Latest / Cash Flow for Life / Chapter 20: Sustainable Growth
Transcript
- 01;00;01;05 - 01;00;32;02 Part three Creating a business. Chapter 20. Sustainable growth. Diversify. Diversify. Diversify is the mantra of many financial investment advisors who work with clients in the stock and bond markets. Diversification of your real estate portfolio is also a goal because it reduces risk and can enhance your ROI. Now that you have a foundation in how to purchase and manage properties and work with tenants, you'll want to grow your business. 01;00;32;04 - 01;01;00;03 When you are taking that rent check to the bank, you'll be thinking about how great it would be to take several of them for our rental property investment business. Diversification can take three main forms property type, geographic location, and cash flow types. There is no rush to build your investment portfolio, but developing a diversification plan ahead of time is a great goal at this point. 01;01;00;05 - 01;01;30;03 Property types. You'll want to purchase different types of properties in order to offer a broader selection to prospective tenants. This selection could be about the property type itself, or every bit as much about different rental costs you can offer. Due to your cost of ownership, condominiums, we've discussed condominiums and the way fees work. Generally, the exterior maintenance and landscaping are included in the condo fees, so your ownership maintenance expenses will be reduced. 01;01;30;06 - 01;01;56;28 Also, some tenants like to rent where there are common areas, possibly even a clubhouse and pool. Single family homes. Most of our discussion has used examples of single family home purchases and rentals, because this is usually the way new investors get their feet wet. Single family homes may end up being the dominant property type in your portfolio, but consider the other types of properties as well. 01;01;57;00 - 01;02;29;08 Duplexes and triplex. Economy of scale in purchase and costs enters into these property selection decisions. Having 2 or 3 units in one location and under one roof cuts maintenance and purchase costs per unit. This usually translates into lower rental amounts that attract the other strata of tenants. Geographic locations. Early in your investing business, you'll be unlikely to want to invest outside of your city, but that could come later. 01;02;29;11 - 01;02;54;05 Early on. Just make sure to look for opportunities all around the city. Diversifying your property holdings by buying in different neighborhoods with different rent points. All people are different and their needs and desires for housing are different as well. They could select housing based on proximity to work or play, and most of them do consider rent amount as an important factor in their decision. 01;02;54;08 - 01;03;11;13 By purchasing different types of properties in different areas, you'll appeal to a broader base of renters and be less likely to suffer losses in one area if it trends downward or has softer rents, because another area will make up the difference. 01;03;11;15 - 01;03;38;05 Cash flow types. While our major focus is on long term sustainable cash flow, there are other opportunities for profit and cash flow in real estate investment. Some of them may present themselves to you in the course of your market watching. In our experience, there are three common types of investment opportunities. One. Cash flow rental. The focus of our courses. 01;03;38;12 - 01;03;56;05 This is the property that generates solid cash flow for you. Two rental property flip. You can make such a good deal on a property that you can turn right around and sell it for a profit, well, over the cash flow you have received over the first year or two. 01;03;56;08 - 01;04;20;23 Future development potential. You're purchasing the property with an acceptable, although not necessarily great, cash flow. However, it has the potential for future renovation or development that will significantly increase its value. In most of this book, our focus will be the cash flow rental property. But let's take a moment to look at the other two opportunities we just talked about. 01;04;20;26 - 01;04;53;12 Rental property. Flip. There are people who make this the focus of their real estate investing business. They locate properties that aren't renting out to their potential due to condition or just below market rents. We often call these underperforming properties. They buy a property, renovate it, and do whatever else they need to to increase rents. Once the rents are higher, the value of the property is greater and then they sell it for a profit, often to another investor. 01;04;53;14 - 01;05;18;21 Underperforming rental properties provide a lot of potential, because the value of the rental property is determined in large part by the income they generate. Locating a property that can be improved or otherwise changed to increase rents will increase its value. Some landlords, often the older owners, may have tired of tenant turnover and the management chores associated with that turnover. 01;05;18;24 - 01;05;46;22 Frequently, they'll be charging lower than market rents in order to keep tenants and avoid the work of turnover. Future development potential. Many of you reading this book may not be interested in doing any development of a property. However, if you recognize potential, you'll understand that the value of a property can increase with changes in zoning or with population growth in an outlying area of the city, or with land use policy changes. 01;05;46;24 - 01;06;10;00 So you may purchase a home in a newly developing area and accept lower cash flow. Now in exchange for the probability that the development is moving. That way, you'll be able to sell later at a nice profit. Or you could actually purchase a large home, as we discussed before, and split it into multiple rental units at some point in the future. 01;06;10;02 - 01;06;18;21 It may only be a plan for the future, but you have recognized the potential and that influences your decision to by. 01;06;18;24 - 01;06;42;21 Resale due to surrounding development. An example of this would be an older house on 2 or 3 acres of property in the outskirts of town. You go to the courthouse or municipal office and do some research on zoning and population growth and movement, as well as checking out how developers are building more in that direction by creating new subdivisions with tinier lots. 01;06;42;23 - 01;07;02;28 Your research indicates that it shouldn't be too long before development reaches that house, that property and builders will be willing to pay a pretty penny for the land. That could be multiple small lots with houses on them. You're still realizing some positive cash flow with the property, though you could have done better with a home closer to town. 01;07;03;00 - 01;07;21;08 However, the chances are excellent that you'll be able to sell this property in a few years for a nice profit. That will be much more than the cash flow you could have generated in other investments. Now always be careful. This is a speculative investment move. The safe bet is to always go for as much cash flow as you can. 01;07;21;12 - 01;07;43;09 But once you have a few properties in your portfolio, sometimes it's okay to diversify. Take a little bit of a lower cash flow for this speculative opportunity in the future. Addiction to buying real estate. Hey Scott, I know we have two already, but it's going so well. Let's look for a third house this year. I'm with you all the way, Michael. 01;07;43;10 - 01;08;10;04 I love this cash flow thing. We were so happy with our first two home purchases that we jumped right into the third in that first year. It was almost too much. And we definitely felt the strain because both of us were working as well. Three properties in a four month period for two new investors was maybe not a good decision, and we don't recommend it for most people unless you have a really, really strong support group. 01;08;10;06 - 01;08;33;26 But we fell in love with real estate and you probably will as well. The trick is to not become too addicted to the point that you make decisions that grow your business too quickly, or you make decisions based on emotion. Instead of loving the numbers, buying properties and seeing the cash flow coming in is a strong motivator. But you need to control the urge to multiply your results too quickly. 01;08;33;29 - 01;09;00;23 Using leverage, you can also grow your business too quickly, increasing your risk of financial pain due to economic cycles. Think of the word sustainable growth rate and that is something different for everyone. You have to think of the growth rate that works best for you, your resources, the time you can dedicate your emotional stamina, and all of the different factors that are involved with renting out real estate. 01;09;00;25 - 01;09;27;29 When you know you're addicted. One of our friends recently became a landlord. I toured the place he's renovating and noticed a mattress in one of the spare rooms. When I asked him about it, he said that he had been sleeping at the property many nights because he was finishing the renovations late. You know you're addicted. If you're spending a lot of nights sleeping in your properties as you're renovating them a night now and then might be fine. 01;09;28;00 - 01;09;48;23 I've got to say, I've done it before, but sleeping there most of the week could signal an addiction, and if you have a family, it could bring about other problems. We are addicted to real estate and we could a minute. The trick is to manage your addiction so that the rest of your life is in some kind of balance. 01;09;48;26 - 01;10;11;19 Don't quit your job yet. You're watching TV and you see an infomercial with a new investor saying, I bought this real estate investment program a year ago, and I already own 27 houses and 13 apartment buildings for portfolio valued at $6 million. Well, it could be a very inspiring and even true story. Don't quit your day job because of it. 01;10;11;22 - 01;10;38;03 It's more than likely not completely true, and you need to understand that few investors go full time that quickly, and nobody, nobody does it overnight. Don't buy that first property or two and say to your boss, take this job and will you get the point? Reduce anxiety by keeping your job. There is still a learning curve involved in the ownership and management of your first few properties. 01;10;38;05 - 01;10;59;07 You want to do that learning curve with as little as possible. Keeping your job will give you a cushion that will allow you to sleep soundly at night. But I hate my job, you might say. Some people gravitate to real estate investment because they want to get out of the profession or job that they have hated for a long time. 01;10;59;09 - 01;11;18;10 It's a great goal and one that can be achieved. However, you may find that generating more and more rental property cash flow can actually make you like going to work and make your job a little more enjoyable because you don't really have to be there. Few people will quit a job that's supporting their lifestyle and spending for a job with lower income. 01;11;18;12 - 01;11;43;15 For example, why would you want to quit a 5000 year job when your properties are generating not even half that in cash flow? Real estate investing is a process. It's long term, and before you quit your current job, you want to be totally assured that your real estate investing business will not only support your current lifestyle in spending, but also grow and add to your net worth in the future. 01;11;43;17 - 01;12;06;25 Your job has another role. It's very likely that your current jobs income will continue to be necessary in order to qualify for mortgages and lending. As you grow your rental property inventory. While rental income is often considered in mortgage qualification, a steady salary almost always trumps it and value to the lender. 01;12;06;27 - 01;12;40;09 Avoid overextending yourself. Overextending yourself can be seen in two ways financially and in the availability of time. We've seen investors who grow too quickly reach an unsustainable growth rate that runs them out of both time and financial resources. Some will stop, but others will try to hammer through this perceived barrier. And sometimes it can bring disaster. Here are some quick rules to help you avoid overextending yourself as long as you have vacancy. 01;12;40;14 - 01;13;11;14 Don't buy another property. Fill all vacancies before considering another purchase. If your vacancy rate across all properties is 20 to 30%, consider selling a property or properties with the highest vacancy rates. Reallocate your resources, sell high vacancy properties, and buy in lower vacancy areas. Vacancy rates of 20 to 30% can indicate that you are overextended, or that the market isn't supporting future growth. 01;13;11;16 - 01;13;35;18 This usually requires you to cover some of the mortgage payments out of the income from your job. Warning bells are going off and you need to heed them. You might want to consider selling off one or more properties to get on a more secure financial footing first. Build cash reserves. Just because it's coming in doesn't mean you should be letting it all go out. 01;13;35;20 - 01;13;59;21 Have some fun and reward yourself, but be sure to build up some cash reserves when you have an unexpected uptick in vacancies. Those reserves can carry you until you can take action, fill the units, or sell the property one property at a time. We would advise you to buy only one property at a time for most of your first few years in this business. 01;13;59;23 - 01;14;17;02 This is especially true if there are going to be renovations required before a property is generating cash flow. You'll have a negative cash flow during the renovation period, and you don't want to multiply that negative cash flow across multiple properties at the exact same time. 01;14;17;04 - 01;14;42;15 The safest rule to apply is to never buy another property until the previous one is rented out, and generating a positive cash flow. It's simple. A red flag to alert you to possible. Trouble is when you're making decisions based on estimated or projective incomes and rental cash flows, instead of the actual occupied properties and real numbers. Discipline in financial and management practices. 01;14;42;18 - 01;15;07;05 Rule number one is not to buy just because you qualify. Real estate agents and mortgage brokers make money only when you buy something, so their general goal is to make that happen. Their goal isn't always your goal, so resist any temptation or pressure to buy just because you can manage what you have. Make it good. Make it efficient before you add to your inventory. 01;15;07;07 - 01;15;34;18 It's easy to get caught up in moving forward and growing your business, but beware of dropping balls in the management of what you're already own. Don't ignore the needs of your current properties from a management and maintenance perspective. Manage your credit lines as you grow, you'll use leverage and have various loans and credit lines outstanding. Always seek to minimize and pay down debt with the highest interest rates first. 01;15;34;21 - 01;16;02;23 It can be a much better decision to take the proceeds of a property sale and pay down some high interest debt, than to take on debt to buy one more property. Just apply our top ten rental practices. Number one. Do not overextend yourself. Don't over leverage to buy properties and always manage your expenses. Ask yourself if you could cover your costs if the property is empty for a couple of months. 01;16;02;25 - 01;16;36;23 Two. Use good agreements, forms and leases. Do your research and adopt forms that are legal and clear and that protect your interests. Resist the temptation to grab one off the shelf at the office supply store. Work with a qualified lawyer or attorney whenever needed. Three. Always properly screen tenants. All of those credit checks, interviews, references, and employment calls are absolutely necessary to avoid problems and evictions. 01;16;36;26 - 01;17;10;23 For late rent requires prompt action. Whatever your laws and lease terms, follow them to the letter and promptly. Five. Keep your property 100% safe at all times. This is a liability issue, but you also never want to experience an injured tenant if that can be avoided. Six handle security deposits properly. There are laws to follow here, and you want to carefully follow the lease agreement terms as well. 01;17;10;25 - 01;17;39;07 Seven. Always provide notice before entering. Learn the laws in your area for how often you can access the property and the notification timing that must be made to the tenant before entry. Eight disclose environmental hazards. You don't want to experience the huge fines and possible legal actions involved due to failure to disclose hazards such as lead based paint and mold. 01;17;39;09 - 01;18;18;07 Nine playing contingencies and budget for damages. Set aside security deposits and rent amounts to fund anticipated damage and cleaning requirements. Ten resolve disputes issues with the tenant should always be resolved without attorneys or lawsuits, if possible. It's much cheaper and easier to give a little in a disagreement than to go to court. Just paying attention to what's in this chapter will help you avoid overextending yourself, and the financial or life problems that result from an addiction to real estate, or from growing your business too quickly. 01;18;18;10 - 01;18;55;15 Action steps. One. Look back at the goals you developed early in this book. Put some more thought into sustainable growth plans and how you can avoid overextending yourself. Two. Start a diversity plan for property purchases by studying your market area. Look for opportunities to diversify your property inventory into multiple asset classes. What's next? We'll deal with the formation of your business and the protections and tax trade offs of incorporation versus other business formations.