#509 Build A Passive Income Empire With Rental Properties (Here's How)

In this episode of the Main Street Business Podcast, hosts Mark J. Kohler and Mat Sorensen unpack the secrets of building long-term wealth through rental real estate. Join them as they delve into real estate deal analysis, key performance indicators, cash flow, ROI, and other valuable insights.

Here are some of the highlights:

• Mark and Mat provide real-world examples taken from experience with 20,000 consults and various client scenarios.
• Mark and Mat discuss the importance of adding assets for small business owners and W-2 employees.
• How to properly analyze and determine which rental property to buy
• Reminder to consider other investment opportunities besides real estate.
• Significance of understanding the 'why' behind buying a rental.
• Overall ROI includes strategic advantage, cash flow, and appreciation.
• Different appreciation rates for residential vs. commercial properties.

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Transcript

Analyzing Rental Real Estate Investment

Speaker 1 0:00

Wealthy people buy rental real estate because it makes sense, as I do pay the mortgage, or the tenant pays it for me, the mortgage is going to go down, so I'm building equity without putting any more money in there.

Speaker 2 0:10

We love rental real estate. Why do we love it? Because we get to add assets. We're talking about this for the long haul. We're not talking about flipping a property. We think the most successful real estate investors go for the long haul. Let's be honest you have other investment opportunities you could put your money into. Why are you buying this rental? Welcome everyone to the Main Street Business Podcast. This is Matt Sorensen, and joined by the great and powerful Mark J Kohler. Today, we are talking about should I buy this rental or not?

Speaker 1 0:38

Between the two of us we have done 20,000 consults. We've been helping clients make these tough decisions and we see really successful clients doing real estate, clients that are moderately successful doing real estate train next. We've seen it all.

Speaker 2 0:52

The good, bad and the ugly of rental real estate. We've seen it all and I think for any of you that are like maybe I'm a small business owner or I got a W-2 job and I want to start building assets we talk about the trifecta One of the most common recommendations we like, particularly for Main Street business owners, is to just buy rentals. We love rental real estate. Why do we love it? Because we get to add assets. We're working so hard to make money in our business or in our job. We need to start taking that money and deploy it into assets that can make money for us.

Speaker 1 1:20

Today's podcast is more okay. You've decided you're going to buy real estate. Which one should you buy and how do you analyze it? And we know there's a lot of gurus out there teaching workshops this weekend that have done more real estate deals than Matt and I. On the flip side, I think we've maybe seen more real estate deals than they've seen, and we see the tax returns and the legal ramifications that can be good and bad, yeah but there's good deals and bad deals, and so that's what we want to kind of get at today is should I buy this or not?

Speaker 2 1:48

Just because rental real estate is good doesn't mean every deal is good, and so you want to know which ones to sink your money into. And, let's be honest, you have other investment opportunities you could put your money into. Maybe you're investing it back in your small business, maybe you're buying an oil and gas deal, maybe you're investing in another company, or I don't know.

Speaker 1 2:04

You're going to leave crypto out of there.

Speaker 2 2:05

Okay, that's fine. Yeah, I mean you have plenty of options. Yeah, plenty of options.

Speaker 1 2:11

No, you do, and we've never been ones to say put all your money in real estate by any means. But, in summary, wealthy people buy rental real estate because it makes sense. We've seen it over and over again. There's multiple facets to rental real estate. Now, it doesn't mean you put all your money there. There's times and seasons of life where it does or doesn't make sense, and what type of deals you enter into, of course, are a huge factor, but I think we need to look at it as an option and I think it's an important choice. Yeah, let me throw this out too If you're looking for a resource to analyze it and look at deals around the country, frankly our most favorite right now for giving just deals to clients and walking them through options is RealWealth RealWealthcom with Rich and Kathy Fetke.

Speaker 1 2:50

They do a great job and if you go there, please mention our names and we don't get any money out of it. We just want you to get a little extra TLC, which they'll give you. So if you're analyzing, you'll give them a call. They're doing deals just like this all over the country and helping clients of ours get into property. So I'm going to leave it there and we're going to say should we do a deal? Let's do a deal, let's do a deal.

Speaker 2 3:13

Okay, let's make a deal. Let's make a deal All right.

Speaker 1 3:16

We're going to throw out a few numbers of some examples and what we think. The KPIs, or key performance indicators, really matter when you're looking at a real estate deal, but I think there's almost one that's a little bigger than any of the numbers and that's your why. Why are you buying this rental? Is it an area you like to vacation and you're going to check on it? You see an opportunity to create some immediate equity in it through some unique asset acquisition strategy or some sweat equity. Is it where your kids are going to college and they're going to rent from you? Self-rental?

Speaker 2 3:48

Yeah, self-rental definitely. For any of you business owners it's like would I buy that commercial property and do that deal? If I was leasing to some other dentist? Probably not, but if it's leasing it to me, there's a lot of business reasons why the location makes sense and that adds benefits besides just the financial stuff. And so the self-rental could be one. I've always liked, of course, like you know, the rehab projects and we certainly have come across a lot of those clients that they like that stuff. You know that's not a Matt Sorensen deal. I do not want to buy fixed rubbers, okay, but there are certain clients who can make that instant equity. But this is also, I'm adding in some time in my work, but again, it's real well-being. Was that a?

Speaker 2 4:25

dig on me. Was that a dig? Mark likes to put the tool belt on still and go to his rentals. I see him on the weekends. He's like he's just Got a little chip in me. Yeah, a little chip yeah, so Chip gains.

Speaker 1 4:45

So I'm want to say what is your strategic advantage in this deal? I really think if you're just going to look cold heartedly at what might be called turnkey properties, I'm just going to go buy this property just for the numbers. I trust the promoter, the seller, the realtor that's helping me acquire this property. I'm just looking at cold hard numbers. Those are hard because you're relying wholly on that. I like to have an X factor and I think if you ever have a strategic advantage to a deal now, it doesn't mean it makes the deal a go, oh, but it makes those numbers a lot more understandable. And because we have some other factor again, it could be renting to ourselves, our kids, an area we're confident in. There's a unique strategy where we know we're going to have some equity right out of the gate. I think that X factor has to exist for me on a deal generally. Yeah, Not all the time, but I really like that.

Speaker 2 5:36

Yeah, and I think a lot of successful real estate investors do get very location specific. I was even talking to Jameson Manwaring, CEO of Neighbor Adventures. They have, you know they do apartment buildings and all this, and he's like we are not buying anywhere else right now. We have a team here from contractors to property management. We know where rents are going to go, when we're going to raise them. We understand what's going on with the local economy from a short-term to long-term perspective.

Speaker 2 5:57

It's like that makes that's a strategic advantage Exactly To to, like someone else is buying in some rando market, you know, oh yeah, how many times have you seen this?

Speaker 1 6:05

I've had clients come in so many times over the years. Hey, I just bought some rentals, I need some LLCs. I'm like, okay, well, I bought a rental in Dallas, I bought one in Ohio, I got one in Miami and then I bought one where my grandma is in Minnesota. You bought all those this year. Yeah, yeah, your property manager. Well, I don't know, I'm going to do this, I'm going to do it. I'm like, oh my gosh, we've got to set up four LLCs in four states. Property management's already a train wreck. But they're like but the deals were so good when you look at them on paper. Okay, that's great, but how in the hell are you going to manage this? And it created a strategic disadvantage.

Speaker 2 6:45

Yeah.

Speaker 1 6:45

Because that shotgun approach.

Speaker 2 6:45

Yeah, and I always get the answer. Well, I wanted to diversify. You're going to pay the price for that. You're going to be doing all the work, all right? Well, let's dive into it, and I think we did, and that's my first point.

Speaker 1 6:51

First point is if you're analyzing a real estate deal, I want to hear your strategic advantage that's, and how you're going to manage it more efficiently, how it's a great deal, how you're going to have equity out of the gate, how you're going to help defer some of the risk because there's an internal rental and maybe some of you are doing it just because you want to teach real estate to your family. We're going to do this as a family. I mean, whatever that strategic reason is, you better have one, or I'm going to be like, okay, that's number one.

Speaker 2 7:17

Other thing I'll just say a couple other points here too is we're talking about this for the long haul. We're not talking about flipping a property. We think the most successful real estate investors go for the long haul. Real estate's very cyclical. Okay, the real estate market's cyclical. It goes up and down. Rates are all over the place right now, which has a significant impact on the value of a deal when the rates are shifting so much.

Speaker 2 7:37

The other thing I would say is we're not going to be talking about, like the real estate, you know, the realtor that might be showing your properties. We don't care if it looks cute, we don't care if it's, like you know, in the best location. We care if it's priced right, cause the price is going to win how much you're gonna have to put down on it and your mortgage. We're going to be caring about the interest rate You're going to get on it and we're gonna be caring about what's the rent you're going to receive.

Speaker 2 7:59

We are going to get very specific to the numbers, and that's maybe the tax lawyers in us. We just want to pencil this out and just the to the numbers make sense because, let's be honest, at the end of the day, this isn't a house you're going to live at, and that's one thing I you know. This is a house that's going to produce income for you and it whether it's rent, rent or appreciation gain when you sell it. So I it's all about dollars and cents. To me, this is numbers. That's why we're going to focus on numbers here.

Speaker 1 8:27

You're not buying a house, you're buying numbers and as we have heard it termed as well. Now, if any of you would like, I have a spreadsheet I send out to followers on my social media and in our network of tax pros. And if you want to email me and mark at markjkohlercom and just put in the subject line real estate spreadsheet, so I'll send you a spreadsheet that you can plug in some numbers and we're going to analyze these four or five factors here in one particular deal and just give you a feel for it. I want to say, as we go into these numbers, here's my perspective.

Speaker 1 8:58

The second factor, other than a strategic advantage, is what is the cash flow? And what I mean by cash flow is what is your cash on cash return? You've got $100,000 to deploy. I think in this example we're going to do 80 grand. But let's say you've got 100,000 to deploy. Where else could you deploy that Hell? I could put it in a money market at TD Ameritrade and get four and a half percent right now. I could go do promissory notes. I could go do a S&P 500 ETF and maybe get even nine or 10%. So where am I going to put that a hundred grand and to compare it to if I go do this real estate deal, what is my?

Speaker 1 9:32

I want to start with cashflow. I'm going to I'm pretty adamant about that. What is my cashflow going to be at the end of each month, annualized out on that a hundred grand? Now, yeah, I might get appreciation and, oh, I'm going to mortgage pay down. We're going to come to tax benefits too, fine, but what's my freaking cash on cash return? Because at the end of the day, I don't want to have a negative cash flow problem and I don't want to be just rolling the dice on cash flow. Been there, done that 2005, 6, 7, 8. I bought crap. I shouldn't have bought. Music stopped. I'm left holding the bag with crappy cashflow. I learned some hard lessons, so I am a little jaded.

Real Estate Investment Analysis and Cashflow

Speaker 2 10:05

Yeah, You've been hurt. You know I got hurt. You know I got hurt too. I had a. Anyways, we'll get into the stories here. We got to get into the numbers. Cash is king. Okay, Cash is king. So that's we're going to look at. And I think the probably the biggest thing I agree with what you said there on the cash is I don't want this to cost me. I'm putting money into this. It better be sending me money back If I got to start contributing money into this because it goes upside down, or I got a tenant out for a month and I wasn't planning for this. Emotions change. This is not a good deal, Okay, and if you're like, well, it's going to appreciate one day, I will get to that. Let's talk about appreciation here in a moment.

Speaker 1 10:39

But you buy the deal because of cashflow and then it's possible to do that, by the way, yeah, and I'm going to say the third KPI or the third issue here is overall ROI, which I'm appreciate. I appreciate overall ROI. After I've got a strategic advantage, I know the cashflow is going to be okay. Now show me that overall ROI, which we're going to come to Okay. So give us some numbers, matt, give us a deal. Give us some numbers, matt, give us a deal.

Speaker 2 11:01

All right, let's say you got a single family rental 400 K purchase price You're going to put down 20%. Now I know you could do some creative financing or maybe get a five or 10% down mortgage or something we're just going to go with. Let's assume you get the rank and file 20% real estate investor loan. You got to put 20% down, which is 80 K. Then we're doing a 7% interest rate right now. Now we're going to come back to interest rate here because this is critical on a deal, but we're going to just price it right now, with the current market will do at a 7% mortgage rate.

Speaker 1 11:30

All right, good, I'm going to put 7%, which gives us now PITI is an important concept. Everybody. I'll just add to this PITI is principal interest taxes and insurance PITI. So what is this property going to cost me? Cashflow, wise direct costs, and we want to have a cushion for HOA property management and maybe some reserves so that PITI and those direct costs are what we're going to subtract from our rent. So this deal matches throughout $400,000 property 20% down $80,000. What's our rent? What did you say? How much rent we get? We haven't said that yet. Okay, so by P-I-T-I.

Speaker 2 12:08

Let's just go to what it's going to cost to buy this deal. Okay, and this number? How much does it hold this property?

Speaker 1 12:12

Okay, it's 7%, matt. You give them the number.

Speaker 2 12:25

All the total number. This is taking in principal and interest for your mortgage payment, property taxes, insurance on the property and we've got about 4K and other contingency there, about 333 a month, which is, you know, maybe you have some repairs, some property management fees or something like that. Yeah, no, rent one month, we'll come back. You might need to bump that up, but let's just say that we assumed 4,000 in contingency.

Speaker 1 12:41

Now, if some of you are really wanting to, you engineers out there, we assumed 1.2% of the property value and property tax, 1,500 in homeowner's insurance and then that 4,000 in other costs. So when you add that up with a 30-year 7% fixed rate mortgage, you're at 2,987. So I'm going to put in 80 grand and I'm going to be out 2,987 a month to keep that property with no tenant in it. That's it. That's my direct cost. I'm off to the races, but I want to rent it, man, yeah.

Speaker 2 13:10

So let's just obviously that was the whole point here. So let's say and we're trying to be reasonable here you can get 3,500 bucks a month rent. This is a long-term rental, we're assuming and, by the way, I've had a lot of clients that have done short-term rentals and I'm doing one right now. Mark's got some short-term rentals. One thing I like to do when analyzing a short-term rental I talked to a client about this the other day. He was like man. The income on this really fluctuates. Even from the last owner they were buying it from an existing owner. I'm like what does this rent for in a long-term rental? It because your fallback of a short-term rental that doesn't work is always too long-term rent. All right, 3,500 bucks a month, though in rent. So we're assuming you're going to make $513 a month in cashflow.

Speaker 1 13:54

That's $6,150 a year annually. And here's the magic equation what am I going to make in annual cashflow divided by my cash investment, assuming I'm not going to put any more money in? So I put in my 80 and I'm going to walk away with 6,156 at the end of the year, all things considered, with a little bit of contingency there, and we know it's not a perfect world. Sometimes you get lucky and get better. Sometimes there's some hearts and some bumps in the road. Your, your cash on cash return is 7.6%. Now that's respectable to me. I like that. I want to be over 5%, bare minimum, because then I'm going to get into my other benefits and our total ROI. But I want to make sure at least I'm maybe 5%, 6% or 7% in cash flow with some really conservative assumptions. Now we can play around. You'd ran some numbers with a lower interest rate.

Speaker 2 14:48

Yeah, let's say, and let's say that you could get this at a 5% rate. Maybe you'd buy this subject to to the existing rate that's a little bit lower. Maybe in two years rates are down to five and you can refi on this. Maybe there's some pay down of the rate at the time of purchase.

Speaker 1 15:02

I know you've seen some of those deals recently. New Contractors are buying down rates to get people to buy and things like that. So some of you are freaking out going you can't get 5% Okay.

Speaker 2 15:10

We've seen it. Yeah, we've seen it, but we were trying to do the easy one to 7%. So let's say it was at a 5% rate. Well, now this takes my mortgage payment to only 17, 17 and total PITI 2576.

Speaker 2 15:23

Yeah, so now I'm making my. Now my cashflow goes up by 5,400 a year. Okay, 5,400 a year, which means I've got 11,556. Because I've reduced my interest cost, I've increased the amount of cashflow there's that. That's the theory. 5,400 is not going to the bank anymore. That's now income to me. So now I'm taking home 11,556, which, if you divide by 80,000, because that was my cash I had to put down. Now I'm getting a 14% return back on my cashflow.

Speaker 1 15:56

I mean you're turning me on all this talk of numbers here. This is like so sexy.

Speaker 2 16:00

This is pretty hot right.

Speaker 1 16:01

Yeah, this is, this is the room is heating up here. So 14% Now. I think this is really, really powerful because we can start with our spreadsheet, which I'll email to you guys if you want Just email, market market put in real estate spreadsheet and you want to have this spreadsheet and look at rental after rental after rental and start tweaking these. One thing that Matt did here before the show started. He goes well, let's drop one month's rent out.

Speaker 2 16:29

Let's say we don't get rent for one whole freaking month. Yeah, and we already had some contingency in the first model of 4k. But let's just say, on top of that we have another month bad month.

Speaker 1 16:34

Then our, our, our cash on cash goes down to 3.32. Now that's on the 7% assumption of interest rate. But 3.2, not good.

Speaker 2 16:45

So, but at a 5% rate, I. That takes me down to 8,000 a year in cashflow, which, on 80 grand, is 10% cash on cash return.

Speaker 1 16:55

Yeah. Now Matt asked me he would. When we played with this, he goes would you buy this rental? And I said no, not without a strategic reason. It's good but it's not great. I see it's almost like you go to the store. Have you ever done that? You go to the store and you're like going to buy a pair of jeans and you're like, eh, I look good, but you take them home. You don't wear them.

Speaker 1 17:16

Yeah, but you got to. When they're in there, when you put them on in the store, they better look great or you're never wearing them. Yeah, and so this is one where it's good, but I need a reason to make it great. Now some people and this is where Matt and I may differ a little we'll go well, let's look at the overall ROI. Yes, there's mortgage pay down. This is going to appreciate. I'm going to get some tax benefits. Now you can see I'm a little. I'm okay with that, but that doesn't get me over the hump. Yeah, I got to.

Speaker 2 17:47

I want to go back to my first reason. Let's go to ROI. I would do this deal. I would do this deal. Let me give you a number of reasons why. Now, first let me say some of the negative things.

Speaker 1 17:55

I'll send over the Repsy contract I've got this afternoon.

Speaker 2 17:58

Someone's got one of these deals, send it over. I'm a buyer. Right now I'm buying. Here's why, when you run this model, one thing I've noticed over the years myself investing in rental real estate is this initial rent payment is just what I'm going to get now. One of my last rentals. I started at 950 a month in rent. In the year two or three when I was renewing the leases that first tenant moved out, I was at 1200 bucks a month rent. That is pure cashflow on the model that I already had in place because my mortgage didn't go up. Maybe my homeowner's insurance went up a little bit. Property taxes, nominal went up, but my rent significantly went up. So now I was almost doubling my rate of return just on the cash, on cash. So as a landlord you get the benefit of the rent's going to go up over time. So the longer I hold this property I can get more cash flow.

Speaker 1 18:47

Okay, I'll get on your bandwagon. I would.

Speaker 1 18:49

I would say too, you're going to look at, hopefully, refine and getting the lower interest rate, and one might argue, you have a strategic advantage because you may say well, over the next two years, I'm going to put the yard in or I'm going to put in another RV pad on the side. I'm not going to. You are, though, but here's what I'm saying. How you're going to exponentially increase rent is to maybe you see some sweat equity opportunities. The fence has fallen apart, the landscaping sucks, the house needs to be painted, and you can still get $ 3,500 and all that's going on. See, that's strategic advantage to me, because even if I hired a contractor to go knock it out now, I'm increasing the rent exponentially.

Speaker 2 19:35

So, but okay, you'd like it, cause you just buy natural rent increases and I'm still just on just the cashflow from the rent is because I do think over time your rents go up and you get the benefit of that, and I'm assuming you're buying fixed rate mortgages where you're not affected when rates go up but you get the benefit of refiing when they go down. So you don't want to lock yourself into the adjustable rates where you can lose on the way up, get them fixed and you can always refi on the way down. Of course, gosh this is so good?

Speaker 1 20:03

because now the blending between the overall ROI and your long-term play and your strategic advantage, they go hand in hand. Because another factor is you're going to say, well, this is an area where some big Fortune 500s are moving into the area. There's going to be a drive up in rent rates. Number two this is a new build. Let's say You're like I'm not going to have any repairs for eight years at least, before even appliances are going to be a problem.

Speaker 1 20:29

But if you look at this one and holy crap, this is a 40-year-old house. There's going to be issues Sewer, furnaces, roof, driveway. So then you're like I better have more of a cushion. The deal falls off the table. So I think again you can say, well, I'm going to just buy this rental where my kids are at college and they're going to be my tenants and they're going to learn how to manage the property together, and so for five years I've already saving paying rent to someone else strategic advantage which will change your ROI. So tell me some of your favorite ROIs. Do you like appreciation more or mortgage?

Speaker 2 21:00

reduction. I'm definitely an appreciation kind of guy. You know I'm. You know I like to appreciate things. So no, appreciation is awesome because I'll be honest and this is again the perspective we get in talking to clients over the years that is where they've really made their wealth. They got cash flow from the rental that maybe helped them buy more assets or live a better lifestyle, but they really built wealth by the appreciation over time. And that happens because real estate goes up over time. And here's the one thing that's the counter to the S&P 500. A lot of people might have said that hey, matt, that 7.6% that you did on that first model, cash on cash at a 7% interest rate for the mortgage, I know I can get 8 to 10 in an S&P 500 fund over time. That's pretty predictable and is zero work. I got to put you know, type some letters into a computer. Why would I do that? Well, because I'm going to. I can get that in the rent plus the appreciation.

Speaker 1 21:59

Okay, my counter to that, and I agree, and I let's see you're in that for 10 to 20 years.

Speaker 2 22:04

Yes, that piece of real estate, this 400K piece of real estate, in 10 years is going to be 800.

Speaker 1 22:09

Okay. Well, this is where you have to analyze the deal carefully. For example, I have two deals where I've had no appreciation in 10 years. For example, I've got a little low-income housing rental in South Chicago, great cash flow, no appreciation. Yeah, so I went in with my eyes a little more focused.

Speaker 2 22:26

Yeah, you knew that.

Speaker 1 22:27

But it's a high cash flow, yeah yeah, this is why and I'm not disagreeing with you if you bought the raw property, if you bought a property on All cash rental, yeah, you know that there's going to be a new. Well, I'm going to come to that in a moment, but oh, you mean the first of the month. I think too, when you're looking at this is commercial doesn't appreciate as fast as residential. I've got a commercial property. That's been wonderful, and that's a different model with commercial. It's cap rates, it's commercial buildings are not skyrocketing in value, as you'll see. Their demand for residential housing, which is there's a shortage in residential housing in the United States Right now. You could argue there's a surplus of commercial space, so not all deals are going to appreciate the same. So you want to say what area am I buying, in what region? What strategic advantage would give me more appreciation, as it's near a golf course they're going to be remodeling soon. La, la, la la.

Speaker 2 23:27

Let me say this too the, the properties that seem to appreciate the most and the real estate market that seemed to have the most appreciation, are the tightest on cashflow. They just seem to be like even a lot of the Midwest stuff. You know, we both own properties in the Midwest as rental properties. Great cashflow markets, excellent cashflow markets. Terrible appreciation markets here in Phoenix, where we're at kind of a tight cashflow markets, particularly for long-term rentals. Awesome appreciation market, at least for me on a number of my properties. And so, um, and you got to time it right. You got to time the real estate cycles right, of course, but, um, so keep in mind, you don't have to hit every one of these. You don't have to like win on cash flow, win on appreciation. You're not going to hit a home run.

Speaker 1 24:10

You're just base hits, exactly. I'm sorry, let me point at you we just want to get on base folks.

Speaker 2 24:15

Okay, thank you. I'm Brad Pitt in that one, jonah Hill, thank you.

Speaker 1 24:18

Now I want to throw money ball. Now I want to add I agree with you entirely. We can't get all four quadrants every time, but if we can hit a double, get a couple of quadrants, a triple, great, you know in high school I was good with a triple.

Speaker 2 24:33

We're not talking about baseball anymore, are we? What were you?

Speaker 1 24:35

talking about. That was totally inappropriate. Okay, softball, okay Now, yeah, softball. I will say this too. Let's throw in a couple of variants. Let's say it is a self-rental for your business. I do this every day and on Sunday, because if I'm already paying rent as a business owner for a commercial building, a warehouse storage, you may be having four. You might have four storage units for your company. Like, holy crap, I'm going to buy a storage unit facility, maybe a smaller one, a mom and pop, there's a lot of opportunity there. You, smaller one, a mom and pop, there's a lot of opportunity there. You just spoke up in Boise. What's his name? I'm going next month. Oh, is it next month? Yeah, great conference. Coeur d'Alene again. Yeah, coeur d'Alene, idaho. Yeah, self-storage summit yeah, it's really good.

Speaker 1 25:16

Now, another factor I throw out that I would go the other direction is I was telling Matt about a console I had with these clients out of San Clemente, california. They were like we got our house and we just moved into a new one. We're going to rent our old house and I'm like, oh, okay, tell me your argument there. They had close to 800 grand in equity. We won't dive into the numbers in full detail here but they had about 800 grand in equity and they were going to pay off the mortgage like that, with a little influx they had, and they were just going to sit back and collect rent and they thought it was the cat's meow. And I said, really, you're going to get maybe 36 grand net cashflow out of this, maybe 40 grand, and you got $800,000 in equity that could be deployed somewhere else maybe three or four rentals and get some leverage going.

Maximizing Rental Real Estate ROI

Speaker 1 26:00

And they're like, oh my gosh, no, this is and I said that's a 5% return. You're making 5%. Well, it's going to appreciate. You're in California. You're at the top of the last cycle. California is cyclical. What was the last low? You're at the top right now. You're sure you're going to get another 400 grand in appreciation before there's a drop. You want to marry this for another 10 years in lucky. And they're like, oh, we didn't look at it that way and so I have concerns. Now. It doesn't have to be your prior residence, but whenever you pay off a property and you say, well, I don't want a mortgage, I'm going to Dave Ramsey route, I'm not going to have any mortgage on this rental. You're a rent collector for leverages out the window, your ROI starts to plummet.

Speaker 2 26:39

Yeah, it's really hard to win on rental real estate just with all cash. It is Now, right now, when rates are a little high even Grant Cardone's talking about this right now buying properties with all cash but because rates are high and there's a cost of debt right now. But we're definitely fans of leverage. And I had Jaron Bergeson on. He's one of the partners in our law firm Stop Choosing to Be Broke is his book Awesome book. But he made one of the partners in our law firm. Stop Choosing to Be Broke is his book awesome book. But he made one of the greatest comments about when to get debt is when it's an appreciating asset.

Speaker 1 27:11

Hold on At Macy's when they ask you at checkout if you want the card and save 10%.

Speaker 2 27:14

It can be 15% you go for, but at 10% it's not worth it.

Speaker 1 27:17

So Memorial Day special at Macy's, yeah, yeah, or if you get the triple points, points and you do it.

Speaker 2 27:22

That's when you do it, okay. But depreciating assets, like a car loan, he's like. I'm just not a fan of that. A car is a depreciating asset. You shouldn't get debt for a depreciating asset but an appreciating asset whether this is a home or a rental property. It makes sense to get debt and leverage it because now I'm increasing my purchasing power and I'm getting the benefit of the appreciation, not just my cash but the bank's money that's sitting on the property. I'm obviously getting the benefit of the appreciation. Now can we hit mortgage reduction? Can?

Speaker 1 27:49

we transition. That yeah, we haven't flushed it out.

Speaker 2 27:51

Go ahead, let's flush it. I do like mortgage reduction and I don't know if you've looked at this, because Mark and I own a commercial property in Utah that our law firm rents from. We bought this 15 years ago yeah, 14,. 15 years ago we actually assumed the mortgage from someone else. It's an old SBA loan.

Speaker 2 28:07

It's got like three years left on the mortgage. Our mortgage payment right now like $100 of four grand is going to interest because we're on the back end of the mortgage We've held it so long. So that mortgage payment, that payment we send every month, is really just paying down the mortgage. I mean it's. And so this is again why long-term vision on this stuff, my ROI really starts to increase on this and um and so I. I do like mortgage reduction but don't think about it as helping you. Now you have to be like if I'm an owner of this property 10 years, that mortgage production really starts working in my favor because you look at any amortization schedule, now half your mortgage payment is going to pay down the principal versus interest.

Speaker 1 28:52

And I'm going to say this two points. One is I'll just quick definition for those that are still scratching their head You've got your cashflow, your P, your, what is the cost of the property and my rent? Minus those costs, what's my cashflow? Number two how much does this property going to appreciate over time? And third, as I do pay the mortgage, or the tenant pays it for me, the mortgage is going to go down. So I'm building equity without putting any more money in there. That's what we're talking about with mortgage reduction and it's very easy to calculate because you're going to have an amortization schedule that's going to show more and more of that mortgage going down over time. So the fourth benefit will come to taxes in a minute and our opinions on that issue. But on mortgage reduction, matt, one thing that you said that I really liked and I want to reiterate when you analyze a real estate deal, it's at least a seven-year play. I think you really need to say I'm going to hold this at least seven.

Speaker 2 29:40

If you're going to do three to five, you're almost talking about a fix and flip yeah All the transactional costs from the realtor fees to the title insurance and escrow. It's tough to make money in that.

Speaker 1 29:53

Yep, yep, okay. Now tax benefits. This is an interesting one because, as you folks can imagine, we get a lot of phone calls with people I need to buy this rental, the tax benefits are incredible. I'm like, okay, so I'm just going to throw this out. The first thing we do when someone says that is we verify if the tax benefits would benefit you, if the tax benefits are incredible.

Speaker 1 30:17

Those are two different issues, because sometimes a cost seg analysis or the depreciation or some factor on the tax write-offs that year are going to be great, but if you don't qualify for those tax deductions, you're not getting them, and so it makes the whole question of what the tax benefits are irrelevant. So I want to ask my clients are you a real estate professional? Are you doing a short-term rental? Is it a self rental? Because those are going to be different lanes on the freeway where you might get the benefits tax-wise or not. And this is where it pisses us off that we have these cost seg companies that are pushing cost segs on everybody. Clients walk in with a cost seg and, look, I got a hundred grand of depreciation I can take. Yeah, if you qualify, but you don't. You're not in one of these lanes. So first point is be really, really careful, focusing on the tax benefits if you qualify at all, and what they are. And then the third piece I'd like from your point of view is Matt, I don't buy a deal for tax.

Speaker 2 31:17

I don't buy a deal for tax. That's probably one of the most oversold benefits of buying. I buy it for income, like I want to make money on this thing. The tax benefit is another thing down the road.

Speaker 1 31:26

You might be surprised.

Speaker 2 31:27

Yeah, you might be surprised as a tax lawyer. We're not leading with that. That's the last thing here. Now the most oversold thing we get is a lot of high income professionals. Doctors are notorious for this. They go out and buy a bunch of rental real estate and they think it's going to help them on their business or their W-2, and it does nothing for them.

Speaker 1 31:45

Or it does, and then they're stuck with real estate they don't like.

Speaker 2 31:49

Yeah, it's more likely it doesn't help them because they think it's going to offset their business income or their high income, w-2. But here's why I like it. Okay, I do want to say why I do love it. Love tax.

Speaker 2 31:58

Yes, love the tax strategy on this and why I think it's better than what again you can get in the stock market, or even if it's the money market. Let's go back to that same deal. We talked about $400K purchase price and we ran that deal. Let's say we were making $11,556 a year in cash flow on that. We did the 5% rate, so we're getting $11,500 for the year of income. Now that's going to hit my 1040 as rental income. But for the year of income. Now that's going to hit my 1040 as rental income.

Speaker 1 32:27

But there's an expense on here for tax purposes. You get called the big D and I don't mean Dallas the big D. It's a great country song, by the way.

Speaker 2 32:32

Yeah, we've got some big D energy coming in here. Depreciation All right, so depreciation Now. Here's the cool thing on this deal. This numbers just work this way. Now depreciation is a $400,000 purchase price. Let's assume the building percentage of that is 320 K. Okay, cause you don't get to appreciate the land.

Speaker 1 32:48

Take 20% of land off.

Speaker 2 32:49

Okay, divided by 27 and a half years, okay, that's what you get for single family rentals, right, the 320,000, I get a. Depreciated over 27 and a half years that comes out to $11,636. In other, words on this deal of $11,556,. I got $11,556 of cash flow. It's in my bank account. I made 11 grand. I'm going to pay zero taxes. I don't have to be a real estate professional, it doesn't have to be a self-rental. I get it, so it saves me. I pay no tax on the cash flow.

Speaker 1 33:19

Oh, and by the way, on our amortization schedule, because you looked at the 5% first year's interest deduction $15,893. Oof so boom. So now we're cashing in on that. Building this carry forward loss.

Speaker 1 33:33

I didn't even need the depreciation yeah but you're going to carry this loss forward and everybody. I want you to know this too. I mean, I talk about buying rental real estate for tax benefits in my books. But it can be a delayed gratification too, because if Matt wipes out the cashflow on that, the tax on that cashflow, right out of the gate with depreciation, then we've got the mortgage interest deduction, travel, home office repairs, maintenance, home Depot, lowe's, the kids I'm writing off everything under the sun. I might have 20 grand in additional write-offs. And Matt said well, the doctor, do you get that write-off? Well, he didn't get it this year, but he'll get it when he sells. So all those losses carry forward and that passive loss carry forward is extremely valuable. You may not even have to do a 1031 exchange down the road.

Speaker 1 34:19

So I want to be very clear here. I am hopped up on the tax benefits. I want you to extort every tax strategy you can out of this, you to extort every tax strategy you can out of this. But you may not get it this year and you and it may not, and I don't think it changes the equation nine out of 10 times on whether you buy or not Now if you're going after some cost seg on a short-term rental for one year and you've got a long-term plan to do more of that. Okay, I'm listening, but we do not want to let the tax tail wag the dog.

Speaker 2 34:40

Yeah, and I think that even if I could get all those great tax deductions, tens of thousands of deductions and I got these losses on my return, you only buy the property if it makes money. Like you can give money to a charity if you wanted and get a tax deduction, let's not have a rental property that's a charity just so I can get tax deductions. I want it to make me money, which it can do. On this example, we showed it can cashflow. So I'm actually getting money in my pocket. Because of the depreciation write-off, I'm having no taxable income. I'm building wealth through appreciation. The mortgage is getting paid down a little bit now. Over time it could really make a difference. So that's why I'm going to do this deal.

Speaker 1 35:17

Okay, well, mark Cuban, you can do that. I'm going to walk away from this one.

Speaker 2 35:22

Okay.

Speaker 1 35:23

So are you like you can do the deal in the back room at the Shark Tank with these people? Done, done.

Speaker 2 35:27

Done. I didn't want to have to compete on this deal. It's perfect, all right.

Speaker 1 35:32

Well, everybody, we hope this was helpful and lots of, frankly, I think great takeaways. And this is coming from, again, guys that buy real estate, invest in real estate and consult with clients hundreds and thousands of clients every year about this. So please keep up the good fight, continue to please listen to this podcast. And, by the way, our podcast over at Directed IRA is about how to use an IRA to buy real estate. So that's our sister podcast, the Directed IRA podcast. So that's our sister podcast, the Directed IRA Podcast. Please get over there and listen to that. On using your IRA to do the same analysis. We're going to go through the process over there. I'm not going to do the analysis and so it's going to be the sister podcast, and I think doing it in a retirement account is incredible.

Speaker 2 36:18

Yeah. So any of you looking to do this in your IRA or 401k, or roll over an old IRA or 401k to a self-directed IRA to do this? We've I mean, every hour we have a client doing that here. So, um, we'll get over to that podcast, We'll go through the mechanics on doing it and this is the one to just think of the numbers. Should I do the deal or not? There's a lot of reading and education Of course you can do in real estate. We have some other great experts on real estate stuff so you can continue to learn from them.

Speaker 1 36:45

Thanks everyone and I appreciate you being here this week and we'll see you next week for another episode of the Main Street Business Podcast.