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Debt is a Bad Idea for Real Estate Investor Beginners
Joe: Debt is a bad idea for real estate investor beginners. Debt is what kills your business, interest is what eats up your profit. Debt also allows you to leverage your investment. So if you buy a $100,000 property, put $10,000 down on it you get the purchasing value of $100,000 with only $10,000. But if you don’t know what you’re doing and you buy incorrectly, if you buy with negative cash flow, you have the risk of losing that property and screwing up your credit and losing your $10,000.
Joe: Now if you have $100,000 to put down it’s a lot less likely that you’re going to lose that property, you know, unless you don’t pay your taxes. So it’s not as big a risk. But it’s a lot harder to come up with $100,000 than it is to come up with $10,000.
Joe: Now instead of using bank loans use seller financing. So instead of going out there and putting 10% down on a property and buying a property go and get a property subject to, put nothing down on the property. In fact, you’re going to sell that property on the same day that you buy it to a lease option buyer who’s going to give you $10,000. So when you close instead of coming up with $10,000 you’re going to get $10,000 from the buyer. And you’re going to do it on the same day. So you’ll never have any real risk there, at least until it goes vacant. And if you’ve set that $10,000 aside for a rainy day you’ll be able to make those payments on it and you’ll be able to do any repairs that are necessary and you’re going to be able to keep the cash flow on that property because hopefully you’re going to have bought that property with a little bit of cash flow in it so that your monthly payments, your taxes, insurance, principal and interest and your property management are all going to be covered by the income that comes in on that property.
Joe: You always want to know your potential for negative cash flow. Negative cash flow will eat you alive. It’s absolutely the worse thing that can happen in your business. Don’t allow negative cash flow in your properties and if you find that you’ve bought a property you accidentally got negative cash flow on, which shouldn’t happen, but if you accidentally screw it up and you have negative cash flow, get rid of that property as quickly as you can. Don’t hang on to a property that’s eating you alive. Even if that property is making you a little bit of positive with buying down the note or getting you some tax benefits or going up in value a little bit, you have to really pay attention to negative cash flow. Because even a few hundred dollars on multiple properties can eat you alive pretty quickly.
Joe: You also have to think about vacancies. In 1991 when everything crashed for me vacancies didn’t matter because I was building new construction. But when 2008 came a long I had a big portfolio, mostly positive cash flow, but I had a lot of subject tos. And suddenly my vacancy rate went from 3% to 20% which is substantial when you’re making the whole payment on those properties. So I was very concerned about negative cash flow because the rest of the portfolio was just barely covering those costs. And that was the portfolio that’s outside the Roth. I’ve talked about inside and outside the Roth before and I won’t get into that right now.
Joe: So the part of the portfolio that was outside of the Roth had negative cash flow. And I wanted to make sure that that didn’t happen for very long. So I was able to get those properties refilled pretty quickly, and I had enough reserve to be able to cover those costs. But if you have too much debt and you don’t have enough reserve you’re not going to be able to cover vacancies and repairs when they crop up.
Joe: You also need to worry about values dropping. Now I had values drop during 2008 but it wasn’t dramatic. I wasn’t in California, that market. The markets that I was in dropped 10%, 20% but not much more than that. But the thing that stayed pretty stable was the rents. They dropped a little bit but maybe 5%. So I didn’t see much reduction in rents other than the vacancies that happened immediately during that first year or so. But the values kept solid. So because I bought properties that could support themselves with rent I didn’t have to worry about that negative cash flow or worry about losing those properties.
Joe: Back in ’91 when I was building new construction and I didn’t have any income on those properties, you know, not until the work is done. As soon as the values dropped there’s no way I could make payments on a property like that. Now I was in construction loans so I wasn’t making payments. They were built in to the loan. But what the lender wanted was for me to come up with more money because they wanted me to have more skin in the game based on the value of the property. And when the values dropped they wanted me to have more money into it. And I was so leveraged that I couldn’t make that happen either. Leverage is a two-edged sword. It can be wonderful and make your portfolio grow. It can also eat your portfolio alive. You have to balance it and make sure that you’ve always got enough cash flow. And I would not buy a property that is just a break even property if it’s the only property that I had and I was counting on the income on that property to pay for it. If I don’t have another source of income to cover those costs, if I don’t have a way to make sure that that, you know, a reserve to make sure that that property will be repaired and taken care of and refilled and continue to work properly for me I don’t want to take a loan out on that property.
Joe: Now, if I buy a subject to which the loan is not in my name, I don’t have any money down on the property, I haven’t put any money into the property to fix it up, and I put a lease option tenant in that property I can be a little bit more flexible on those things.
Joe: Now I have to make the payment and I want to make sure I have a reserve to cover that payment but I’m going to get a lease option fee and that lease option fee I’m going to put in a bank account. I’m going to save that lease option fee or at least a portion of it to make sure that I have enough to cover a month or two or three months plus maybe some repairs if that property goes vacant again and I have to start making payments on it.
Joe: The worst thing that could happen to somebody in this situation is a pandemic could happen. And the tenant may stop paying. And there may be a moratorium on evictions. And if that happens, and I know it’s happened to me with a couple of my tenants, thank goodness it’s only been with a couple of my tenants, but I know people that have one property and it’s happened with them. And when that happens, and it’s the only income you’ve got, it’s going to eat you alive.
Joe: For me it’s not a big deal. I can support my properties. But for a small business person, a small landlord who’s only got a few properties, if they have one or two people that stop paying it’s going to eat them up. It’s going to send them into a bankruptcy, into foreclosure. So be careful when you buy properties like this that you kind of think about the contingencies and the things that could go wrong in a deal like this.
Joe: So there are a few things to worry about as far as negative cash flow, you know, vacancies, your values could drop in value, your payments come due that you can’t afford. You could have vandalism or other repairs that you can’t afford. Insurance costs money, taxes go up over time. You know, the difference between buying a property, when you buy a subject to property that is owned by the person who is living there the taxes are going to go up because owner-occupied taxes in Indiana at least are 1% and for non-owner occupants it’s going to be 2%. So your taxes are going to double. So make sure you know where your taxes are going to go when you buy those properties.
Joe: And even if you own a property that you know, for the long term, you know your taxes are going to go up on a regular basis because taxing authorities are getting stronger and stronger about raising those taxes every year and you have to deal with that and know that those, what may be a positive cash flow this year next year may be negative cash flow if you have a very small margin on that.
Joe: You also have to worry about economies crashing, you know, we’re in a volatile time in our existence as a country. And the economy could take a hit. I think we’re going to see another real estate crash here in the next year or two and we’re going to see values drop. So make sure that the income that you have on those properties is going to be able to make the payments on the mortgages that you have. We also need to worry about climate change. Weather is out of control in some areas.
Joe: Just last week we were at a restaurant and it started hailing. And we had hail the size of my fist that were coming down. And that kind of hail does a lot of damage to a Land Rover. Broke the window, it put so many dents in that care it’s going to take, you know, it’s going to take weeks and weeks of going to the shop and getting that stuff taken care of. Now we’ve got insurance that’s going to cover it but it’s also going to damage the houses.
Joe: Now again, we’ve got insurance to cover it but that damage will not be covered if we had a flood, an unexpected flood. It’s possible that the insurance companies aren’t going to be able to handle all the claims that are happening. And just the claims on that hail damage, when I talked to the shop that’s doing the work on the hail damage, they are inundated with business, which is great for them, guess, but they’ve got so many people that have dents in the hood of their car that they’re trying to repair that, you know, it’s going to take weeks and weeks for me to get that done to my car. So I guess I’m not trying to scare you away from owning properties, these are all expenses that are acceptable expenses for you as an investor. And just make sure you know that they exist, that they’re going to happen and it’s likely that you’re going to be surprised sometimes. But the longer you do this the more you’re going to understand where those surprises are going to come from and you’re going to be able to set yourself up with reserves and with cash flow to be able to handle those problems.
Joe: My suggestion is when you’re just getting started as a real estate investor that you start by flipping properties which means using the For Rent Method. And getting control of a property, turn around and selling it, making a chunk of money, you’re in and out of the deal, you don’t have to worry about keeping it, you don’t have to worry about cash flow. All you have to worry about is depositing that money into your bank account.
Joe: That’s a good way to start this business. You learn how to put deals together. You learn what kind of deal makes sense. You learn how much profit you need in a deal, how much profit you can make. You learn how to negotiate bigger down payments, more rent, you learn how to take care of your properties, how to manage them. You learn how to get good tenants in there. You learn what happens to other people. And you can do all this in months, you know, it’s not years. We’re talking months.
Joe: You can learn how to put deals together in a way that makes sense. And once you learn how to put together a deal that makes sense then you can start building your own portfolio. And you can keep them for the long term.
Joe: All right. I hope that helps. If you like this channel hit the subscribe button, hit the thumbs up button and if you’re interested in my mentor program go to ZeroDownInvesting.com There’s also a video on there of interviews with some of my mentor students. Not so much to tell you how great I am but to tell you how they do their business and what’s working for them. I’ve got over a hundred and fifty interviews with past mentor students on my website so go take a look a ZeroDownInvesting.com.
Joe: The other place you might want to take a look at is PushButtonAutomarketer.com. That’s my automation site and it’ll show you how to automate your business and give you the software tools you need to make that happen.
Joe: All right. I hope that helps. Good luck to you.