Your ambitions have lead you to do big things in life, and real estate is the vehicle to get you there. When you’re down, there’s a reason why and when business is booming, there are numbers certainly attached. Knowing your numbers and understanding how to keep score is important because it is a indicator of how to attain success.
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Jason Hartman Real Estate Background:
– Founder and CEO of Platinum Properties Investor Network, The Hartman Media Company and The Jason Hartman Foundation
– Host of The Creating Wealth Show
– Has 21 businesses in the investing, financing, real estate development and tech spaces
– Owned properties in 11 states, had hundreds of tenants and been involved in several thousand real estate transactions
– Based in Las Vegas, Nevada
– Say hi to him at http://www.JasonHartman.com
– Listen to his Best Ever Advice here: https://joefairless.com/podcast/jf38-dont-you-dare-lose-control/
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Joe Fairless: Best Ever listeners, welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any fluff.
I hope you’re having a best ever Sunday, and because it’s Sunday, we’re doing a special segment called Skillset Sunday. By the end of the conversation you’re going to have a skill that you didn’t have before, or perhaps hone a skill that you had before even further.
With us today, Jason Hartman. Nice to have you on the show again! Best Ever listeners, if you recognize Jason’s name, that’s because you are a listener of one of his many podcasts. One of them is the Creating Wealth Show, or perhaps you recognize him from a previous episode. If you wanna hear his best ever advice – in episode 38… We’ve had him also on the show I believe one other time since then.
Also, Jason is the founder and CEO of Platinum Properties Investor Network. He has 21 businesses in investing, finance, real estate development, tech spaces. He’s owned properties in 11 states, had hundreds of tenants, and been involved in several thousand real estate transactions. Based in Las Vegas, Nevada… With that being said, Jason, before we dive into our Skillset Sunday, do you wanna give the Best Ever listeners a little bit more about your background and your focus?
Jason Hartman: Sure. Really quickly, I got into the real estate business because at age 16 I became interested in being an investor after growing up poor, and seeing one of those gurus on an infomercial that impressed me. I got my real estate license in my first year of college, I was 19. I bought my first investment property from one of my clients about 6 months later when I was 20 and a half, and it’s just gone on from there.
I love real estate. Income property is the most historically proven asset class in the world, and it’s great that guys like you on your show are spreading the virtues of it, because the world appears to be catching on, Joe, that Wall-Street isn’t the way to go; real estate is the way to go.
Joe Fairless: I always love being able to control my own investment dollars, versus having someone else do it. What we’re gonna talk about today is how to analyze a deal better and understand how we may be winning even though we think we’re losing… So basically, how we keep score in investing.
Jason, how do you wanna kick this off?
Jason Hartman: Well, Joe, that’s a great thing, because my real estate company helps people invest in real properties nationwide, and we’ve had thousands of clients over the years. We’ve been doing this for 13 years, working exclusively with investors. Of course, I have my own investment portfolio; it consists of about 270 units now, something like that. I’ve got some partners on some of them.
Sometimes in real estate we get discouraged. Things aren’t working out – we have an eviction, we have a tenant who trashes our property, we have a tenant that just is perpetually late every month with the rent, and it’s just important to understand for our own psychology in evaluating what other people tell us also out there in the marketplace, understand how to properly keep score.
Many times I have seen investors, and felt myself, like I am losing. I’ve seen these other investors telling stories of tales of low, like they’re losing, but they’re winning and they just don’t know it, because they don’t know how to keep score… So that’s what I’d like to dive into today.
Joe Fairless: I would think that intuitively we would know if we’re winning or losing, because we’re looking at the money that comes in and out of our bank account, so what are people missing?
Jason Hartman: Well, it’s a lot more than money coming in and out of the bank account. If we just looked at it that way, Joe, and I know you realize this, but maybe some people listening don’t always see this… If you look at the story of the Titanic, for example – the Titanic hit an iceberg and it sank, and what they didn’t realize is that most of the impact, most of the mass of that iceberg is underwater, and that’s true with income property too, because it’s a multi-dimensional asset class.
As such, looking at the money coming in and out of our bank account is just one measure of ROI (return on investment). That would be considered our cash-on-cash return. But there are many other dimensions that are not apparent necessarily to investors, that they realize later. So if they just look at it from a cash-on-cash perspective, and if they have a couple of bad months, if they have a vacancy, if they have a big maintenance issue or a tenant that trashed the property issue, and they gotta spend a bunch of money, they wouldn’t be evaluating it holistically.
What I say is you’ve gotta look at the big picture. It’s important in real estate and in life in general to step back, like a painter from that canvas, and look at the big picture once in a while. Sometimes we have to be looking at the brush strokes, but sometimes we also have to step back and look at the big picture, and that is why real estate investors can feel like they’re losing when they’re actually winning sometimes.
Joe Fairless: And are you talking about tax benefits and long-term appreciation, stuff like that?
Jason Hartman: Yes, and I’m talking about those and other things. I’m talking about the value of leverage. Of course, that’s one of the things we love as real estate investors, the fact that we automatically, on most of our deals, have a partner. That partner is called the bank, the lender, whoever finances that property for us. Well, we’re probably only putting in one-fifth of the cost of that asset, and they’re putting in four-fifths of it, if we’re putting 20% down. So we get leverage, we get appreciation over time; appreciation is not always instant. Sometimes we have depreciation. But the nice thing is, in those depreciating markets, typically rents will strengthen, because people aren’t leaving the renter pool and entering the buyer pool, because they don’t have any urgency to.
In depreciating markets, rents will a lot of times strengthen, so we can adjust strategy and we can either be in a capital gain strategy, where we’re banking on appreciation, or we can be in a cash flow strategy, where we’re banking on upward price pressure on our rents – multidimensional, very good there.
Tax benefits, of course… We don’t realize until the following year. Sometimes we don’t realize them until much later, when we do 1031 exchanges on our properties. Income property is the most tax-favored asset class in America, and there are three primary tax benefits. Number one – and it’s the smallest I’ll start with – is that if our properties are local, or especially non-local, we can deduct a lot of expenses associated with running our real estate business, because it is a business just like any other business, where we have business expenses. Maybe some of our travel expense, maybe some of our cell phone expense, our internet service expense, software that we would otherwise use anyway in our lives… A lot of these things can be expensed off with the properties. So that’s a small one.
The next one, that is really one of the Holy Grails of tax benefits is depreciation, where we can take and depreciate the property over 27.5 years if it’s a residential property and 39 years if it’s a commercial property. Residential has about a 25% faster depreciation schedule, and if we qualify for the depreciation benefit, it’s a non-cash write-off. As a non-cash write-off, we don’t have to actually spend money to get a tax benefit.
Every other area of life we have to spend money to get a tax deduction – donate to charity, or spend more money on our business, and we get a deduction with income-producing real estate. We could have the property appreciating in value, we could have positive cash flow… In other words, everything could be going great, yet the IRS will still let us use a paper loss, a phantom deduction, to get a tax benefit, and that is an absolutely beautiful thing.
One of the ways that wealthy people can pay little or even no income tax if they own enough real estate, and really benefit. And we have to remember, Joe, taxes are the single most expensive thing in any of our lives, for the vast majority of people listening.
Then the third one – and this is not realized usually until much later – is that we can trade the asset all our life on a 1031 tax-deferred exchange and not pay any tax. If we have a business, if we own stock, and if we sell it, we gotta pay tax before we get to reinvest it. With income property, we can sell it, trade around, move around maybe to different geographies, different product types… A couple of times I’ve exchanged single-family homes for apartment complexes or a mobile home park – I still own those now – and that’s just great, that I get to reinvest everything – the government doesn’t take a cut – and reduce the amount that I get to reinvest.
Of course, I sold a business years ago, and when I sold my business, the government took a cut before I got to do anything else. There was no ifs, ands or buts about it. If I sell a stock, the government takes its share, and then I get to invest what’s left over… Not true with income property, using the 1031 tax-deferred exchange, which is a tremendous benefit.
Joe Fairless: So you listed out ways to keep score – cash-on-cash return, the value of leverage… I love that one-fifth of the cost example, I never thought about it that way. Appreciation, tax benefits, and then you listed those three primary ways.
Now, if we’re building a scorecard, how do we know what grade to give each of these? Is there a certain range or a milestone that we’d like to reach within cash-on-cash return, leverage, appreciation and tax benefits?
Jason Hartman: Yeah, that’s a great question. Some of them are pretty hard to quantify, and the Holy Grail of metrics used by real estate investors to evaluate return on investment is something called IRR – I’m sure you’ve talked about it on prior episodes. IRR stands for Internal Rate of Return, and it basically evaluates every aspect of the real estate deal; usually you’re not gonna get a proper evaluation of internal rate of return unless you do it over at least maybe five years.
That internal rate of return is the Holy Grail of metrics, because what it does is it takes into account cash flow closing cost in and out of the deal, leverage, expenses, income… Basically, everything except one thing that I’m gonna tell you about, that is one of the things in keeping score I did not mention, and it’s a little more exotic. I wanna say it’s my own invention – it’s certainly not my own invention… But I will say that it is one of my main discoveries, that many people aren’t aware of. We’ll talk about that in just a second, if we can. Basically, internal rate of return will evaluate all of this.
See, it’s hard to build that scorecard because if you sell the property on a 1031 exchange and you go into a new property and you hold that new property for five years, and the first one for five years, and now ten years have gone by, the way you would have to compare that can get pretty complex… Because if you were saying, “Look, I owned a mutual fund for ten years” or “I was a stock market investor for ten years” or “I bought bonds for ten years and I traded them, and each time I traded them, if I took a loss on a stock, for example, the government would only let me write off (I believe the rule is) only up to $3,000/year in losses”, although you might have half a million dollars a year in losses. Now, you can carry it forward, but who’s gonna live long enough to write off all those losses, right? That yield sucks.
If you have a gain – and hopefully you have a gain – you sell, you pay your tax, either long-term or short-term capital gains, and then you get to reinvest what’s left over. So I think it’s pretty easy for most people listening to understand how this picture can get pretty complex, and I would love to just put a number on it for everybody… The closest I can get is the way we do performers on my website. I have a 27-minute video that any of your listeners can take advantage of – it’s right there at JasonHartman.com, it’s totally free, and it really guides into how to analyze a real estate deal and how to keep score.
Joe, I said that there was one more exotic or esoteric metric, and I say that, but it’s not exotic at all; it’s real. It’s just something that is hidden from view for most people. I believe when you had me on before we talked about it, and I call it inflation-induced debt destruction. Basically, what this is is it’s this hidden wealth creator that happens behind the scenes. When you syndicate an apartment building and you have financing on that, and all of your investors go in on that deal, that debt is getting constantly debased by inflation.
Now, yes, the tenants of your project pay it off over time by reducing the loan balance and that’s great, but that’s the minor benefit. The big benefit is this inflation-induced debt destruction.
Take for example a property or a portfolio… In my world, I love just little simple single-family homes. Say someone buys ten single-family homes, and they have one million dollars in leverage or debt against those single-family homes. Maybe the portfolio is worth 1.2 million when they bought it. Now, they will get their mortgage statements right after they buy it, and they can look and see that their loan balance today is one million dollars. But with the Trump administration, pretty much everybody believes – including myself – that Trump is inflationary.
From a philosophical perspective, if we were to talk about the Federal Reserve and central banks and all of this, I would say I hate inflation. But for my selfish perspective as a real estate investor, I love inflation. Love it, love it! It is the true home run for income property investors.
I’ll just take, for easy math’s sake, and just say that if we look at an inflation rate of 5% – now, from 1992 to 2002 the official stat was 5,3%; some years inflation was high, some years it was low, but if we just average it, the real number at 5% – of course, the government understates this for people – then that million dollars, inflation is basically paying off $50,000/year of our debt for free, every year, in the background.
Most people think they made money because the value of their property went up, but the property really doesn’t go up that much compared to inflation. It kind of keeps pace with it pretty well. The way investors beat inflation is they use leverage. If they have a 4:1 or 5:1 leverage ratio, then they outpace inflation by 4:1 or 5:1, and that’s beautiful. But in addition to leverage, inflation is also reducing the value of that debt because we pay it back in cheaper dollars every year, and it’s beautiful.
When I was on Ryan [unintelligible [00:18:38].18] – and I know you know Ryan – he said “Jason, I’m having a braingasm right now.” [laughs] I thought that was a funny word.
This is something like a hidden wealth creator in the background, and most people don’t even know it made them rich – but it did – because they haven’t been able to quantify it. Just know, with 5% inflation and a million dollars in debt, you’re getting 50k/year that is just a free ride, in addition to all of the other multi-dimensional areas in which we own our return.
Joe Fairless: Does that assume that the debt is at a fixed rate, not a variable?
Jason Hartman: Great point, I’m really glad you pointed that out. I love three-decade long fixed rate mortgages. They are incredible. Because look, if someone borrows money today on a 30-year fixed rate mortgage, just think about this thought experiment, Joe, of understanding that you will not make the last payment on that mortgage until 2047. 2047! That’s insane, it’s incredible. The fact that we can get three-decade long incredibly cheap fixed rate mortgages is like the gift from — well, it’s not a gift from God, but it’s a gift from the government, because real estate in American by the Federal Government, and it has been ever since the Great Depression through Fannie Mae and now Freddy Mac, too.
Other countries do not have these benefits. In most other countries, you will not be able to get a 30-year fixed rate mortgage; you’ll get a 30-year mortgage amortization, but it’s renegotiable every 5 or 7 years. In the U.S. we have a very special real estate market.
Joe Fairless: Jason, where can the Best Ever listeners get in touch with you?
Jason Hartman: My website is JasonHartman.com, I have a podcast, and we have had Joe Fairless as an over-distinguished guest. It is available on iTunes, Stitcher, Soundcloud… Any podcast platform. Just search Jason Hartman or go to JasonHartman.com.
Joe Fairless: Well, how we keep score – you listed four things: cash-on-cash return, leverage, appreciation, tax benefits… You got into the details on three primary tax benefits: deducting expenses, running the business (because we are running a business), taking depreciation, and 1031 exchange, as well as looking at the IRR (internal rate of return) and pointing out that the inflation-induced debt destruction term that you use – basically, we’re locking in financing at a fixed rate, and then inflation happens… So we’re using today’s inflated dollar to pay down yesterday’s fixed debt.
Best Ever listeners, if you go to a website I have just become familiar with – ShadowStats.com – they’ll actually say that the inflation is higher than the 5% that the government reports, which that $50,000 on a million bucks that you just mentioned, Jason, would turn to — they say 8% is inflation… So $80,000.
Jason Hartman: Yeah, 80k/year, free money.
Joe Fairless: Jason, thanks so much for being on the show. I hope you have a best ever day, and we’ll talk to you soon.
Jason Hartman: Thank you, Joe. Happy investing to you and your listeners!
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