Why Investing in Real Estate is the Best Way To Create Wealth – Video 1 & 2
Video 1 Transcript
Kathy Fettke: I want to talk to you about the top reasons why I think real estate outperforms other investments, starting with growth. Real estate has provided investors with steady growth since 1940, even in spite of the housing recessions of the ‘70s, ‘80s, ‘90s, and the zero years. Of course, we know all about those because we just survived it. In 1940, 1950, 1960, 1970, we didn’t see such huge gains in real estate until after the ‘70s. I’m going to go into that a little bit later, but still, even though it’s small growth, look from the ‘40s to the ‘50s, it more than doubled. From the ‘50s to the ‘60s it almost doubled. From the ‘60s to the ‘70s, it more than doubled. Then wow, look at the jump from the ‘70s to the ‘80s and single-family home prices tripled nearly. Then from the ‘80s to the ‘90s, ‘90s to the 2000s, you just see massive growth in real estate.
Now, is it that real estate became really that much more valuable over time? Or is it that people have started to see it as an investment and they’re jumping into it more? Well, you can see with growth numbers like this, no wonder the hedge funds are jumping into real estate now because of these huge returns. Again, I’m not so sure that it’s because real estate has become that much more valuable, but what we do know is there’s a limited amount of land and a population that’s growing, so that may have something to do with it. But really what happened is in 1971, Nixon took us off the gold standard.
Now, up until then, we had to have a certain amount of money tied to gold. In other words, the Federal Reserve couldn’t just print money out of thin air like it can today. It had to be tied to the amount of gold we had- money represented the amount of gold we had. Well, we needed more money. Politicians needed more money. They wanted to spend it. We didn’t have more gold. Nixon just changed things and said, “Well, it doesn’t really have to be tied to gold.” That’s when the Federal Reserve had the freedom to just print, and the US government can borrow from the Federal Reserve.
Our constitution says that we can’t just print money because our forefathers knew that wasn’t a good idea, but it didn’t say anything about the Federal Reserve printing it and the United States government borrowing from the Federal Reserve. That is what’s happening and that is why we see this massive growth in home prices after that happened because it just represents inflation. Inflation has gone rampant since that day happened and real estate moves along with inflation because it’s a hard asset. As long as we’re going to be in this inflationary environment where our government can just keep printing money out of thin air, this is probably the results we’re going to see.
Leverage is another reason why I really like real estate because prices are going up. It’s harder and harder for people just to pay cash, but you don’t have to. You can use a loan. If you were to buy $150,000 home, you would only have to put $30,000 of your own money into it. Then, in addition to that, you can rent out that home and let your tenant pay the payment that the money that you used to borrow to buy this asset. You can have someone else pay it off for you. You’ve got double leverage here. Not only that, they can pay the taxes, the insurance cost, all the repairs. It’s incredible leverage.
Now, if the home were to appreciate at about a 5% growth rate, it would be worth $611,000 in 30 years. You would own it free and clear at that time. Again, where else can you put $30,000 into an investment and come out 30 years with $600,000? I’m sure there are other investments, I just don’t know of them. If you know of them let me know. Now, you might be saying, “5%?” Well as you saw from the last slide with prices going up even in spite of recessions every single decade, home prices go up on an average of six and a half percent. I think using a 5 percent growth rate is pretty fair.
Well maybe you’re saying, “I like all this, I like the idea of leverage but I can’t wait 30 years. I’m old.” All right, well maybe you’re not old but you still don’t want to wait 30 years. Here’s the thing you can do with leverage, you can work with it. If you made an extra $1000 per year towards your mortgage on a $100,000 loan you would pay it off in 22 years. If you want to do it faster than that, you say I don’t have 22 years, how about you pay an extra 2500 per year and pay it off in 17 years? Is that feeling more doable-closer to your goal of retirement? If not, all right. I don’t know that I can do it a whole lot faster for you but let’s look at this. An extra $5,000 per year paid toward your $100,000 mortgage, you’d have it paid off in 12 years. Now, we can see our future 12 years from now and say, “Hey, it wouldn’t be so bad to own a bunch of properties free and clear in 12 years.” This is how you can do it by paying a little extra.
Again you might be saying, where am I going to come up with $5,000 a year to put towards my mortgage? Here’s how: We are finding cash flow properties that cash flow about $400 a month. If you take that $400 a month extra cash flow and this is after all expenses, the rental income is that good and mortgage rates are that low that you can get this kind of cash flow today still. With that extra $400 a month you put it towards the mortgage, you can pay that property off in 12 years. Now, all that rental income just goes in your pocket to help you with retirement.
Accelerated growth- again, this is another reason why I love real estate. Let’s say instead of putting up $30,000 there’s a down payment you put into stocks or gold or other investments on wall street. If you got a 10% return which is really good. Let’s say you’ve got a 10% return on your $30,000 you’d get $3,000 per year. But, if you put that $30,000 as a down payment on a property, now you’ve been able to leverage and buy a $150,000 property. When you leverage you still own that property. Other countries aren’t like this, but in the US you put that $30,000 down, you get $120,000 mortgage but you own the asset even though you don’t really. I mean the bank does, but your on title. Which means that you get to reap the rewards of growth.
Even though you only put $30,000 in, you own $150,000 dollar asset at 10%. Your ROI, or return on investment is $15,000. That’s way more than if you had just put that $30,000 in stocks or gold. You’re going to say, “where am I going to get 10%?” Well, let’s say that you get 5%, which I said is about the growth rate that’s been the average since the 60’s on real estate even with the ups and downs and all the recessions and everything. I think you can pretty safely say you’ll get 5% on real estate if you’re buying. That’s a $7,500 annual return still- double what you would have gotten if you just bought stocks or gold or other investments.
Let’s just say you’re very pessimistic and you think it’s only going to be 2%. That’s where you will make the same kind of return on investment that you would get had you not leveraged and just put the $30,000 into buying stocks. Again, accelerated growth is a wonderful thing.
Now, add to it taxes and the tax benefit. It’s no surprise to anybody that taxes are going up. Taxes and inflation destroy your wealth. Here’s just a quick look at some of the increases that the top income tax rate in 2012 was 35%, in 2013- 39.6 %. What’s it going to be in 2014 and moving forward? Well, we know we have a big problem and in our government being in debt and borrowing money that we don’t have to pay back. There’s a good chance they’re going to find a way to get it from you. Top rate on long-term capital gains has gone up from 15% in 2012 to 20% in 2013 and probably will go up. Then, it goes on and on. I don’t know how much of this applies to you but I think we can all agree on one thing, the taxes are not going to go down, unfortunately. I wish they would but they’re probably not.
How can real estate help you with this problem? Let’s take a look at some of the tax advantages that I’m surprised a lot of people still don’t know about. Here are some of the things you can deduct when you buy rental property. You can deduct the mortgage interest, the property taxes, insurance, maintenance, repairs, professional fees. When you go to your CPA and you need them to work out all these tax advantages that you get, you get to write that off too. Education, just the money that you’ve paid to be a part of the academy, that’s a write-off. If you own property, traveling to your properties, these are all things that you can deduct. It makes a big difference on your final tax return. I haven’t even begun to talk about depreciation. This is on top of all that.
The IRS lets us write-off our rental property as if it’s worth nothing in 27.5 years. Now, is it true that a property gets worn out and turns into nothing in 27.5 years? Of course not. We’re buying properties that are 100 years old in some places and they’re beautiful and well-built. I don’t know where the IRS came up with this, but basically, how this works in numbers is that you take 80% of the value of the property. Let’s say you bought $100,000 property, the government would say, “Well 20% of that is probably land. You can’t depreciate that- land isn’t breaking down, but your house might be.” They take 80% of that $100,000 which is $80,000 and divide it by 27.5 years which is a $2,900 annual deduction approximately per rental property at $100,000.
There are a lot of rules around this. You’ve got to talk to your CPA. If you earn more than $150,000 a year, you may not be able to take advantage of this. You might have to just use it for the future. But again, this is where you need a very good CPA. We can certainly give you a list of accountants who understand these kinds of tax advantages because there’s a chance the one you’re working with isn’t an expert in real estate investing.
Then, on top of this, there’s that 1031 exchange. You can defer the capital gain. Let’s say you’re in a high-income tax bracket and you buy a house for $100,000. It’s worth $200,000 and you want to sell it. You made $100,000 dollar gain. Right now you’d have to pay 20% of that to the government unless you exchanged it and bought more property. Again, there’s all kinds of rules about the 1031 exchange but it is a wonderful way to not have to pay those capital gains taxes until you die basically. You know the funny thing is, well not that it’s funny that you die, but when you die the properties can be passed on to your children and that capital gain just disappears because the properties are marked up back up to today’s value.
Again, any of this can change. There’s discussion now about some of these things changing. I want to let you know that in July 2013, I’m telling you this and always talk to your CPA to make sure that you know about any changes. As of now, this is a wonderful benefit.
Video 2 Transcript
Kathy Fettke: Tax deferred real estate- This is maybe surprising to a lot of people, but you can self-direct to your IRA and buy property. There are no penalties for doing this. It’s different than the idea of borrowing from your 401k; it’s not that. It’s not taking money out of your IRA. Instead, you can actually have your IRA buy property, invest in property. But you probably can’t do it where it is right now. You can’t do it with your Schwab account. You can’t do it when you just have a normal IRA. You have to self-direct your IRA. That costs depends on the IRA custodian but a few hundred dollars to self-direct your IRA, and then you can direct it to buy real estate.
Let’s say that all the rental income from that property brought in cash flow every year of a 10% return. Let’s say that in addition to that, after 15 years, the property is doubled in value at a 5% growth which is been the way it’s been since the ’60s, so there’s a good chance that could happen. Then let’s say you went and sold it. Now you’ve made all this cash flow that’s gone back into your IRA, the property is now worth $200,000, and you sell it. You don’t have to pay the taxes or the gain on that because it just goes right back into your IRA. This is, again, a wonderful way to defer those taxes and build a retirement portfolio.
Passive income, this is another reason why I love real estate as an investment. You can earn income from it whether you’re working or not because it’s an asset. It’s something that somebody needs and will pay you to use. When you buy a good house in a good working neighborhood and somebody wants to live in it, they’re going to pay you every month to live in it. That’s passive income. Really, cash flow is the number one best reason to own property today because you can count on that cash flow coming in month after month after month.
The wonderful thing about buying today is that prices are still down, and mortgage payments are low. That combination means that you can get a really low monthly payment but still have high rental income. The difference is the cash flow you put in your pocket. It’s just a great combination, not one that we’ve seen in a long time- getting this kind of cash flow. I know when I was buying properties, we were just happy to break even because prices were high and interest rates were high, but the opposite is true today. But that window is changing. We’re seeing prices go up and mortgage rates go up. It’s not going to be this good forever for sure, but what we are seeing is that rents are holding steady.
We don’t know if they’re going to continue to go up, although historically they have, but we’re not seeing them go down unless you’re buying property in areas that are 100% rental. We’ve seen that in parts of Arizona where so many investors have gone in between hedge funds and foreign investors and domestic investors, buying property, renting it out. There’s a lot of competition for those rents. We’re seeing in some areas those rents going down, but in other areas where there’s the fundamentals in place that we like- the job growth, the population growth, affordability- we’re seeing rents holding steady or going up. Those rent ratios, like I said, are the best we’ve seen in a year, 1 to 2% of purchase price.
Let me give you an example: You’re going to buy that $100,000 home, you should be getting $1,000 a month in rent. Why do we not buy in places like California? Because it’s hard to get that rent ratio, it’s not going to be that good. Now there’s some places where I’m buying, or I can buy a $50,000 home in a very good neighborhood and rent it for a $1,000. That’s a 2% rent ratio and is just unheard of. I don’t know where else you’re going to get that kind of return. I don’t know how long it’s going to last but believe me I’m personally buying as many of these as I can.
Now the reason I love real estate as an investment is that you’re in control. What this means is no asset manager is skimming the profits except you. Let me just say, I always found this very interesting, that when you use a financial planner, and you have your money invested and the stock market tanks, and you lose money, I find it interesting that the asset manager still gets paid even though there’s losses, and nobody sort of blinks at that. It just has become the norm, and we’ve been taught by our financial planners and the stock market that it is going to go up and down. You should expect it to and therefore that’s just the way it is. Well, I don’t want to buy into that, that I need to pay somebody in spite of me making a gain or a loss. I don’t like that.
In real estate, there’s nobody skimming profits except you. It’s tangible, you can see it, touch it, drive by it, and walk through it, whereas a lot of the investments that we put our money in, we don’t know what it is. We haven’t driven by it, we’ve not been to the offices, we haven’t looked at the financials- it’s just pure faith. It’s a little different with real estate. You’re the one who can order the inspection, you can order the appraisal, you walk it, you learn it, you meet the people that are working on your property. Again, you can verify through inspections, appraisals, title reports and tax records. You can understand it, it’s not just a pile of paperwork that is written so that you won’t understand.
Then asset protection- this is another thing I love about real estate as an investment. You can hide your identity. First of all, you can get liability insurance on each property. I don’t think you can get that on other investments but sure if something breaks or someone gets hurt on your property, you have liability insurance to take care of that. The same with umbrella insurance. You can get an umbrella policy on your primary residence that covers your rental properties. If you have a lot of rentals, you’ll need to get a commercial umbrella policy to cover it. Still it’s very, very inexpensive and can cover two to five million dollars worth of liability. I just can’t imagine there’d be much more liability than that. I mean if there’s a slip and fall or a fire, someone gets hurt, I don’t imagine that the liability will be over five million. You can have coverage against that.
Equity stripping- Now I just did a segment on Fox News about this, and it was very controversial. I’ll try to explain it here about what equity stripping is, is basically if you own a home free and clear in your name, you would not believe how easy it is to do a title search and find it. Basically, Kathy Fettke, look in California title reports, you’ll be able to pull it up and see she owns a property in Lafayette that’s worth a million dollars. That’s a million dollars that’s just kind of sitting there exposed.
If somebody wanted to “earn” that million dollars, they could come to my property and accidentally slip and fall and sue me and get at that equity because they can find it. Or let’s say somebody wanted to sue me for something else. Their attorney could do a very quick title search to see what I own, they can sue me and take that equity. We call this equity stripping where you actually take a loan out on your property or an equity line. Then when someone does a title search what will come up is yes, the property is worth a billion dollars, but she has an $800,000 loan on it. There’s no equity there, nothing to take, not as interesting.
Now you can take that $800,000, and let’s say I’m talking about your primary residence, and you could buy eight $100,000 properties elsewhere, let’s say in Dallas or Atlanta or Pittsburgh or some of these areas that have really great cash flow. Now you have your equity spread out, it’s diversified. You can put all of those rental properties into an LLC so that here it is a limited liability company so that it’s very difficult to find what you own and where you own it. Now you’ve diversified, people don’t see this big bucket of money all in one place that they can go after, and you’ve got all this rental income coming in that helps to pay off that $800,000 loan because as I said, we have the 1% that we’re looking for which is $100,000 property should bring in $1,000. If you bought eight of them that’s $8,000 income. Of course, there’s going to be expenses and so forth, but that’s more than enough to put towards the mortgage that might be $800,000 mortgage. That mortgage payment at 5% is going to be around $4,000. Again, you have more than enough money to pay it, and you’ve got some asset protection.
All right, on to inflation. Real estate is known as a hedge against inflation. All right, let’s look at this closer. A $100,000 home and an $80,000 mortgage at 4% inflation, I think we’re much higher than that but let’s just use that number, means that each year of inflation $3,200 of debt is just eaten away just merely by inflation.
Now, why does the government want to create inflation? The Federal Reserve has stated that it wants to create inflation, that’s its stated goal. Now, why? You don’t want it, I don’t want it. I don’t want to go pay more for goods. Why would we want to be creating inflation? I will tell you why because it eats away debt. Who’s got a lot of debt? The US government, right?
When the government is inflating by creating all this money to help pay off the debt and create inflation to wipe that debt away, we’re going to lose at that game because again, would you rather the inflation beast eat your debt or your cash? If you have a bunch of cash sitting around or a bunch of home equity, the same thing happens to it that happens to debt, it gets eaten up. That is one of the reasons why real estate is a wonderful hedge against inflation when you’ve leveraged it when you have loans on it. There is a difference between good debt and bad debt. Good debt is the kind of debt that buys you assets that make you money.
Bad debt is like credit card debt where you went out and bought things that you couldn’t afford otherwise. I’m not suggesting that kind of debt, but I am suggesting good debt that gets eaten away each year to inflation and allows you to buy these assets that grow in value with inflation it’s a total win-win.
All right, look at this slide, this is kind of depressing. Really, this is super depressing. This only goes up to 2009 but imagine what it would be today. I mean it’s just going to keep going down because of this radical money printing that has happened. Again, the red line is currency in circulation. That’s all this money printing, and you can see when did that start? 1971.
What did they say about that? Nixon took us off the gold standard and, all of a sudden, no one was watching the bank. They just printed money, no one cares how much, so that created all this currency in circulation which then devalued the dollar, it gives you less purchasing power every year. Again, did the US went off the gold standard in 1971? Look at the money creation that happened afterwards, unbelievable. We are in uncharted territory people. We have not had our government go crazy like this ever, so we don’t know what the consequences will be. But, the only thing I know to do is to play their game because we can’t really fight the US government at this point.
Hyperinflation, is it coming, is it not? Some people say no, some people say yes. I don’t know. I’m not an economist, but I can tell you this, Casey Research, it’s a group I follow, they came out with this in 2010. Look at that. Year over year change in pricing for wheat 74%, oats 68%, pork maybe you shouldn’t eat it, 60%, cotton 66%, gold, silver, now that’s gone down. Let’s not look at that but how can you say that we’re not already having inflation. We are. Look at this, look what the government reported in the CPI index, 1%. Huh? Where do they come up with these numbers? I don’t know.
All right, but what I do know is that assets inflate when the dollar deflates. It’s just the way it is, that’s why people are running to gold. Even though gold is not the best investment which we’ve seen lately, but people are running to gold because they knew that the dollar was deflating. The problem is gold isn’t that useful, housing is. Gold doesn’t pay you monthly for using it, housing does. In my opinion, gold is a major risk again, which we’ve seen.
Look at this. Look at the increase in median single-family home prices since 1971 and look at the dollar devaluation since 1971 and the red line there which is the currency in circulation. See all that red line is right in line with the home price increases. Again, the more money is in circulation that the government’s creating out of thin air, the effect is higher home prices, higher asset prices, higher prices in real estate. We’re going to keep seeing that trend.