"The things that come to those who wait, are the things that are left behind by those that got there first."
Reduce the Risk of Real Estate Investing with a System
So, get there first... just make sure you are prepared with a plan based on a system that is well thought out and complete. What is a complete system? One that is self-sustaining and repeatable. It starts with where you are now, and ends with... well, it should actually never really end since it must be repeatable. That, and being self-sustaining, allows this perfect system to go on successfully forever.
Planning the system starts with the end though... the exit strategy, and works its way to where you are now... the beginning. The most familiar description of this process is called reverse engineering. This works. Its success is due to the simple fact it is incredibly efficient in use of resources. By focusing your efforts on a pre-determined target, you eliminate the waste found when you have a great idea, develop a product or service that you love and believe others will to, only to find out you were wrong, and wasted a lot of time and money... yours and that of others.
This is particularly true with investing in real estate. Real Estate investing should not be risky. You read that correctly. How often have you heard others saying how risky investing in real estate is, and all the reasons, due to the risks, you should not pursue it. What they lack, which is what makes it risky... to them... is knowledge. Their box is too small. I'll explain that last sentence a little later.
https://www.wikipedia.org
One of the most important elements of real estate investing, actually any investing, is risk control. If you don't have risk control as part of your system, you are going to be taking on a lot of unnecessary risk. So, control the risk.
The first Risk Control should be to address the risk that is part of the funding for the purchase and rehab of the property or note. The obvious risk here is the ability to pay back the debt... the debt service... and the risk of losing the asset you are using the funding for.
Regarding the latter, the risk of losing the property, our feeling is to acquire financing/funding that is not directly attached to the asset itself. This means you will be looking for funding that would be defined as "associated debt", as opposed to "lien-able debt". The difference is should, or will, be obvious. If you default on the associated debt, the property is not put at risk. In addition, another great advantage of associated debt is you don't have to pay it back right away... like you would if you were using lien-able debt. We refer to this type of funding as using "cash like substances". The advantage of this type of funding is a major contributor to both the repeatability and self-sustaining attributes of the perfect system. We'll discuss this a little later.
Regarding the former, being able to make the debt service payments, involves a little bit of creativity based on the structure and terms of the actual funding source. The fact that our funding source will not be based on lien-able debt makes this problem much easier to solve. One of the best ways to address this is by placing part of the initial funds in a cash reserve. This cash reserve is set up specifically for the purpose of paying the debt service over a period of time. The length of time covered (reserved) depends on the investor and their time table. The purpose of this reserve is to "buy the investor time" to develop the system to the point where the system can take over the monthly payments while also expanding the investment vehicles.
Let me explain. Let's say we bought a property, rehabbed it, and flipped it. If we were using lien-able debt, when we sold the property we would first need to pay back the debt as shown in the following example.
Example 1:
We bought a house for $35,000 and spent another $15,000 to rehab that property. We sold the property for $75,000 for a profit of $25,000. First thing we need to do is pay off the $35,000 debt... actually that would be $50,000 debt since the $15,000 was also covered by the loan/funding. That would leave us with the profit of $15,000 to do with as we pleased. This is a very "s l o o o w" way to make money in real estate investing.
https://exed.canvas.harvard.edu/eportfolios/3028/Dumps/Believing_In_600210_Exam_Dumps_Myths_for_Far_better_Outcome_in_600210_Exam
https://exed.canvas.harvard.edu/eportfolios/3030/Brain_Dumps/Amazing_640878_Exam_Hacks_with_Valid_640878_Exam_Dumps
https://exed.canvas.harvard.edu/eportfolios/3030/Brain_Dumps/Get_300170_Exam_Dumps_for_Simple_Good_results
https://exed.canvas.harvard.edu/eportfolios/3030/Brain_Dumps/Get_C1000022_Exam_Dumps_for_Simple_Achievement
https://exed.canvas.harvard.edu/eportfolios/3030/Brain_Dumps/Get_21289_Exam_Dumps_for_Simple_Achievement
One of the problems with this Example, and this is a very common example of real estate investing/funding, is not only do we have to pay the debt back right away, but we have to go after brand new funding for the next deal... and all we have to show for it (in this example) is $25,000 profit.
What you need to do is be able to accelerate the timeline to profits. To do this, you simply need to disconnect the funding from the asset. Use associated debt. It really is that simple. The power this gives us as real estate investors is wide ranging. The impact it has on the overall system is enormous.
Here I would like to interject a comment made by a pretty smart guy... Albert Einstein. When asked what he thought the greatest invention of the 20th century was he answered, "Compound interest. Those that understand it make money off of those that don't". Compounding, or exponential expansion is a very powerful thing... almost as if it has a life of its own. How powerful can it be? Well, if you take a penny, 1 measly little penny, and every day you double it the next day and add to the previous day... as in the first day it's a penny, the 2nd day you add 2 cents, the third day you add 4 cents, the 4th day you add 8 cents and so on, what do you think you would end up with after 30 days? The answer comes later. Think about it now though. The answer may shock you.
Another problem with this type of funding is LTV. Not many sources of lien-able debt will give you 100% of the funds you need to both buy and rehab the property unless the value of that property is much higher than the amount of funds you are requesting. That ratio is called LTV, or Loan to Value. If you can get an LTV (ARV/LTV would be the After Repair Value/LTV and include funds for rehab) as high as 80%, let me know where. It's quite common to see ARV/LTV as high as only 70-75%, with Hard Money even lower than that. That would mean you would need to either have a lot of potential equity in the property after rehab, or need another source of funds... like cash. Again, this is not a really great way to fund your flips... although this is the norm.
The ability to use the funds more than once, but only having to pay for it once, is an application of that same exponential expansion applied to real estate investing. This means you're system is repeatable. Here's how it works.
Example 2:
Let's take that same house from Example 1. Let's also say that the funding source we used was a form of associated debt instead of the usual lien-able debt we used in Example 1. Since we don't need to pay the debt back right away, we can use it again... on the next deal. We don't need to get a new loan, we don't have to pay again for the use of the funds we acquired from the original loan, and the funds from that loan generate a new set of profits on this next house flip. Then we continue to repeat these steps over and over again.
This also means that due to the repeated use of the same funds, the actual cost per use (per property) of these funds is reduced for each re-use. The only other issue is the debt service on these funds, but that is where the cash reserve comes in. The cash reserve is buying you time to develop your system. This cash reserve is what makes this system self-sustaining. Now it's just a matter of developing the system to the point where it goes on auto-pilot.
That isn't where it ends though. All you've done up to this point is setup the system. You still need to apply it. You still have to have a plan of what to do with your profits from each flip in order to keep it going, and to achieve what your ultimate goals are. Everyone has their own set of goals of where they want to go with their real estate investing. The specific goals are what you need to do with the profits. The mechanisms that you apply these profits to are called "exit strategies". The exit strategies are what help you achieve these goals. As always, my ultimate goal has been cash flow. "Cash is King" is a common phrase. The key is to make it keep coming. To that end I follow the overall investment strategy of "Flip to Hold", meaning I flip properties/notes for profits that I use to buy cash flow properties. I only buy "Hold Properties" with cash (I can refi later to get my cash out... but that's for another discussion). So, let's expand this system and put it on steroids so to speak. Let's go back to Example 2, and remember that after the flip we have the entire $75,000 to use as we see fit in our overall system. Here is where the fun begins. You thought we were already having fun? Just wait. It gets better. From the proceeds from Example 2, we can use (re-use) the original buy/rehab funds of $50,000 to buy/rehab another house. We take the $25,000 and (no, not spend it. Maintain discipline and you'll be very thankful you did) set it aside. You can put it into an investment that you can access it quickly without penalty if you want. If you can do this, why not waste the opportunity?
When you flip this next house, the one you bought/rehabbed with the re-use of the original funds from Example 2, you should have another $25,000 profit... to add to the previous "banked" profit from the original house in Example 2. You now have an added $50,000 to use. Again, discipline is needed here to stay with the system. I bet you are looking at this $50,000 and saying to yourself, "now I can buy a house with cash to cash flow"... and, you'd be wrong. Well, you can do whatever you want with it... it's you money, but that wouldn't be following the system. The system says, "to buy another house that you will be flipping for profits... just like the house you flipped from Example 2". You would now have two houses to flip for profit, both using the same financing (but paid for only one time) that will generate profits and where you will be able to re-use the principle (buy/rehab money) over and over again. Each re-use of these funds will generate another profit.
Now the fun really begins. Real estate investing should be fun... right? If you have risk controls in place it can be. Keep in mind our Cash reserve is still making the debt service payments for us while we are expanding our system... and we are NOT DONE YET. How you ask? Let's take stock in where we are at this point:
1. We have debt, associated debt, which is being paid off by our cash reserve.
2. We have used the cash like substance from out financing to buy/rehab houses to the point of having two lines of repeatable flips to generate profits, where when each house is flipped, over and over re-using the funds for the buy/rehab) they will be continually be generating new profits.
What to do next? Let's expand our width of repeatable flip houses. This means that when we flip these two houses, the profits will buy/rehab for us another repeatable line of flip houses... so we will then have three. Flip these three houses, and then there were four. I say four because by now your cash reserve needs to be funded again to buy you more time to develop your line of houses. How wide you go with additional lines of repeatable flip houses is up to the individual investor. Don't take on more than you can handle. That too is part of risk control. OK. For argument sake, let's say we have four lines of houses to simultaneously flip and that's as far as we can widen our set of repeatable houses since our team can only handle 4 houses at a time. That's fine. That's really all you need to do in most cases. Here's why. Using this system, you will have four basic uses for your profits from flipping. With four houses to flip at a time, that gives you one for each... if that's the way you want to go. Here are your four options:
1. Add money to your cash reserve. Keep an eye on the reserve. It is the guardian of your system. If it goes dry you could be in trouble. Also, it is important to mention the funds you are using in your cash reserve should be paying off the debt... not just paying the minimum payment until someone calls to get the payoff "now"... like some sort of balloon note. In other words, don't just make interest only payments. That's just foolish... sorry for the bluntness, but... The amount you originally place, and add to the cash reserve, should be based on what you need to have in there to buy you the time needed to develop the system. Think this one through very carefully.
2. Yes. Now is the time you can start pocketing profits.
3. Buy/rehab another house to expand your width of repeatable flip houses.
4. Use these funds to start buying your cash flow houses. See, these funds will continue to be generated every time you flip the house designated for this purpose. This is why I stated when you first made your profit form the house in Example 2 that you should employ discipline and not to use those funds for profit or to buy the cash flow house. If you had, these funds would have produced only one cash flow house. Waiting until now will generate what could be an unlimited number of cash flow houses... all from the same funds. Timing is everything. That wasn't the right time, now is.
Just keep repeating the system as you see fit. Think of this as the gift that keeps on giving. As you can see, it's amazing what combining the power of exponential expansion, discipline, the perfect system, and non-lien-able funds can do.
$10,609,878.59... that's the answer to the question of "How powerful compounding interest can it be", if you take a penny, and every day you double it the next day and add to the previous day... as in the first day it's a penny, the 2nd day you add 2 cents, the third day you add 4 cents, the 4th day you add 8 cents and so on, what do you think you would end up with after 30 days? Impressed?
No comments:
Post a Comment