Use Your Education to “Deal” Your Way into Long-Term Holdings in Real Estate
By: Matt Fagerness
The three primary financial reasons to be a real estate investor are quick cash, long-term wealth, and residual monthly income. In this article, I’m going to focus on quick cash and long-term wealth pursuits because they are closely linked.
Quick cash is your immediate payout from a short-term real estate transaction. These could include wholesale deals, rehabs, lease options, and even foreclosures. Depending upon how actively you are working your business and what kinds of deals you are pursuing, quick cash deals can add up fast, bearing the question “What are you going to do with all of it?”
I like to use a series of levels to illustrate how quick cash is used by real estate investors. Everyone is different, so these are not intended to be across-the-board descriptions, but I think you will see where I am going with this.
Level One use of quick-cash proceeds from deals would be to put food on the table, pay bills, and cover business-operating expenses. For most new real estate investors, I suggest you focus on Level One use of quick cash because this can help liberate you from your current job and empower you to work your real estate business as much as you would like.
Level Two use of quick cash is to follow the middle-class formula and use it to buy “stuff,” creating the illusion of a better quality of life. What I’m talking about here is the bigger house, the new car, etc. Your choice of how to use your cash is entirely up to you and I’m not here to lecture. That said, this is a type of spending that has no long-term value to you and thus, is one with which I suggest you be cautious. However nice it is to show off your newfound success to the neighbors, it does little to promote your long-term success.
Level Three use of quick cash is to reinvest it in appreciating assets. This is standard operating procedure for the wealthy, and is a practice you should give strong consideration to once your business is generating cash. Reinvesting proceeds from your business into other assets (including real estate) is a proven way to long-term wealth and success.
The reality will set in at some point (usually after you have done a few really grueling rehab deals) that you can make a lot of quick cash in real estate using the training that you’ve had, but it also will not make you healthy, wealthy, or wise. True wealth comes from investing in appreciating assets and having your investments and money work for you. Fortunately, real estate does offer this opportunity, but only when you hold onto some of the properties in which you invest. This, of course, begs the question “Where will the necessary money come from?”
One of the easiest and most convenient sources of capital for your real estate investments are proceeds from your own business. “What about OPM?” you may ask. Yes, there are plenty of upsides to using other people’s money, but follow with me here and you’ll see what I’m getting at.
Let’s say you start in the same way as many investors, by wholesaling and quick turning single family homes. This is as common as it is potentially lucrative, so it provides us with a good example scenario. In this example, your current household income is $50,000 per year. In one year, you wholesale or quick-turn 10 properties, representing a total revenue influx of $100,000. That’s a good start, and questions will abound as to what you’re going to do with that money.
A Level One approach to using these quick cash proceeds would be to use them as fuel to replace your current household income, giving you the option of giving your boss the pink slip and/or more time to work your business. A Level Two approach, even though I still don’t favor this one, would result in a new car, a bigger house, and that fancy home theater system, none of which benefit you all that much long-term.
What would happen with a Level Three approach to the same scenario? In this example, you could take a percentage (say 75 percent) of your real estate proceeds and reinvest them in a small multi-unit building. Using your training and your instinct for good deals, you find a four-unit apartment that you can purchase for $350,000, even though the rents suggest a value of $500,000. The approximate numbers for this example are shown below:
Market Value: $500,000
Purchase Price: $350,000
Down Payment: $70,000 (20%)
Mortgage Balance: $280,000
Monthly Pmt.: $3,000
Rental Income: $4,800 ($1,200 per unit)
Monthly Expenses: $600
Net Monthly Income: $1,200
How does a Level Three use of cash affect your overall financial situation? You would still have your base income (at least for now), plus an extra $25,000 a year (leftover deal proceeds) to cover your business operational expenses and put some extra money in your pocket. But it gets even better. You have an extra $1,200 a month in net residual income, an increase in net worth of $220,000, ownership in an asset that is paying for itself, and a legal tax shelter for a large percentage of the revenue your business produced. This is what the wealthy do!
Now, imagine repeating this same process for a few years in a row. Your overall income and quality of life will improve, but only at a pace that works for you since you are in control. You’ll be increasing your monthly income, but more so from the cash flow given off by your real estate assets, which means that you aren’t having to work more in order to earn more. The best part of this equation is that the whole time you are accumulating valuable assets that pay for themselves, you are building for your future. You simply have to love this business!
A simple commitment to reinvesting a portion of the proceeds from your business back into your business can put you on the fast track to long-term success. There’s an old real estate adage that I really like and that applies here: “We buy and sell real estate to create the capital, so we can buy and hold real estate for long-term wealth.” If you practice this in your own business, you will be well on your way to building your own real estate business and creating a life of success and the wealth that you deserve.