Welcome to The Get Real Podcast, your high-octane boost and in the trenches tell-it-like-it-is reality therapy for personal, business and real estate investing success with your hosts, power-preneurs Angela and Ron. It’s time to get real!

Angela: Hey, this is The Get Real Show. I’m Angela Thomas and I’m here with Ron Phillips. Hey Ron.

Ron: Here we are, here we are.

Angela: Hey, so today, I mean I’m sure you guys have picked up from if you’ve listened to any of our other podcasts that we really, really like investing in real estate and today we’re going to talk about basically the main reasons why we think real estate is such an amazing investment. So if anyone was wondering about that, here it is.

Ron: Yeah, get ready. Well, and these are only some of the reasons. These are some of defining reasons.

Angela: These are, they’re pretty big reasons though, right?

Ron: They are. And who knows where this goes today. We might, we may throw in some other reasons other than financial.

Angela: You never know. You never know.

Ron: With us anything is possible.

Angela: Yes. So, I mean, what, what is the first thing like when you’re looking for an investment, you know, what is the first thing you’re looking for, Ron?

Ron: Well, the first thing a wise person once told me that the first thing you should always consider when you’re investing in anything is return of investment and then you should look at return on investment. In other words, don’t do something stupid don’t go gamble with your money. Because the first thing is you want to make sure you get your investment back right. You need like the digging to go somewhere and you can’t get it back. Which is one of the great things about real estate because when you, when you purchase real estate you own, you know, it’s not like a stock where you own a piece of a company that could completely go away tomorrow the real estate’s not going away, you know?

Angela: Yeah. That’s a huge thing for me, that you’re investing in something physical that you could see and touch. And I mean, I think that’s, that just feels safer, you know?

Ron: Yeah. I mean, and I think after we get done, people will start to understand that in addition to that, some of the highest returns ever other than maybe creating a business yourself, are made in real estate from all the asset classes. And there’s, and there’s, and there’s reasons for that because there’s four specific returns in real estate, Angela. So it’s not just, it’s not like a stock where you go buy a stock and you get one return and then yeah, it’s funny because I was on, I was on doing a search I was kind of preparing a presentation the other day for some people. And I just wanted to see what the market’s said people made over the last decade right. From the crash to kind of where we are today. And it’s funny because it says that people made, let me, let me just, this is pretty small let me just make sure I get this right. Says that they made 8.6%. That includes the crash and then the rebound, right. But then I went to a compound interest calculator, which is kind of funny, you know, like if you made 8.6% on your money compounded annually what your money would be. And Man, those numbers don’t square very well because there’s this, there’s this other site that actually calculates if you ever money in the Dow, like just, just in the Dow, right. And because that’s what everybody, that’s what it really puts out. That’s the chart everybody looks at, right? If you put $100,000 in September of 2007 right before the crash and then you were looking at June, 2018 your value would be 151,000. Which I mean there’s, that’s not 8.66 right. They will tell you that it was 8.66 because averaged out 8.66 but that’s not really what you made.

Ron: So if you actually opened your statement, yours won’t say, it might even say 8.66 but then it was going to have 151,000 and then if you’re quick with math, you’ll go, that doesn’t work, that’s not right. He goes at 8.66 you should have 229,000 in there. Which is a little, I mean it’s just a little small discrepancy in the numbers, right. So the actual gain over that period was 3.82%. I think I just find it remarkable that an industry is able to just completely lie about the real average. I guess it’s not a lie because it did average over that time, but when you figure the losses and the fact that you’re paying fees the whole time and all that, you don’t make anywhere near 8.66. That’s a complete tangent, but it pisses me off a little bit…

Angela: Well, I mean, you know, even if you did make a 8.66, which is, you know, not bad, compared to real estate, you know, with the same cash on cash return of 8.66, they’re not comparable, right. Because you’re only getting one return.

Ron: Yeah. Not even close, not even close. And I, you know, there may be some people on here don’t know how to figure a return on investment so maybe we should start there, Angela.

Angela: Sure, let’s do it.

Ron: So let’s say you invest 100,000 and that year you get $10,000 in your bank account, right? So that’d be a 10% return because you take the 10,000, you divided by 100,000, which was your invested capital. That gives you a percentage, which in this case would be 10%, right. So anybody listening, if you’re by a computer or you got your phone handy, you want to do a little bit of math, we’re going to do a little bit of math. It’d be a lot easier if you can see it so, you know, maybe you’ll punch some numbers into your calculator or something, or write something down and do it later I don’t know, whatever. Or maybe just trust us that our numbers are right.

Angela: Yeah. That’s the best way to do it. Come on, obviously we know.

Ron: Obviously we know that’s the best way to do it. Okay. So let’s talk about, let’s talk about cash return, right. And I think maybe, maybe we should start also with the fact that when you buy real estate, you can leverage it. And before somebody makes some comment on here about how you can leverage options within stocks. Let’s just out of the gate, understand that 90% of the people who go buy a house don’t pay cash for it like they do stocks, okay they get a mortgage in addition, let’s just get out of the way that when you buy a stock on an option, nobody’s paying it off for you and in real estate, they are, I mean, there’s just a few things like that, right. They’re not apples to apples.

Angela: Sounds like there’s another tangent in there.

Ron: There may be, there may be.

Angela: So we’ve established there’s four returns in real estate investment. Is there any other investment where you get four returns?

Ron: None that I’m aware of.

Angela: Yeah, me either. So sorry you were going to say the first return and the one everyone thinks about is cash flow, right?

Ron: Well maybe somebody can enlighten us, right. So I mean if someone else out there knows of another investment that provides four different returns.

Angela: Please let us know.

Ron: Like put it in the comments, just put it in there but first, first like our episode and share our episode and then you know, put it in the comments so that we know what this other investment is because that would be fantastic.

Angela: Yeah help us out, we’d love to hear about it.

Ron: (Inaudible) in there because we all know that’s not true so don’t do it. Okay so the first one is cash return and that means I put cash in or in other words I put like 20% down on a property and then I pay all my expenses and my mortgage and all that stuff and I have cash flow leftover and I take that cash flow that’s left in the bank and divide the cash flow by the amount of money I put into the property. So in our example, we have $160,000 house we put 20% down, which is $32,180 we’re going to round it off to 32 okay, so 32,000 bucks we’re going to put into this property, okay, so we’re not going to do our calculations on the full price of the property because that’s not how much money we actually put into the property.

Angela: It’s crazy how many people get that mixed up like they think about the return on 100 and what did she say it was 160,000 not on their 32 but you only put in 32 that’s important to remember.

Ron: It’s very critical on all of these returns incidentally.

Angela: Everything we’re…

Ron: If you do it on the full cash amount, it’s called a cap rate. It’s not called a cash on cash returns it’s called a cap rate and you use that a lot in commercial real estate, apartment buildings and things like that, okay. But on this little house, we’re not going to do that, okay. So today we’re going to talk about that and, and let’s just, and this is a real property. So here we have this $32,000 that we’re putting into the property at the end of the year we’re leftover after we pay principal interest, taxes, insurance, property management fees, maintenance, vacancy, all of our stuff. We’ve taken all that stuff out. We’re left with about 4,600 bucks. Pretty good deal. Probably isn’t going to change anybody’s life overnight there with 4,600 bucks, you know you go on vacation with that somewhere.

Angela: That’s a Disneyland trip if your on the West Coast.

Ron: Yeah, I mean, unless you get crazy, okay. If you take $4,605. So if you’ve got your calculator handy to take $4,605.00 and then you divide that by $32,000 it’s going to give you roughly 14%, okay.

Angela: That’s 14% cash return.

Ron: Cash returns. So that means I got, I put cash in, I got 14% of my money back first year. Now that doesn’t mean that we, the rest of our money’s is not accessible because it’s in the property, but we could sell it and get the money back out, okay. So that’s, that’s number one and 14% return. If that’s the only return you got it’s pretty good.

Angela: Yeah, definitely.

Ron: At least two times what you get in the stock market, unless you’re day trading. And then, you know, I know a lot of day traders that say they, they say they make a lot of money and that’s just because they don’t tell anybody when they lose a whole bunch of money.

Angela: You only hear about the wins.

Ron: Yeah. On Facebook they only put out there that you know, hey I bought this one stock and it was killing it, whatever, okay. But don’t tell them about the five that you know, ate your shorts last month either.

Angela: No one wants to hear that right.

Ron: Second return Angela is what?

Angela: Tax Breaks.

Ron: Tax Breaks now…

Angela: And you need to put a disclaimer in here…

Ron: You can count on this audience out there, we’ve already like dissed the government a few times in this show maybe we should stop doing that otherwise they’ll audit me or something.

Angela: Oh man, don’t say it out loud.

Ron: I said it out loud. I don’t know. But in this particular instance, they actually do provide and we can’t count on it because they could take it away anytime. But I kind of doubt that they will because the reality of how government works is that the people who are in charge well they all own real estate so it’d be really, you know, self sacrificing for them to eliminate this as a perk. So, but when you own rental properties, you get to depreciate the structure off of your taxes over time. It’s fantastic, right. So they allow you to do that on a residential property over 27 and a half years, that’s about 3.6% per year, okay. So on this hundred $160,000 house, we get to write off 3.63% so if you put that in your calculator, put a six what’s actually not $160,000 because you have to take the land out.

Angela: I was going to say, it’s only the structure, not the land.

Ron: Because you can’t see any of this and it’s going to get really complicated with numbers your just going to have to believe me that after you take, and this is a Midwest house, so it’s basically an 80/20 rule. So take 20% off for the land, 80% for the structure and then you multiply that by 3.6% you come up with a number. If you multiply that by your tax rate, ultimately get to have about $1,100 almost $1,200 off your taxes, which is, I mean, that’s fantastic, right.

Angela: Yeah you’ll take it, right.

Ron: And some people don’t even think that’s a return, but it is because otherwise you would have had to pay that on your taxes.

Angela: I don’t want to get more complicated here, but I know that these tax breaks don’t apply to everyone. When do you not get those, do you know? Well I know it kind of depends on things but.

Ron: It depends on the year and it depends on whether you’re a real estate professional. Depends on a lot of things. But there are some places where you start to make too much money and the government says, well, we’re going to phase that.

Angela: Too much money I hate it when that happens.

Ron: And the arbitrary too much money is we don’t have enough time for me to go on that tangent today. Don’t, don’t try to bait me into, you know, just government anymore.

Angela: You’re blaming me for that. Wow.

Ron: You just did it so.

Angela: That was the first time I can think of. Okay, well moving on then.

Ron: It was like the 4th time Angela. So the third one is, and this is one is really overlooked to Angela. I mean I don’t think very many people think about this at all.

Angela: This should be one of the first things you think of with a rented property I think.

Ron: I agree. It just silently sits out there and makes you money it’s fantastic. And that is principal reduction, right. Because we’ve used a mortgage purchase the property and incidentally right now mortgage rates are crazy low. I bought my first property, the interest rate was eight and a quarter.

Angela: Yeah. I remember my mom saying, her first property was 14%.

Ron: Yes my parents first property was 18% I can’t even believe people bought houses at that price.

Angela: Yeah. And they cost less to.

Ron: Well so I think on in this one, when you’ve got somebody actually paying off your property and you’re not doing it, that’s another thing you know, when you’re comparing this to a stock, I mean, you can’t go ask your stockbroker to buy a stock on payments over 30 years at a fixed interest rate that’s ridiculously low. And oh by the way, I need somebody else to pay for it.

Angela: And then their going to pay off your loan for you and just…

Ron: Yeah, just somebody, I need somebody to just, you know, want to hold onto my stock for a little bit, pay the payments on it, and then just give it back to me when they’re done with it, right.

Angela: Having a, having been in real estate and worked with you this long, it’s crazy to me that, you know, people just look at the cash flow number and don’t think about the fact that they’re not paying their mortgage and it’s actually going towards equity, right.

Ron: It ends up being a pretty decent return. In this example, first year principal reduction would be $1,892 so almost $1,900, right.

Angela: And the first year is a lot of interest. So that grows over time, right?

Ron: Yeah. So the return continues to increase over time, but the, but that return is still, if you get, if you got your calculator out, you put like $1,900 divided by $32,000.

Angela: Your initial investment, your down payment.

Ron: You’re going to get almost 6%.

Angela: Not too shabby.

Ron: Which we just learned is better than what the stock market did over the last 10 years, even with it’s crazy run up, right. Just in principle reduction. And I think the reason that most people don’t think about this one is because they don’t get the cash in their hand.

Angela: Right you can’t see it.

Ron: The people that we help, Angela, just like Carol recently, and Jane and all the other people that we’ve helped do 1031 exchanges, which is a tax deferred exchange by the way, where you sell your property and it’s another way that you can not have to pay taxes, which is awesome. It’s not true. Let me just, somebody’s going to make a comment that you do have to pay taxes eventually and yes, that’s true. Your tax, you’re deferring the taxes later. And then if you set it up properly, your kids can get a stepped up basis. So let me, let’s not get into a big complicated thing because somebody wants to make a post about it, but…

Angela: Or we can do another show on just that.

Ron: We’ll do that on 1031 so that’s great. But what they learned is that. The equity gain they’ve had over the last four or five years is massive because people keep paying down their principle. So not only did they have appreciation on their property, which is, you know, spoiler alert, that’s the fourth one. They also had people paying off their mortgage. So when you go to sell your property and harvest the equity and put it into more properties, that’s probably when you’re going to see this a lot more because it’s not cash in your pocket just yet.

Angela: And you’ve probably seen it even with personal homes. I know when I had my townhouse back in the day, I lived in it for like a year, year and a half, it wasn’t that long. But I, I mean, I didn’t, when I sold it, I didn’t just get back my down payment. I had a nice little hefty bonus in there. So you know, you…

Ron: So how cool would it have been if somebody else made your payments the whole time.

Angela: I know, I know, then it would have been even bigger, right.

Ron: It’s fantastic. It feels better anyway when you didn’t have to pay for it.

Angela: Yeah it’s awesome. So, yeah, so when our clients sell their rental properties that they’ve held, you know, even for a couple years, um, you know, the amount that they have to reinvest is, is impressive so.

Ron: It really is. I mean, that one just happens all the time. So that’s not…

Angela: You don’t worry about it.

Ron: Nothing has to happen to the market for that to happen. It just happens. It just sits there quietly happening all the time you know. Fantastic.

Angela: Awesome. So fourth return, appreciation. We never count on this, right?

Ron: Yeah. I mean, this one is, obviously this is completely dependent on the market and it could be depreciation, right? You could, you could have a return that’s negative here. And I just was beating up on the stock market, but everybody knows the real estate market did the exact same thing. It went, you know, in the crapper before it came back. The difference though, I think is that when the real estate market goes in the crapper and you have depreciation, if your property’s cash flowing and your still getting 14% cash return, you’re still getting a 6% return from principal reduction and you’re also getting tax breaks. Your property’s still returning at big double digits at this point, and it doesn’t make any difference if you have appreciation because the market’s going to come back at some point and then you’ll have appreciation.

Angela: You just don’t want to sell if it depreciates, you just wait, you just continue to collect your other returns.

Ron: And the same thing with the stock market. If you hold your stuff, you hold your stocks too long in the market takes a dip well don’t sell and lock in your losses that, that’s dumb. Same thing with real estate, right. So don’t sell them.

Angela: It’s just because the fear of losing is more powerful than the, you know, anticipation for gain, right? You’ve got to fight that.

Ron: This one is really powerful on the return side though, because if you just get a small little bit of appreciation, because you get the appreciation on the full value of the property, you know, so we used 5% on this particular property it’s a $160,000 property. If you use that on just a 5% appreciation, which is not that much, that’s only $7,550 right, so $7,500 bucks. But if you get your calculator out again and you do $7,500 divided by $32,000, you’re going to get over a 20% return.

Angela: That’s crazy.

Ron: And this is the one that really boggles people’s mind. They’re like, how do you get, how do you get a 23% return when you really only got a 5% yield? And again, I just got to bring everybody back and go, okay we got 5% on $160,000 right. But we didn’t put $160,000 into this property we only put 32,000.

Angela: Yeah, that is mind boggling.

Ron: That’s why the numbers are so powerful. They’re staggering. If you add them all up, I mean, and this is, this is not that crazy of a, of a case study, it’s a real property. Not that crazy of a case study appreciation actually was a little bit more than that. But you add all of this up. It’s a $15,000 return on investment. $15,000 in one year. Now you didn’t get all 15 in your pocket. The appreciation sitting there in the property, right and so is the principal reduction there all sitting in there in the property. The other two you did get in your pocket, okay. But when you divide, get your calculator, you don’t even need your calculator for this one. I don’t think it’s $15,000 divided into $32,000 that’s almost half. It’s 47%.

Angela: It’s crazy. And those, when we show people those returns on, you know, a pro forma, they, they’re really hard to believe. Which is why it’s so important to understand these four returns so you realize how we got there.

Ron: And then you know, if you’re familiar with the rule of 72, I mean, if you still got your calculator handy, the rule of 72 is really simple. You divide your return into 72 and I didn’t do this, so I’ve got, if you, if you got me on the video here, I’ve got my, I got my phone out just like I told you guys to do. What are some of these returns? So one of them was 14% so at 14% you divide that into 72. 72 divided by 14, that’s five years. That means your money doubles just on that one return doubles every five years, which is pretty cool, alright. And if we add the 6% to it, that’s 20%, right. So we got to do 72 divided by 20, that’s 3.6 years. And then we add the other one. What was the, what was the taxes Angela, do you remember?

Angela: The taxes were 14.3, oh no, that’s the cash flow sorry. A return of 3.6.

Ron: Okay. So we’re like 20, well, let’s just call it 25 for giggles. So 72 divided by 25, 2.8 years. Every, I mean it’s just a little crazy. And then we’ve got 47 right? So let’s just, let’s just do something…

Angela: Just for fun. If you got all of them.

Ron: That means every 0.6 years. So if we bought it in January, then in by August we would have doubled our money.

Angela: Awesome.

Ron: So why, let’s talk about why we don’t count appreciation because this is really important. And a lot of people back in like 2006, 2007, they pretty much, they only bought it for appreciation because it’s a sexy number as we just went through. It’s, I mean, it’s impressive when you can make it…

Angela: It’s the most fun after cash flow really, right? It’s exciting.

Ron: Yeah. I mean, when the, when the market is going up at 40% per year, it’s hard to not get excited I mean it just is. But we can’t lose our brains because I remember, I remember back in 2006 or seven, I think it 2007 beginning of 2007 I’m out in California at an event and I’m there to sell real estate in the Midwest. And you know, our appreciation rate was like 4%, four to 6% you know it’s pathetic.

Angela: Boring, boring market.

Ron: It’s horrible, right. So I go out there and everybody’s selling, everybody wants a appreciation everybody. So I get up there and I do this. I mean, I did, I mean, I’m going to patting myself on the back, but I did a pretty good presentation about why you want to buy in the Midwest in the market that I was there presenting about, right.

Angela: Yeah. I’m sure you did.

Ron: Well I mean, it was really good. You know, nobody really got up, came to my, I have a little booth in the, you know, out in the hall and then this dude gets up, next dude gets up and he’s from, like he said, from some town in Florida, I can’t remember what it is, Port Saint Lucy or you know, Port Charlotte port something. And he gets so everybody’s dressed up except this dude, he looks like he’s from Florida. He’s in like shorts…

Angela: Permanent tan.

Ron: Shirt unbuttoned like down like halfway down. He just looks like he’s from Florida. No offense to any people from Florida because I actually am that way quite a bit now that I live in…

Angela: It’s kind of a fun look anyway. You know he likes to have a good time.

Ron: I don’t know that I would go that look for a business presentation.

Angela: No me either.

Ron: But it seemed to work for him. He went up there and instead of like giving all the statistics of why anyone should want to like invest in that market or in his product or anything like that. He just got up there and he said he put the microphone up to his mouth and he says appreciation, appreciation, appreciation and then he put the mike down and he walked off the stage and I thought, and like half the place stood up, half the place stood up and they go out to his booth and they’ve got this guy mob. He doesn’t have enough properties for these people. So the people are there trying to like shove themselves up to the front so that they can get some of this. They don’t even know what it is.

Angela: He just says appreciation and they run.

Ron: They don’t even know what it is. It was the most, it was the craziest I’ve ever seen in my life and it was a lot of people. He ran out of properties immediately. I mean it was nuts Angela. And all of these people, like a year later, I mean some of them probably didn’t even have houses because they were building these things new and the builder was just taking the money. I mean, it was just a, it was such a joke. Never buy only on appreciation, that’s what all these people did. They lost all their properties and then…

Angela: Weren’t a bunch of them like cash flow negative. I mean most of?

Ron: Oh yeah, all, every one.

Angela: Every single one, wow.

Ron: Yeah. I mean, they were buying $350,000 houses and the rent on the house is, you know, 15 to $1,900. And you can’t, there’s no way on in the earth you can make those numbers work. But most of those people never even got a tenant in the property. Most of them didn’t even get a property built because everything fell apart before that. Which is really unfortunate. And the ones who did get their properties built, I showed up in 2009 and bought them at the auction for 35,000 instead of $350,000.

Angela: I was just going to say that. Then we swooped in and yeah.

Ron: Which was some of the most fun I’ve ever had in my whole life. You know, it was phenomenal. Like everyday in Florida, in one county, in Florida, there are 200 properties going to auction every day. It was nuts. It was equally as nuts as the craziness that happened and before that in California. So we, that’s just the reason why we don’t, we just don’t count appreciation.

Angela: It’s an amazing return, but we don’t count on it, right.

Ron: Right. When it happens, you take it off the table and then you go in and you 1031 it somewhere else. We’ll do a show on that some other time about 1031 exchanges. But yeah crazy.

Angela: Cool Ron. Well that’s just, you know, part of the reason we’re so passionate about investing in real estate. So, yeah, thanks for, it’s crazy it really is. If you guys want more detail on this, we have, we’re going to post a video on GetRealEstateSuccess.com. You can check out the video that kind of shows you this on a Whiteboard. I think you did on Whiteboard, right?

Ron: I did yeah.

Angela: So you can actually watch Ron do the math there live, so that might help. And we also have a blog post about it on our other website, RPCInvest.com so feel free to check those out. Also make sure you go subscribe to our podcast. So you don’t miss out on any other topics.

Ron: Share it with all of your friends and like it and all that. I don’t think there’s a love button.

Angela: Love it if you can.

Ron: When you like it, if you’re feeling love when you like it, we will feel it anyway, I think.

Angela: Exactly. So thanks for listening. We’ll see you next time.

 

This has been The Get Real podcast to subscribe and for more information, including a list of all episodes, go to GetRealEstateSuccess.com.

Angela and Ron are focusing on the financial reasons they are so high on real estate investing. The 1st thing to understand is return OF investment; the 2nd is return ON investment.

With investment in real estate, you actually own something tangible. That’s different from owning stock, which means you own a small portion of a company. Owning property brings return OF your investment.

Return on investment (ROI) is the percentage you receive over and above the dollar amount you put in. Stocks, bank accounts, real estate (basically all investments) report gains this way.

Angela and Ron take you through a case study of a $160,000 rental house in the Midwest. It’s a little tricky without seeing the calculations; just listen carefully and explore again on RPC websites shown below.

There are 4 returns on rental real estate: cash flow (cash on cash return), tax breaks via depreciation, principal reduction (increases your equity gain), and appreciation (dependent on the market).

Since it’s so variable, RP Capital doesn’t include appreciation in its pro formas. Appreciation is not a reason to buy property… remember 2008, 2009. While appreciation can be an incredible return, you simply can’t count on it.

And remember—someone else is paying the mortgage on property you own. And, don’t forget: when you sell, you get your entire investment back plus the lump-free gravy!    

What’s inside:

  • Learn about the 4 returns on real estate investments
  • Cash flow is generally the greatest of the 4 returns
  • Be wary of buying property based on appreciation
  • See below for ways to get more info about the case study after listening.

Mentioned in this episode:

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