First Rental Property Purchase – How I Bought My First Rental Property At 25 Years Old

First Rental Property Purchase – How I Bought My First Rental Property At 25 Years Old


Hey Jeff Lerner here and in this video
we’re going to talk about buying your very first rental property. I’m going to
walk you through specific tips. Basically give you a formula for how to,
there’s no guarantees, right? But how to have the highest, absolute highest
probability of a successful investment on purchasing your very first rental
property. I’ll tell you a little bit about how I got started in building my
real estate portfolio and walk you through the current conditions I got
started a while ago. Some things have changed a little bit. I’ll walk you
through the current conditions of the market today and how to set yourself up
for the highest probability of success and get started. Even if you’re very
young. Even if you’re very inexperienced. Again, get you the best
shot at hitting a home run on your very first property. Cause if you get that
first property right, it can catapult you to an amazing life. Literally you
take that first success, quickly, turn it into a second and a third and a
fourth and next thing you know you have a dozen properties and you don’t have to
have a job, but if you mess up that first one, it can set you back for
years. So let’s get that first one right and I’m going to walk you through
exactly how to do that. To start, I’m gonna actually tell you a
little bit about my story of how I got started and, and it’s not because
how I got started is how everyone needs to get started. It’s because how I got
started illustrates a point, a really important point about this, which is
that no matter how formulaic we try to make it, no matter how much we try to
boil it down to a simple checklist, there always are going to be variables
and unknowns. And there’s always going to be a certain way of being a certain
character or almost personality that has to drive the entrepreneurial or the
investor minded person to live this nontraditional life and create this type
of an outcome. The fact is most people aren’t successful at doing this kind of
thing. And so if you want to be one of the people that are successful, it’s not
enough to just say, okay, well give me the steps. It’s also important to talk
about how you need to be. So let me start with a little story that I think
illustrates one of the reasons why I was successful at this and why I’ve been
successful at several other things as well. When I got started, I had like no
money. I was a jazz piano player at the time and even even then I was, I guess
when I started was like maybe 2004 so I was like in my early twenties like 24
years old, 24, 25 and so I wasn’t even that far along in my career as a musician. I wasn’t even making $40,000
a year yet. I was struggling. I had like no extra money. I had a couple credit
cards that was like really the one advantage that I had. But you know, you
can’t show up at a real estate closing and say, here’s my credit card. Will you
take what you know, swipe my card for the closing. You don’t want to draw cash
advances off your credit cards in order to pay for real estate closing because
then you’re basically paying 30% interest or whatever the cash advance
rate is on. You know on that, that amount of money, which is supposed to be
your, your down payment are supposed to be cash and it’ll just bog the whole
thing down. Credit cards are great, but they’re in very, except for very few
rare circumstances, they’re not actually going to help you acquire your first
property. You’re going to have to find a way to come up with some cash that
you’re not having to pay interest on, even if it’s just to pay closing costs,
even if it’s maybe just to pay for a few repairs. You know, I was in a harder
position even than most people because there was just nothing I could do. As a
musician, you know, there’s a finite supply of jobs. It’s not like I could
work over time. It’s not like I could pick up extra shifts. There was just a finite supply of jobs that even paid
very well for me to try to get my income to the point. And I lived in a major
city. So for me to try to get my income to the point where it was significantly
above my cost of living, it didn’t really matter how much I suppressed my
cost of living or how many gigs I was willing to work. I just couldn’t save up
an extra 10, $20,000. So for me, I had to go find a partner. I had to pair up
with somebody to get help. That was its own, its own challenge, right. How do
you go to somebody and say, look, I’m a, I’m a broke jazz musician and if I
wasn’t broke I wouldn’t be having this conversation. So I can’t pretend that
I’m not, and clearly I don’t have any experience, but here’s what I can offer
you as a way of saying, Hey, will you put up this initial amount of money to
help me acquire this property? And at that time, and there still are these
loan types of loans available. You know, I had decent credit. I hadn’t, I hadn’t
made any catastrophic mistakes. I just didn’t have much money. And so I was
able to get qualified to only have to put 5% down on my first house. It was a
single family home, but it was part of a pair of homes that had been built to be symmetrical. So it was kind of like half
of a, almost like half of a duplex. But it was, it was freestanding. I want to
say it cost me like $90,000 and I had to come up with 5% down. So for me, I had
to come up a 4,500 bucks. Then I was able to get a primary mortgage for 80%
of that. And then I needed to come up. I needed to get a secondary mortgage for
15% of that, but I had to come up with $4,500 plus closing costs. So I was able
to basically convince a buddy of mine to put up $7,500 so how did I do that?
Well, the way I did it, obviously I couldn’t claim to have a bunch of
experience, but what I could show was this is a really good deal. And if worst
comes to worse, we have an agreement in writing that says basically you get the
property. So no matter how bad I bungle this, no matter how bad I screw this up
for helping me come up with basically $7,500 your absolute worst case scenario
is that you can have a property that’s realistically probably got about $20,000
in equity in it. And yeah, it would be annoying. And yeah, you don’t want to be
in the real estate business and yeah, you don’t want to have to deal with it.
But that’s the worst case scenario, which at least means that you’re not going to lose your money. I think
the thing that stops a lot of young people I get, I get so many messages
from young people that are like, how do I get started? And the crux question,
the thing that we bump up against so often is like they don’t think they can
get started because they haven’t already started. It’s a chicken and the egg
problem. It’s like they think, well, if I have started then I have results, then
I can show my results and then I can use that to ride a wave of momentum and you
know, do the thing. But it’s like you can’t do the thing if you haven’t done
the thing. At least that’s, that’s the mental trap. And so, you know, I say
that again, that’s not necessarily a formula. That’s not necessarily a
situation that everybody’s in, but it’s illustrative of the mindset that you
have to have, which is like you have to believe, you have to believe it’s going
to work. You have to be able to convey that belief to someone else and get them
excited. And the nice thing about real estate, one of the reasons I think real
estate real estate is really one of the only two things that I advise for people
that want to start a side hustle or deploy some capital into a line of
investing that I think ultimately set them free or really changed their life. It’s really just
digital marketing and real estate or internet business and real estate. Those
are the only two things I teach. And one of the things I love about real estate
is that it has that intrinsic security that like there is a physical thing,
right? So to my buddy it was like, listen man, if everything else falls
apart, you can have the house, you can have the thing. Right? So that said,
let’s look at the other things that have to be in place because obviously not
all, not all real estate deals are created equal. What are the other things
that have to be in place to be able to go forward with confidence? Whether it’s
you, whether it’s you with a partner, whether it’s getting somebody else,
whether it’s even convincing just a private lender or a bank to loan you the
money. Whatever it is. Here are the things that have to be in place to have
the highest degree of confidence that your first real estate investment is
going to be a good deal. So to start this conversation, I want to talk about
four basic concepts. We’ll call this the general concepts portion of this video.
These are basic concepts that you have to kind of have an understanding of an
buy-in on and we, you know, we kinda gotta be in agreement for the rest of
this video to be practical and useful. The first one is, I believe that when you’re starting out
and probably for a very long time in your, your real estate investing career,
you should really only be investing in markets that you actually know. Like
ideally your hometown or wherever you live. A you have sort of the level of
understanding of that can only come from actually living in a place. You know,
things like you understand traffic patterns, you understand, you know what
neighborhoods are sketchy and there’s, there’s neighborhoods that maybe look
pretty but they’re close to another neighborhood that’s not so nice and the
people from the not so nice neighborhood come and cause problems in the nice
neighborhood and like, you know, you’re not going to find out on a flyer. Most
realtors aren’t going to know or if they do, they may not tell you. Like there’s
just some things that it helps to have that deep familiarity with, with the
market that you’re going to invest in. And also it means you’re in proximity to
your investment. I can tell you from experience, there’s a whole other level
of issues and concerns and, and liabilities that come with investing in
properties that are out of your market. This is a life changing thing to invest
in real estate. So if you’re serious about it and you don’t feel like you’re
in a good market to do it, I would even suggest that it might be worth
relocating to a market where you think it’s, it’s better to do frankly. Here’s
why that that’s maybe better advice. And even though it seems like big advice
that I probably shouldn’t be giving as a, as a general recommendation cause
it’s, it’s kind of, you know, a big thing to do to relocate. But usually
markets that are really good for real estate investing are also really good
for employment because you look at the factors that drive good real estate
investments and it’s like access to good education, good job markets, you know,
high population that generally has, you know, income and good credit, which
means there’s probably good jobs in the area and also a relatively affordable
standard of living or cost of living relative to the average income in the
market. Those are factors that drive good real estate economies, but there
are also factors that just drive good places to live. You want to have
proximity to the properties that you’re investing in and ideally be in a market
where you, you kind of know the lay of the land. And the next general concept
is understanding property classes. Now there’s not a, a formal system for this.
I kind of have a, a heuristic where I kind of lump everything into A B and C
class and I’m talking residential here right now I really don’t recommend for
people that are just starting out to try to get into commercial properties. I
personally did residential properties for like a decade before I ever dabbled in commercial. And
actually if you look at the historical ROI, the historical return on investment
of real estate in general, it’s actually a little bit higher for residential
properties. The financing is easier. Getting loans and commercial real estate
financing usually is more expensive, little higher interest rates, higher
standards to qualify then than residential. So I really do recommend
starting with residential real estate. But again, the second concept is
grouping everything into classes. So here are the three basic classes that I
sort of organize residential real estate into. First of all, you have class a,
which is basically like the really nice neighborhoods there. The neighborhoods,
I would call them the aspirational neighborhoods. Like if you’re a young
couple or a young person and you’re like, man, what’s our dream house? Where
do we want to live some time? And you go drive around neighborhoods and the yards
are all in great shape and the houses, you know, and there’s a lot of nice big
pretty houses with gorgeous facades and all that. That’s probably a class, a
neighborhood, an aspirational neighborhood. In those neighborhoods,
the majority, the vast majority, probably 90% plus of residents own their
homes. Those are great neighborhoods to live in. Totally what you should aspire
to, but actually not the best neighborhoods to invest in because
there’s just a built in premium in the pricing of those neighborhoods because
of the desirability of the neighborhood.
And because most of the people who are moving into those neighborhoods have a
level of income that allows them to pay a little extra for amenities and the
perks and just the quality of life that comes with those neighborhoods. Right.
So it’s, it’s a little, I would say it’s a little inflated for investment
purposes and that’s, that’s one of the things you have to be as a real estate
investor is you can be, you can not be emotional. You have to be ruthlessly
unemotional and frankly a lot of the investment or a lot of the houses you
would want to live in are not the houses you want to invest in. And getting
emotionally attached to a house is actually a negative. In fact, I would go
so far as to say you should never invest in a property that you feel emotionally
one way or another about even if it actually papers out to be a good deal
because your emotions are a, I would say an indicator that you can’t trust your
opinion about the property. So be very on guard against that. Class A
neighborhoods, great places to live, not great places to invest. The next class
is class B neighborhoods. And again, I’m painting with pretty broad strokes here,
but you know, I’ve looked at a lot of markets and these classes tend to hold
up. A class B neighborhood is going to be kind of a lower middle class to
middle class, mixed neighborhood, a lot of blue collar, lot of, you know, people
that have like vans and trucks and you literally one of the ways, you know,
you’re in a class B neighborhood as you drive down the street and you see vans
and trucks parked in the driveways that have, you know, people’s, uh, company
names painted on the side or, or you know, stenciled on the side. It’s kind
of a blue collar, but, but also very stable good families. You know, it’s
not, not like craziness, not, not a lot of crime. Um, and in these
neighborhoods, here’s, here’s really the, the true, you know, fabric of why
these are great neighborhoods for investment and, and not surprisingly,
class B is, is kind of where I like to focus my investment dollars is you
typically have a mix of owners and renters. It’s usually about 60, 40,
maybe two thirds, one third owners to renters. Because the majority of people
in the neighborhood are owners. You still have a lot of the stuff that goes
with pride of ownership. You have well-kept lawns, you have properties
that are maintained, you have maybe some, some civic organization like you
know, community organizations or neighborhood watches or they do block
parties, you know, at Halloween or there’s this stuff that goes with
neighborhoods that people are invested in. But you still have about, again,
maybe a third of the properties that that are, you know,
turnoverable in terms of renters, tenants and whenever you have properties
that are, you know, coming and going in vacancy and you have transfer of
ownership and you have people moving in and you have people moving out. There’s
just like a lot of different conditions that create good buying opportunities
and you basically learn how to spot those, how to, how to be alert to those.
And that’s where you go in and you can have really great opportunities. So
that’s class B, we’ll talk more about that. Then you have class C properties,
which are, you know, neighborhoods that have, the vast majority of people that
live, live in those neighborhoods are renters. You kind of know them when you
see them right there. The neighborhoods where maybe you don’t want to spend a
lot of time at night, maybe you don’t feel comfortable if you have a nice car,
you wouldn’t want to like leave it parked on the street. And you know, as a
real estate investor, you don’t, your job is not to be politically correct.
Your job is to be really, really sane and realistic about the world as it is
and just, you know, not, you’re not hurting anybody’s feelings saying I
don’t want to put my money in that neighborhood because even though there
can be good opportunities and we’ll talk a little bit about how there can be good opportunities in these
neighborhoods for the new investor, there’s typically going to be too much
risk. I’m talking about risks like, you know, properties being vandalized, you
know, having your copper wiring stripped out, having your air conditioning unit
stolen. Like I’ve actually been through some of this stuff. I’ve learned this
the hard way that you have higher default rates, higher incidences of
tenants that don’t pay their rent and you have to deal with more evictions.
And it’s just hard. So I don’t recommend it as a new investor starting out. Cause
one of the characteristics of a new investor is that typically you don’t
have the base of capital and the base of recurring cashflow to be really, really
well insulated against, you know, dramatic disruptions in the, the orderly
functioning of things, right? So if you have 25 properties that are consistently
rented out, paying the bills, and then you, you take a shot on getting a great
deal in a neighborhood that maybe you wouldn’t want to live in, but you’re
like, ah, there’s, there’s a great opportunity to make a margin and then it
all goes wrong and somebody moves out. But you have to, you know, take six
months to evict them or something. You can sustain that if you have 25 other
properties. But if it’s your first property, it’s a real problem. And
again, it could set you back for years. What if you ended up defaulting on the mortgage? So I
don’t recommend classy neighborhoods for brand new investors. So that’s the
second general concept is kind of understanding the taxonomy or the
classes of neighborhoods. And hopefully agreeing with me that class B is kind of
what you want to hone in on as an investor. The next general concept is
basically your financial metric. Now there’s a lot of you know, money
formulas and alphabet soup type, you know, acronyms that you know are
involved in real estate, but you basically, I think to keep it simple as
a new, a new investor, you can boil it down to really just two things. One is
cap rate and one is cash on cash return. And if you, if you find properties that
check those two boxes based on your own standards, then you’re going to be in
good shape and you can, you can always get more sophisticated and learn a lot
from there. But you know, one of the things a lot of people do is they sign
up for these courses and gurus and whatnot that are so complex that it
makes the whole thing feel intimidating. And underneath all conversations about
real estate is this core, this core belief that I have very much, which is
that don’t wait to buy real estate, hurry up, buy real estate and wait like
you want to get your money. You have the opportunity to get your money into the
real estate game as long as you don’t really screw
it up. It’s in terms of the upside reward and protection on the downside
risk, I still haven’t found something maybe other than internet business but,
but in that, you know there’s, that has its other issues and I talk about that
extensively in like hundreds of other videos. There just aren’t that many
things where you say, Hey, I can put my money into something and have as much
upside with as little downside as real estate, as a general principle. So what
you don’t want to do is complicate it to the point where it paralyzes you and you
don’t take action. So we’re going to say, just focus on understanding these
two principles, cap rate and cash on cash return. And I’m going to just
quickly explain what those are. First of all, I’ll do cash on cash return first
cause it’s like so easy. It literally means how much money does it take you to
acquire the property and get it to the point where it’s actually producing
income and then what is your return on that cash? So let’s go back to my first
property, right. And cash on cash return is totally unique and different for
every single deal. It totally depends on the circumstances, you know, for me and
treating my partner and I as a unit at the time it costs us, like I said, about
$7,500 to acquire that property. We had to come up with a $4,500 down payment and
we needed some money for closing costs about which was came out to about 3% of
90,000 so it was 2,700 so maybe that was, call it 7,500 bucks. That was what
it cost us in cash to get the property. Everything else is like monopoly money.
If it’s bank money and money getting transferred from here to there, if it’s
not coming out of your pocket, it’s not a part of the cash on cash return
calculation. And then similarly if it’s not coming back into your pocket, it’s
not a part of the cash on cash return calculation. So for that property, let’s
say we had 7,500 bucks in and we did all the math and we said, okay, you know,
projected over the course of a few years, this property is going to rent.
And I think that property rented for like $1,200 a month, which was a pretty
good deal. As as we’ll talk about in some some other little number crunches
we’re going to do. You’ll see $1,200 on a $90,000 property that only costs
$7,500 cash to get your hands on is probably a pretty decent deal. But on
the 1200 we’re going to have so much to service the debt. We’re gonna have so
much to pay taxes. We need insurance, probably want to get a home warranty.
We’re going to have to budget a little bit for vacancy or we’re going to have
to budget a little bit for ongoing maintenance. We
have a property management fee. That’s a whole other conversation. But I
personally, I have never tried to manage one of my own properties and I never
would. Um, I would say, you know, you need to build into your deals enough
margin that all of your math is based on what happens after I pay for property
management. And again, it’s case by case. Your life may be different than
mine, but I just, I don’t want to be in the property management business. Um, so
anyway, in that property, let’s say after we crunched all those numbers that
it was producing $100 a month in net income based on assuming that there
might be some vacancy and, and some maintenance, right? Well $100 a month it
would be $1,200 a year. $1,200 on $7,500 is, you know, what’s that? That’s a
little, sorry, I’m slow with the math. $1,200 a year based on $7,500 out. So
that’s like 15 to 17% roughly cash on cash return. It’s no different than if
you went to your friend and said, Hey, I’m going to give you $7,500 and you
gave me back $100 a month, calculate, you know, what’s the return on that? And
that’s it. And we’ll talk about here after we get through these general
concepts about what you should accept as a bare minimum cash on cash return. And
as I’ll explain that one actually did make
the cut cause it was, it actually paid a little over a hundred dollars a month in
net operating income over time. Then you have cap rate and some people kind of
confuse these two because they’re based on, you know, the return of the
property. But cap rate actually is more of almost like an ethereal metric. It’s
not actually based on money in money out hard dollars. It has more, it’s more
tied to the value of the property and the and the money that comes in from
operating the property. And thus the longterm value of the property. Because
you have to understand not every investor situation is going to be your
situation. So for me, I came up with the cash, but I had to, I had to get an 80%
primary loan, I had to get a 15% secondary loan, and that secondary loan
might have had or definitely had a higher interest rate than the primary.
My carrying cost of capital or of the debt to own the property was higher than
maybe somebody else who’s like, Oh, I got 20% down. It’s the $90,000 property
you need 18 grand down plus closing costs. Oh no problem. Here’s 20 grand.
Right? So then he’d have 20 grand into the property, but his monthly carrying
costs wouldn’t have a second mortgage for 15% at a higher interest rate.
Right. So his monthly return metrics would be different. So his cash on cash
calculation would be very different than mine. He put more money in, he gets more
money out and it would change the numbers. But his cap rate would be the
same. And the cap rate is simply this, the net operating income of the
property, which basically means exclusive of debt service. So exclusive
of any payments to a mortgage company for money that was borrowed to acquire
the property. So it’s basically saying if you owned the property free and clear
and you weren’t having to pay for borrowed money, what would the net
operating income be on the property? So that would be, you’d still have to pay
taxes, you’d still have to pay insurance, you’d still have to pay
property management, you still have to pay, you know, assume prepare for
vacancy. You’d still have to prepare for maintenance costs. So basically, and you
know, the other ancillary things like you know, if there’s a pool or there’s
lawn care or whatever, right? So take those costs and then look at what’s the
actual amount that the property brings in, in terms of rent and divide the
first or, or, and then come up with your net operating income. Right? It’s
expenses or it’s income minus expenses, then take that amount. So let’s say on
that property it brings in $1,200 but exclusive of debt, it costs maybe $500 a
month to operate that property. Well, 1200 minus 500 I would say this property has an NOI or a
net operating income of $700 a month. $8,400 a year. Right? Okay, well what’s
the property worth? Not what did you pay for it, but what is it actually worth on
the fair market? So I paid 90,000 for it, but it was actually worth, I think I
bought it with about 20,000 in equity. So it was actually worth about 110 so I
would simply say, okay, divide my, you know, $700 a month, which is $8,400 a
year. Divide the annual net operating income of $8,400 by the market value of
110,000 and in that case, you come up with a number that’s about 8% that’s the
cap rate. So the value, so the cap rate on that property was about 8% but as we
saw the cash on cash return for me in the particular way that I was able to
acquire it of $7,500 in and what I say $1,200 out, my cash on cash return was
like 16 or 17% the cap rate was 8% the cash on cash was 16% those are two very,
very important numbers to understand about every single property before you
even remotely consider putting your your hard earned money into acquire property.
Okay, so we’re going to circle back to those numbers here in a little bit, but
for right now let’s talk about one more general concept that’s actually related
to cap rate. Then we’ll get into the actual numbers and how you can structure
deals to have the highest probability of success. And this last general concept
is actually the correlation between cap rate and class of property. And it’s
just kind of a general, I would say it’s an extension of the previous concept
about cap rate, but it’s just something that’s important to understand because a
lot of times you’ll, and this is why it became important for me to understand
this in my career because you know, you, you listen to these different teachers
or gurus or you talk to successful investors and you understand that cap
rate is a very, you know, call it a, a, an a fungible or malleable number based
on who you’re actually talking to because cap rate correlates with risk.
So, and here, here’s what I mean by that. If you think about what it is, the
operating income of a property as a, as a percentage of the value of the
property, right? We’ll remember those class a properties. So class a
properties have essentially a premium built into the value because of the
desirability of the neighborhood, the affluence of the type of people that can
afford those properties. And because of the market dynamics, there are very few
renters in those markets. So if you go into a town, you know it has a nice, you
know, nice suburbs area with big 5,000 square foot houses that average, you
know, one point $5 million a piece and it’s all doctors and lawyers, that
type of people that live there and you buy one of those properties, you’re
buying a really nice one point $5 million property, but you’re not very
likely to be able to turn around and rent it out because there aren’t that
many people trying to rent in those neighborhoods. And the people who can’t
afford to rent that level of property in that type of market probably have good
enough credit and good enough income that they can just buy a house. And so
the operating income on a property like that, you know, you might only be able
to rent it for, I don’t know, maybe $2,000 a month, which if you look at the
rental market, you’d say, Oh well a $500,000 property would have also rented
for $2,000 a month. And it’s not because it’s not a nicer property, it’s just
because there’s not much demand for rentals in that type of property. So you
would say the net operating income on this property is relatively low relative
to the cost of owning the property because the cost of owning the property
is based on the desirability of the property. So that property would have a
really, really low cap rate. That’s why it actually doesn’t make sense to invest
in class a properties. But nonetheless, you wouldn’t say, Oh well it’s a garbage
property. No. On the contrary, it’s actually a really great property and
frankly, if you are going to live there, there’s a pretty
good chance that if you move out in five years, you’re going to be able to sell
it for a profit cap rate is somewhat inversely correlated to the quality of
the property in some ways. So on the flip side, let’s go into a class C
neighborhood, right? And let’s say we’re talking about a neighborhood that does,
you know, you don’t have a lot of professionals with, you know, high
incomes trying to live in these neighborhoods. It’s almost all renters.
The properties aren’t very well maintained. There’s, there’s not a lot
of curb appeal to, to the properties. You might be able to go into one of
those neighborhoods and literally, and I just, I just did this with a couple of
houses in Atlanta, like go in and buy properties for like 40 $50,000 maybe 70
$80,000 and turn around and rent them out because you can put a premium on
rentals because you know maybe that maybe because of proximity to mass
transit like bus stops or or train systems or maybe because of proximity to
employment centers. Like I’m thinking of a property I used to own in Houston,
Texas. That was very, very close to the medical center, the Texas medical
center, which is a giant hub of employment, but it was also in a
relatively low income kind of rundown neighborhood. This was one of my few
experiences of investing in classy neighborhoods and frankly for the time that it worked, it had a
great return. It was like, I think I bought it for $80,000 and was able to
rent it for like 1300 a month because of just the dynamics of that neighborhood.
Well that would be a great cap rate if you actually did the math on that, you’d
say, man, the cap rate in lower class, lower income neighborhoods as a property
owner is generally much higher than the cap rate in nicer incomes where there’s
less demand to rent the properties and more built in value to the underlying
assets. And frankly, again, our job as real estate investors is not to be
politically correct. Frankly. That’s why being a slumlord is, you know, forgive
the term. But that’s why slum warding is so profitable because you can get
properties cheap and there’s a built in Mark up to the rent because you’re
essentially absorbing the liability of the type of renters that are willing to
move into those properties. And so again, I don’t recommend class C
properties as a starting point, but once you get a little bit along in your
career, they can be great investments. And in fact I did find in that one
property, for example in Houston, I found a renter who actually was a really
great couple. They had family in the area. There were, there were reasons why
they came from the area. They were reasons why they wanted to live in that area. But you know, I think at 1400
bucks a month she had a really steady job and they were a great renters and I,
that was one of the most dollar for dollar. It was one of the most
profitable properties I ever owned. I ended up, when they moved out, I ended
up selling it because it was going to be unlikely that I was going to be able to
replace them with tenants of equal quality again because of the type of
neighborhood. But that’s just to illustrate the inverse correlation
between cap rate and the quote quality of the property. And it’s an important
concept to understand because again, it drives the individual requirements of
the investor. So there’s some investors who they don’t need the money right now.
They’re not as fixated on like, I need to turn a profit on day one in my
property, cash on cash. It’s got to be net positive because maybe they’re
sitting on $20 million and they just want to know that they bought something
that 10 years from now they’re going to be able to sell and double their money,
and in the next 10 years they don’t need to make a buck, right? So they’re going
to have a different standard. They’re going to accept properties that have a
lower cap rate and basically your cap rate. Another way to think of cap rate
is what is it that the investor demands as a base rate of return. So again, think about like
wealthy, older, retired people. They’re more concerned with not losing money
than they are with making money. So they invest in things like municipal bonds or
stocks that pay dividends and they’re totally happy with like a four or 5% a
year return because it’s a really stable underlying investment that could also
grow in value. And most importantly for them, they’re not losing money. But
that’s not your average person who’s necessarily going out and trying to do
their very first real estate deal. So for like maybe you watching this or for
me who I was at that time in my life, I needed a cap rate of like eight, nine,
even 10% or else it likely wasn’t going to be a property that was going to serve
my needs in the moment because I needed to generate income. So understand that
as a, you know, the cap rate is a really interesting concept, but it doesn’t mean
the same thing to every person. So just be careful when other people say, well,
this is what the cap rate has to be. You got to realize not everybody’s in the
same boat. Therefore not everybody has the same demand in terms of return on
their investment. Okay, so we’ve covered the general concepts of buying your
first property. Now let’s talk about what I call the magic formula. This is
basically, if you’re starting out and you’ve been able to kind of wrap your head around these concepts
that I’ve given you, but you don’t, you don’t have experience. And there’s
unfortunately no way to get experience other than to go out and get experience.
Right, which means that first time you do the thing, you have to do it without
the benefit of experience. That’s the only way to get experience. So if you,
as long as you’ve understood those basic concepts, this is the closest thing I
can give you to a security blanket to say, here’s how to not screw up on your
first deal, first of all. And there’s a saying in real estate that you make
money when you buy. And that’s true because what happens, it’s not so much
that you make your money when you buy because you’re going to need that money.
It’s more like you build in your cushion, you build in your margin of
error when you buy, because one of the truths, one of the greatest certainties
of real estate investing is there is no certainty. The only certainty is that
bad stuff can happen. So take that first property that I bought, I bought it for
$90,000 it was worth 110 now typically, if you have to sell a property in a
hurry, you’re going to have to price it a little below market and you’re
obviously, you’re going to have to pay full commission to a good rep. you’re
going to want to get a good realtor. Who’s going to charge you full commission. So
you’re going to pay probably another 6% so on $110,000 property, if I, let’s say
all hell broke loose, I ran out of money, my partner and I split up. I got
sued, I broke my leg, I lost my job, whatever the condition is, and I had to
unload the property. So my $110,000 property immediately, I’m probably gonna
only price it at like 105,000 cause I want to price it for a quick sale, then
I’m going to have to pay another 6% to a realtor. $6,300 so now my, my sale is
down to below $99,000 well I bought it for 90 so I’m going to be okay because I
bought it with that margin built in, I’m able to absorb, you know, Murphy’s law
so to speak. If the worst case scenario happens, I can still come out of it.
Okay. But if I had paid full market price and then was forced to try to dump
the property in a hurry, I would lose money. I’d be upside down on my very
first deal and I might never be able to do another one. So I recommend that you
never buy a property for more than 90% of market value. And that makes it
obviously harder. It makes it take longer to find your first deal. But it’s
just for reasons I just explained so much better to just take that approach
and the nice thing nowadays is you don’t actually necessarily need to
go hire a realtor to do what they call a CMA comparative market analysis to find
out what the value of a property is. Frankly, in most major markets, if you
do an appraisal or an analysis on Zillow and an analysis on Trulia, which are two
sites, we can put the links for below this video. You’re going to honestly
land pretty close Zillow and Trulia, but if you do the average of their two sort
of valuations, the second part of the magic formula to lock in your real
estate success is to demand 15% cash on cash return. You know when you’re
getting started in real estate investing and well, really always in business,
cash is King. Cash flow is King. You’ve got to maintain positive cashflow. If
you want to build any momentum, you may have heard the term success loves speed.
Speed’s derived from cashflow. Cashflow in real estate as a function of cash on
cash return. I suggest you, you demand no less than 15% so again, if we go back
to that first property, I put 7,500 feet and that’s an annual number, not
monthly. Obviously I put $7,500 in, I’m getting $1,200 out. That’s again, I
didn’t, I knew I should sit down with a calculator, but I’m feeling like that’s
above 15% it’s like 15 to 17% cash on cash return that makes the cut bottom
line. Don’t settle for anything less and that’s why you have to be unemotional. You can find
a property that checks every other box. You go, Oh my gosh, this is going to be
worth triple in 10 years. I love it. I would want to live there, but if it
doesn’t do 15% cash on cash return, don’t do it. The second part of the
magic formula that’s kind of tied to that is just about the gross rent. You
want to do an analysis of the rents in the area and for that you can literally
go into the the multiple listing service in your area or you can hire, you know,
talk to, talk to a real realtor, talk to a property management company, and
basically figure out based on the square footage, based on the number of
bedrooms, based on the location, based on the condition of the property, what’s
a reasonable rent that you can expect? Not necessarily what are the properties
listed for, because most properties actually rent for a little less than
what they’re listed for. But what’s the actual rent that you can expect to get
for a property and that number. Again, this is a way to super simplify the
whole thing into a formula. That number should not be less than 1% of the value
of the property or, or of the total price, the purchase price of the
property. Remember, cap rate was based on the actual value. This, I’m basing
off a purchase price. So when I bought that property for $90,000,
regardless of how I financed it or came up with my own cash or whatever, my
acquisition costs was $90,000, I would demand at a bare minimum that that
property be able to rent for $900 a month or more. And as it turned out, it
was, if I remember again, closer to 1200 great. It checks the box. So it checked
the box on cash, on cash return, which is specific to how I have to acquire the
property. It checked the box on gross rents, which it doesn’t matter how you
acquire the property, it’s just a function of the price and the rent. And
the next part of the magic formula, and this is frankly something that I came up
with, I have not actually found this. I’ve never heard somebody else say this.
Um, but I, it’s, it lines up with a core belief of mine is that when you
calculate the cap rate of the property, the cap rate should always be equal to
or greater than your cost of capital. So your cost of capital is basically
whatever money you do have to borrow to acquire the property, you need to figure
out the average interest or interest rate. So if you’re, if you’re borrowing
80% you have one mortgage at 6% interest in your cost of capital is 6% if you’re
borrowing 80% at 6% and then you’re borrowing a second mortgage of 10% or
15% at 8% you need to figure out what’s the
average cost of capital across the whole borrowed amount. So if I was borrowing
80% at 6% and 10% at 8% my cost of capital is basically a little over 6%
it’s like 6.2 or 6.3% then I would want to sit down and crunch the cap rate on
that property. What’s the actual market value of the property divided by the net
operating income of the property? Independent of my cost of debt. Cause
remember NOI doesn’t factor in your debt and say, I want the underlying asset to
be generating a return equal to or greater than any money that I’m
borrowing to the cost of any money that I’m borrowing to acquire the property.
And it’s almost just sort of an ideological principle. I don’t want to
be paying more for money than I’m getting back in value of the asset. I
don’t want to borrow money at 8% to acquire an asset that has a cap rate of
5%. That’s just bad, a bad macro economic for your whole deal. Um, so
make sure that the cap rate of the property is equal to or greater than
your cost of capital. And the next part of the magic formula, which I actually
already kind of gave away, is generally when you’re starting up, only invest in
class B properties. Um, don’t go class eight, don’t go class C. again, it’s a
heuristic. It’s kind of a, you know, something you, you go off of how you see it, how
you feel. But in general, if you’re driving down a neighborhood, you see
utility bands and trucks. And a lot of, you know, kind of some blue collar
action and you know that a decent percentage of the people in the
neighborhood are renters but they’re not all renters. That’s a good market. Don’t
go below that. Don’t go above that. Especially when you’re starting out. And
then the final part of the magic formula is don’t buy a property that you can’t
afford some fluctuations in and that’s not so much a function of the property.
It’s a function of you. I recommend that everybody has a reserve fund equal to
the, of owning the property for six months if it was vacant. So after you
spend the money on the down payment, after you spend the money on any
necessary repairs after you spend the money on, you know, closing costs, once
you’ve got the property, assume that it’s not going to rent out for six
months and make sure you have enough money in reserve to be able to stomach
that. That’s the Trump card to the all the rest of the formula. All the rest of
the formula is based on factors related to the property. That one is just based
on like don’t get in over your head, don’t put yourself in a vulnerable
position. Okay, so that’s a lot of information. This has been a long video. I’ve given you a lot of
information but you know to get an entire formula and an entire set of
concepts that can tee you up for real estate investing success in a, you know
where a 30 or 40 minute video, however long this has been, I promise you it’s a
lot faster than going out there and stumbling and fumbling around for years
and or getting a zillion different pieces of advice from people that are
all trying to sell you a course or whatever. At the end of the day, this
has been my proven formula now that I’ve used to acquire multiple dozens of
properties basically on the side while I do my other main businesses, which are
all digital marketing businesses and it can save you a lot of headache if you
are uncompromising about everything that I just shared with you. So those are the
concepts. Those are the formula or the or that’s the formula. Now, let me share
with you just a kind of a few last, last couple of notes and then we will wrap
this thing up. Dough, first of all, my kind of first final note is to
understand, and this is just a general push towards doing what I’m talking
about, and again, not waiting. You have to understand the population dynamics.
So one thing that a lot of people don’t realize is Jen, you hear generation X,
you hear generation Y, you hear millennials, generation Y is three times has three times as many units as
generation X. And when I say units, what I mean is individual people who could
potentially be acquiring a place to live. So if generation X is a married
couple, that counts as one unit, there’s actually fewer married people in
generation Y. So each individual, you might have a male and a female that
count is two units in generation Y, but in generation X, they’re one unit
because you’re only going to, you’re not going to lease a property to a husband
and a wife, right? So they’re three times as many units and generation Y
they’re ex their, their educations were far more expensive. They carry far, far
greater amounts of debt. And then you have underneath generation Y you have
millennials who have more job volatility, even still more student debt
and even less clarity. And this is based on statistics, not just my judgment,
less clarity and specificity about what they’re doing with their lives, where
they’re going to live, and sort of tying them down onto a longterm track. Which
means if you look at population trends, generation Y and millennials are ma have
a much higher incidence of renting properties. They’re much less likely to
own properties anytime soon. And for the real estate investors who acquire
residential rental properties, this is, we have a decades long bull bull market
in front of us. The population trends have just created such a mass of, you know, upcoming and, and projected
longterm demand for rental properties. Um, that again, I think this is the
strongest, safest place to put, put money for the average person. So that’s
kind of my, uh, my general note on population dynamics and hopefully a
boost of security for why this is such a strong idea. Um, the, I am going to put
below this video a list of resources you can use to actually identify properties.
There are certain websites that are tied in with the MLS, they’re the listed
properties or certain websites that you know, more focused on commercial
properties. There are certain websites that help you actually find foreclosures
and bank owned properties where you can get a lot of good deals. There’s even a
website I’ll put below where you can actually be, uh, participate in auctions
for tax auctions, bank auctions. And actually sometimes you can get crazy
good deals at auctions because it just, it’s just a function of who’s at the
auction and who’s bidding. Right? So I’ll put those resources below. And then
the, the final note that I want to talk about, and I have other videos that
focus on this more in depth, but it’s basically to talk about the way Airbnb
has kind of come along and disrupted the market. I think we’d be remiss in a
conversation about rental properties, not to at least say that it’s good to
know what the weekly or nightly or even monthly rental value of your property is
relative to the traditional longterm leasing value of the property. Um, and
the, it’s beyond the scope of this video to really get into the different
dynamics there, but I think it’s at least good to understand the value of
your property that like, Hey, if maybe I’m having trouble leasing it out
longterm, I could turn around and lease it nightly or weekly and maybe get a
different, a different amount of money and at least know whether your property
has value. Because there’s some properties that have much higher values
as longterm rentals and much lower values as short term rentals. And
there’s some properties where it’s flipped around and the best site, the
site that I use to, to, to know those values, I mentioned Zillow and Trulia
for longterm rentals. And for basic basic asset value, I use a site called
air dna.co two you don’t pretty quickly assess the viability from for nightly
and weekly rental. So I’ll put a link to that below this video as well. Okay. I
think that does it. I think that says everything I wanted to say about how to
ensure success as much as possible with your first rental, if you are into this
type of content, if you’ve appreciated the value that I’ve shared, I would love
it if you’d subscribe and get more. I focus on business entrepreneurship,
sales investing, personal development, general life awesomeness, and that’s
what I talk about on this channel. And I’m going to
keep bringing you as much great content as I can and I appreciate it. If you
choose to subscribe, make sure you click the little bell so you get notified when
I put out new videos. And with that said, I thanks for watching and I’ll see
you on the next video. Okay.

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