Though most are acquainted with self directed IRAs, the majority haven’t heard of or don’t know much about self directed 401k plans. I’m speaking of what’s known as a Solo 401k.

Download Audio

 

Transcript:   When you establish a self-directed solo 401(k) plan, that plan — the key word there is solo. It is for you. Its’ not for anybody else. Now there’s an exception to that. You can have a self-employed business and if your spouse is an active participant and legal participant in that business, your spouse can be included on that solo 401(k) plan and the IRS still considers that a one-person plan. Also keep in mind if you hire a spouse and he or she is part of your business, you of course have to follow any state or federal regulations pertaining to the establishment of the business, so always keep that in mind and review things with your tax professional. The bottom line is solo plans are just for you. Saying that, what are some pitfalls or some traps that people can intentionally or unintentionally get into with a solo plan? Let’s say a person hires a spouse or their spouse is part of that business. That’s great. They can be an active participant, they can be paid wages, they can make their own contributions as elected deferrals into their 401(k) plan, but, what if the spouse is added as a participant but they’re not truly a participant? They’re not truly an employee of that business? Well, now let’s say that spouse rolls over funds into the plan. Big problem, because that person’s not even an active, justifiable participant of that plan. Better yet, what happens when somebody, they’re getting busy, they’re making a lot of money, they’re doing a lot of transactions. All of a sudden, they’re getting busy and they hire somebody and they don’t even necessarily intentionally think about this. The bottom line is, remember, those documents for your plan, for that solo 401(k) are just for you and potentially your spouse; no other what’s called common law employees. Common law employees would be somebody that you hire on full-time. They’re not part-time, they’re not seasonal, they’re not under the age of 21, and you bring them on. Guess what? Now you’re plan documents are no longer valid documents because they were written solely for that individual solo plan and by you adding on that participant, that just created a problem with compliance with your plan documents. Remember, always keep in mind that if you’re establishing a 401(k) plan, it’s a great plan because there’s a lot of great benefits that are going to be afforded to you, but keep it simple. Make sure that it only is a plan for you and potentially your spouse.

Here’s something in which many have expressed interest. A case study part 1.

 

Transcript:   Here’s a case study, and it’s about a young couple. They both work, maybe they have kids, maybe they don’t. Between the two of them they’re highly paid, but not super highly paid. Between them they make somewhere around $180,000. They own a small home, and they don’t have a lot of toys. They don’t live up to their eyeballs. They save a lot of money but they have fun, too. Here’s their goal. They’re 32 years old. They want to retire before they’re 65. When that happens is up to how things work out, and everybody’s crystal ball is as reliable as the other guy’s. If they can retire in 20 years, that’s great. If it takes 30 years or more, they understand. What they have now is $150,000 that they’ve saved up, and $100,000 is in a personal account, $50,000 is in a Roth IRA. Now, that Roth IRA can’t be rolled into anything. They were not happy to hear that. Just so you know, almost anything can be rolled into anything else, but a Roth IRA just stands alone. Here’s the thing, we’re going to take a lot of different plates that we’re going to have spinning at once. The first is going to be because they were young enough, in their early 30s, we’re going to get them hooked up with David Shafer in what’s known as an EIUL. We don’t need to go into that. I’ll give you the bottom line. It’s an acronym for Equity Index Universal Life. It’s an insurance policy designed to hold assets or create retirement income. For them, it’s going to be income. The income, by definition in its IRS definition, is tax free. It’s way down the road, at least 20 years. The second plate is going to be real estate investment. They’re going to buy a small Texas duplex. They’re going to pay $300,000 or less. It’s going to cash flow. They’re going to love it. It’s going to be managed, blah, blah, etc. The third thing they’re going to do is take that $50,000 in the Roth and buy a discounted note with that. That play is going to be, give or take, at least 17 years because 59 and a half is the earliest they can access that. What we have is EIUL, real estate investment, and notes personally versus notes in your qualified retirement plan which is IRAs and 401ks. The next step we’ll be talking about specifically how we’re going to interweave those investment strategies together to enhance one or more of them such that they’re either bigger at retirement when it comes to income, they’ve been turned into after-tax or tax-free income, or they’ve been turned into greater income at retirement. Here’s the first thing they do. They buy a piece of real estate. They have $100,000 saved up, I said. It’s going to cost them about $80,000; maybe $75,000, maybe $85,000, down payment, closing cost, and all of the different things that come in an escrow when you buy. They’re going to end up owning a property that the spreadsheet says is going to yield north or south of $5,000 a year. You know what Murphy says? Murphy says we’re just going to take the gross rent for the years scheduled and divide by two. Their cash flow’s going to be a little over $2,000 a year. I much prefer that. Let’s do the spreadsheets, but let’s just believe that Murphy exists, and he knows where we all live. Now, that left give or take $20,000 in their bank account. Now, they make about $180,000 a year. They told me when they did their budget that after taxes and after everything, their family is able to save, give or take, about $4,000 a month. What I’m going to have them do for the first six months is add give or take $25,000 to that $20,000 extra. Their cash reserves are now going to be labeled “untouchable” in bi...

Here’s something in which many have expressed interest. A case study part 1.

 

Transcript:   Here’s a case study, and it’s about a young couple. They both work, maybe they have kids, maybe they don’t. Between the two of them they’re highly paid, but not super highly paid. Between them they make somewhere around $180,000. They own a small home, and they don’t have a lot of toys. They don’t live up to their eyeballs. They save a lot of money but they have fun, too. Here’s their goal. They’re 32 years old. They want to retire before they’re 65. When that happens is up to how things work out, and everybody’s crystal ball is as reliable as the other guy’s. If they can retire in 20 years, that’s great. If it takes 30 years or more, they understand. What they have now is $150,000 that they’ve saved up, and $100,000 is in a personal account, $50,000 is in a Roth IRA. Now, that Roth IRA can’t be rolled into anything. They were not happy to hear that. Just so you know, almost anything can be rolled into anything else, but a Roth IRA just stands alone. Here’s the thing, we’re going to take a lot of different plates that we’re going to have spinning at once. The first is going to be because they were young enough, in their early 30s, we’re going to get them hooked up with David Shafer in what’s known as an EIUL. We don’t need to go into that. I’ll give you the bottom line. It’s an acronym for Equity Index Universal Life. It’s an insurance policy designed to hold assets or create retirement income. For them, it’s going to be income. The income, by definition in its IRS definition, is tax free. It’s way down the road, at least 20 years. The second plate is going to be real estate investment. They’re going to buy a small Texas duplex. They’re going to pay $300,000 or less. It’s going to cash flow. They’re going to love it. It’s going to be managed, blah, blah, etc. The third thing they’re going to do is take that $50,000 in the Roth and buy a discounted note with that. That play is going to be, give or take, at least 17 years because 59 and a half is the earliest they can access that. What we have is EIUL, real estate investment, and notes personally versus notes in your qualified retirement plan which is IRAs and 401ks. The next step we’ll be talking about specifically how we’re going to interweave those investment strategies together to enhance one or more of them such that they’re either bigger at retirement when it comes to income, they’ve been turned into after-tax or tax-free income, or they’ve been turned into greater income at retirement. Here’s the first thing they do. They buy a piece of real estate. They have $100,000 saved up, I said. It’s going to cost them about $80,000; maybe $75,000, maybe $85,000, down payment, closing cost, and all of the different things that come in an escrow when you buy. They’re going to end up owning a property that the spreadsheet says is going to yield north or south of $5,000 a year. You know what Murphy says? Murphy says we’re just going to take the gross rent for the years scheduled and divide by two. Their cash flow’s going to be a little over $2,000 a year. I much prefer that. Let’s do the spreadsheets, but let’s just believe that Murphy exists, and he knows where we all live. Now, that left give or take $20,000 in their bank account. Now, they make about $180,000 a year. They told me when they did their budget that after taxes and after everything, their family is able to save, give or take, about $4,000 a month. What I’m going to have them do for the first six months is add give or take $25,000 to that $20,000 extra. Their cash reserves are now going to be labeled “untouchable” in bi...

Many will be surprised hearing an investment real estate broker advising some investors not to buy real estate this time out. It can be confusing at times, whether to invest in real estate or buy notes. Here are some thoughts to ponder.

Download Audio

 

Transcript:   So, let’s say you’re one of those guys that have been investing for quite a while. You have a portfolio of anywhere from three to ten properties. One or two of them might even be free and clear. You call a guy like me up and say, “What should I do? I want to always make sure I’m maximizing my position for the future, because you know what? I’m 35, 45, 50,” however old you are, and you know that you are going to retire at a certain birthday—it might be 60, it might be 65. I’ve had many people lately tell me they don’t want to ever really retire; they just want to slow down and do more of what they want. In any case, there is a period of time where they are either not going to be working or they’re going to be working by choice. There is a certain amount of income they want, and so they say, “I have all of this investment property. It’s been performing very well,” and maybe I look at it and I go, “Man, you’ve been kicking some major booty here. Way to go! I wouldn’t change much, but I think it’s time to stop buying real estate. At least pause before you buy any more.” Now you say, “Well I’ve got $100,000, what should I do with it?” Well, I would buy a discounted note. Get that started. Now, we can talk later on as whether or not you bought it in your own name, or you bought it using your IRA of some sort or 401K of some sort, if you were self-directing it. Let’s just say in this case, you were buying it yourself. Well, instead of getting your normal five, six, seven, eight, whatever cash-on-cash return on real estate plus any appreciation, if it should happen, you’re building that profit in because you’re not paying the face value of the note, so what is that discount? Typically it’s going to be 25% to 50%. So let’s slice that down the middle, and say it’s give or take about 35 cents off. You’re buying at 65 cents on the dollar. Well, give or take what that means is you might be making 12, 13, 14% cash-on-cash. Now, unlike your real estate, there is no tax shelter on that. So let’s say you’re making $13,000 a year on your hundred grand. Let’s say that $13,000 a year gets peeled down to $8,000 or $9,000. Let’s be really Draconian and say $8,000. Well, that’s $8,000. That’s 8% cash-on-cash after tax. You’re not doing that on your real estate usually, but here’s why it’s beneficial. First of all, on one level, you’ve got more money available to you now, and right now you don’t need the cash flow, that’s why you’re investing. You can use that $8,000 to either do some maintenance or some rehab on some of your properties. Maybe you’re going to add that kitchen island you’ve always wanted to in that duplex you have, or you just use that $8,000 that year to pay down one of your properties’ loans. Meanwhile, you’ve paid $100,000, and you might have bought $170 or $180,000 in notes. At some point, those notes get paid off. No appreciation, right? You’ve built that in because of the discount. Now you get paid back $170 or $180,000 close to it. It could be three years, it could be five years, it could be 12 or 15, but normally these days it’s around 9. It used to be six or seven. But when you get paid back, you’re not going to pay normal income tax rates. You’re only going to pay capital gains much smaller amount, in most cases, for big earners. It ends up being give or take half the tax rate. Now,

Wanna have fun at HappyHour? Pose the question to a buncha real estate types, ‘What is leverage?’ It’s possibly the most misunderstood principle in real estate investing.

Download Audio

 

Transcript:   Everybody wants leverage, and leverage, as we all know, is little or no down payment; the smaller down payment, the better the leverage. Then they get all old school stories on me with how to move rocks with big sticks, and etc. At best, that’s a secondary definition. Whether you put 5% down, no down, or 50% down, that’s not the primary leverage that is going to necessarily dictate whether you succeed or fail, long term, in that investment. It’s not about down payment. It’s about the cost of your money versus the yield of your investment. Whether you put zero down or 90% down, if the cost of your money exceeds the ultimate yield on your investment, you just had what we call negative leverage. So the guy that puts zero down and loses money, because his cost of money was 6% overall and his return was 5%, that’s negative leverage. He loses, and yet he had zero down and he brags about it all the time. The guy next door to him that bought the same property down the road had 20, 30, 35% down. The cost of his money might have been the same 6%, and somehow—through management, or the fact that he rehabbed it better, or maybe it was just a next door neighborhood a little bit better—his return was 8%, he had positive leverage. Neither return had much to do with down payment. Now sometimes that’s not the case. Sometimes that extra 10 or 15% down actually makes the yield go up. Well, duh, that’s a Captain Obvious thing, right? But typically, the long term, do-it-yourself investor will rely on the size of the down payment to indicate to them whether they have sufficient and helpful leverage or not. We need to look at what’s the cost of my money. Let’s do a quick example. So you’re going to buy something for $100,000, and you’re going to put $25,000 down. You’re going to borrow $75,000 at 5%. Well, if your cash-on-cash is 5-7%, let’s call it 6%, you have positive leverage. If down the road, you sold that and for whatever reason, we won’t talk about why just now, but for whatever reason, you got back a whole lot than you put in, which was $25,000 plus whatever closing costs you got, not the $100,000 you paid for it. So let’s say in 5 years you were making a 6% cash-on-cash cash flow, and your cost of money was 5. When you sold it, you got your $25,000 back plus another $2,000 you put in closing, and you made another 20. Well you got your $27,000 back and another $20,000. So you made way more than your 6% cash flow yield alone. That’s positive. You have to understand that when you talk leverage, the only thing that matters to you, in the end game is if your cost of money is less than the money you’re making on that investment, the yield. If that’s not the case, all the other definitions become irrelevant.

Homeowner property warranties are virtually universally popular. But what about investment property warranties?

Download Audio

 

Transcript:   One of my clients asked me the other day for the millionth time, should they get a warranty when they buy investment property for things to be repaired, this, that and the other. For the longest time, I was against them only because I thought they were a waste of time for the newer well-located properties. I’ve come around to change my mind most of the time and here’s why. When you can spend $200.00 to $500.00 once a year and every year your property’s another year older, you get something go wrong — air conditioning, dishwasher, whatever — and you start to come into these repairs. More and more, you want that warranty to come in. When you look at it as the cost of doing business and not just, “Well I got paid off or I didn’t paid off this year,” it works out for you. Don’t look at it as anything but a cost of doing business. When you’re buying brand new property, there’s always the debate do I wait until the second year because usually the builder’s on the hook for most of the things anyway. If somebody else is paying for your warranty the first year, get it. In the end, I think it’s a good investment especially when you’re buying one-to-four properties where they come by, they do the audit, they say here’s what it’s going to cost, and every time something goes wrong, you know that even if it’s going to cost you money, it’s going to be either zero or a whole lot less than it would have. That’s all I have for today but I think it really hits your bottom line in the way you want it to.

What is the importance of cap rates? Too many real estate investors give the cap rate a crown it sometimes doesn’t deserve.

Download Audio

 

Transcript:   Cap rates is the rage. It’s always been the rage. It goes up and down in popularity, but so often people get lost in the forest with it. Here’s the deal. First of all, check out the quality of the location. The cap rate is going to go down in relationship to the higher quality locations. There’s a reason for that. You have to pay more for the property, there’s more demand for better located properties than poor located properties. That’s no news. Here’s the problem. When you go to the poorer neighborhoods because you get better deals and you get higher cash flow and that higher cash flow is a result of maybe double digit cap rates, you might have a ten, eleven, twelve, I’ve seen people brag about fifteen percent caps and higher. The problem is your expenses are going to be higher because the quality of tenant is lower. You’re going to have higher maintenance because typically in those neighborhoods the properties are older, not newer. They’re not young properties. Many times they’re built not quite as well as in the better neighborhoods. That’s not universal, but I’ve seen it too many times in many big cities. People get … They fall prey to the allure of the romance of high cash flow, and here’s what happens, they find out that that twelve percent cap rate really turned out to be a whole bunch of nine because when they look at what the real expenses are, they look at what the real vacancy rates are, and it’s not just vacancy rates themselves, it’s how long it actually takes them to find a good client … tenant rather, and then that tenant is late and they don’t get the income. It goes on and on. The turnover is higher. That makes the vacancy cost higher. You’re cleaning up more times. You’re spending more money. All that lowers the cap rate. You might think you bought twelve percent but what you’re living is nine percent. Meanwhile, back at the seven percent cap rate property that your friend bought three miles away, his property was anywhere from new to ten years old, it’s in a very well-established neighborhood that has exhibited high demand for a decade maybe, maybe more. The neighborhood schools are well thought of. It’s got all the retail outlets you want. It’s close to this mall or that mall. It’s got the grocery store. In other words, all the things you grew up with that you like in your good neighborhood as a kid. Now what happens is instead of living there for six or twelve months many of your tenants will live there for one, two, or three years, maybe more. You’re not having all those expenses. Plus, they tend to treat the property better. When you go to sell a lower cap rate property in a much higher quality neighborhood, for every buyer you have for that high cap neighborhood you’ve got ten for yours because investors who know what they’re doing would much rather have the higher quality tenants, the lower vacancy rates, the lower operating expenses. When they buy a cap rate that is much lower than the twelve you thought you were getting, in real life that’s exactly what they got. That’s why you want to pay attention to real cap rates in better located neighborhoods.

Been doin’ this a pretty long time, and I’m still mystified by how many real estate investors pay little attention to the importance of cash reserves. It’s NOT just about real estate, or your job.

Download Audio

 

Transcript:   So many people I’ve heard talk about cash reserves and they talk about this formula or that formula. I’ve tried to have formulas based on my decades of experience, and I’ve been somewhat successful, but mostly not. It just depends too much on subjective factors, your comfort zone. Are you really going to make, for the next five or 10 years, what you’re making now? Or are you going to make more? Is your industry downsizing? We don’t know. Is there going to be a black swan event? I don’t know. We didn’t have any knowledge of what was going to have on outside economic forces in the last 20 years, but the things that we didn’t like happening, all happened. Now, let’s take an example of one of those events, which was known as the S&L crisis. Now, that occurred in the early and mid-‘90s. What really happened there was that we had a whole bunch of commercial properties go belly up, and the savings and loans back at the time, which pretty much aren’t around anymore today, had to get rid of them. It caused a lot of problems. Now, personally, I went fishing for two years. It’s the only time in my career, over 44 years now, where I not only went fishing for two years, I told my clients when they asked me, to come along with me, because they shouldn’t be doing anything. They said, “What about buying all these properties that are coming on at pennies on the dollar?” I says, “Well, the problem is, there are people with $10 million in cash that are being outbid by people with 50 million.” Unfortunately, and I think wrongly so, back then, those people with one to 10 million were being shut out, and the properties were being sold for less than these guys would have paid, in order to sell 40 properties in one bag, as opposed to one property to that investor. But that’s another story. The key was, when those kind of times hit, here’s what happened in San Diego, and they weren’t the Lone Ranger. We had courtesy vacancy rates back then. What that meant is that if you had a move out on Friday and Saturday, your only vacancy was how fast your cleaning crew could get done before the new client or tenant moved in. Almost overnight here’s what happened. The vacancy rate went up to 15, 20%. Simultaneously rents dropped 10 to 20%. Think about that for a second. That’s a whipsaw. Then, in San Diego, who in my opinion was the hardest hit county in America by the savings and loan, two of our three biggest employers left town almost the same week, and they were huge. Think about that. Well, I had a client who decided that they were going to put a second trustee loan for 12% on their duplex for $25,000. Now that doesn’t sound like much today, but you’re talking over 20 years ago. The payment on that thing was a lot of money, and his wife had wanted to redo their kitchen. It was going to cost 25 grand. To make a long story short, they ended up losing that fourplex because of the combination of newly incurred debt that they had to pay off monthly, plus increased vacancy rates. For the longest period of time, over a year, they were almost always only 3/4 occupied of the four units. That just did not work. Now, he was a business owner, and he was a business owner of a plumbing company. His plumbing company was attached to the building industry, not fixing bad plumbing. Guess what happened in this S&L crisis? Builders stopped building and he just had to hire himself out, put his business on hold. If he’d have kept the cash reserves, he would have not only saved the fourplex, he would’ve been able to weather the storm completely, and yet still be able to make his eggs and bacon in t...