Real Estate has five fundamental benefits that make this asset class stand out from the rest. Each benefit on its own is powerful, yet together they make real estate the smartest and most reliable investment you can make.
Real Estate has five fundamental benefits that make this asset class stand out from the rest. Each benefit on its own is powerful, yet together they make real estate the smartest and most reliable investment you can make.
Key Takeaways
Steven Pesavento 00:05
This is the Investor Mindset podcast and I'm Steven Pesavento. For as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And each episode we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.
Steven Pesavento 00:24
And so I want to walk through is the five benefits of investing in real estate? Y'all should know this, for sure. But the question is, how many of you guys are implementing and using this in your life today, my hope is that maybe half of you guys will take some action to make some changes. Maybe all of you guys will do something with it.
Steven Pesavento 00:24
But the first benefit of real estate investing is cashflow. We all know of this, this is where you get that $100 a month on that rental unit that you own. But this is money that's coming to you every single month or consistently. And the more cash flow that you build up, that's, the more you have that ability to be in that position for what I call financial freedom, it's that ability to say, Hey, I'm making more money passively than I am actively. Now, it's a hard place to be when you're looking at $100 a month, versus you're gonna make 1020 30 $50,000 on a commission. The point is, you want to get your investments in a place where those $100 start adding up, or you're investing in much larger assets with much more money. So that, you know, you're able to instantly step into that place where cash flow is replacing your long term upside.
Steven Pesavento 01:48
The other big benefit of investing in real estate over almost any other asset class is the ability to use leverage. And so leverage can be your best friend, it can also be your worst enemy. When you hear about people losing money investing in real estate, it's usually because they were over leveraged, and they didn't have the ability to pay their debt. So anytime you ever lose money in a real estate transaction is when you can't afford to pay the debt. So that's what happened in 2008. A lot of people they had too much leverage, they thought they were safe, the market went down by 40%. All sudden they were underwater, and the banks weren't willing to work with them. So the key to leverage is always having enough money in the bank to make sure that you can keep paying those debt payments on a consistent basis. But the benefit of leverage is that it takes something that you would make, say, in a perfect you know, an example, I'll show you an example here in a second, but an example where you're gonna make 6%. So small return, if you're buying real estate in Denver, things are selling at a three or four cap. And for those you guys who don't know what cap rate is, it is essentially just a measurement of value. So it's like a multiplier effect, you divide cap rate by the income the property produces. And that's how you get the value when you're looking at commercial property. So when you're looking at a duplex, or a four Plex, most of that's valued based on comparables, you're saying hey, this four Plex sold for this, this one sold for that, then I think mine is going to sell for that as well. When it comes to commercial property, it doesn't matter what the other property sold for it's 100% Based on what that cap rate is, and what the income is. So what's good about that is when you understand that commercial real estate is based on income for every dollar of value, or for every dollar of income that you create. Or for every dollar that you save and expenses, it goes directly towards value. And so at a 5% cap rate, which we would be blessed if we could buy real estate in Denver at a 5% cap rate, most stuffs trading a three cap or a four cap and a five cap you're looking at for every dollar earned is $25 in value. So imagine if you increase rents by $100. That is, what is that $250 $2,500 of value times that by 12 months times that by 200 units, you can see that, you know simply 25 or $100 a month in increased rent adds two or $3 million to the bottom line. Now when you look at Denver, we're at a three cap or four cap here, it's radically higher, instead of being $1 equals 25. It's one equals 35 or 40. So there's a big, big difference. And that's what's different about commercial real estate versus residential. But the benefit of leverage is that when you're buying something at a cap rate of 3%, if you paid all cash, roughly you'd make a 3% return. But if you pay with leverage, if you put 25% down, and 75% of that money's coming from the bank, instead of making 3% You're making 15 or 20. So leverage is huge. It's overlooked. It's one of the biggest values of being investor in real estate. But the other big benefit is is the return profile that's going to come from that. So this example you guys can see on screen, what we're looking at is simply the difference between paying 100% cash on the right. And putting 25% down, it's twice the amount of return now, the profit, you can see is about 50%. It's 1.3 million versus 2.5 million, but the return on investment is 54%, instead of 25. So by putting leverage in place by using a loan, right, we make twice as much money, you can go by four times the amount of property, instead of making 25%, you'd make 200 plus percent over those four properties. So this is important for your clients to know. But it's important for you. And since remember, you know, five out of 25 people in the room own real estate. Y'all got to be taken advantage of this. This is where the real wealth comes to play. And because you guys are experts in your market, you're going to know what's going on in these different neighborhoods, you have the ability to be an inside trader, right? If you go buy stocks, and how many people in the room own stocks or on some kind of publicly traded thing, how many I can't see your hands up, my eyes are bad. Okay, so almost everybody in here on stock, it's probably the only place that you guys don't have insider information, right? You're competing as hedge funds, who have billions of dollars, everyone wants to own a piece of apple, but everything about Apple is public. And if it's not public, then it's probably illegal to be making investment decisions based on that. But if you know what's happening in the Colfax neighborhood of Denver, or an aurora or in Highlands, if you know, there's a new development coming, or some new employer, that's going to drive up the value of that real estate. And that's insider info, like other people don't know that we're in California trying to buy here, that's something you can take advantage of. It's something you can leverage for your clients as well.
Steven Pesavento 07:02
The other big thing, almost, there's never really been a time where there's been no appreciation in Denver Real Estate over the long term. It's never happened in Boulder, it's probably never gonna happen. And so there's obviously huge benefit, you got both two types of appreciation, real estate, you have, you know, organic appreciation, property values naturally increase more people want to live there supply and demand happens. And then you also have, where inflation is driving up that appreciation, right? We've been dealing with massive amounts of inflation over the last year, we're seeing that happen in the market, and then with the lack of supply that's driving it up. But the other kind of appreciation that happens is forced appreciation. That's what happens when you go buy a rental property, or go buy a flip, and you renovate it and you drive up, you force that appreciation, you move it from being that crappy house in the neighborhood to the nicest house. And also now you've got value.
Steven Pesavento 08:00
So the other piece Oh, great. Now my clicker works. The other piece is equity growth and loan pay down. Right? So with equity growth, that's where every single month that your tenant pays your mortgage, you're paying down that principal, right? So that's one way to grow equity. We just talked about the second forced equity growth. But over time, you essentially have this little forced savings plan on every one of your properties. that's growing, your net worth net worth is at the end of the day, what is wealth, like you see people who are rich, and they're driving nice cars and are flying in private jets. I'm not against any of that. But that's, that's rich, right? That's not wealthy. Wealthy is where you have net worth, and it's on paper, and it's in the assets you hold. And that net worth of those assets are driving both appreciation, meaning growth in your portfolio, but also cashflow which we talked about first,
Steven Pesavento 08:57
the final piece, and the most important for every single one of you guys is that you're leaving one of the biggest benefits on the table. Because all of y'all are real estate professionals, real estate professional, you know, the I'm not a CPA, you're gonna have to talk to yours button. But my experience, real estate professional is somebody who spends more than 700 hours a year on real estate and is their primary focus and function. In my experience, as well, there's no board that's going to come in and say hey, you're a real estate professional, you're not but if you're focused full time on this business, your real estate professional and my experience, what that means is that you have the ability to write off 100% of depreciation. Right? So for how many people in the room paid taxes last year? Okay, so everyone paid taxes? Well, I just want to let you guys know that was the biggest mistake you guys have made. Because as real estate professionals, you should never be in a position to pay taxes no matter how much money you Make, as long as you invest enough and buy enough assets, you can put yourself in a position to never pay taxes. And so when you hear that you think, hey, well, this guy is talking about tax evasion. Is that legal? Is he being aggressive? No, the tax plan, the reason why it's a million pages long, is because the government is the only way the government can incentivize behavior in its citizens. So it's the only control they have over us to do things. And so the tax plan is essentially a treasure map. If you follow it, you don't have to pay taxes. So all these companies that are, quote, avoiding taxes, or, you know, evading taxes, no, well, the tax map, the treasure map, says, Hey, go do this, go do this, go do this, you don't have to pay taxes. Well, real estate is one of the best tax advantaged assets in out of anything that's available. And so a perfect example, in the type of deals that we do. When we're buying commercial real estate, and it applies to residential as well, when I'm buying a multifamily building, typically, for the investors who invest in the deals we do, for every 100,000, they invest, they get somewhere between 60 to 120% of that initial investment back year one is a passive loss. But because you're a real estate professional, you get to write that off against active income. So what does that mean? That means if you invested 100,000, you're gonna get at minimum 60 to $120,000. Back that you do not have to pay taxes on, right? It's deferred through depreciation. Why is that there, because the government wants to incentivize you to buy and own more real estate, to create more housing, to be able to take care of this problem. So if you're a real estate professional, which all of y'all, all of you guys are, you can set yourself up to not pay taxes. So what does that look like? Okay, well, if you made $300,000, last year, you simply invest $400,000 In real estate, in equity, and you get to write off 100% of the money you made. So what is that if you're in the highest tax bracket that's 40 to 50%, maybe even more when you take in a self employment tax as well. So you might be writing off 50% of that $150,000? Well, now your investment is actually much less, because instead of giving the government that money, you invested it, now you're gonna make somewhere between six to 10% a year, or maybe you're gonna make 15%, like we talked about. And although you, you invested more than you made that single year, you're gonna get that benefit moving forward. Now, you could keep doing it, eventually, you'll have to pay that tax back. But it's at a lower tax rate. And you could never pay that tax back as long as you keep buying and owning more real estate. So it's the whole idea why you here rich people, they buy until they die, they keep buying more real estate to keep eliminating taxes. And then when they die, their family receives that the real estate at a stepped up basis, meaning nobody ever has to pay the tax. So it's one of the biggest reasons why rich people don't pass their wealth through money, they pass it through real estate. It's a big, big thing.
Steven Pesavento 13:17
And if there's nothing else you get away from this, this conversation today, I hope that you'll go invest into some real estate yourself. Now. We're going to talk about passive investing and the benefit of that and why you might want to do that. But you guys have the ability to go buy single family rental properties yourself right now. And you can do a lot of this stuff. It's at a different scale. There's different way to get there, but it's available
Steven Pesavento 13:47
Thank you for listening to the investor mindset podcast. If you liked what you heard, make sure to rate review, subscribe and share it with a friend. Head over to the investor mindset.com to join the insider Club, where we share tools and strategies from the top investors and entrepreneurs and how to take it to the next level.