Wed, 27 June 2018
#179: Money is an abundant resource. I tell you why.
When you’re looking to move accumulated equity, should you do a: 1) Straight sale. 2) 1031 Tax-Deferred Exchange. 3) Cash-out refinance.
Avoid lazy money.
My personal internet bill is $145, cable $126, phone around $100. Who cares?
You learn how much I like to spend on a hotel.
Uber and Lyft are killing the parking business.
Learn how to estimate rental property operating expenses.
Want more wealth?
1) Grab my free E-book and Newsletter at: GetRichEducation.com/Book
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Listen to this week’s show and learn:
00:52 Wealthy people’s money either starts in RE or ends up in RE.
02:03 Listener question about 1031 Exchange vs. Cash-Out Refinance.
13:20 Lazy money.
15:04 Other podcasts.
16:09 Free book.
19:11 More on Dave Ramsey.
20:26 Why money is an abundant resource.
24:36 “Uber Really Is Killing The Parking Business”.
29:18 Residential real estate is here to stay.
30:07 “Return On Life” and passivity.
32:47 Don’t underestimate rental property expenses.
Welcome to GRE, Episode 179. I’m your host, Keith Weinhold.
From Saratoga, Australia to Saratoga Springs, New York and across 188 nations world wide.
This is Get Rich Education and we are cultivating a Real Estate Of Mind here.
That is because wealthy people either start out in RE, or wealthy people’s money ends up in real estate. It’s either one or the other.
...and you know, the most important piece of real estate may very well be - that real estate right between your two ears - your mind
We come from an abundantly-minded place here at GRE.
If you want to learn about combining vinegar and water in a bottle because it’s cheaper than Windex. Well, you’re not going to learn about that here.
If you’ve been wearing the same pair of monthly contact lenses for the last two years...then, well, you didn’t learn to do that here either here.
In fact, money itself is an abundant resource, not a scarce one. We’re going to talk more about that today.
We’re going to talk about passive income and define what exactly that means.
We’re also going to talk about how to best increase your velocity of money. Is it by doing a 1031 Tax-Deferred Exchange or a Cash-Out Refinance - with your income property.
Let’s go to the listener question about this.
Listener Jacob Ayers asks: To move equity, should I do a 1031 Tax-Deferred Exchange or a Cash-Out Refinance?
Thank you for that rather eloquently-stated question there, Jacob - and it is a germane time to discuss this. There’s a lot of equity out there that is ripe for harvest because most markets have appreciated a good 7-8 years in a row here.
Really, this is a question about moving equity to keep it working for you. What is the best vehicle for increasing your velocity of money?
Since the return from property equity is always zero, ideally you want to take a big chunk of it and splinter it off into a bunch of little pieces and that way you can leverage more property.
Let’s back up. There are actually three ways for you to move equity should you so choose that it’s right for you.
The first way is to...
Sell Your Property - That way, you can get all of your equity out.
Now, Jacob, you’re a savvy investor so that’s why you probably didn’t even bring that up as one of the ways that you can move equity. Because, of course, the big problem with this is that when you sell an income property.
You could sell your current equity-heavy property and buy another. But the problem with selling is that you'd probably have to pay capital gains tax, which would reduce the equity you have available to re-invest. You’re also going to have to pay depreciation recapture.
Yep, that is all of the depreciation that you wrote off against your taxes every year that you owned the income property will be recaptured off that first income tax return you file after the building sale.
So you might have a nice gain but the tax hit is harsh.
That is, of course, unless you move your equity in the second of three ways and you perform a 1031 Tax-Deferred Exchange.
If you meet the rules of the 1031 Exchange, you can avoid all of the nasty bite of the capital gains tax and all of the depreciation capture. Yes, it can be 100% avoided.
In fact, the Exchange is the best way to move your equity. If you follow the rules and do the exchange properly, you can move 100% of your net equity, tax-free.
Sometimes people point out that exchanging is really tax-deferred, not tax-free. But, c'mon, the exchange itself, if done correctly, is tax-free. The capital gain is carried to the next property without being taxed. Therefore, in real estate, capital gains is a voluntary tax.
What I mean by that is the gain is not taxed unless the you, the owner, volunteers … by selling the property outright.
Instead of selling, savvy investors continue to exchange until they die and then your cumulative gains over your entire lifetime - they are forgiven upon your death - and that’s because of the stepped-up basis rules.
Be sure to ask your good tax manager about the details of the stepped-up basis rules. I’m not going to get into that here. But that’s why it’s effectively tax-free
But whether you call it tax-deferred or tax-free, exchanging is one of the most powerful things in the entire tax code, but it’s very much misunderstood by many accountants, attorneys and real estate agents.
Actually, during my first-ever 1031 Exchange I soon learned that my income property agent had never gone through this before.
Now I devoted an entire episode to the 1031 Exchange here for you a few months ago, so I’m not going to get into all the details and rules again here.
The most important thing that I can tell you, to pull off a 1031 Exchange, is to enlist a 1031 Exchange Qualified intermediary early on - before you even sell the property that you want to sell.
From the time that you sell the equity-heavy property that you want to get rid of, you have 45 days to identify a qualified replacement property, and 180 days to close on that identified replacement property.
...and there are all kinds of rules and limits around how to identify property. But it must be specific. You can’t say that your replacement property is going to be a green duplex in Kansas City. You’ve got to give a specific legal address.
The episode that I completely devoted to he 1031 Exchange topic a few months ago where I discuss the rules and the critical mistakes to avoid, and the deadlines and everything else for you, that is Get Rich Education podcast Episode #143.
So the first way to access equity in a property is to sell it outright, the second way is through the exchange, and the third way that you mentioned, Jacob, is with the cash out refinance.
The problem with the cash-out refinance is that you typically cannot access all of the equity in a property because you are not selling it like you are with the other two methods.
So if you’ve got 50% equity in a property that you want to get rid of, you can get all 50% out with the straight sale or the exchange.
But you might only be able to access 30% of the property value with a cash-out refinance because you might only be able to get an 80% loan-to-value loan. A bank is going to make you keep 20% equity in there as your skin in the game.
The advantage of the cash-out refinance is that you shouldn’t have to pay tax on the equity that you extract because the IRS classifies this as debt. There’s no tax on debt that you’ve originated.
One advantage of the cash-out refi over the 1031 is that the cash-out refi is faster & less stressful. You can move at your own pace.
With a 1031, you’re selling at least one property and buying at least one property, so now you have all these steps - inspection, appraisal, you’ll incur make-ready expenses, and you’ll often be paying an agent commission too.
With a cash-out refi., you typically just have an appraisal - no inspection, no make-ready, and no agent commission.
But a 1031 is typically the best vehicle for moving equity from a “dollars” perspective.
A 1031 is also a better move if you want to sell a “dog” of a property that you can’t seem to keep rented to decent tenants or something, but yet you’ve built equity in the property.
If you own a property that’s been good to you but it’s become too equity heavy, you might be tempted to do a cash-out refi instead of a 1031, but yet if you can replace your nice cash-flowing property with one that cash flows even better, look at the 1031.
When it comes to the cash-out refi, if you think that’s a better choice, remember - and this is especially true if you’re looking to do a cash-out refi of your own home - your primary residence, you can often take out a second mortgage and keep the first mortgage in-place, untouched.
That might be a good option if you still like your first mortgage’s low interest rate or it’s advanced amortization schedule.
A cash-out refi doesn’t mean that you have to restructure every part of the debt on one property. You can keep a first mortgage in-place and see if you qualify for a second.
Just a word of caution on the second mortgage cash-out refi - if your second is a HELOC - home equity line of credit, those HELOC interest rates are not fixed. They float in lockstep with the Federal Funds rate which is expected to increase.
To be safe, you want the CCR from your new purchase to equal or exceed that of the mortgage interest rate on the property that you just took cash out of.
Although I like the 1031 more than the cash-out refi overall, I can think of a couple other disadvantages of the 1031.
With the 1031 Tax-Deferred Exchange, you might experience a degree of stress, much of it having to do with the timing of meeting those 45 and 180 day milestones that I mentioned earlier.
You don’t really want to be on a 3-week vacation to Peru and Ecuador during a 1031.
On the properties that you identified as replacements for moving your equity into them tax-free, something might get slowed down in your ability to buy them that’s out of control, or if you’re looking to 1031 your equity into new construction property and the new construction is going too slowly, that can create some stress.
With the cash-out refi., you’re on your own deadlines, not the 1031 deadlines that the IRS sets for you.
You know another thing - another small disadvantage with the 1031 Exchange that people never think about - and everyone overlooks this. I didn’t really see it coming until I had the ball rolling with my first-ever 1031.
It’s that during that time - those three months or so after you’ve sold your relinquished property and before you’ve closed on your replacement property, you’ve lost cash flow…
...because there’s that gap there - that delayed exchange gap where you don’t own some property for a period of a few months.
I’ve done a 1031 with a substantial chunk of my portfolio, and I had about three months where a major piece of my cash flow was cut off until I closed on the replacements.
1031s & cash-out refis have definitely been good for me.
I’ve made some mistakes in real estate investing for sure, but having an early awareness of the fact that dead equity isn’t serving me and then actually doing something about it really helped me get me to where I am today.
If you’ve got a lot of equity in a property or a property paid off, you’ve got to realize that your money just got lazy. Not only is it not working for you, you’re paying the opportunity cost of not using it to also leverage other people’s money work for you.
Don’t let your money get lazy.
So when I’ve built up around 35% equity in an income property, that’s when I’m looking forward to moving it. It’s that 35% mark.
With a primary residence, it would be less than 35% because I can pull more out - I can pull out equity up to a higher loan-to-value ratio.
Just think about property that you have 50% equity in. Your leverage ratio is been slashed to 2:1. If you reposition it with 20% down payments on multiple properties, now your leverage ratio is 5:1.
That is just huge, and it’s great as long as you’ve safeguarded controlling your cash flow…
...and we love cash flow - but what has created more wealth for real estate investors is really leveraged appreciation so consider keeping your leverage ratio up there by maintaining small equity positions in a bunch of properties.
You know what else? The more that you learn about the economy, pulling $ out of property and transferring it into another property actually expands credit, that very act expands the money supply, and it stokes inflation…
...and as you know from listening to this show, inflation is actually our friend.
Great question from Jacob - asking about the pros and cons of a 1031 Exchange vs. a cash-out refinance.
By the way, that “Jacob” was “Jacob Ayers” - he is the host of “The Real Estate Way To Wealth And Freedom” podcast. That’s another show that you can listen to.
You know what’s funny - some podcasters don’t want to talk about other podcasts similar to theirs or they’re afraid that they’re going to lose listeners to that other show that they talk about.
Well, I just don’t feel that way - and well, maybe that’s part of my abundance mentality. Of course, I value my listeners and anyone wants more listeners just like an artist would want more people to see what they’ve spend weeks working on - on canvas.
You can check out The Real Estate Guys Radio Show with Robert Helms and Russell Gray. That’s a really good one.
Sheesh, I’ve even got a commercial on my show that tells you about someone else’s podcast - the Cashflow Ninja hosted by my friend M.C. Laubscher. That’s another good show that you can check out. He’s had some great guests on that show like Ron Paul, Robert Kiyosaki, and Jim Rogers.
Once again, Jacob Ayers’ show is called “The Real Estate Way To Wealth And Freedom”.
Uber and autonomous cars are killing the parking lot and that’s going to change real estate. I’m going to discuss that in a bit. I’ve also got some Dave Ramsey fallout from our episode from two weeks ago.
You know, if you want to learn more about the misconceptions around debt and equity - which have been woven into this discussion so far - and how to use debt and equity to your advantage - and in the way that affluent people use them…
...and why getting your money to work for you won’t create wealth and how to get other people’s ethically working for you to create wealth for yourself and a lot more...
I wrote a book less than 9 months ago about how you can do that.
You can get the e-version of my book completely free. Not just a free chapter or something but the complete e-book free...
...Robert Syslo is going to tell you how easy it is to do that now. Go.
Welcome back to Get Rich Education. I’m your host, Keith Weinhold. We got more great feedback on our episode from two weeks ago when we were talking about the largely - really - antiquated Dave Ramsey ‘debt-free’ School Of Thought.
We’re talking about a School Of Thought that has - in the past - suggested that people eat things like cheap processed Ramen noodles - and beans and rice - so that they’ll have more money in their pocket so that they can pay off a car loan or a mortgage loan.
When you pay down debt that’s lower than the rate of inflation, you’ve actually diminished your prosperity now.
So now you’ve diminished your prosperity and you’ve eaten Granola bars and Cup O’ Noodles so now you’ve sacrificed your health - just to diminish your prosperity - plus...you took your time to learn about how to live like that!?
That is just so absurd, scarcity-minded, and that is not serving people. Ugggh. I’m not going to go on, I don’t want to dip into hyperbole, but hearing about that stuff is just really dispiriting.
If I’m going to use my time to learn about something, I want to learn about how to produce, not reduce.
I think part of that is realizing that money is actually an abundant resource. Yes, money is an abundant resource.
How much currency does the Treasury Department print every day? During Fiscal Year 2014, the Bureau of Engraving and Printing delivered approximately 6.6 billion notes to the Federal Reserve. They produced approximately 24.8 million notes every day with a face value of approximately $560 million.
Those numbers are so large, some people can’t even fathom it.
Those stats right there can actually be picked apart all day. Most dollars aren’t even printed, of course, they’re digital and they’re created out of thin air when dollars are borrowed into creation - but it just gives you some idea of how abundant money is.
Look, my monthly internet bill is $145 and my Cable TV bill is $126 - yes, I have cable because it’s just a nice option and money is an abundant resource. I just learned this because I just saw the bills come in.
You know, I’m just really barely aware of my consumer bills. I’m into expanding my upside instead.
I don’t even know how much my monthly phone bill is. Maybe $100. So for internet, cable and phone combined, that’s...what three hundred seventy-some dollars a month? Is that a lot? It just doesn’t matter that much. I’m focused on what matters.
Expanding the upside. Money is an abundant resource.
How much do you like to spend on a hotel? To me, it seems like $300 a night is a common number to spend at a good hotel.
What about a $79 hotel? I wouldn’t even want to stay there. I might not even want to stay there for free.
But you know what, everyone has learned how to tap into abundance at a different level. Everyone’s got their price.
OK, what about a $2,500 hotel. What if I were staying there? I might think that that price is pretty steep.
I’ve got to admit, I would be asking myself a question like “Now why am I staying at a $2,500 hotel? Is this my honeymoon or something?” Maybe I would soon move to another hotel.
Well, didn’t I just say that money was an abundant resource, so what’s my problem?
Maybe the Amazon Founder, Jeff Bezos - he wouldn’t want to stay in a $300 hotel like I’m more used to and I just think of as standard. He might live in the $2,500 hotel year-round if he had to because it doesn’t matter to him.
See Jeff Bezos and Amazon.com have figured out how to provide more value to more people than you have - and than I have.
Money is an abundant resource. But just because something is abundant, doesn’t mean that it has no value.
Look, the air that you breathe is pretty abundant all around us but it’s also really valuable. We would die without air just like we would financially die without money.
But yet they’re both abundant.
Right now I’m not too far - and maybe you’re not too far - from a parking lot with hundreds of cars in it.
So cars look pretty abundant but each one still has value and utility just like dollars.
So the point is that a scarcity mindset and an abundant mindset are relative in a sense.
But really, if you’re looking to produce before you reduce, it’s an abundant mind.
Money is an abundant resource, and the amount of the world’s abundant supply of money that will be allocated to you on this earth is directly proportional to how much value you create for others…
...how much sound housing you can create for others.
Money is an abundant resource.
Well, way back in Episode 13 of Get Rich Education, more than three years ago, I did an episode called “Autonomous Cars Will Soon Disrupt Your Life and Investments”...and I talked about how this will have implications for real estate investing.
Well, we’re already seeing the world go that direction. In fact, ride-sharing services are accelerating this effect.
Fortune magazine just reported this in the last couple weeks here, in an article titled “Uber Really Is Killing The Parking Business”. In the article, it outlined how
Ride-hailing services like Uber and Lyft are having a negative impact on the demand for parking. The picture, at least for those trying to rent you a parking spot, is bleak.
In the email, unearthed from a company report by the San Diego Union-Tribune, Ace Parking CEO John Baumgardner says that demand for parking at hotels in San Diego has dropped by 5 to 10%, while restaurant valet demand is down 25%. The biggest drop, unsurprisingly, has been at nightclubs, where demand for valet parking has dropped a whopping 50%.
The numbers appear to be estimates, and Baumgardner doesn’t describe a timeframe for the declines.
The assessment, written last September (6 months ago now), is also limited to San Diego, though an Ace Parking executive told the Union-Tribune that it has seen “similar” declines at its 750 parking operations around the United States.
The company is focused on using technology, including better parking scheduling and booking options, to try to remain healthy.
But much more is at stake than the revenues of the parking business – cities stand to benefit immensely as demand for parking drops. Parking spaces and lots generate relatively little tax revenue or economic activity relative to commercial operations, and increasing sprawl may actually harm the economy of cities like Los Angeles.
Even back in 2015, cities were already relaxing zoning requirements that set minimum parking allotments, and there are now even more signs that city planners are thinking differently about parking.
[Now get this] - Perhaps most dramatically, a new Major League Soccer stadium being planned for David Beckham’s Miami expansion team may include no new parking at all – but will have designated pickup zones for Uber and Lyft.
The decline of parking will only be accelerated if and when autonomous vehicles become widespread. That sea-change which will make it easier to locate parking at a distance from urban destinations, and could further reduce car ownership.
That will be bad news for the Ace Parkings of the world – but everyone else should welcome the decline of the urban parking lot.
...and that’s “it” for the article.
I told you back in Episode 13 that this will spell a dramatic shift in the character and makeup of inner-cities and suburbs alike.
Right now, many U.S. cities have central agglomerations where the surface area is 40 to 60% parking spaces. When you hire a ride-share car, you didn’t need to drive your own car to work and you didn’t have to park your car.
Soon autonomous cars are expected to be all over the road and they’ll just always stay in motion.
You know what else this means for homes in the suburbs - homes with garages could become less desirable over time.
Now, they’ll probably just repurpose the garages, but…
In any case, so many trends are changing the way humans interact with real estate and the economy…
The internet diminished the need for office space as that almost completely wiped out the need for things like travel agencies.
The internet reduced the number of all kinds of other business like the number of bank branches.
Of course, Amazon keeps killing off traditional retail consumer good purchases.
Ride-share services and autonomous cars are diminishing the parking business - this one is now happening in front of our eyes - it is happening now - there’s no more “someday” on that one.
...And despite all these trends, the residential real estate space is hardly impacted. That’s why we focus on the residential space here - not only is it easier to understand because you interact with residential space every day of your life, but residential is here to stay.
Well, because we’re around residential real estate every day it’s kind of paradoxical that it’s so misunderstood by so many people.
When you tell a lot of people that you’re a real estate investor, oftentimes they think that you’re a house flipper, and then if they hear that you’ve got rental property, the next thing that they think about is that you must be the landlord.
If you’re either of those things - especially the landlord - you’re not getting a very good ROL - Return On Life.
So let’s talk about passivity.
You have the ability to make real estate investing passive - and at the beginning of this show - it says that you’ve created more passive income from this show than nearly any other show in the world.
Well, even if you’re “hands-off” and you’re not the landlord, it still doesn’t feel so passive if you’ve got a week where your rental property’s roof blew off and you’re looking at contractor quotes that your manager has pulled together for you and managing an insurance claim that you had to put in.
Aren’t you working for your passive income a little bit then?
...and I would say that, yes, you are at that time.
Your property might operate 24 hours a day, 7 days a week for many weeks in a row or even months in a row without your involvement at all.
It probably operates for you passively 98 or 99% of the time or more...passively. That’s why it’s called passive income. For you, it’s hands off. You’re not fixing leaky faucets and you’re not collecting rent checks.
When the problem that you have 1% of the time blows over, you’re right back to passive again.
Alright, compare that to your work-a-day job. What happens when you have a problem at work? You handle it, and what happens when that problem is handled and goes away - you go right back to active income.
At work whether you have a problem or whether things are going fine, it takes your involvement. ...and that’s really my point here for you.
It’s NEVER passive - unless you’ve got some vacation time. Then maybe you can say your active job is just 5 or 10% passive.
In real estate investing with the way we do it, passivity is the norm, not the exception.
So, just keep that in mind if - not if - but when - you have to be resilient during some bumps in your “almost-always” passive real estate investment portfolio.
You know, there is so much that I want to talk to you about every week that I just can barely fit it in. That’s why I do these monologue shows with no guest once in a while.
I haven’t even told you about my recent RE field trips to Florida or Belize yet, though I’m really looking forward to telling you more about those here.
You are really out there taking action so before you go, let me just help you with one other thing while you’re out there looking at properties.
Don’t underestimate the expenses that you project that your property will have.
Of course, your mortgage and all of your other expenses are 100% outsourced to your tenant in a cash-flowing property!
It’s easy for you to remember that you have a mortgage payment (principal plus interest) because that’s your largest expense.
You know that I’ve mentioned that an easy way to remember your other recurring expenses - which are really all of the operating expenses - because mortgage principal and interest are not an operating expenses…
...is with the acronym “VIMTUM” - and I mentioned VIMTUM last week when Clayton Morris interviewed me, but let’s hit each one of these:
Vacancy – This depends on your property type, the local job market, and more. 8% of the gross rent amount is often a good number, equating to about one month per year of vacancy. If you’re in a strong job market, 4-5% might work. You’re guessing here.
Insurance – Your lienholder requires you to have property insurance. Having a policy reduces your risk too. You can get quoted an exact number here.
Maintenance – Now here is where a lot people underestimate this number, which can be 3% to 15%+ of the gross rent amount. This is where you must make your best guess based on the property age, history and other factors.
Taxes – You have a property tax obligation, often 1 to 3% of the property value annually, depending on the area. This is an exact number that’s easy to find in county or municipal records.
Utilities – In a single-family income property, your tenant typically pays utilities. The more units in a property, the more likely you’ll be paying the heat, electric, refuse, water, etc. Utility companies have historical records so you can make a close expense determination.
Management – If you don’t have a Property Manager then your income isn’t passive. If you self-manage, then you must factor in your time expense. Management fees are typically 3% to 10% of the gross monthly rent amount. The more units in a building, the lower the management expense.
People like easy ways to remember things. That’s why I like VIMTUM.
I also made a video for you about these income property expenses where I’m talking directly to you. I’ll put that video link in the Show Notes for you.
So when you connect with an income property provider at GREturnkey.com - if they haven’t - then run your own numbers on an income property using that VIMTUM acronym.
Those providers are at GREturnkey.com - download a market report and get their contact information, and see what they have for inventory. It sure is thin in most markets these days.
I appreciate the time that you spent with me today, but you weren’t here for me you were here for you.
Until next week, I’m your host Keith Weinhold. Don’t quit your day dream!