\n<\/p>\n
Real estate investing <\/strong>is known for one thing: cash flow<\/strong><\/a>. No matter who you talk to, investors always seem to be hypnotized by this single metric<\/strong>. Rookie investors love to chase after cash flow and cash flow only\u2014often completely disregarding the much more lucrative benefits of real estate investing for the shiny object of monthly profits getting deposited into your account. But, if you\u2019re buying, analyzing, and negotiating deals based on cash flow only, you could be making a huge mistake.<\/strong><\/p>\n In the new book Real Estate by the Numbers<\/em><\/strong><\/a>, Dave Meyer <\/strong>and J Scott,<\/strong> both veteran investors in their own regards, give you the numbers behind the NOI and show how real estate will make you rich<\/strong> in much more ways than one. They give you the exact calculations, framework, and mindset to use when analyzing real estate deals, and will show you how you can build wealth<\/strong><\/a> faster, smarter, and with less effort <\/strong>than the cash-flow-crazed investor down the street.<\/p>\n On today\u2019s show, Dave and J walk through the four ways that investors can build wealth through real estate<\/strong>, which questions real estate rookies should start asking, and debate whether or not the 2022 housing market<\/strong> is one worth buying in. Real estate rookie or not, this show will give you everything you need to start chasing better deals with hidden profits others are too blind to find.<\/p>\n Ashley: Dave: Ashley: Tony: Ashley: Tony: Ashley: Tony: Ashley: Tony: Dave: Tony: J: Ashley: J: Ashley: Dave: Ashley: J: Dave: J: Ashley: J: Tony: Dave: Tony: J: Ashley: J: Tony: Dave: Ashley: Dave: Tony: J: Ashley: J: Tony: Dave: J: Ashley: J: Tony: Dave: J: Tony: J: Tony: Dave: J: Tony: J: Ashley: Dave: J: Ashley: J: Ashley: Dave: J: Ashley: Dave: J: Ashley: Interested in learning more about today\u2019s sponsors or becoming a BiggerPockets partner yourself? Check out our\u00a0<\/i>sponsor page<\/a><\/i>!<\/i><\/p>\n Note By BiggerPockets:<\/b> These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.<\/p>\n
This is Real Estate Rookie.<\/p>\n
More good deals will come on the market over the next couple of years, but you do have to contend with some risks of declining value and high interest rates. I think that\u2019s just because over the last couple of years there\u2019s been super high competition and that makes it really hard for investors to land under market deals. Now the markets are shifting a little bit away from probably one of, if not the strongest sellers market in history, to one that is a little bit more balanced. And so that could create some more opportunity for people.<\/p>\n
My name is Ashley Kehr and I\u2019m here with my cohost Tony Robinson.<\/p>\n
Welcome to the Real Estate Rookie Podcast, where every week, twice a week, we bring you the inspiration, information, and motivation you need to kickstart your investing journey. We often like to start these episodes by shouting out on some folks who have lend us some reviews. This week\u2019s review comes from the Skids85. The skid says, \u201cThis podcast has great tidbits for rookie investors. Anyone looking to start in real estate investing will find nuggets of valuable information throughout the podcast. And if you couple this podcast with the original BiggerPockets Real Estate Podcast and all of the BP books, it\u2019ll give you the courage to dive into investing, which is what it did for me after five short months. The rookie replies are shorter, but I love them because that\u2019s what all the good information is.\u201d
The skids, we appreciate you, brother. And if you haven\u2019t yet, please you\u2019ll leave an honest rating and review for the podcast because it helps us reach more folks and that\u2019s our goal here. So Ash, how about we skip the boring banter for today? I think the guests were bringing on\u2026 They\u2019re too boring enough guys so we don\u2019t need to add to that, huh?<\/p>\n
You know what Tony? I was hoping that you would say that line because I was still debating in my head, \u201cWas our producer joking when he said that we could say that?\u201d<\/p>\n
No. Ashley and I are joking. We got two absolute studs on the podcast today and I think that\u2019s why Ashley and I are excited to get into the content. We\u2019ve got J. Scott and Dave Meyer. You guys probably know Dave from the recently released On The Market podcast. J, he ran the BiggerPockets Business podcast. He\u2019s written four, now five books for BiggerPockets. These are literally two of the absolute smartest guys I\u2019ve ever met when it comes to real estate investing. I\u2019m so excited we got to share their knowledge with you guys in the podcast today.<\/p>\n
And by boring, we mean there\u2019s no stories of bears coming on to your Airbnb or exciting things like that, the click bait things in. This is basically what you need to know. As a real estate investor, they wrote this book about running the numbers and how to analyze a deal efficiently and effectively, everything that you need to know. I think the book is like 450 pages long with all this data. It took them several years to write it because they really got down into the nitty gritty of it. It\u2019s not only you have the BiggerPockets calculator reports, which are great, but it\u2019s more than just plugging in the numbers. It\u2019s understanding why you\u2019re plugging in that number and what that number means and what outcome you want from that. So they break it down into four different ways that you can generate money off of your investment. We\u2019re not going to tell yo. You have to listen and listen to all four.<\/p>\n
Yeah. I asked them two questions that I think most new investors are probably thinking as well, the first one is, is now still a good time to invest if you\u2019re a new investor. And you get to hear both of their explanations or answers to that question. The second question I asked them is like, \u201cOkay, what is a good cash-on-cash return or investment metric I should be using?\u201d So these are two questions that Ashley and I get all the time. Both the answers that Dave and J. gave, I think, were phenomenal and you guys are going to get a lot of value from hearing it.<\/p>\n
Make sure you check out J. and Dave\u2019s new book Real Estate by the Numbers, available at the BiggerPockets bookstore. They\u2019ll tell you guys about all the benefits you get if you purchase it directly from the bookstore, maybe even a call with them. So listen for that. And then at the end of the episode, they give you a discount code. We are super excited to see who you guys like better because there might be a little competition at the end of this.<\/p>\n
Guys, I am so, so, so excited for today\u2019s episode. You two are literally probably two of the smartest people that I know when it comes to real estate investing in the economy and just all the data points that folks should be looking at when they\u2019re thinking about investing in real estate. This is honestly probably the episode I\u2019m most excited for. So Dave, we\u2019ll start with you. Can you just give a quick background on who you are and kind of what we\u2019re talking about here today?<\/p>\n
Sure. So I work at BiggerPockets full time. I\u2019m the vice president of data and analytics where I handle a lot of our internal data analysis and business intelligence, but also get to spend time studying the housing market and trying to understand what\u2019s going on in different markets and different opportunities that exist for the BiggerPockets audience. And in that effort, I am also the host of BiggerPockets newest podcast, which is called On The Market and is focused on just that, examining trends, data, news that impact the lives of real estate investors.<\/p>\n
Dave, we also had you on the Rookie podcast. I can\u2019t quite recall which episode it was, but folks can go back and listen to that episode because I think it was one of our top performing episodes because people love when we talk about the economy and it just shows the kind of wealth of knowledge that you are, man. So excited to be chatting with you.
Our next guest, we\u2019ve got two guests for you guys today, I just want to give a brief introduction because this man\u2019s resume is quite impressive. But he\u2019s written two books I think already for BiggerPockets, a book on flipping houses. Four books. So I\u2019ve read two of them. You can tell us what the other ones are. He was on number 10 on the Real Estate podcast. He was on episode number 10. He\u2019s been on multiple podcast episodes since then. A successful house flipper, now a successful real estate syndicator, apartment syndicator. I\u2019m just super, super, I think, humbled and happy to have this guy on the podcast. So J, tell the folks, I guess, what I might have missed.<\/p>\n
No, it\u2019s okay. So I found BiggerPockets back in 2008 when I started flipping houses. I was flipping my first house and doing an internet search for how to learn how to do it and found BiggerPockets and started becoming involved in BiggerPockets. And so a lot of people think I work for BiggerPockets, I don\u2019t, but I\u2019ve been so intimately involved with BiggerPockets over the last 15 years sometimes it feels like I do.
And so yeah, I\u2019ve written four books. I think The Book on Flipping Houses, Estimating Rehab Costs, also The Book on Negotiating Real Estate that I wrote with Mark Ferguson and my wife Carol Scott, two amazing investors. And then my most recent book up until now called Real Estate\u2026 Wow, I don\u2019t even remember the name. It\u2019s called Recession-Proof Real Estate Investing, which is a book all about economic cycles and how they impact real estate investors. I was also the host of the BiggerPockets Business podcast for a couple years where my wife and I talked with literally over a hundred different entrepreneurs and business owners about all things business. And that\u2019s still out there for anybody that\u2019s interested in that topic and want to learn more about business and entrepreneurship. Check out the BiggerPockets Business podcast.<\/p>\n
Well, J. and Dave, we have you guys on here for a reason because you have written another book. It is Real Estate by the Number. So do one of you want to give us a brief description of what this book is about?<\/p>\n
Sure. So Dave and I have been working on this book for a really long time. The goal of the book, and I think I\u2019m proud to say I think we\u2019ve accomplished the goal, but the goal of the book was very much to dive into and delve into all aspects of the math and the concepts and the strategic thought that goes into real estate investing. In fact, I think if we were to rename the book today, we\u2019d probably call it Think Like An Investor, because that\u2019s really what the book\u2019s all about, how to change your mindset and really learn how successful investors think, again, from a concept standpoint, from a strategy standpoint and also from a math standpoint. And so it\u2019s a long book, it\u2019s over 400 pages. I think it\u2019s the longest book BiggerPockets has published. We\u2019ve been working on it for many years. But it\u2019s something I think Dave and I are very proud of.<\/p>\n
I can\u2019t wait to read it because I think too, for rookies and even experience investors, it\u2019s like going back to the basics of is it a good deal, is it a bad deal, should I do this deal. Well, run the numbers. That\u2019s very, very common where I think people are looking for somebody to give them the answer if they\u2019re making a good investment where if you run the numbers and you know how to properly do that, then you\u2019ll be able to figure that out on yourself.<\/p>\n
Yeah, I just want to add to that this book I do think does make sense for rookies, even if you\u2019re thinking math is not your thing or that this sounds complicated. J. and I, it took us so many years because we\u2019ve gone through painstaking efforts to make sure that this is applicable to anyone. Whether you haven\u2019t bought your first property yet or you\u2019re an experienced syndicator at this point, we want to make sure that everyone, whether you\u2019re a rookie or experienced, can analyze deals like professional. And as J. said, I think we\u2019ve accomplished that.<\/p>\n
One thing too, I\u2019ve noticed if you go out and buy calculator reports or the BiggerPockets\u2019 reports that they do to analyze deals, all of them will vary. They\u2019ll have different formulas or ratios that they calculate for you or different inputs for them. So instead of going out and buying all these calculator reports, I would think it would make sense to buy your guys\u2019 book and kind of develop your own from it. Can you go through that as to once you have this book, how do you put it to use?<\/p>\n
Yeah, well I mean I would start with, again, for anybody that might be a little bit math phobic, I\u2019m an engineer by education, so I like the math, and I know Dave is a numbers guy. But here\u2019s the cool thing. If you take this book and you literally cut out all the math, you cut out all the formulas, you cut out anything math related from the book, you\u2019re still left with\u2026 What do you think, Dave? 250 pages of concepts and stories and narratives and examples of just deals that Dave and I have done throughout our careers. Then you add in the other 150, 200 pages and then that\u2019s all the math behind it and you get everything. But even if you don\u2019t care about the math and you don\u2019t want the math stuff, I think anybody, now I\u2019m not even going to say including, but especially new investors, if you want to know how successful and experienced investors think, this book is going to really going to help you achieve that.<\/p>\n
Ashley, I think one of the things that is tempting because the BiggerPockets\u2019 calculators are extremely useful and helpful to people, especially rookies, is that you have to understand the concepts and what the numbers deeply mean. Of course you know that a 7% cash-on-cash return is not as good as a 9% cash-on-cash return. But when you actually go through the process of learning how to calculate these things, it adds new meaning and I think it allows you to make more confident decisions.<\/p>\n
Here\u2019s the other thing. We often talk about getting the right answers and figuring out if something\u2019s a good deal. And so we start with this assumption that we know what questions we\u2019re supposed to be asking so that when we get the answer we know that that answer is meaningful to us. Dave and I actually approached this book from the other side. We approached this book not from the perspective of you asked the question, we\u2019re going to give you the answer. We approached this book from the perspective of, let us help you ask better questions.
And in fact, I don\u2019t remember, there\u2019s like 40 chapters in the book. Each chapter starts with, \u201cHere\u2019s a list of questions that this chapter is going to be answering so you know the right questions to be asking.\u201d And because I find a lot of new investors, they happen upon a deal and they get into a situation and they think, \u201cOkay, I need to know if this deal makes sense, did the numbers make sense?\u201d but they don\u2019t know how to formulate the right questions to be asking to look at the deal.
So for example, a seller finance deal. You\u2019re not going to evaluate a seller finance deal the same way you\u2019re going to evaluate just a regular purchase or a note or a commercial property or a deal where\u2026 I give an example in the book of a deal I did where I\u2019m going to sell a house and I list the house and I get two offers. This was a true story. I got two offers. One was a full price offer, basically quick close from a cash buyer. The other one was another investor who had a deal that was closing seven months later and basically said to me, \u201cI really want your house but I can\u2019t afford it for seven months because I have another deal closing. I\u2019ll get a bunch of cash in seven months. So I\u2019m happy to close on the deal now, but I kind of don\u2019t want to pay you for seven months.\u201d
I own the house for cash so I could afford to basically just not take the money for seven months. But then I had to ask myself the question, \u201cHow much more should I be selling it for if I\u2019m not going to be selling this house for another seven months where it still makes sense? How much more would I have to ask him to pay where his offer is now as good or better than the guy that was willing to pay me in two weeks full price cash?\u201d The nice thing is when you know how to ask the right questions, when you know how to ask the question, \u201cHow much is this house going to be worth if sold in seven months compared to if it\u2019s sold in two weeks?\u201d, when you know to ask the question the right way, then you can start evaluating the answer in the right way. And so I think a lot of new investors, they\u2019re not always sure what the right questions are. And so we start with the questions and then we jump to the answers. And so it kind of hits both sides of the equation.<\/p>\n
J, in that scenario, would you go and would you look at, \u201cOkay, what would my money look like in a year?\u201d So if you got the money in the two weeks and you went and invested it into something else, what would your return be in a year from that pile of money? Or if you waited in seven months and gotten it, what would you actually do when you\u2019re asking that question as how would you run the numbers on that exact situation?<\/p>\n
Yeah. I don\u2019t want to go into any of the math because a lot of us don\u2019t care about the math right now, but the concept behind it like you just said is immensely important in real estate. It\u2019s called the time value of money. It\u2019s basically this concept that a dollar that I get today is worth more than a dollar I get a year from now or seven months from now. Because if I get it today, what am I going to do with it? I\u2019m going to invest it. And in seven or eight or nine or 12 months, it\u2019s going to be worth more than a dollar. And so I need to figure out that dollar that I\u2019m not getting today, how much more would it have been worth in seven months if I had gotten it? And that\u2019s the amount more that I\u2019m going to need to get for that property to make it worth it to wait seven months to get the money.<\/p>\n
We\u2019re like five, I don\u2019t know, 10 minutes into this episode already and you guys have dropped an immense amount of knowledge, which is why I was so excited to chat with you guys. But I want to ask one question that I\u2019m sure a lot of rookies are asking and then we can get into the meat of the episode. But there\u2019s a lot of information floating around that I think has some new investors afraid to get started. There\u2019s the two quarters of the GDP getting smaller, which some people makes us feel that we\u2019re in a recession. There\u2019s the climbing interest rates, which we all have reason to believe might continue to climb. So I guess my question to you guys, and Dave we\u2019ll start with you, if I\u2019m a new investor, an aspiring investor, I have no deals, is now still a good time to get started?<\/p>\n
Oh, you\u2019re hitting on our most beloved topic that everyone loves talking about right now. I think it\u2019s hard to say categorically whether it\u2019s a good time or not. I think it comes down to individual investors and goals. And J. actually and I, talk a lot about this in the book, is a big part of being a successful investor is identifying what types of deals are good for you personally. So there might be times\u2026 Like say for example you\u2019re a house hacker. I think in almost any market conditions, house hacking is usually a pretty good idea because if you\u2019re comparing that to paying rent and rent is super expensive right now, it\u2019s really great. I don\u2019t flip houses, but I\u2019ll just say I\u2019m not going to start flipping houses right now. I think that there are different strategies that people should be taking depending on their personalized situation.
I know that\u2019s sort of punting on the answer, but I\u2019ll just say that my guess is that more good deals will come on the market over the next couple of years, but you do have to contend with some risks of declining value and high interest rates. I think that\u2019s just because over the last couple of years there\u2019s been super high competition and that makes it really hard for investors to land under market deals. Now the markets are shifting a little bit away from probably one of, if not the strongest seller\u2019s market in history, to one that is a little bit more balanced. And so that could create some more opportunity for people.<\/p>\n
And J, what are your thoughts?<\/p>\n
Yeah, I 100% agree with Dave. There are lots of factors at play. Keep in mind that when we say real estate investing, if I say that to a hundred people, I\u2019m going to get a hundred different thoughts of what that means. If you\u2019re flipping houses, that\u2019s a very different strategy than if you\u2019re buying notes, which is a very different strategy than if you\u2019re buying RV parks, which is a very different strategy than if you\u2019re house hacking. And so there\u2019re literally dozens, dozens of strategies out there and not all of them are going to work as well at different points in the market cycle. Some are going to work better during a recession or equally well during a recession. Some are going to work really poorly during a recession. Likewise, different strategies are going to work differently in different areas.
So what we\u2019ve seen over the last couple years, not only is the market changing, but also the demographics and populations have changed in the US. People are moving from certain areas to other areas because we have a lot more remote work and people have the opportunity to go where they want. And so we\u2019re seeing certain areas that are still seeing huge population growth. We\u2019re seeing other areas that are seeing population decline. And during even the best market in history, I don\u2019t want to flip houses in a place where we\u2019re seeing population decline.
So even going back to 2015 when it was a great time to flip houses, it wasn\u2019t a great time to flip houses someplace where people were moving out of. And so you can\u2019t just look at the economy, you can\u2019t just look at any one or two factors. You have to look at all of these factors. You have to look at the economy and you have to look at population growth and you have to look at employment trends and you have to look at the specific strategy that you\u2019re looking to employ. And then you kind of put all of this stuff together and you ask the right questions about specific deals and then you determine does this deal make sense. And so again, like David said, I\u2019m not looking to punt on the answer, but it really is, it depends. It depends on what you\u2019re trying to do, where, when and how.<\/p>\n
Okay, so even if you\u2019re\u2026 Whatever strategy you\u2019re doing, running the numbers, the reason you\u2019re doing that is because you want to generate revenue, you want to make a profit or you want to have a good investment for down the road. What are some of the ways that you talk about in your book that you can generate money from making this investment into real estate and how does that kind of factor in when analyzing the deal?<\/p>\n
Yeah. So first let me step back and just say this one other thing. For anybody that\u2019s out there that\u2019s listening, this is the Rookie Show. So a lot of people that are listening are probably either just getting started or getting ready to get started in real estate. Something to keep in mind when we talk about the economy is that things move in cycles. And so, well, we may be headed into a recession, some people would say we\u2019re in a recession. Historically, recessions last 12 to 18 months. So even if now isn\u2019t the best time for you to be doing whatever strategy it is you want to do in whatever location you happen to be in, there\u2019s a good chance that in 12 months or 18 months or 24 months, it could be a really good time. So it\u2019s always a good time to be learning.
So even if now isn\u2019t the right time to be flipping houses in New York City or whatever it is, now is a great time to learn about how to flip houses in New York City because in a year it may be a great time to be doing it again. So let me start with that.
But going back to your question of how do you make money in real estate, this is actually a really interesting question that we don\u2019t talk about enough. A lot of us, especially when we\u2019re new investors, we tend to look at real estate returns one dimensionally. If we\u2019re somebody who is working a 9:00 to 5:00 job and looking to escape that 9:00 to 5:00 job, it may be that all we care about is cash flow. We want to make as much money every month as possible so that we can quit our job as quickly as possible and we can replace our income with our cash flow from our real estate. Other people aren\u2019t in that situation. Other people might be thinking, \u201cI love my 9:00 to 5:00 job. I\u2019m going to be working for another 30 years. All I care about is that I build up enough net worth enough equity over the next 20 or 30 years so that when I retire, when I\u2019m 50 or 60, I have plenty of cash that I can invest and get cash flow then.\u201d
Other people are thinking they don\u2019t care about either of those things. They care about the fact that they have a high paying W2 job right now, or they\u2019re making a lot of money from some investments right now and they want tax benefits. Real estate\u2019s a great way to get tax benefits. So there are all different reasons why we may be want wanting to invest in real estate, and the reason you invest may not be the reason I invest.
And so when we look at how real estate actually generates money for us, generally it falls into four categories. So number one is cash flow, and that\u2019s exactly what we\u2019re saying. That\u2019s the monthly income or the quarterly income or the annual income that your cash flow is going to pay you when you invest in it. Number two is this thing called appreciation. And I know we think about appreciation as like if we invest today, the market\u2019s going to go up 10% tomorrow and we\u2019re going to have a whole bunch more money. There\u2019s actually a couple different ways that we see appreciation in real estate. It\u2019s not just waiting for the market to go up and we can talk about that. But number two is appreciation.
Number three is this thing, the fancy word is amortization. The layman\u2019s term is principal paydown. If I get a loan on a property, I\u2019m paying that loan every month. I\u2019m paying my bank every month on that loan. Part of the money that I\u2019m paying is interest. And so interest kind of goes away, it\u2019s an expense. But part of the money I pay on my loan every month is actually paying down the balance of the loan. And so on day zero, I might take out $150,000 loan. In 30 years after I\u2019ve made my final payment, that loan is now zero. I\u2019ve made $150,000 by paying off that loan. It didn\u2019t really make 150,000 and I still paid it, but presumably my tenants paid it. And so over time I\u2019m paying down the loan and I\u2019m accruing equity. I\u2019m building up equity in the property. So this principal paydown or amortization is the third way that we typically see real estate make money.
And then the fourth way I mentioned it is tax benefits. So real estate provides tax benefits that you really can\u2019t get from any other investment on the planet. Some amazing tax benefits. And when you know how to think about taxes and you know how to think about the benefits of real estate investing, you can find ways of basically offsetting income that you\u2019re making today through those tax benefits, which is really as good as it\u2019s cash in your pocket today. So cash flow, appreciation, principal paydown, and tax benefits. Those are the four ways that real estate makes money for us. And anything else, I mean there are lots of other things people can suggest, but that\u2019s really going to probably fit into one of those four categories.<\/p>\n
J, what an amazing breakdown. I\u2019m so glad that we kind of covered those four different categories because I think a lot of folks, especially those that are getting started, like you said, they just kind of look at real estate investing as this one dimensional kind of return that they should be looking at. But you really gave all these different categories that they can look at. So if we can, I want to just dive into each one of these in a bit more detail. So you had cash flow, appreciation, principal paydown, and then tax benefits. So Dave, I guess I\u2019ll start with you first and we can go to you afterwards J, but let\u2019s talk about flow. What exactly do we mean when we say cash flow? What kind of metrics should I be looking at when it comes to cash flow? And in your mind maybe who is it, what kind of investors should maybe value cash flow over some of the other types of investments?<\/p>\n
Yeah. Cash flow is a great place to start because I think most real estate investors get into real estate investing because they want to generate cash flow. I don\u2019t know about you, Tony and Ashley, but that\u2019s certainly where I was coming from when I first got started. Basically I was just hoping I produced more cash than I spent each month. And that was sort of the extent of my knowledge of these four different things. Like I knew of the other ones, but that\u2019s really what I was hoping for when I got started. But cash flow is wonderful because it basically can end supplement or eventually replace your W2 income and it provides something that you can live on. If you\u2019re investing in the right way, then it is a very reliable source of income and it could be used for whatever you want, either reinvesting or for covering your regular expenses.
Cash flow is relatively simple to calculate. We give some ways to do that in the book. But basically you add up all of your income, you subtract all of your expenses and after that you have your cash flow. You can also calculate easily. Once you have that, once you know that and how much you\u2019ve invested into the deal, you can calculate what\u2019s probably, I don\u2019t know, I\u2019m just assuming this is the most popular metric in real estate investing, which is cash-on-cash return. And that basically is a great measurement for how efficiently your investment is producing cash flow for you, because it\u2019s great. I hear a lot of investors say like, \u201cI did this deal. It\u2019s producing $300 a month of cash flow. Is that a good deal?\u201d Well yeah, if you invested 10 grand, it\u2019s a great deal. If you invested 300 grand, not such a good deal. So you have to be able to calculate both the absolute number of cash that you\u2019re getting in your bank account every month and be able to calculate how efficiently your investments are generating cash flow for you.<\/p>\n
Before you go on there, can you just tell us, define cash-on-cash return is, so what the formula is, how somebody can figure that out.<\/p>\n
Sure. Yeah. So you just basically take your annual cash flow and you divide it by the amount you invested into that property. And so for each person, that\u2019s going to be a little bit different. For most people getting started, it\u2019s going to be your down payment, maybe some closing costs. And if there\u2019s any maintenance that you did right at the beginning, that came out of your pocket, not like your mortgage, basically the cash that you took put into the property. So you take the annual cash flow, divide it by all of your expenses, that\u2019s going to get you your cash-on-cash return. In the book we also talk about how you can advance your thinking about cash-on-cash return over the course of your investment using a metric called return on equity. But we won\u2019t get into that nerdy here.<\/p>\n
One follow up question. J, I\u2019ll point this to you first, and Dave we can go back to you. What is a good cash-on-cash return? In today\u2019s market, say I\u2019m buying maybe like a long term single family house, what\u2019s a good cash-on-cash return?<\/p>\n
It\u2019s a great question. It\u2019s a question we get all the time. Let me step back before I answer that question. But as Dave said, it\u2019s really important when we think about cash-on-cash return, it\u2019s an indication of how efficient our investment is generating cash. So if I invest a hundred dollars in a deal, and obviously not real estate because it\u2019s only a hundred dollars, but let\u2019s say I invest a hundred dollars in something and I get back $10 at the end of the year, I then invest a hundred dollars in something else and I get $11 back at the end of the year. The second thing that I invested in is doing a better job of it\u2019s more efficiently returning me cash on the money I invested. 10%, 11%, it\u2019s just numbers. But the important thing is, the more money I\u2019m getting back means that the money I invested is working harder for me. Obviously, we always want our money to work harder for us, we want it to be more efficient.
But here\u2019s the other nuance that we really need to keep in mind, and too many newer investors don\u2019t think about this. Returns are correlated with risk. And if I told you I could give you an investment that generates 50% returns or an investment that generates 20% returns, which one\u2019s better? Well, you may want to just jump to, \u201cOf course 50% is better.\u201d But in the real world, returns are correlated to risk. A deal that returns 50% or projected to return 50% is typically going to have a lot more risk associated with it than a deal that\u2019s projected to return 20%. So that 50% return deal, you might have a much higher risk of losing all your money or you might have a much higher risk of making zero return or losing a little bit or making a little bit. Your chances of actually making 50% return is going to be lower than your chances of actually making a 20% return with the deal that projects to return 20%.
So anytime you see returns, always think about it from the lens of how much risk is involved and what is the specific risk, what kind of risk is it. Is it a binary risk? So if I told you that we have a deal where there\u2019s a 50% return projection and another deal where there\u2019s a 50% return projection, even though the risk might be the same, it may not be the same type of risk. For one, the risk could be, yeah, there\u2019s a good chance you\u2019re going to lose all of your money, but there\u2019s also a good chance that you\u2019re going to make a hundred times your money, or a small chance you\u2019re going to make a hundred times your money.<\/p>\n
Well, J, I have a question too. Do you think, is time put into the deal kind of considered into that too as to like, okay, you can look at the cash-on-cash return, you only put 10 grand into the deal, you\u2019re getting a 20% cash-on-cash return, but you also didn\u2019t hire anyone to do the labor for the rehab. So is that another thing besides just risk, is taking into consideration the time that you\u2019re putting into the deal too?<\/p>\n
Yeah, absolutely. This is where this idea of hourly return comes in. And so yes, one deal might generate 10% cash-on-cash return, another deal might generate 8% cash-on-cash return. Is the 10% better? Well, no. If I spent 10 times as many hours doing that deal and generating that return, that 10% might be a whole lot worse than the 8% return if that 8% return is completely passive.
And so, certainly in addition to risk, we need to be looking at things like what is the amount of time we spent and what is our hourly return. And this is why it gets back to the fact that there\u2019s not just any single metric that we want to look at. Certainly there are some metrics that are more important than others, especially depending on our goals. But we need to be able to think about things multidimensionally from different aspects. And you have to be able to put all these things together so at the end of the day you can say, \u201cOkay, I have two investments. Which one is better?\u201d And generally the answer is we don\u2019t know until we answer a whole lot of other questions about what our goals are, what we\u2019re trying to achieve and what the risks are.<\/p>\n
J, I think so often, new investors, they just want the answer given to them around these different decisions that they need to make in their businesses, which I get it, right? Because it\u2019s scary, you\u2019re investing maybe your life savings, you\u2019re buying this several hundred thousand dollars investment, it\u2019s your first time doing this, you want some reassurances that you\u2019re doing the right thing. But like you said, it\u2019s hard for Tony or for Ashley or for J, or for Dave to know all the intricate details of that person\u2019s life, their goals, their personalities, their skills, their abilities to be able to tell them, \u201cYes, this is the right deal for you.\u201d
I\u2019m glad we\u2019re talking about these four different categories because like you said, if someone\u2019s focus is appreciation, maybe them buying a deal that only cash flows 6% makes sense for them because they know 10 years from now that building will doubled in value. But for the person that\u2019s focused on cash flow, maybe they want a 15% cash-on-cash return and they don\u2019t care about appreciation. So everyone\u2019s personality, situations, et cetera will dictate something different. So Dave, I just want to kick it back to you. Any other comments on that on the cash-on-cash return piece?<\/p>\n
Well, hopefully you\u2019re picking up on the trend. If you try and pin J. and I down to answer any question directly, we\u2019re going to say it depends. But it really does. It really is. You said it really well, Tony, that we all wish someone could just tell us what to do, but ultimately financial decisions are deeply personal. And they should be. You should have your own set of goals and ideas about what you want.
I\u2019ll give you a quick example. In March or April, I sold a rental property and I wanted to do a 1031 exchange and I had an intention to buy a small multifamily. I just couldn\u2019t find a deal that penciled. As you guys might know, I live in Europe, so it was really hard for me to go look for deals. And so I was looking at syndications, but I couldn\u2019t find one in a market I understood. And so I didn\u2019t have time to understand a new market. I wound up doing a deal that took about 5% cash-on-cash return, which is lower than a lot of people would accept and it\u2019s lower than other syndications that I was looking at. But it was in a market I really understood, I felt like there was very little risk. My primary objective with the 1031 exchange was to preserve my capital and to defer my taxes.
And so I was able to accomplish all those things. Did I take a less cash-on-cash return? Yeah, but as J. said, I think I took a lot less risk too. And with this set of money that I had, my goal was long term preservation of capital. And so I think I made a good decision there, where someone have made a totally different decision. Someone might have taken that money and rolled the dice and been willing to take on more risk than I was because they wanted a 12% cash-on-cash return. So I think you guys said it really well, but I just wanted to hammer home the idea that you have to really factor in everything and personalize these decisions to your specific circumstance.<\/p>\n
Yeah. And keep in mind, I mean, going back to this whole risk profile thing, there are investments out there that have zero risk. If you want to invest in treasury bonds, like government bonds, you can do that. You can make 2 or 3% per year on your money. Now, a lot of us would sit here and say, \u201cWe\u2019re real estate investors. I\u2019m not willing to make an investment that only generates 2 or 3% per year, even if there\u2019s zero risk.\u201d But there are trillions of dollars worth of investors out there who are very happy to invest for 2 or 3% at zero risk. Their goals are very different than ours or yours. The fact that maybe they\u2019re retired and they have enough money that 2 or 3% is great, but they want zero chance of losing that money.
So again, every everybody\u2019s goals are going to be different. Everybody\u2019s risk tolerance is going to be different. If you want super low risk deals, then you\u2019re going to have to accept super low returns. If you want super high risk, if you want the potential to make tremendous amounts of money, you\u2019re going to have to accept super high risk deals. And then there\u2019s everything in between. So you really need to figure out where you are on that risk\/reward spectrum to determine the types of deals that you should be doing.<\/p>\n
And J, for our next one, appreciation. Can you go through and define appreciation and then what metrics are tied to appreciation that you talk about in the book? Then also, who\u2019s the ideal rookie listener that actually should value appreciation maybe even compared to cash flow?<\/p>\n
Yeah. Again, cash flow is the money that our deals are giving us every month for investing in them. We\u2019re basically getting\/spending money or investing money every month or every quarter, every year after we invest. Appreciation is kind of just the opposite of that. That\u2019s the money that builds up in the investment that we\u2019re not actually getting back. So for example, just the simplest example, if I buy a house for a hundred thousand dollars today and in 10 years I sell that house and it\u2019s worth $200,000, that\u2019s appreciation. The value of that property went up a hundred thousand dollars over 10 years. There are two types of appreciation that we typically talk about.
The first is this thing called natural appreciation. This is the idea that just holding real estate over time, it\u2019s going to go up in value. Why? Because it always has. Realistically speaking, real estate tends to go up in value over time. We\u2019ve seen it for 150 years, it\u2019ll likely continue. That said, a lot of people, they don\u2019t have a true understanding of how much real estate tends to go up over time, especially for younger investors. If you started investing in 2008 or \u201909 or \u201910 and you\u2019ve only seen what\u2019s happened with real estate over the last 10 years, or worse yet, if you started investing two or three years ago and you\u2019ve seen what happened with real estate values over the past two years, you probably think real estate tends to go up 5% a year or 10% a year or even 20% a year.
But the reality is, over the past hundred or so years, on average in most places in the US, real estate has tracked inflation. So if inflation has been somewhere between 2 and 3%, real estate values have tended to go up 2 or 3% per year. Not bad, but it\u2019s not something that\u2019s going to make you rich. Basically, your real estate is going to keep you from losing money to inflation. So that\u2019s the first aspect of appreciation. Just overtime the market is going to tend to go up in value. Our houses are going to tend to go up in value and you\u2019re going to make money typically at least enough to cover inflation, hopefully a little bit more.
But the real value of appreciation in real estate is what we call forced appreciation. And this is the idea that as real estate investors, a lot of us have the ability to buy real estate that\u2019s undervalued and we have the ability to increase the value through the work that we do. And so when we talk about that work, it\u2019s really in two areas. Number one, we can do physical renovations on the property, we can improve the property. So when we think about flipping a house, we buy a house for a hundred thousand dollars. By the time we sell it, it\u2019s worth $250,000 let\u2019s say. That\u2019s appreciation. We\u2019ve added value through renovations that we can then capture when we sell the house.
The other way we can capture appreciation is through management improvements. So number one is you make a whole lot of money by improving the physical aspect of the house. Number two is you actually lower the cost of holding that house. So if you\u2019re a landlord and you can buy a property and you can make it a whole lot less expensive to hold, you can appeal your taxes or you can get your insurance costs down or you can get your other holding costs down, you\u2019ve now increased the value of that property. So as good real estate investors, yes, we love the natural appreciation, we love that 2 or 3% per year that we\u2019re going to get that\u2019s going to offset inflation, but we should also love the idea of we can increase the value of a property through renovations and management improvements. And then once we increased the value, we then have the ability to capture that increase in value either by selling the property for a profit or refinancing the property and pulling out some of that value that we\u2019ve added.<\/p>\n
Dave, let me ask you a follow up question here and then we\u2019ll go back to you, J. What kind of rookie investor is the focus on appreciation best for? What kind of questions should I be asking myself to determine if focusing on appreciation is the right kind of, I guess, wealth tool for me to focus on?<\/p>\n
Well, to echo what J. said, I think for rookies really the key is to focus on forced depreciation. And particularly in this type of market cycle that we\u2019re in right now, I just think that\u2019s even more important. For most rookies, I would recommend being very cognizant about the amount of work that goes into forcing appreciation and making sure that you take on an appropriate amount of effort, risk, and capital that needs to go into a renovation.
When I was getting started, I did a lot of what you call a cosmetic value add, where you\u2019re painting, you\u2019re updating the appliances, maybe you\u2019re putting in some vinyl flooring to make it look better. That to me is a little bit more manageable especially if you\u2019re handy yourself or a good trades person. I wouldn\u2019t be looking for places with foundation issues or who need a new roof if this is your first time out there. If you\u2019re a contractor, if you have experience in construction, maybe you could. But for me that\u2019s just my personal advice. People can take that on as much as possible. But for your first deal, I think those types of cosmetic value ads really can be achievable and are relatively low risk.
Another thing that I\u2019ve done pretty successfully a few times now is, repurposing space is a great way to force at least rent appreciation and some value appreciation. For example, if you take a place that has a lot of living space but only has two bedrooms, can you add a third bedroom? Can you add a fourth bedroom given the existing structure so that you\u2019re not building new walls and taking on a lot of construction risk? You\u2019re just sort of repurposing the space in a more manageable type of value add situation that can add value to the property and can increase your cash flow as well.<\/p>\n
I think Dave and I both ignored the question. Tony, you and Ashley both asked the same question, we both kind of ignored the answer. So let me try to cover the answer that we ignored. Who is the right person that should be thinking about appreciation? Generally, you\u2019re going to think about appreciation when you have a longer term wealth horizon, when you\u2019re thinking about building wealth over time. Somebody that wants cash flow is somebody that needs the income every month, maybe somebody who\u2019s looking to quit their job and wants to replace their income. Somebody that\u2019s looking for appreciation is looking for a bucket of cash at some point. That could be a bucket of cash in three months by flipping a property. It could be a bucket of cash in 30 years when you sell your rental property. But typically the person that\u2019s looking for appreciation is the person that\u2019s looking for that bucket of cash, which I talk about how real estate has tremendous tax benefits.
Sometimes it doesn\u2019t when you\u2019re getting buckets of cash. But in general, if you\u2019re looking to increase your net worth over time, appreciation is one of the best ways to do that. Let me also answer a question that you sort of asked. I used to work for eBay. At the time the CEO, a woman named Meg Whitman, used to say to the company, she had a really popular quote that she would always say, which was \u201cEmbrace the end.\u201d Too often we think about do we want A or do want B without thinking of \u201cIs there a way for us to get A and B, or A and B, and C and D?\u201d
And in this case, when I say cash flow is right for this type of investor and appreciation is right for this type of investor, what I would encourage every investor to do is think about what\u2019s most right for you, but don\u2019t exclude those other things. So maybe your primary goal is flow, but still think about how you can get appreciation at the same time. Because even though cash flow today is great, you\u2019re going to want that bucket of cash when you sell the property in 20 years and you\u2019re looking to retire. So embrace the end and don\u2019t just think about these returns as which one is most important or what\u2019s the only one I want. Think about maybe which one\u2019s most important, but how do I get the others as well.<\/p>\n
J, I\u2019m so glad you mentioned that and it reminds me of you and I were having lunch in Maui. And when I asked you about why you switched from flipping houses to apartment syndication, that was kind of what you mentioned to me, is that when you looked at flipping, it was these big chunks of cash but there wasn\u2019t that consistent cash flow. There wasn\u2019t the necessarily appreciation long term. But it\u2019s like when you went to apartment syndication, you kind of got the best of both worlds where you\u2019re able to generate these big cash flows and oftentimes these big chunks of cash, refinancing and the fees that come along with putting those things together. And then when you go to sell, raising the value of an apartment complex is significantly bigger than one single family home.
When I think about why I started investing in Airbnbs, it was really the same thing. I felt like when you talk about risk adjusted returns and accessibility to a new investor, I feel like Airbnbs and short term rentals were the best asset class to do that because you don\u2019t need to raise funds typically like you would for a syndication, but you get these much bigger cash flows than you do from long term rentals, but necessarily it\u2019s not the same as flipping because it\u2019s not as risky about like, if the market turns today, I\u2019m not going to be stuck holding this property that I\u2019m going to lose money on. So I mean, I just love that point of thinking of all the different ways you can combine some of these things together to get the best end product for yourself.<\/p>\n
Yep. Sometimes appreciation can be a tricky thing. It isn\u2019t always obvious. Like when we want appreciation there, there\u2019s cases, and we talk about this in the book, where appreciation might hurt you. So for example, let\u2019s say I buy a rental property for a hundred thousand dollars and I can rent that property out for X dollars a month. I also have the option of doing a renovation on that property and now I can rent it out for more money per month. Should I be doing that renovation so that I get more money? Well, it\u2019s a difficult question because depending on how much I spend and how much more money I put in, that\u2019s going to affect my cash flow.
So the decisions I make around appreciation, I could potentially do a huge renovation. I could knock the house down and rebuild it and now make that a hundred thousand dollars house worth a million dollars potentially. But that\u2019s not necessarily a good idea. If the rent\u2019s only going to go from a thousand a month to 2,000 a month. I\u2019ve created a ton of appreciation, but now I\u2019ve reduced my cash-on-cash return, that other metric that we talked about with respect to cash flow. So all of these things play off of each other.
And so maybe appreciation, maybe doing a renovation on the property is a smart thing to do before I sell, but maybe it\u2019s not a good thing to do now. Maybe it\u2019s a good thing to do five years from now or 10 years from now. And so we constantly have to be looking at all of these different scenarios. And again, it goes back to asking the right questions and not just saying more appreciation is good, more cash flow is good. Yeah, in a lot of cases it is, but in other cases now might not be the right time or it might not be the right thing to do for this particular property, for this situation, for my particular goals.<\/p>\n
So we\u2019ve hit two of the kind of ways that real estate can generate wealth and profits. I want to focus on those last two. So principal paydown. Dave, I\u2019ll start with you. If you can, same as the other two, define what principal paydown is and what metrics I guess we should be looking at to kind of measure how well a property does with that specific metric.<\/p>\n
Sure. Yeah. So principal paydown is basically a way of generating returns that exists for pretty much any long term investment. Basically when you take out a mortgage, you pay back the bank every single month. There are two components of that payment. It stays the same every month, but every month you\u2019re sending the bank principal, which is basically repaying the amount that you borrowed slowly over time. And then there\u2019s interest, which is the bank\u2019s profit. Unfortunately with interest, that\u2019s just gone. As J. was saying earlier, that\u2019s just the bank takes that, you don\u2019t get anything back. But when you pay down your loan, that means that you owe the bank progressively less and less and less. And over time when you go to sell it, you may owe the bank half of what you used to owe them, or hopefully maybe you pay it off over 30 years and then you don\u2019t own the bank anything at all.
The beauty of this is that it\u2019s not you who\u2019s paying the bank back, it\u2019s your tenants who are paying the bank back. You are taking part of their rent and paying the bank back with them. And so over time, basically they are allowing you to owe the bank less. And when you go to sell your property, you\u2019re going to realize that gain. And unlike cash flow, it\u2019s not something you realize immediately. It\u2019s much more like appreciation that we were just talking about that you see the benefits of loan paydown when you actually go to either refinance your loan and pull some cash out or go and ultimately sell your property.<\/p>\n
I like to think of the principal paydown sort of like cash flow. So every month if we\u2019ve done things right with our property, we get this cash flow, we get this profit that goes into our pocket. Principal paydown, it\u2019s not quite as good as cash flow. We don\u2019t actually get money every month that goes into our pocket. But what we are getting every month is equity. We\u2019re getting value added to the property when we resell it or refinance it. And so we can evaluate this principal paydown in a lot of ways the same way we evaluate a cash flow. So Dave talked earlier about the metric that we use for cash flow as this thing called cash-on-cash return. So for every dollar that we get out of the property, that dollar is working for us. Or for every dollar, excuse me, that we put into the property, that dollar is working for us and is allowing us to get money out of the property. And the more money we get out compared to the amount we put in, the higher our cash-on-cash return is.
We can do the same analysis. We can do the same kind of calculation on principal paydown. So if at the end of the year we have a property that we paid a hundred thousand dollars for and we paid down $5,000 of our loan balance after a year, we\u2019ve basically earned $5,000 out of that a hundred thousand dollars we invested. We\u2019ve now made 5%, not cash-on-cash return because it\u2019s not cash that we\u2019re getting, but what I like to call 5% equity on cash returns. So we\u2019re getting 5% of whatever we invested back in equity. Now, how do we capture that? Well, since it\u2019s a lower amount of our loan, we capture that by either selling the property, in which case it costs less to pay off the loan than the total loan that we took out, and that goes into our pocket. Or we refinance the property. We can actually take more money out of the property based on the amount that we\u2019ve paid down in the loan.
So this idea of equity on cash return is very similar to cash-on-cash return. And when I look at a rental property, I\u2019m going to look at my cash-on-cash return. So let\u2019s say I put a hundred thousand dollars into the property. Let\u2019s say I get $5,000 in cash flow at the end of the first year. 5,000 divided by a hundred thousand dollars investment, that\u2019s 5% cash-on-cash. But then when I realize that I\u2019ve paid down $5,000 in that loan the first year, that\u2019s another $5,000 that I\u2019d gained in equity. So 5% equity on cash return. When I add those two together, I\u2019ve now made the equivalent of 10% return on my investment. Now obviously again, the equity on cash I can\u2019t actually capture that unless I resell or refinance, but I\u2019m going to do that eventually. So I can look at my return now as 10% return, not just 5% if I were just looking at the cash-on-cash.
A lot of people ignore the fact that they\u2019re building up equity every year by paying down their loan. But this can be a huge part of the total returns that you\u2019re generating. And if you ignore this, then your returns are going to look a lot smaller than what they actually are.<\/p>\n
J, I\u2019m so glad you mentioned that. It kind of gets my mind spinning here a little bit, but we talked about metrics for each one of these individually, right? Metrics for cash flow, metrics for appreciation, for principal paydown. Is there one master metric that I can use to combine all four of these things together to say, \u201cOkay, cool. This is the one\u201d?<\/p>\n
There isn\u2019t. Unfortunately, I wish there was some grand unification metric, like this one formula that you can plug all your numbers in and it comes out and it tells you this is how much money you\u2019re making. But at the end of the day, again, each of these four ways of making money in real estate are going to have different benefits and drawbacks for different individual investors. And so you need to know what\u2019s important to you, and then you need to analyze those metrics. If you really have no care in the world about tax benefits, well, you can ignore that and you can just look at the other three. But most of us care about all four of these.
And so what we do is, in the last part of the book\u2026 There\u2019s several different parts of the book. The last part of the book kind of puts everything together and analyzes and looks at a couple different types of deals. And at the end of the day, it really boils down to, you need to run the numbers for cash flow, you need to run the numbers for appreciation, you need to run the numbers for principal paydown, you need to run the numbers for tax benefits and then put all of those numbers together in a way that you can see a holistic view of the investment itself.<\/p>\n
Dave, let\u2019s start with you for the last one, the tax benefits. So how are you generating money from the tax benefits of investing in real estate?<\/p>\n
Well, let me just start by saying that I think taxes are probably the last thing most investors start thinking about. I know when I first got started, I really wasn\u2019t even thinking about this. If you\u2019re a rookie, you\u2019re like, \u201cI just want to generate money first and I\u2019ll figure about taxes and hanging onto it later.\u201d I definitely fell into that camp. And I think as you mature as an investor, you realize how important taxes are, because the more money you can keep, the more money you can reinvest. And if you\u2019re familiar with the concept of compound interest, which we talk a lot about in the book, basically if you\u2019re able to keep more money into your investment machine, that means you can generate more and more returns and you can defer your taxes for longer and longer. And maybe in some cases you can defer them all together.
And so basically, similar to some of the other concepts that we\u2019ve been talking about here, taxes are obviously, they\u2019re not putting more money in your pocket every single week, but if you can strategically use real estate to optimize your tax mix, you wind up having a lot more money to invest into your deals that can generate you more appreciation, more cash flow, and more loan paydown over the course of your investing career.<\/p>\n
Here\u2019s something a lot of people don\u2019t think about. They think, \u201cHow do I lower the amount of taxes I ever have to pay?\u201d But it\u2019s just as important to be thinking about, \u201cHow do I put off paying taxes for as long as possible?\u201d I talked earlier about this concept of time value of money. A dollar today is worth more than a dollar 10 years from now because I can invest that dollar today. Well, likewise, having to pay a dollar in taxes, not today but five or 10 years from now, allows me to keep that money, not pay it to the government and invest it for the next 10 years so I can earn more on it before I actually have to give it away to the government.
So a lot of what we talk about when we talk about tax benefits of real estate, it\u2019s not necessarily that you\u2019re going to pay lower taxes throughout your entire life. You will actually, and there are a lot of tax benefits there. But a lot of the things that we tend to think about less is how do we just push off paying our taxes till next year or the year after or five years down the road so that we can take that money and we can invest it in the meantime and make a whole lot more money before we have to give any of it to the government.
And so real estate kind of gives us these two benefits. One, it gives us the ability, one, to pay less total tax over our lifetime of the investment. But two, more importantly it gives us the ability in a lot of cases to defer those taxes for a long time. And we can do that through a couple ways. Number one, we have this thing called depreciation. And basically what that means is just like anything else we buy for our business, and real estate is a business expense, that thing is going to wear out over time. If you buy a car for your business, the government says, \u201cYeah, your car\u2019s going to wear out about 20% per year for five years,\u201d and they\u2019re actually going to let you take a tax deduction for 20% of the car\u2019s value every year for five years. I\u2019m making that up, I think it\u2019s five years. But it\u2019s some amount of time. And you can take a deduction every year for your car.
Likewise, if you buy a printer, you can take a deduction because the government knows your printer\u2019s eventually going to go obsolete. Or if you buy basically anything, a piece of office furniture or a computer, basically the government allows you to take a deduction against that every year as a tax benefit. Same way with real estate. So the physical real estate that you buy is going to deteriorate over time. Your properties, you basically need to maintain them and upkeep them. So the government\u2019s going to allow you to take a deduction against the value of your property over time.
For a residential property, a single family house, you can take that over 39 years. So if you buy a property that the physical structure is worth a hundred thousand dollars, the government\u2019s basically going to allow you to deduct $2,500 a year over 40 years, 39 years actually. And that\u2019s a tax deduction that you get every year. You eventually have to pay it back. When you sell the property, you\u2019re going to have to pay it back, but you can defer taxes for as many years as you hold it. And remember, deferring taxes is good because time value of money.
So depreciation is number one. Number two, we have this thing called a 1031 exchange, which allows you to take an investment property, a rental property or a commercial property, and it allows you to sell that property for another similar property under certain circumstances and not have to pay taxes on that sale. You can then basically hold off paying taxes until you sell that second property, or you can do a 1031 exchange on the second property and defer paying taxes potentially until you die. So between depreciation and 1031 exchanges, there are two great ways to basically put off having to pay taxes on your property for potentially years or even decades. There are plenty of other ways, but those are the two big ones.<\/p>\n
J, a kind of a follow up to that is, what rookie investor would make this, I guess, route of investing their priority? Who would choose this one as, \u201cThis is the way I\u2019m going to generate money off of my investment.\u201d?<\/p>\n
Yeah, so there are a couple things to answer in that question. Number one, if you\u2019re buying rental property, you\u2019re getting depreciation. A lot of us, if we buy a single family rental, we\u2019re going to pay close to zero taxes these days on that rental property simply for the depreciation that the government gives us. We have to take that\u2026 Well, we don\u2019t have to take it, but we\u2019re going to have to pay it back at the end so we might as well take it every year. So what we typically find is, if we buy a rental property, we may not be saving taxes on all the other things in our life, but we\u2019re going to typically save taxes on that particular property. And for a lot of my single family rental properties, the income I earn from the rent that I collect, I pay close to zero taxes on that every year. So if I buy 20 rental properties, I may pay close to zero taxes across those 20 rental properties.
Now, in some cases, I may even get more tax benefits than I made in income on those properties and now I might be able to use that income to offset income I\u2019m making from other places. I might be able to offset income I\u2019m making from a consulting job I\u2019m doing or from stock income that I\u2019m making or from a W2 job. And so it has nothing to do with whether you\u2019re a rookie investor or you\u2019re a seasoned investor, it really depends on the type of properties you\u2019re buying. If you\u2019re flipping properties, you\u2019re not going to get any tax benefits. Flipping properties is\u2026 If you\u2019re getting into real estate for tax benefits, don\u2019t flip properties. I\u2019ve paid more in taxes then most people should have in a lifetime because I flipped so many properties.
But if you\u2019re buying investment properties, if you\u2019re buying rentals or you\u2019re buying commercial property, you\u2019re automatically going to get some of these tax benefits. And then if you\u2019re smart about the way that you get rid of your properties when you sell them or exchange them, you have the ability to push off paying taxes. So it\u2019s not a question of who should be focused on the tax benefits, I\u2019ll get into that question in a second, but all of us, if we\u2019re buying rental properties or commercial properties, we have the ability to take advantage of those tax benefits even if we don\u2019t try. So that\u2019s number one.
Then we get into the question of who should be investing primarily for the tax benefits. There are a couple people. One, if you are a real estate professional, which means you spend most of your time in real estate but you make a lot of money doing other stuff, you can then take the tax benefits you\u2019re generating from real estate and you can apply it to all the other stuff.
So just to give an example, and I don\u2019t say this to brag or to kind of mention numbers, but the reality is I work in apartment complexes now. We buy and sell apartment complexes. This year I\u2019m going to have over a million dollars in tax benefits that I can use for any income that I might generate. Literally, if I make a million dollars from selling books or a million dollars from consulting or a million dollars in the stock market, I can take up this million dollars in tax benefits I\u2019m getting from real estate and I can offset all that other income, and I can literally pay zero tax this year thanks to what I\u2019m doing in real estate no matter where my income might be coming from. So for me, if I\u2019m making a lot of money selling books, or if I\u2019m making a lot of money consulting, or if I\u2019m making a lot of money flipping houses, the fact that I\u2019m doing apartment complexes and have a million dollars in tax write offs, I basically pay zero tax on anything.
Now, again, I\u2019m not going to pay zero tax forever. I\u2019m just deferring that. At some point I\u2019m going to sell these apartment complexes, at which point the government\u2019s going to say, \u201cOkay, now you owe us all the taxes that you saved on.\u201d But at that point, I\u2019m going to buy more apartment complexes and do the same thing with the income I made from those. And so I\u2019m able to kind of push my tax burden down the road. Hopefully I can push it down the road until the day I die, at which point it\u2019s my kids\u2019 problem. But more importantly, if I die, a lot of it is just going to go away because a state tax allows me to kind of generate a certain amount of net worth before I have to pay any taxes.
So somebody that\u2019s a high net worth earner that\u2019s working primarily in real estate, they may be looking for tax benefits. But even if that\u2019s not you, even if you\u2019re just a new investor that doesn\u2019t make any other income and you\u2019re just buying your first rental property, you\u2019re going to be able to benefit from the tax benefits if no other place than just in that rental property that you\u2019re buying. You might make $10,000 on that rental property just in income this year, and you might pay close to $0 in taxes. That\u2019s a huge savings.<\/p>\n
And even for rookie investors, if you don\u2019t even have your first deal yet, it\u2019s great to start your tax planning. BiggerPockets does have a book for this by Amanda Han, it\u2019s The Book on Tax Strategies. It goes through basically a lot of what J. just talked about and kind of breaks it down for you if you want to learn more about it. And then that\u2019s where you can take it to your accountant or your CPA, but better yet to find somebody who\u2019s going to tell you to do these things during your tax planning instead of having to figure it out on your own.
But speaking of books, Dave and J, can you tell everyone where they can find your new book?<\/p>\n
Yeah, you can find it on the BiggerPockets store or you can go to numbersbook.com. Either one will take you to the BiggerPockets\u2019 store where you can find the book. We just wanted to let everyone know, if you order now, it is still during the pre-order period. And if you buy it now, you have the opportunity to attend a webinar that J. and I will be hosting to talk about the state of the economy. We\u2019ll also be giving away coaching calls. So if you buy the book, you might be able to win a coaching call from either J. or myself, and you can use the free code, DAVE, for a discount of 10%. Or I think you can use the name J. as well.<\/p>\n
I think JSCOTT or DAVE, if you put that into the coupon code, you get to save 10%. Whole bunch of other bonus materials as well that haven\u2019t been announced yet, but you\u2019ll see them if you go over to the bookstore. But yeah, a lot of bonus content. The book is called, I don\u2019t know if we\u2019ve even mentioned the name, but the book is called Real Estate by the Numbers. And like Dave said, if you want to get it, you can go to the BiggerPockets bookstore, biggerpockets.com\/store, or you can go to numbersbook.com, which will take you right over there.<\/p>\n
And where can everybody find out more information about each of you? Dave?<\/p>\n
Yeah, so either on BiggerPockets or Instagram where I\u2019m @thedatadeli, or check out the On The Market podcast.<\/p>\n
Yep. And for me, obviously, BiggerPockets. Or you can go to www.connectwithjscott.com and that\u2019ll kind of link you out to everything I have going on.<\/p>\n
Well, thank you guys so much for joining us today on the Real Estate Rookie Podcast. I\u2019m Ashley, @wealthfromrentals, and he\u2019s Tony, @tonyjrobinson. And we\u2019ll be back on Wednesday with another episode.<\/p>\n<\/div>\n