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SFREI #20: What Financial Independence Means to a TREE: Part 2

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Episode #20: What Financial Independence Means to a TREE: Part 2

Episode Summary

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For most real estate entrepreneurs and investors, the goal is freedom and financial independence.  In this episode, we conclude our two-part discussion discussion about the principles of financial independence, and how those principles apply–often somewhat differently–to Thoughtful Real Estate Entrepreneurs. We cover the unique ways real estate entrepreneurs can build toward financial independence, the most important skills a real estate investor must have to achieve it, and the unique freedom formula for Thoughtful Real Estate Entrepreneurs.

Free PDF Guide: 5 Critical Mistakes That Make Most Real Estate Investors Accidentally Lowbrow

We’ve created a free PDF guide just for listeners of the Sleaze-Free Real Estate Investing Podcast, called “5 Critical Mistakes That Make Most Real Estate Investors Accidentally Lowbrow.”

For instant access to the PDF, just go to http://Pod.thoughtfulRE.com

References in this Episode

Music Credits

The theme song is an excerpt of “No More” off the album “Golden Era” by Forest For The Trees.  You can check them out on Amazon, iTunes, and Spotify.

Full Episode Transcript

This is Jeff

This is Jeff from the Thoughtful Real Estate Entrepreneur. Welcome to episode number 20. Kind of a little milestone episode of Sleaze-Free Real Estate Investing. The show for those of us who never felt at home in that we buy houses type of crowd. In this show, what we do is we take a stand against what we call the lowbrow approach. That’s the mainstream guru seminar, distress seller approach that ends up giving real estate investors a slimy reputation. And instead, we discuss the strategies, tactics and philosophies that we call the thoughtful way. And enlightened approach to real estate entrepreneurship that focuses on constantly sharpening this sophisticated real estate entrepreneurs the three most critical capabilities, seller relations, skills, deal architecture, skills, and opportunity vision. When all three of these capabilities are successfully in motion, you can make an excellent living today and build long term wealth, while creating value for everybody that you touch along the way. Show Notes for today’s episode are at www.thoughtfulre.com/e20. Please do yourself and do us a big favor hit that subscribe button in your podcast app now, so that you make sure you get the next episode as soon as it’s released. Now in the last episode, we discussed part one of a conversation about what financial independence means to a TREE to a Thoughtful Real Estate Entrepreneur. So go back and listen to that one if you haven’t already, because today, in the main course, we are going to wrap up this conversation about what financial independence means to Thoughtful Real Estate Entrepreneurs. But of course, as always a little bit of food for thought. Because after all, as Thoughtful Real Estate Entrepreneurs we’d like to well think and we like to feed our minds with interesting things to think about. And here’s what we’re thinking on today. Today’s Food for Thought is about a character named Harvey specter. And Harvey specter is a character on the show called suits, which is a drama about a law firm. And Harvey’s one of the main characters and Harvey is kind of a badass, and he’s a dealmaker, and a tough guy and a savvy negotiator and a smooth operator. And Harvey is also a poker player. And so there’s a scene where one of his colleagues, Lewis is playing a hand with Harvey, and another guy whose business they’re trying to earn. Okay, poker is Harvey’s thing. And Lewis kind of felt like he needed to show that he knew what was what was going on as well. And at one point late in the game, Harvey folds, he folds his hand. And later Lewis finds out that Harvey actually at that moment, had a strong hand. And Lewis complains, he says, Harvey, why would you do that? You know, the odds of that hand that you had, and Harvey responds, and he says, Louis, I don’t play the odds, I play the man. And I thought that was a profound statement that just made me think all about what we do as Thoughtful Real Estate Entrepreneurs. So what he was saying was, this one hand, was not just one hand, in a vacuum, it was part of a bigger picture with the relationship he was trying to build with that guy, the prospective client, it was just one hand in a bigger picture of an ongoing strategic effort to position himself in the way he wanted to position himself with that prospective client. And he wanted to let the guy the client, come to the conclusions that Harvey wanted him to come to. So Harvey was dropping bread crumbs along the way, and allowing this guy to come to the conclusions that Harvey wanted him to come to. It was sort of like saying, I’m willing to lose this battle in order to win the war. And I was really struck by this. It’s really so much like how we approach working with sellers as thought for real estate entrepreneurs, because average lowbrow investors play the property, but we play the seller. Now, I want to note, this is not to say that we are trying to beat the seller, it’s not a zero sum game. And we’re not trying to manipulate the seller, this isn’t play the seller, as in, Hey, you got played. But it is to say that if we’re going to get a deal done, it’s going to be by focusing more on playing to the seller, who they are, what they need, watching their actions, reading their body language, reading between their lines, then it’s going to be about the sticks and bricks of the property itself. That’s why at the end of the podcast, we always say, solve the person to unlock the deal. So I leave you with this thought, how can you start to not play the odds, but to play the person, don’t play the property, play the seller. And a second thought to leave you with is maybe go check out suits, quite an entertaining show. That is today’s food for thought.

Alright, we’re moving on to the main course of today’s episode. And that would be of course, our continuation part two of our discussion about what financial independence means to Thoughtful Real Estate Entrepreneurs. So as a quick recap of the last episode, we started by discussing that for most real estate investors, the common goal that we hear when we talk to each other is the goal of freedom. And freedom comes in a few different forms. But the most prevalent one that people tend to talk about in this context is financial freedom. I told you that I had recently watched a newly released documentary called playing with FIRE, that’s capital F capital IR E, and that stands for financial independence retire early. And FIRE is a whole movement unto itself. That has gained a lot of steam in the last couple of years. And we discussed some of the main principles of the FIRE movement and the thoughts behind it. And what I mentioned was that I felt like the spirit of all the FIRE movement ideas really feels good to me. But tactically, some of the things that are common in that space, don’t feel like they fit completely for Thoughtful Real Estate Entrepreneurs. And when it comes to income, life is very different for real estate entrepreneurs than it is for sort of regular people with day jobs and predictable paychecks. Our financial dynamics of our life are very different. And I believe that that means we have to have a slightly different playbook for how we achieve that outcome. Much of the financial independence traditional wisdom is really designed for those people with stay steady, regular paychecks w two income. And with that type of scenario, they can actually calculate the amount of time it’s going to take them to get to financial independence, because everything in that formula is really quite predictable. And you know what’s coming up. But as real estate entrepreneurs, we actually have a lot more control over our future income, even though that future income might not be quite as regulated and coming out everything in the same predictable manner as it is for people with w two jobs. So our income can vary wildly based on how successful we are using our real estate investing skills, or just the timing of the way deals come together. It would be not unsurprising for a thought for real estate entrepreneur to get a $100,000 hit of income in February, have only you know, five or $10,000 for the next few months, until August, and then you know, $50,000 in August, and almost nothing and it’s just not quite as predictable, although overall, it can generate a lot more money and a lot more control. At the end, the last episode, I mentioned the questions that we as TREEs need to ask ourselves and in which order. Because for TREEs, we already know that we love and we want to use real estate, we already know how we’re going to get to our big picture. So our sequence of questions is like this. Question number one, what life outcomes? Exactly? Are we trying to accomplish using real estate? Right? This is like our Why? Why are we employing the tool of real estate? What are the outcomes we’re seeking to achieve? The second question is of the many approaches and strategies for investing in real estate? Which ones will best get us to those outcomes? That we just decided where our Why? Right? So this is kind of like the how of the different ways you can go about investing in real estate? How are we going to do it? That’s going to get us to RY? And then the third question is, what is my plan for excellence shooting those strategies? In other words, what am I going to do to execute that? How? So I can get to my why. So what I did at the end of the last episode is I left you with a very specific question that I hope has been rolling around in the back of your mind. And that question is this? What are the ways that Thoughtful Real Estate Entrepreneurship can create financial independence? So let me answer this question. With the big picture. First, I’m a big picture kind of guy, I like to always start with a 60,000 foot view, and then drill down from there. financial independence, regardless of the strategy that you use to get there is clearly about structuring your finances in a way that works, right? It doesn’t matter if you use index funds or any other form of investment vehicle. It’s about structuring your finances. And in real estate, it’s really no different financial structure is really what matters most not just the sticks in the bricks. And we do as an industry tend to get kind of lost in that point and forget that the sticks and the bricks are less important than the structure of the financing that we put in place with a property or with a deal. My coach, my mentor, Greg PO says that real estate is the clothing, the finance, where’s, that’s such an interesting way to put it. And the first time I heard that, and just about every time since that I’ve heard that it’s really made me stop and think and actually even kind of visualize what that means. So let me translate that real estate is the clothing that finance where’s my translation of that is, is it’s like saying that real estate is just the physical embodiment of financial instruments, but it’s really financial instruments that are at play here, what we see is the real estate and what we can feel is tangible and wrap our brains around is the real estate, the sticks and the bricks, but it’s really the financial instruments. So I want to tell you that I really believe your ability to negotiate to acquire excellent financing. And your skill in structuring that financing is actually more important to your financial independence than your ability to buy a property and fix it up, etc. Okay, I’m gonna say that again, because I want you to understand the importance and the weight of this point, your ability to negotiate to acquire excellent financing. And your skill in structuring that financing is more important to your financial independence than your ability to buy a property and get it fixed up, etc. So let’s talk about real estate strategy. Now we’re coming down from 60,000 foot view, to 30,000 foot view. What are the ways that Thoughtful Real Estate Entrepreneurship can help you build towards financial independence? Well, of all the ways we’re going to talk about, there’s one common theme that I want you to keep in mind. We’re Thoughtful Real Estate Entrepreneurs. That means the things we’re going to do our entrepreneurial, those approaches create new value, we don’t just sort of Park money and take a non entrepreneurial approach to real estate, you can do that. But we’re focused on being entrepreneurial in our approach. Real estate is famously fantastic for being one of those assets, where simply adding time to the whole equation really helps a lot, right. If you simply own a piece of property over a long period of time, even if you’re not acting entrepreneurial Lee, you will benefit from the effects of appreciation or inflation, the tax benefits compounding over time, Principal pay down if you have a renter paying things for you. But that’s actually not what we’re going to focus on here. Because that’s not terribly entrepreneurial in and of itself, we’re going to focus on going beyond that to more entrepreneurial ways to approach the creation of value that’s going to help get us to financial independence. So what are some of the ways that we can entrepreneurial II create value? Well, we’re going to focus on three ingredients, there’s like a recipe. For a result we’re trying to bake right, we’re trying to bake a cake called financial independence. And there’s three ingredients in the recipe for that cake. Those three ingredients are equity, financing, and cash flow. And all the time we’re constantly working on growing and improving all three of those ingredients. And we don’t just think about those three ingredients on the level of a property by property level, right, I’m not just thinking about equity financing, and cash flow for 1234 Main STREEt, and then separately thinking about equity financing and cash flow for 234. Oak STREEt. Instead, I’m thinking about equity financing and cash flow globally across my entire portfolio. So let’s start the each of these three, one at a time. The first one is equity. And what we’re talking about here is the opportunistic creation of equity. In properties. This is where we’re going to buy something that we think we can make worth significantly more if we use our savvy in our negotiation skills, right. So to some degree, it’s buy low, and not necessarily sell high because you’re not necessarily going to sell it but buy something for one price and make it worth a lot more than that. This is really especially powerful in multifamily and commercial properties as well, where with every single dollar of net operating income that you create, the more value you create, right, and this gets into a bigger conversation about what cap rates are and how income property is valued with the income approach to valuation, which is beyond the scope of our conversation today. But suffice it to say that if you were able to raise rents on your multifamily property by hundred dollars, and you decrease expenses by $100, that $200 of improvement you just made, increases the value of your building doesn’t just increase the cash flow, and it actually increases the value of your building. Now, it’s important that I note that we’re not talking about creating equity for the sake of having equity, like having equity feels good. And we all kind of like the idea of saying, well, I’ve got a lot of equity in that property. But that’s not really what we’re talking about here. Today, we’re talking about creating equity, because equity is a tool in our overall effort to build financial independence. So when we create equity, equity created is not a reward to us, is a tool for us to keep using in our building efforts. And we can really use that tool of equity in one of two ways we can harvest it, or we can harness it. Okay, harvest it would be like selling the property and taking that equity out and having it liquid in a available for us to use. But there are other ways of harnessing that equity instead of harvesting that equity.

Yes, so the more equity you have in a rental property right, the more cash flow you have, and that sounds good and feels good. But that also is not really what we’re talking about. Well we’re talking about is creating equity, so that you can use that equity to buy more value adding property. And then once you’ve got enough equity in your value adding properties, you can convert that equity to cash flow. If that doesn’t make sense to you, I would highly recommend you go back a couple episodes to episode number 17. And listen to that one again. Because in that episode, we talked about the two different ways to create cash flow. And we dig into that idea right there of how you can use your equity in a property to acquire more value add properties, which ultimately can be converted to cash flow. The second thing besides equity that we’re trying to create all the time, what the second ingredient in our recipe is great, excellent financing. And we create excellent financing through our ability to negotiate. So what is it that really makes for good financing? Like what’s the definition of good, and I think there’s two elements that define good in this context. The first one is affordable financing, right? This probably more obvious, lower interest rates, fewer points, no prepayment penalties, and things like that. So more affordable financing. And secondly, though, is flexible. The second attribute of good financing is flexible. financing, we’re going to come back to that in just a second. Because when you buy a property, most people don’t think about it this way. But when you buy a property, you actually acquire or create two things. One is the property itself, the sticks, the bricks, the dirt, and the second one is the financing. And when you buy a property with seller financing, you are acquiring the property and the financing from one source all in one fell swoop. If you’re not buying a property with seller financing, you’re going out and you’re acquiring financing in another way. But at the end of the day, if you put a deal together, there are actually two products to that deal, the property itself, six bricks under and the financing and the money behind it. So what does flexible financing mean? It means that the lender who provided those funds has fewer restrictions on what you can or cannot do with that financing. So let me just give you a common example. If you go get a loan from a bank, that bank loan is going to have what’s called a do upon sale clause, a clause that says we’re loaning you money for the purchase of this particular property. And if you sell this particular property the loan is due.

That is not what we would call particularly flexible, it’s very average, it’s very common, but it’s not particularly flexible. On the other hand, a seller loan may or may not have that do upon sales clause, it’s part of the negotiation with the seller. If it doesn’t have that do on sales clause, which you could find yourself in that position for lots of different reasons, lots of reasons, the seller would be motivated to do that lots of reasons you would be motivated to do that perhaps, if it doesn’t have that do on sales costs, you have a lot more flexibility. And in a literal sense in this case, that means that when you sell that particular property, you might not necessarily have to pay that loan off. Now there is a lot, I mean a lot to know about that exact topic. And that too is sort of beyond the scope of what we’re going to talk about today and how you would actually go about executing something like that. But suffice it to say that when you have flexible financing, you are enabling yourself, to engage in it in a ongoing activity, where you’re constantly preparing, and repairing and optimizing and rearranging the two elements, you have their properties, and your financing, and that those two elements aren’t always married to each other that there is flexibility for rearrangement of those. The third recipe ingredient is cash flow. And when you’re creating cash flow in a property, there are a few important elements of this. When we buy a property, we can improve its income in many different ways, can raise rents, you could find new income sources, etc, you can reduce his expenses, like I mentioned before with a multifamily or commercial building is a great example of that. And if you improve the income, if you reduce the expenses, you’ve now improved the cash flow. But similar to my point earlier, regarding equity, we don’t want to fall into the trap of creating cash flow for the sake of creating cash flow, while we’re talking about in this moment is not about the creation of cash flow for the sake of having cash flow, but rather, because cash flow is an important tool and important ingredient in our overall effort to build financial independence. Ultimately, yes, our freedom will come from cash flow. But strategically, we are not necessarily going to go straight to a focus on cash flow, we’re going to keep building cash flow and find ways to use it as the tool it is, again, highly recommend you go back and re listen to episode number 17. If it’s not extremely fresh in your mind, because it’s going to help that make a lot more sense. The cash flow we create, just like equity is not a reward. It is a tool for us to keep using and we can use that tool by harvesting the cash flow. And we can use that tool by harnessing the cash flow.

So when are you financially independent? In other words, when Could you stop focusing so much on growing the three ingredients equity, cash flow and good financing? When Could you stop focusing on growing those in three ingredients and just call it good and sort of retire? Well, here’s my argument for Thoughtful Real Estate Entrepreneurs. financial independence is not necessarily the state of having passive cash flow, that more than covers your living expenses. Rather, to me financial independence for TREEs is the state of being in a position where at your option, you could convert your financial structures into cash flow. Okay, so I want to say this again to to make this point. Well, while for most people financial independence is the state of having passive cash flow that exceeds their living expenses. For TREEs, it’s a little bit different. My definition of financial independence for us is the state of being in a position where at you your option, you could convert your financial structures into cash flow. Okay, so for most financial independence people, their freedom formula goes like this, hey, it’s when your cash flow exceeds the expenses that you’re willing to live within. You’re financially free, right? So if you’re willing to live within $20,000, and you create $20,000 a year of cash flow, you’re financially free. If you’re willing to live within $80,000 a year, when your cast passive cash flow exceeds $80,000 a year, you’re financially free. But for us TREEs, the freedom formula is slightly different. From me, I believe that the freedom formula for us TREEs is this, when your net worth can reliably generate enough cash flow to be greater than the expenses you’re willing to live within. You’re financially free. Okay. So if you’re willing to live within $70,000 a year, and the net worth you’ve accumulated could throw off more than $70,000 a year in cash flow. You’re financially free in the TREEs freedom formula. And why is this the case? It’s because your net worth is what we’re focusing on building, knowing that that net worth can be converted into cash flow when you want. So let me just give you a real concrete mathematical example. Let’s say I’ve decided with my wife that we are willing to live within a budget of $100,000 a year, okay, so we’ve decided where we want to live, you know, what market in the country we want to live in, well, how big of a city how expensive of a place, how we want to live, you know what type of house we want to live in, how often we want to go out to dinner, all that. And we’ve made all those decisions deliberately. And we said, based on how we want to live, we are willing to have that life within a budget of $100,000 per year. Now, if I believe in my ability, as an entrepreneur, to use my skills of entrepreneurship and my skills of deal finding in my skills of negotiation, to generate a, say 6% cash on cash return on my investments, then the question becomes, what amount of net worth equity? Do I need to have that at 6% would kick off $100,000 per year? And if you do that math backwards, you see the answer is $1.67 million. So I would need $1.67 million in equity. And if I had it, and I could generate that 6% return on that equity, then I’d have my hundred thousand dollars to live off of. So now my game becomes not creating $100,000 a month or a year of passive cash flow, my game becomes achieving $1.67 million in equity. Because when I get there, I know that I can convert that $1.67 million equity into the hundred thousand dollars that I want to need to live off of. So now I’m working on growing my three ingredients with the objective of getting to $1.67 million in equity.

Let’s go back to the topic of freedom. This is kind of how we started the conversation. In our first episode of this discussion. It’s all about freedom. And if if we get together a group of 10 Real Estate entrepreneurs and ask them why they’re doing what they’re doing, that is going to be the theme. And to me, freedom through financial independence is a choice. Freedom is not a destination. To me freedom is a choice. So in my own situation, literally right now, as I record this episode, am I financially independent right now? If I look at it by the classic definitions, right, is my cash flow Today, more than my expenses today? No, I am not financially independent right now. But my by my own definition of financial independence? Yes, I would say that I am financially independent today. Why? Because with the amount of net worth that I have accumulated, I could restructure my portfolio, I could reallocate my assets in a way such that without going on in making any more money, I could restructure what I already have, and generate an income from that at passive cash flow income that I would be willing to live within if I wanted to. So to me, the answer to my question of, am I financially independent is yes, because at this moment, I am choosing not to restructure my portfolio, reallocate my assets, and convert them to cash flow, and live within the cash flow that they’re created. I could do that right now. But I am consciously choosing not to. And that’s why To me, this is so much more about choice, and freedom. And why am I making that particular choice? Am I crazy? Am I some kind of masochist? who just wants to work all the time? No, it’s because frankly, number one, I like what I do. It’s fun. It’s challenging. It’s a game. And secondly, I want to continue growing. If I stopped pursuing this and stopped growing, I would find myself very quickly bored and feeling like I wasn’t developing as a person. And that’s just not how I want to be. So in closing, thanks again, for listening to Sleaze-Free Real Estate Investing. I think we’re tackling some important topics here. Hopefully we’re tackling them from an angle that’s different than you can find in other forms of content and podcasts and a different school of thought a different point of view. On the next episode, we’re going to be discussing what we call opportunity vision, which is truly a critical skill for real estate investors. That helps them see all the different types and angles of opportunity that a deal can provide. Again, do yourself do us a big favor by hitting that subscribe button in your podcast app. If you would be so kind as to go to iTunes and submit an honest review. We’d love to hear from you. We’d love to help you or get your review because it will help us have feedback on how we’re doing. But the more reviews there are, the more iTunes wants to show this show to other people who might be interested in it. So we would love to have you review please give us your honest feedback. reminder that the show notes including a transcript can be found at thoughtfulre.com/e20. And until next time, this is Jeff from the thought for real estate entrepreneur and I’m signing off.

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