| Rich Dad's Advisors The ABC's of Real Estate Investing |
By Ken McElroy
Genre: Business & Money
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The Myths and the Magic
In every business and every industry there are people who just seem to drip with success. They seem to know all the right people, make all the right decisions, be in all the right places at exactly the right time. They seem destined for success whether they even try or not. Real estate investing is no different. In every city or town, there seem to be real estate tycoons that struck it rich through real estate.
These are the people who just make success look easy. They appear confident, knowledgeable, savvy, and seem to see opportunities where others don't. It's easy for onlookers to think the achievements of these golden few are the result of luck or some sort of magic. But magic and luck have absolutely nothing to do with it. About fifteen years ago, I decided I was going to be one of the people I just described. I was going to make my own success, be my own boss, and achieve financial freedom. And I chose property management as my route. Call it instinct, call it impatience, call it burning desire. I wasn't about to wait for a lucky break or a magic charm. I set out to make my dream happen, and I did it through action.
In the early days of my first property management and real estate deals, there was a lot of trial and error and I made my share of mistakes. But for every one mistake I made, I learned ten lessons and got smarter every day. I started to see patterns, discover formulas and systems, and develop a network of people I could count on. It took time and it took work, but the more I pursued my dream, the luckier I felt and the more often magical opportunities presented themselves to me.
Maybe there is a bit of luck and magic in success. But it's luck and magic that comes from working hard and being prepared. At the Rich Dad Seminars, where I often speak, I see people all the time who are taking the first steps toward future success, much like I did nearly two decades ago. Many have what it takes: the drive and desire that will help them overcome obstacles and be prepared.
Unfortunately, I also see at the seminars some who lack what it takes. They are the ones looking to get rich quick and have little or no idea of the commitment required to achieve business success. Others have a lot of desire, but lack the technical skill and the knowledge that can only come from experience. I wrote this book for them. This is not a get-rich-quick book. It is not a book written to motivate, although I hope you'll be inspired to follow your real estate investment dreams. Instead, it is a book that will disclose proven methods, remove the unknowns, and shorten the learning curve for anyone who chooses investment real estate as his or her path to financial freedom.
Before we get too deep into the how to's of finding, buying, and managing investment property, let's take some time to drive out a few myths, myths that if you buy into them, will only hold you back. I think you'll find the following list familiar. Have you or others said these very things? Are any of these statements echoing in your head and preventing you from moving forward? Are these untruths paralyzing you with fear? Let's get rid of them right up front. It's time to dump the baggage!
Myth #1: You Have to Already Be Wealthy to
Invest in Real Estate
People think they need to have a large lump sum of money to invest in real estate. They think it is like saving for their first home or that it's something they can only do once they have made their fortune elsewhere. Both of these thoughts couldn't be further from the truth. You don't need hundreds of thousands of dollars in the bank to invest in real estate and you certainly don't need millions. All you need is a good real estate deal that makes sense-one that has profit potential and is based on solid financials.
My partner and I have been working this way for years. My very first investment deal was a condo that I bought furnished and rented out. It was a two-bedroom unit that I put into a rental program. People who wanted to get away from it all could call up and rent my condo or one of a hundred others for a weekend getaway. A cool $116,000 was what I paid and I put down $20,000 out of my own pocket. You're probably thinking, "See, I knew you had to have some cash to get started in this business."
Well, I did that deal before I knew better. Contrast that with a more recent acquisition of a 182-unit apartment complex in Sun City, Arizona. The total cost was $9 million. Before you close the book and say, this is out of my league, let me finish the story. The down payment was $2 million, which we raised from other investors. My out-of-pocket was zip. I gave the majority of the ownership to the people who lent me the down payment; in essence, I formed a partnership with them. My salesmanship had nothing to do with it. The deal was the hero; it was so good that people wanted to be a part of it. What I've come to know is that there are a lot of people looking for good real estate deals.
Some people are partner-averse, but I think partners are valuable. They help you spread your risk by allowing you to own smaller positions in a number of properties rather than a big position in just one. And it's a fact that teams accomplish more. As for the return? Which deal would you rather do, the $116,000 property that cost you $20,000? Or the one that cost you nothing and yielded you 10 percent of a $9 million deal? For the record, that's $900,000 and I'd choose the latter any day of the week.
Once you have located a real estate opportunity, the task is finding investors who are looking to earn a good return on their money. The first deal you do, granted, is the most difficult, because you are an unproven entity. But trust me: It gets easier and easier with every successful deal you put together.
All things are difficult before they are easy.
Today, my partner and I have people literally standing in line who want to invest in our next real estate venture. Not because we're anything special. But because we are thorough. We look at a lot of deals and choose only the ones that are financially viable like the one above. We also communicate with our investors and treat them fairly. They make money when we make money.
You may be surprised to learn that there are plenty of people interested in investing in real estate, particularly when other investment vehicles like the stock market and bonds are flat or declining. Just look around at a Rich Dad Seminar. There are thousands of people in every city in which we speak who are looking for real estate investment deals that make sense. One of the people in a Rich Dad Seminar could be your first investment partner.
Myth #2: You Need to Start Small-Big Deals
Are Too Risky
There is nothing wrong with starting small. Perhaps you're thinking about buying a $250,000 single-family home and making it a rental property. Or even a $320,000 duplex. But why rule out a $2 million, fifty-unit building? Believe it or not, any of these properties are within your reach.
Of course right now you're thinking, "No way! I can't afford a $2 million mortgage!" And to that I say, you may be right, but you don't have to be able to afford it. Here's why. Mortgages on smaller properties like single-family homes are almost always guaranteed through the buyer's own personal earning potential and wealth. You may be surprised to learn that larger investment property loans are secured by the asset itself. In other words, instead of the $2 million building riding on your own wealth, it is riding on its own valuation. This already is less risk to you.
Let's look at the previous example. The condo I purchased for $116,000 with a $20,000 out-of-pocket down payment was 100 percent my responsibility from mortgage to management. The $9 million project that I owned 10 percent of for no out-of-pocket cost was actually less risky because I had no cash invested and the property was professionally managed. The other property was mine, all mine-for better and for worse. Five years later, I sold the condo for $121,000, a gain of $5,000. Recently we refinanced the 182-unit building, which we had owned less than a year. Its newly appraised value was $11.3 million, more than $2 million above what we paid for it. And since I own 10 percent of the project, I made over $200,000 in less than a year. A testament to the power of buying and managing right and managing well.
This example also demonstrates risk related to valuation. When you buy a house or condo and rent it out, appreciation of the property rests solely on the appreciation of the surrounding neighborhood. You better have bought in the right neighborhood, because there is little you can do to increase the value of your property. By contrast, appreciation in commercial property, like apartment buildings, is based on the cash flow of the property itself. The more money it makes, the more money it is worth. Now you're in control! When cash flow increases so does the value of the property. Manage your property right and you'll increase the value. Don't manage it right, and the value will stay the same or go down.
Another way larger properties are less risky relates to occupancy. When a single-family home is rented, it's 100 percent occupied. When it is empty, it is 100 percent vacant, and you are covering the mortgage out of your own pocket in its entirety. In a larger property, even an eight-unit building, if one resident leaves, you still have seven residents paying rent. Your exposure related to occupancy is greatly reduced the more residents you have.
Myth #3: You Can "Flip" Your Way to Success or Get
Rich Quick with No Money Down
Many people think that flipping property, in other words buying it and quickly turning around and selling it for more than you paid for it, is the way to grow wealth. The people who believe strongly in this have been lucky enough to make money this way. But in my opinion, this is like day trading in the stock market. It isn't easy, and it is very risky.
No money down is another way of saying that the property is 100 percent financed. That means a much larger part, if not all, of your cash flow is going toward the monthly payment. In no-money-down deals, you'll be paying higher interest rates because there is greater risk to the lender, have higher loan costs, and have virtually no money to improve the property or even repair it should something break. With this model, you are banking on the property appreciating to make money rather than improving the operations of the property and making money through cash flow. Let's hope the market is high-flying and that you time it perfectly because you'll be banking on external factors being just right. Appreciation, as you'll see in great detail later, is only in your control when you've improved cash flow. In this scenario you have none!
As you might have guessed, I don't believe in zero dollars down, and I don't believe in flipping property. Even in the example where I personally put no cash down on the $9 million apartment building in Sun City, we as an investment team put $2 million down. I believe that buying and holding income-generating assets like rental properties is how you build wealth. You may say, "But I need the capital gain-the additional equity I've made on this property-to buy a second bigger rental property with more units. That means I have to sell the first one." In my experience this just isn't true. What you need is a second investment deal that makes sense that you can bring to investors. They will help you raise the down payment on the second property and you will reward them as the investment makes money.
We recently finished construction of a 208-unit property located in Goodyear, Arizona, which cost us $13.8 million to build. Upon completion it appraised for $16.3 million. We have received numerous offers to sell this property and brokers were standing in line for the listing. As tempting as it was to walk away after two years' work with $2.5 million in cash, we did not sell it. The problem is one of taxation. Had we taken the $2.5 million gain, we would have been forced to place that money back in the market to avoid a pretty hefty tax bill. Sure we had appreciation, but we also had what is known as a "taxable event." Imagine the tax bill of 30 percent on a $2.5 million gain. That's an unnecessary $750,000 tax payment.
If you want the money out, you don't need to sell. You refinance the property and pull out what equity you can. There is no taxable event, and you are not forced to put the money into another investment. In the case of the 208-unit property, we will refinance and we will use the equity that we pulled out of the property to pay back our investors with interest. It's a great system and best of all you still own the property, you continue to receive cash flow from the building in the form of rent, and as the building appreciates, you can refinance and take the gain-tax-free-again. That's the money that you can use for other deals and it's what I do every day.
Property 95 percent of the time is going to become more valuable, not less valuable as the years pass. Especially if you follow the methods in this book that teach you to buy property right so you can afford the necessary improvements that will revitalize the neighborhood and make it a better home for residents. All that adds value and it makes sense to ride the wave of appreciation long term.
Myth #4: Some People Just Have the Midas Touch
It is easy to think that people who are successful investing in real estate have some sort of Midas Touch. But there is no such thing. They are just people who see opportunities and know how to make them real and profitable.
Take any ten-acre piece of land. Let's say this parcel is flanked by significant retail presence on all sides and most of the big retail chains are represented in adjacent centers. There's also a large microchip manufacturer nearby that employs 1,000 people.
Ask a tract home builder and he'll see forty single-family homes on that ten acres. Ask a custom builder, and he'll see ten luxury estates. Ask a retail commercial developer and she'll see a new shopping center anchored by two large retailers, with specialty stores and restaurants as fill-in. Ask a multifamily developer and she'll see a 150-unit apartment community with clubhouse, pool, and work-out facility. Another commercial developer who specializes in office space may see a three-story office building. In other words, everyone sees the property differently, and each vision will deliver a different level of payout-some better than others.
The important part of recognizing opportunities is common sense. People who seem to have the Midas Touch use their common sense when looking at property and opportunities. In the example here, common sense tells me that building custom homes would be a tough sell on a ten-acre parcel flanked by heavily trafficked retail. Single-family tract homes may be just as challenging. Additional retail may be viable if the developer can lure high-quality anchor tenants to the location. But they may already be operating in other nearby centers. By far in this example, either multi-unit housing or office space are the most viable options. Why? Because of the nearby employment base, the absence of apartments in the area, the proximity to retail, and the lack of office rentals. The developer in this instance who builds offices or apartments will have the best chance of success and will appear to have the Midas Touch. There's no magic, just common sense.
How do you know you're relying on your common sense? It's easy. If everyone you talk with is having difficulty seeing your vision for a property it can be either one of two things: A revolutionary idea that will prove everyone wrong. Or a bad idea that everyone recognizes as a bad idea, except you. In 99 percent of the cases, the latter proves to be true. Remember, if you have to hard-sell your vision for a property to everyone you share it with, it is likely your project when completed will be a hard sell, too! And that will cost you money.
Myth #5: You Need a Great Deal of Confidence
Not true. People underestimate themselves all the time. They listen to that little voice of self-doubt that whispers and sometimes shouts in their brain telling them all the reasons why they can't do something, why they shouldn't even try. I believe there are two voices: the voice of reason, and the voice of self-doubt. The voice of reason is common sense; the voice of self-doubt is your past leading your future.
I made a conscious decision not to let my past dictate my future. I grew up in an average middle-class home. There's nothing wrong with that. In fact, in my estimation, there's everything right with that. I worked for what I got. I learned solid values. A good deal of that came from my parents. My father was not particularly entrepreneurial until later in his career. Hardworking, yes, but not entrepreneurial. He worked for the same company for most of his career and earned a stable living that supported our middle-class lifestyle. It was a good life for me, my brother, and two sisters.
When I got out of college I followed in my dad's footsteps and got a job. But while in that job, I began to meet people-people who showed me their entrepreneurial ways. They became my mentors, and from them I became entrepreneurial. Then I combined the innate values I received from my parents and my own newfound entrepreneurial spirit and I became whole.
Nothing in my upbringing would have prepared me for what I'm doing now. And yet everything did. I believe it is up to each of us to let go of the memories and the scars of unsupportive fathers, ultra-critical mothers, ridiculing friends, and teachers who labeled us from the first day of school. Everybody has had negative influences in their lives and every one of us will have lots more. Look at Hollywood. What's a celebrity profile on E! without the struggles, without the strife? Everyone must rise from challenging situations-that's what successful people do. They decide to get beyond their past, whatever it may be. I've chosen to accept my past, learn from it, copy what was good, and realize the bad stuff only makes me stronger.
Real estate investing is a business where you will need to draw on your strength. My advice is not only to look for strength in all that is good in your life, but also to use the hard times for what they are: character-building experiences. And contrary to what most people think, we can never have enough character. That's my soapbox on confidence and character. The rest of this book is dedicated to building your property investment business.
Myth #6: You Want to Do It but Don't Really
Have the Time
This really comes down to choices and priorities. There is always time to do the things we need to do like go to work every day, mow the lawn, feed the dog. Often there isn't time to do the things we really want to do. Learn to speak a second language, build a bookcase, or volunteer in the community. There is a difference between need and want. We'll often do what we need and put off what we want. Unfortunately our wants are what truly enrich our lives.
The investment real estate business is something you should want to do and may even need to do. It's work. To be truly successful, especially in the beginning, you will be involved in the day-to-day activities of finding and evaluating property, negotiating deals, overseeing contract repair work, possibly even managing the property once it's yours. I can honestly say, I find the business rewarding, fun, and because of that, it is profitable.
I fell victim to the myth of not having enough time myself, and I take full blame. Sharon Lechter and Robert Kiyosaki asked me to write this book two years ago. Finally I embraced the idea and actually started wanting to get it done. But wanting was not enough. What got me going was a do-it-or-else deadline. That got my attention and made me realize I needed to get disciplined and write the book. That's what got the book done.
If you don't have the time to begin your real estate investment business, maybe in your mind, you don't really need to do it. Maybe you simply want to do it, and "want" alone may not be enough to get you started. After all, if you work during the week at another job, you will have to search for and evaluate property on the weekends. You'll need to make phone calls when you can during the week or in the evenings. There's always a way to make your dreams come true . . . as long as they are truly your dreams.
Myth #7: You Have to Know Somebody to
Get Going in This Business
While knowing a few key people such as a real estate agent, an attorney, or a banker may save you some time, you don't need to know anyone even remotely connected with investment real estate to get started. In this book, you'll discover the key people you need to have on your team. And you'll find that the goals you set for yourself will actually define the team. People you know today may or may not be the ideal people for your team once you determine what you want to gain from your real estate investment business.
Just get started and you'll be surprised how many people you'll get to know and how much they will teach you. You'll have "friends in the business" before you know it. Here's what I mean. We're doing a deal in Portland, Oregon. I live and work in Arizona. I hadn't been to Portland in over ten years. Anyone I had once known there was long since gone. Neither I nor anyone else in my company knew a soul in Portland. What we did know was that the city was situated on two rivers and that unemployment was high. The latter meant that the people who owned property were probably not doing so well. And to me that spelled buying opportunity. We had one big problem: We knew about the city, but we didn't know a single person in the city. We figured the market conditions were at least worth a plane trip and a few days in Portland.
Before our trip, we made our minds up to find our team, at least the start of it. So we went on the Internet and looked up property managers, city officials, brokers, and so on in preparation for our trip. We were not about to travel that far and not meet with anyone who could educate us about the market. As a result, we had ten or twelve meetings over a period of two days. It cost us a few lunches and dinners, but we had the beginnings of our team.
Myth #8: You Have to Be a Seasoned Negotiator
Again, this is just not true. Experience in business may make that first walk into an investor's office more comfortable, but that's all it will do. Your true power and confidence won't come from your past experience. Instead, it will come from the solid deal you assemble that is a win-win for everyone involved. This book will show you how to find and evaluate property with the ultimate goal of establishing a realistic purchase price that maximizes your monthly income and appreciates the asset. Find a deal like that and everyone will want a piece of the action.
Over the years, I've walked away from a lot of deals, and negotiation had nothing to do with it. One of those deals was a 205-unit building in Glendale, Arizona. About a year ago the listing price was $7.9 million, and the broker told me there were other offers-the highest one being $7.2 million. We did our homework on the property and by my estimation, $7.2 million was fair based on the operations of the property. The seller declined every offer and pulled the listing. Six months later, the seller relisted the building for $8.1 million. If I had still been interested in the property I would have made an offer based on operations. It would have been the same $7.2 million offer I made before. The seller would probably kick me out, along with everyone else who made him an offer based on operations. Are you surprised to learn that he still owns the building today?
With the method in this book, you'll find out that the listing price is meaningless. There is no point negotiating based on this number, and actually doing so is a recipe for disaster. That's because in most cases, the listing price is the seller's opinion of what the property is worth. It is not founded on the actual operations of the property. What most people consider negotiation meetings are for me more accurately described as presentation meetings. That's when I present the numbers, and they are pretty much take-it-or-leave- it deals. When I get kicked out, and in truth, usually it is a mutual parting of the ways, it's because the numbers don't work. Walking away is a good thing.
Myth #9: You Have to Know a Lot About
This myth holds people back every single day. They feel they have to already be experts in a field in order to be successful, whether it is real estate or stock investing or dry cleaning! First of all, success is a journey, it's not a destination, and all successful people start at the same place. One day they wake up, they throw their legs over the side of the bed, they yawn-and they begin.
Only by beginning and by continuing day after day do we ever become experts. We gain expertise through experience. By reading this book, you'll get a solid framework from which to begin. And you'll gain enough knowledge to sound really smart at cocktail parties and backyard barbecues, but more importantly you'll learn tons more from your first deal. And more still from your second and third. And even more from your fourth.
I learn something new with every venture. Some of the buildings we recently bought in Portland were built on an old wooden pier constructed in the 1930s. Who would have guessed when I embarked in this business that I would have to learn everything about the structural integrity of seventy-year-old piers? Not me, but we needed to find out everything about the condition of that pier before we went forward and purchased the property. I live in the desert. So you can imagine how foreign it was for me to hire divers and a boat and structural engineers to do the inspections. It was a real learning experience. I'm always encountering something new. That's part of what keeps it all interesting.
The only way you'll know a lot about real estate is to begin in real estate. Once you do that, you'll meet people, learn your market, see the patterns, and understand the trends. You'll encounter your own seventy-year-old wooden piers, but that will keep it fun. And before you know it, you'll be wowing people at cocktail parties and barbecues with experiences you've lived rather than just read about.
Myth #10 You Can't Be Afraid of Failing
Show me an entrepreneur who says he or she isn't afraid of failing and I'll show you a liar! A bold statement, absolutely, but a true one. Everyone is afraid of failing. The difference is that some of us let that fear of failure hold us back. Sometimes fear stops us from beginning altogether and that's unfortunate. If that's the case, make the decision now to just begin putting one foot in front of the other, making one phone call at a time, visiting one property, and then another. It's not hard, but it can seem so if we focus on the end result instead of the tiny-and very doable-steps in between.
Sometimes fear of failure occurs when it comes time to "pull the trigger" on a property. I call it analysis paralysis and people fall into it all the time. They overanalyze an opportunity and are never quite able to sign on the dotted line. This book will prove especially helpful to people with this sort of fear because it will show you exactly what you need to know to analyze an investment property. When the numbers add up, no further analysis is necessary. Frozen in fear will be a thing of the past.
Another way fear of failure presents itself is through regret. In other words, we've pulled the trigger, but then when difficulties occur-and they will occur, they always do-we regret the decision and waste energy by asking "Why did we do this?" instead of "What can we do to get past the hurdle?" This form of fear can turn an otherwise great opportunity into a bad investment. In my life, I don't regret decisions. I just consider the place where I'm at as the starting line and go for the gold every day.
I admit when I was just starting out I had an acute fear of failing. The difference is I knew that if I did nothing and remained frozen in fear, I would fail. I felt I had a better chance of success by just going forward one step at a time to make some opportunities pay off. That's the thing about fear of failure, if you don't use it to your advantage as a motivator, it becomes a self-fulfilling prophecy.
Myth #11: You Have to Know the Tricks of the Trade
There are no tricks of the trade in the purest sense of the term. But there are secrets to success in life. And as long as you know those, you'll be successful at anything. First, you have to set goals. Goals will be the foundation of the roadmap for your success. They will also tell you when you have arrived, so you can pat yourself on the back. Everyone needs that reinforcement. Not coincidentally the next chapter is all about goal setting.
Second, you have to persevere. Quitting when things get tough doesn't produce winners. In fifteen years, I could have quit a hundred times. I've had plenty of tough problems. Financing that falls through, employee problems, and downright frightening resident issues. But successful people work through difficulties and they come out on the other side stronger, more confident, and better prepared for the next challenge. And trust me, there will be more challenges. Finally, you have to understand the process. That's what this book will do. It will take you from beginning to end and every step in between. From setting goals to setting up your team, to finding property, to evaluating it, to determining a purchase price, to managing it, I'll let you in on fifteen years' worth of experience. I hope this book will become your handbook for success.
CHAPTER 1 ACTION STEPS
Understand the myths in this chapter.
Ask yourself if there are any others.
Identify the ones you believe to be true.
Determine which myths have been responsible for hindering your success.
Make the commitment to abandon these unproductive myths.
Make the commitment to learn techniques and preparedness so magical things happen.
Excerpted from Rich Dad's Advisors The ABC's of Real Estate Investing , by Ken McElroy . Copyright (c) 2004 by Ken McElroy . Reprinted by permission of Little, Brown and Company, New York, NY. All rights reserved.Back to top