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HOW TO FIND, BUY, AND RENT HOUSES FOR WEALTH
By STEVE CHADER, JENNICE DOTY, JIM MCKISSACK, LINDA MCKISSACK, JAY PAPASAN, GARY KELLER
The McGraw-Hill Companies, Inc.Copyright © 2013Rellek Publishing Partners, Ltd.
All rights reserved.
CREATE YOUR PERSONAL INVESTMENT CRITERIA
After reading this chapter, you will know how to:
* Define your HOLD mission and vision.
* Determine your preferred time frame, rate of return, and risk tolerance.
* Understand the importance of a wealth adviser.
FOCUS YOUR MISSION FOR A CLEAR VISION
You are the head of your investment portfolio. And, as any good leader must do, it's up to you to define the mission—"where are we going?"—and vision—"how will we know when we get there?"—for your investment team. In other words, before you decide what to buy, you need to understand why you are investing in real estate. The HOLD strategy focuses on two primary financial drivers to determine investors' property criteria: cash flow and net worth.
Depending on where you are in your financial journey, your criteria may be very different. If you are a twenty-eight-year-old single female aiming to purchase your first home as an investment property, your personal investment criteria probably looks nothing like a couple in their fifties looking for a property portfolio that will afford them retirement in ten years.
For example, let's go back to the $170,000 single-family home you bought at a 10 percent discount in the previous section. In that scenario, you purchased on a 30-year note and in year one enjoyed total financial returns of about $9,859—a rate of return more than 25 percent of your initial investment—and cash flow of $1,200 from the get-go. What happens when you HOLD that property for thirty years and pay it off completely? In year thirty, your property would be cash flowing $17,908 annually, and would have cash flowed nearly a quarter of a million dollars over its lifetime. Your accumulated financial return would be $812,387, and you'd be turning the corner toward $1 million.
Now, if you rewind again, and buy the same property on a 15-year note, what do you think those same numbers look like? It may be surprising that your investment would have negative cash flow until year six. The same rent that generated $100 in monthly cash flow on a 30-year note won't initially cover the higher monthly note on a 15-year mortgage. But, at the thirty-year mark, the property would have been paid off for fifteen years, cash flowing $27,014 annually and would have produced an accumulated cash flow of more than $340,000. Your property's accumulated financial return on investment in year thirty would be $905,065.
As you can see in figure 1-1, both scenarios prove large financial returns, but each has its own path to get there. The 30-year model immediately cash flows and can be used as a reliable source of income year over year. The 15-year model, on the other hand, has apparent up-front risk, as it does not cash flow until year six. However, if you can afford to put money in for five years with no cash flow, you will reap higher financial returns more quickly as you rapidly pay down the mortgage principal and increase equity.
Of course, it is important to remember this is a hypothetical scenario. The main purpose of showing you the side-by-side comparison on this property is to illustrate how different approaches play out. For the record, we do not advise buying an investment property that does not cash flow—and definitely not one that isn't cash flowing until year six.
Let's take a look at some real-life scenarios.
Increase Your Cash Flow
Again, cash flow is money you get from a real estate investment when the rental income you receive is more than the costs you incur, including maintenance, taxes, mortgage payments, and vacancy. When you buy a property right, finance it correctly, and control your expenses, you will achieve a positive net cash flow from the start. And, as rents increase over time, your cash flow can continue to grow.
Jim and Linda McKissack were already in their 40 s and had four children when they began investing in real estate. Significance? They were looking for the fast-cash chance to rebuild their livelihood and eventually secure their financial future.
The couple came up with a plan to acquire 20 houses, financed on 15-year notes, and rent them at $1,000 a month. Since hitting this target, the McKissacks' plans, like most investors', have changed. With all properties performing, the couple's net worth has continued to grow, at the same time they keep collecting extra green each month. Over the years, they've leveraged the equity to acquire more properties—residential and commercial. Funny thing is, with so much financial security rolled up in their real estate portfolio today, they realized both stakes—cash flow and net worth—and retirement is something they no longer worry about.
Cash flow is king regardless of your personal criteria. If you make sure your property cash flows even $1/month from the get-go, you can hedge your bets on having made a good investment decision. But $1 is obviously not the end goal, so here are a few ways to achieve increased cash flow fast:
1. Put more cash down up front.
2. Amortize your mortgage on a 30-year note, for lower monthly payments.
3. Look at duplexes and small multifamily properties for multiple income streams.
4. Buy properties that are steeply discounted (foreclosures).
Increase Your Net Worth
Net worth, on the other hand, is the sum total of your assets and liabilities—what you own minus what you owe. It's the best and truest yardstick for calculating and keeping track of your financial success, and most wealthy people understand this. When you build your net worth, you increase your financial security over the long haul. With the HOLD strategy, you do this by paying down your mortgages and increasing your equity as quickly as possible. The question to ask here is: Where do you want to be in five years, in ten years, at age sixty-five? And, is building your net worth the best way to get there?
Steve Chader's son Matt bought his first investment property before he was twenty years old. With the luxury of time on his side, Matt pursued the HOLD strategy thinking in the long term. However, he still kept cash flow top of mind to guarantee each property a win. He did this by buying at the right price—meaning below market value—so that he made money going in. He financed his first property for thirty years to keep his monthly payments low, and he earned "sweat equity" by doing many home improvements himself. This not only allowed Matt to command higher rents, but ultimately to increase the value of his property—to add to his net worth.
Today, twenty years later, Matt has far exceeded his original net worth and cash flow goals and continues revisiting his plan to aim at hitting new targets. When it comes to upping your net worth, time is an amazing thing to have on your side. But, it's not the only way to increase your overall wealth using HOLD. You can also do the following:
1. Make sure to purchase on shorter amortization notes (e.g., a 15-year vs. a 30-year mortgage).
2. Be willing and able to make improvements to your HOLD properties for hidden added value, or buy "fixer-uppers" with the intent to add value.
3. Invest in single-family homes, which generally have higher appreciation rates than multifamily properties.
4. Accelerate your debt pay down—regardless of your mortgage length.
Stick to the Standards
The takeaway from both Matt and the McKissacks' stories is regardless of your original reason for investing—cash flow or net worth—
Excerpted from HOLD by STEVE CHADER, JENNICE DOTY, JIM MCKISSACK, LINDA MCKISSACK, JAY PAPASAN, GARY KELLER. Copyright © 2013 by Rellek Publishing Partners, Ltd.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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