a professional drummer and website designer and is now a full time podcaster and coach. His podcast is an interview format that has no structure and he just has free-form conversations with his co-hosts (he doesn’t have guests, just a new co-host nearly every show). He focuses a lot on building your brand and leveling up your thinking and your business. Most of the people he chats with are in the internet marketing and information product space, but his views and points are applicable to all businesses.

The last show I am going to talk about today is another in the online marketing space, and that is Smart Passive Income with Pat Flynn. https://itunes.apple.com/us/podcast/smart-passive-income-podcast/id383084001?mt=2
Website: SmartPassiveIncome.com

Pat was an architect by schooling and trade until he was laid off in the housing collapse in 2008. At first he didn’t know what he would do, but now he feels that was a blessing in disguise. He had a blog about passing the Leed exam for architecture, turned it into an ebook and within a few months replaced his income from the job he just lost with his blog. He has a pretty good mix of interviews and solo shows, and he talks about blogging and the internet world and what works and what doesn’t. Pat was one of the first in the space to publicly publish his monthly earnings statements and he breaks them down in detail since there is something to be learned there. Pat has created several business in the online space and is making money in those niches where he had no prior knowledge or experience. Pat also discusses affiliates and has a large portion of his income derived from affiliate links. Just another way to start a business without actually having your own product.

I hope this has made you interested in some of these podcasts and that you give them a listen. Don’t stay in the learning loop forever without doing, but always be eager to learn something new. Let me know in the comments or on twitter what podcasts you listen to!

Until next time, take some action. Feel the fear and do it anyway.

Rentals Are A Business

Treat your rentals like a business

The other day I was listening to the Lifestyles Unlimited podcast/radio show and a gentleman called in and talked about his rental and the tenant in that rental. The host, Del Walmsley, talked with him and gave him some advice that I wholly agree with. I will get to that advice in a minute, but first want to lay out the rest of the call.

So the caller first says that he is calling because he has a tenant in his property that isn’t paying the full amount on the rent and wasn’t sure what to do about it. He felt that she was a friend now and he just didn’t have the heart to put her out of the house. So clearly he knew what the answer was, and that is what Del told him to do, he just didn’t want to do it. He went on to say that he had $30k and wondered what he should do with it. In questioning from Del it also came out that he thought he had about $40k in equity in the house this lady was in.

In regards to the tenant, Del said he should get her out of the house. I think everyone should have seen that coming. I agree with that completely! The caller argued that he would be putting financial strain on her if he kicked her out, and he felt like he just couldn’t do that. Del told him that she was taking advantage of him. I feel like the caller was putting himself in a financial strain by keeping that tenant. So he took her money problems and turned them into his own! Don’t do that. If you are a landlord your business model is to provide affordable and clean housing to people that want to pay for it. Provide enough value for someone else to pay for, I has I have talked about previously. The caller said that she was giving him more than the mortgage payment, so he was not suffering financially from this. I disagree with him. She was paying a little more than $200 less than market rent according to the caller. So he is reducing his income by $200 a month just by being a nice guy! What could you do with an extra $200 every month? I could certainly figure out something to do with that!

The other part of the call is that the caller had some money laying around as well as equity in the property and wanted to know what to do with it. He was thinking about refinancing the property, but didn’t want to inconvenience the tenant. Selling was completely out of the question because that is the same as putting her out on the street. Letting this tenant abuse him was not only worth the $200 a month…but it was worth $40k to him! That is some expensive abuse! And yet he claims this woman is his friend. Lifestyles teaches that if you have less than $50k, you should invest in single family dwellings. If you have between $50 and $100K you can think about getting into a multi-family syndication, and if you have more than $100k, you should absolutely be in a syndication. This caller had $30k in cash, and thus would fall under the single family bracket. In this case Del told him to stay away from single family. He should probably stay away from real estate entirely, unless he was going to get into a syndication deal as a passive member and let someone who actually knows the business take care of the tenants directly. This is the part I completely agree with Del on. Run the business correctly in a manner that produces repeatable and consistent profits, whatever business it is, and that is the “secret” to becoming wealthy. Do it wrong like this guy was and you just end up hating your business and wanting out.

In real estate, your property is your product and your renters are your customers. If your product is not producing the income it should be producing then you have to fix whatever the issue is. If the roof of the house has a hole in it, fix it. If the AC is broke, fix it. If however the product is sound but the customer has a problem, then fire the customer. If you are in a bar and you get too drunk and break something, the bar will kick you out and never let you back in. If you go streaking though Wal-mart, they will have you escorted out and you won’t be welcome back. Of course after your picture gets all over the internet. If you are a tenant and you are not paying the rent required, the owner has the legal right to kick you out of the house! In none of these situations is the customer right, and in every one of them the customer is to be fired for the betterment of the business. Remember that your business should have repeatable profits. Doing something intentionally that is damaging your profits is just going backwards.

Until next time, take some action. Feel the fear and do it anyway.