For many real estate investors, when they are considering which loans to get, they want to pay those loan off as quickly as possible. But is the goal really to pay off the debt on the property? For some people, it may be; but for many others, that’s not the goal at all. In this episode, Jeff explains why the goal may not be to pay a property off, and explains what the real goal is instead: to create a sustainable deal that buys you the time to get the real win you bought the property for.
Hey, let me ask you a question: when you have rental properties, is the goal to get them paid off so that they’re debt free, and thus they can cashflow at their greatest level possible? Well, that might be one person’s goal. Maybe it’s your goal. But it’s easy for us to assume that by default, of course, that’s everybody’s goal. But in this episode, I’m going to talk to you about why that’s not necessarily everybody’s goal. And instead, I’m going to pose to you what I think the real goal is for all of us. So let’s keep the theme song. We’ll jump right into this important conversation.
Welcome to Racking Up Rentals, a show about how regular people, those of us without huge war chests of capital or insider connections, can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans, nor are we posting WE BUY HOUSES signs, we’re just looking for “motivated sellers” to make lowball offers to. You see, we are people oriented dealmakers, we sit down directly with sellers to work out win-win deals without agents or any other obstacles and buy properties nobody else even knows are for sale. I’m Jeff from the Thoughtful Real Estate Entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media, this show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio.
Hey, thank you for joining me for another episode of racking up rentals. This is Episode 140, which means that the show notes can be found at www.thoughtfulre.com/e140. Please do us a big favor by hitting that subscribe button in your podcast app. It really helps fellow thoughtful real estate entrepreneurs like you and me to find this show because the platforms know that you’re listening. Onward with today’s episode.
So here are a few comments that I often hear real estate investors make, maybe you’ve said some of these things; I’ve probably said some of these things at one point in my journey as well. “Okay, yeah, but I’m not paying this property off very quickly, if I get that type of loan.” That’s one thing they might say. They might say, “Interest only payments? Why would I want to do that; I’m not reducing the principal.” They might say that, or they might say, “If I refinance the property, sure, it’d be nice to have some cash out. But then if I just keep refinancing, I’m never gonna pay it off.”
And all of those things beg the question where we have to question our assumption underlying those comments: is the goal to pay the properties off? And not necessarily, is that always the truth. Now I want to say there’s no right or wrong answer. Maybe that is your goal. And that’s totally cool, if that is your goal. But that’s not everybody’s goal. And it’s not the default objective is to get rid of the debt. And I hope that today’s episode, even if it is your goal, helps you reframe things just a little bit.
So if the goal is not necessarily to pay the property off, but it might be for some people, and that’s not a universal goal, is there a universal goal? And I would say that, yes, there is a universal goal for all of us, no matter what our strategy is. And here is my way of articulating what that universal goal is. Our goal is to buy ourselves the time that we need to get the wins that we want to get. So let’s stop and think about that. Let me say it again first. I think the goal of all of us is to structure deals, such that we get to buy ourselves the time that we need to get or harvest the wins that we want to get.
Okay, let’s talk about what this means. When you are buying a rental property, right, you are doing your monthly cash flow analysis. And a property can have positive cash flow, it can have negative cash flow, it could just break even. But when a property has breakeven cash flow or better, then that property is now sustainable. Okay? What does sustainable mean? Sustainable means that it can continue to hold its own over time, that the situation that’s there can continue to happen indefinitely, right. If a property’s cash flow negative, that has to come to an end at some point because it will just eat up all the resources that are there. But if a property is sustainable, it might not be producing excess cash flow, but it is holding its own and it allows that situation to continue to go on, on a month to month basis. And when a property is sustainable, sustainability buys you time. Because any win that you could want to get out of real estate is going to take a little bit of time.
I mean, just think about this, even to get cash flow for one month takes a little time, right? It takes 30 days to get the cash flow from one month. So the wins take time, some types of wins take longer, some types of wins don’t take as much time. But the goal would be to buy a property and structure that property, that deal in a way such that the property was sustainable, which allows it to go on over time, so that you can then work to harvest the wins that you want to get.
So what are some of the wins that you might want to get, these things that I’m saying all take a little bit of time? Well, let’s talk about the most obvious first one: cashflow. The win you are looking for, the reason you might have bought this property, is for cash flow. And that means that there’s excess money left over after the property has reached the level of sustainability, right? After the property has reached the breakeven point, there is cash left over after that and we call that cash flow. If that’s the win you want, you’ve now structured a deal, so that it breaks even on a monthly basis. And it gives you time to get the wins you want, which is a monthly chunk of excess cash that we call cash flow. So that’s a monthly win, that monthly win accumulates over time, becomes an annual win after 12 months. And that’s the win we want. But the property had to be sustainable and hold its own in the first place to enable the excess cash flow to pile up.
Okay, let’s talk about a different idea. What if the main win that you wanted to get from buying a property was tax write offs? Maybe that’s your goal. Maybe it’s not. But there are certainly people who buy real estate for that reason, primarily right now, if they are wanting tax write offs, right. And that’s from the some of the actual expenses of real estate ownership, but also the phantom expenses of real estate ownership like depreciation, and the things we get to write off like that. Tax write offs can be depreciation and interest expense and all this and that. If a person’s bought a property for the tax write offs, the sustainability of that property allows it to go on month to month, and allow those tax benefits to pile up. It’s because the property is sustainable that it allows them to harvest the main thing they’re trying to harvest with this property, which is the tax write offs.
Okay, let’s talk about something else that’s very common that we think about all the time in real estate. And that is the topic of appreciation. Now we’re gonna have to break this down into lots of smaller categories. Because appreciation, there’s sort of two different things, right, there’s market appreciation. And then there’s forced appreciation. And then there’s a different thing that we often confuse with appreciation, which is inflation.
So let’s break all this down real quickly. Appreciation is different than inflation; appreciation is when the actual property that you have is considered more valuable by the market marketplace of people who might want to buy it, or rent it. People like your particular property better, and thus it has appreciated. Maybe the neighborhood has improved, maybe you have made some improvements to you know. If the neighborhood has improved, you might call that market appreciation. You haven’t done anything specifically yourself, but it’s in a location where people want to live more than they used to want to live there, or there’s a new big employer who’s nearby, but people want to live in that area more than they used to. That might be market appreciation.
Then there’s the idea of forced appreciation, right? If you buy a property that has two bedrooms, and you add a third bedroom to it and a second bathroom to it, now you have forced appreciation because you’ve actually changed what the product is, what the property is. And now it’s worth more because it’s it is literally more than it used to be. Those are two examples of actual appreciation.
But the other thing that we often confuse with appreciation is inflation. And inflation isn’t really about your property at all. Inflation is about the number of dollars it takes somebody to exchange for your property; inflation is actually much more about the currency that they’re using, like a US dollar, declining in its value, so that people have to exchange more of them to get the things that they want, right. You used to only have to exchange $2 bills to get a cup of coffee. Now, it’s not that coffee has appreciated necessarily. It’s that the value of those dollars has diminished. And now it takes you $3 or $4 to exchange in order to get that same cup of coffee. So the same thing could be happening with your piece of property.
And so we can step back from our economics lesson and talk about the wins, right? So maybe you’ve bought this property because you want the win of appreciation, market appreciation, or forced appreciation. Or you bought this property, because you want the win of what it does when inflation happens to it; you like the idea that someone only used to have to trade $300,000 for this property but now, thanks to the declining value of that dollar, now they have to trade $400,000 to get that property. Maybe that was the when you were trying to get. But still, either market appreciation or forced appreciation or inflation, takes a little bit of time as well. So when you structure your deal, you structure it to be sustainable on a monthly basis. So it can hold its own and it buys you the time to experience the appreciation or the inflation, inflationary effects, that you might be wanting to experience.
Okay, let’s talk about another one; this is how we started the show. Principal pay down might be the win you’re looking for; you might say I’m buying this piece of property so somebody else can pay it off for me. That’s the main win that I’m looking for. Right? So you structure your deal so it’s sustainable, and it’s sustainable so that means it can continue happening indefinitely, month over month, because it holds its own every single month. And that buys you time for the tenant to pay down your principal for you basically by making you rent payments that go towards your debt. So paying the debt off, or reducing the debt is a form of principal pay down. And that might be the goal you have, but it might not be. But the goal is to develop a property that is sustainable, month to month, to buy you the time you need to get the win you want.
Let me give you a fifth and sort of final example. Maybe the win you were looking for is to capture some kind of expandability that you see with this property right? You see the opportunity for physical expandability or development opportunity, or something along those lines, right? You buy a house because it’s got a big backyard and the zoning allows for another unit; or you buy a house that has an unfinished basement, because you know that by finishing that basement, which adds a family room and a bedroom, now you’ve increased the value of that house connected to the idea of forced appreciation. But you can’t capture the expandability unless you’ve bought your time yourself the time to do so and buying yourself the time to do so comes from creating a deal that is sustainable.
So I’ve just walked through like five different examples of the types of wins that you might want to get: cash flow, tax write offs, various types of appreciation or inflation, principal pay down, or to capture some form of expandability. Now, of course, you might want a combination of those things. And I would say in reality, in almost all cases, we are hoping and wanting and expecting a combination of all of those things, right. You’re expecting to earn a little bit of cash flow, and to experience some market appreciation and to have principal pay down perhaps, and to capture some expandability perhaps.
But the bottom line is this: the real goal is not necessarily to pay your property off. If that is your goal, that’s great. But that might not be your goal and you can still experience massive wins without paying any debt down at all. Because these other wins that you can get aren’t reliant on principal pay down.
So is the goal to pay off the property? Not by default. No, it’s not necessarily everybody’s goal to do that. If that’s your goal, that’s great; if that’s part of your goal, that’s great. But upstream of that is the real universal goal, which is to buy yourself the time to get the wins that you want to get. And you do that by structuring a deal that is sustainable. And if you do a deal that is sustainable enough to buy the time you need to get the win you want, that is what matters.
And that my friends, is it for today’s episode of Racking Up Rentals. So thank you again for tuning into this one. Keep in mind show notes can be found at www.thoughtfulre.com/e140. Please do us a HUGE favor by hitting the subscribe button in your podcast app, rating and reviewing the show. I’m so grateful every time I see a rating or review and I do see them all so thank you.
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Until then, this is Jeff from the Thoughtful Real Estate Entrepreneur signing off. Thanks for listening to Racking Up Rentals where we build long term wealth by being win-win dealmakers. Remember: solve the person to unlock the deal and solve the financing to unlock the profits.