The Power Of Leverage in Real Estate...

Let me explain by first giving you a definition of wealth that may be different than how you've traditionally thought about it: 

"Wealth is measured in time, not money."

I first learned this definition of wealth from Robert Kiyosaki. After it sunk in, I completely agreed with it and now I live by it whole-heartedly. We need to think in terms of time, and how long we could survive if we stopped working. In order to calculate how wealthy we are, we first need to know how much money we need to live on per month.

  Add up all of your living expenses and come up with your monthly total: 

• Rent

• Mortgage payment (principle and interest)

• Property taxes

• Hazard (homeowners) insurance

• Homeowners association dues

• Tithe/charity

• Health/dental/vision insurance

• Car payments

• Car insurance

• Boat payment

• Boat insurance

• Financed furniture payment

• Financed appliances payment

• Credit card payments

• Electric/gas bill

• Phone bill

• Cell phone bill

• Cable bill

• Internet bill

• Pest control bill

• Security system bill

• Water/trash bill

• Groceries

• Eating out

• Entertainment

• Gas

• Clothing

• Household/personal supplies

• Other

Total Monthly Expenses: $_______________                                                                                                                       Next, we need to add up all the money we have in liquid savings vehicles.

This is money that is accessible, and that we can withdraw monthly to pay for all of the above expenses.

Total Savings: 

$________________

Now, divide your total savings by your monthly expenses:

Savings: $200,000

÷ Expenses: $6,000

Wealth = 33.3 months, or 2.8 years

In our example, this exercise has told us that if we stopped working today, we could live another 2.8 years before we're broke! That is a frightening proposition! At this rate, we would need to keep working for a very long time, and financial freedom doesn't sound possible.

 Financial Freedom?                                                                                    Before we continue, let's consider another alternate definition to a common phrase we hear: financial freedom. 

Take a look at your monthly living expenses. Is all of that necessary? Is there any category that could be reduced or eliminated? If you're struggling to find a way out of the rat race, or if your goal is unlimited wealth, sacrifices will be necessary. If you keep doing what you're doing, you'll get what you're getting. If you want to reach new heights, some things will need to change.

You'll need to reduce expenses, or increase your income, or both. For many people, increasing their income is tougher than reducing expenses. sellers and wholesale buyers, rehabbing – these methods all work and can result in huge profits, but they also require work. These methods generate earned income. If you want passive income, and if you want to be done working, you need to invest in a passive income stream, such as rental properties.

Once your monthly passive income exceeds your monthly living expenses– voilà! You've crossed the threshold into unlimited wealth and you've reached true financial freedom. You can continue to grow your passive income stream in your spare time if you want to, but not because you have to. You have enough money coming in to support your current lifestylevwithout having to continue to work!

There you have it. You've set your goal. The amount of your total monthly living expenses becomes your passive income goal. Once you build up a monthly cash flow stream that exceeds your monthly "nut" you've reached your goal of financial freedom! And then wealth! :) How do you do this? The secret is in exploiting the use of leverage.

 If you've ever heard Dolf De Roos speak, you've heard him compare real estate to stocks. He explains that with $10,000, you can either buy exactly $10,000 worth of stock, or you could use leverage to buy $100,000 or more of real estate. You control ten times the asset base when you invest in real estate! When the value of your stock increases by 5%, you make $500.

When the value of your real estate increases by 5%, you make $5,000!

Which would you rather have?

Get creative with your income!                                                                                                                                    Leveraging money means you are using someone else's money to control an asset. In the simplest form, this means using the bank's money. 

You buy a $100,000 property by giving $10,000 of your own money to the seller, and the bank gives the other $90,000 to the seller. You now owe the bank $90,000 but you have full control over the asset!

One way you can further leverage money is to use someone else's money instead of your own for the $10,000 down payment. This might come from the seller, a money partner, your tenants, or the market.

Seller: You can strike a deal with the seller to provide part or all of the down payment. The seller may loan you part of the down payment, or he may defer the collection of it until a future date, allowing you to use the cash flow that the property creates to pay him for the down payment.

Meanwhile, the bank gives him 80% to 90% of the sales price up front.

Perhaps the seller will finance the entire property for you, preventing you from having to get a bank involved at all. 

In this case, perhaps the seller will finance 100% of the sales price for a certain period of time. 

You may negotiate staged payment sums, where specified amounts of money are time due by certain dates. This may buy you some time to generate cash flow from the property to make these payments, or some time to arrange another form of permanent financing.

Money partner or partners: You can team up with people who have money and they can provide the down payment or the entire purchase amount for the property. You'll negotiate a rate of return or an ownership percentage in the property in exchange for providing the money. Your contribution is that you located the deal, you negotiated the sales price, perhaps you will manage the property, or will manage someone else who manages the property.

Your tenants: If you have other properties that are generating monthly cash flow, you can allow this cash flow to accumulate to a size that is enough for a down payment on another property. Via their rent payments, your tenants will provide the money you need to purchase property. This is a fantastic no money down strategy!

The market: If you own other properties, time and your improvements can increase the value of these properties. The property may appreciate over, resulting in an increased equity position for you. If a property was worth $100,000 when you bought it, five years later it may be worth $128,000 if the market appreciated by 5% annually.

 You can make improvements to the property itself, how it's managed, and its cash flow stream – all resulting in a higher appraised value on the property. Once your property appraises for a high enough value that allows you to refinance and pull out some equity, you could generate enough funds for the down payment on another property. You will generally need to leave 10% to 20% equity in a property when you re-finance it.

Let's use your $100,000 property again as an example:

Let's say you bought a property for $100,000 five years ago and it's now worth $128,000. Right now you could re-finance the property using a lender that will loan you 90% of the appraised value. In other words, the lender will loan you $115,000. Let's say over the course of the past five years, your tenants' rent payments have been covering your mortgage payment and you've been able to pay your principle down by $5,000. 

Original purchase price: $100,000

Current mortgage balance: $95,000

Amount of new loan: $115,000

Difference between new loan $115,000

And old loan ($95,000)

= $20,000

When you refinance this property, you could walk away from the closing table with a check for $20,000 (minus closing costs). You can use this money as the down payment on your next property. The market's money will effectively pay for your new building!

Rental properties are valued by appraisers and lenders using a very specific mathematical formula. The formula is very simple:

1. Figure out the annual income on your rental property.

2. Subtract your annual expenses, not counting your mortgage payment.

3. Divide by the *cap rate used in your market. For our example let's use a 10% cap rate.

4. The answer to this math formula is the value of your property.

* Cap Rate (Capitalization Rate): This is how commercial property and multi-unit apartment buildings are typically valued.

 The cap rate represents the yield, or the return the investor will receive. The higher the cap rate percentage, the better the deal for the buyer. Cap rates are often used as a negotiating tool between buyers and sellers, and there is often a general "going rate," or a range of cap rates, that are currently being used in transactions in any given market.

Because of the way the above formula works, you can influence the value of your property a great deal by adjusting your income or expenses by just a little bit. This is just like dropping an extra grain of sand onto one side of a perfectly balanced scale. One little bitty grain of sand will cause the scale to tip!

Let's apply some real numbers to an example and see what happens:

1. The annual income on your property is $60,000

2. The annual expenses, not including the mortgage payment, are $20,000

3. The cap rate we'll use is 10%

Step #1:          Step #2:

$60,000          $40,000

- $20,000        x10

= $40,000      $400,000

Our property's value is $400,000!

Now let's look for our grain of sand that we can drop onto the scale. 

We need to increase our monthly cash flow by just a little bit. We could enforce our late fee policy, bill our tenants for some of the utilities, increase our rents by a very small amount, charge extra for parking or a storage garage, put a lockbox around the thermostat - there are all kinds of ways. 

By getting creative with our income, and by shaving off some unnecessary expenses, let's say we can create an extra $200 per month in cash flow, or $2,400 annually.

Now let's quickly rework the formula using our new numbers:

Step #1:           Step #2:

$62,400          $42,400

- $20,000        x10

= $42,400        = $424,000

Our property's value is now $424,000!

You've just created $24,000 in equity that you can pull out of the property to use to buy another property. You can buy another cash flowing property without using any of your own cash!

Using incremental bits of cash flow to grow an exponential passive income stream is one of the best uses of leverage in the world! 

Now we will talk about leverage of time! :)

Undoubtedly your most precious commodity is time. 

One of the key incentives behind unlimited wealth and financial freedom is to free up your time and to be able to choose how to spend it. There are two ways to leverage time:

1. Systems

2. Team

If you're investing in rental property as a means to create passive income, you have an incredible opportunity to create systems. You can create systems to avoid effort, prevent problems, and to increase your cash flow. Systems can become the training medium for your tenants and your property management.

Building a team can be part of a system, and then further, your team can carry out the systems you've created. 

So how exactly do you leverage your time? By creating your own personal landlord system, you can use just a small amount of your time on a monthly basis to control a huge asset base.
I've created a 7-step process for doingt his:

1. Set up your team

2. Know your landlord-tenant law

3. Establish your policies

4. Gather your forms

5. Automate your finances

6. Maintain your buildings

7. Hire a manager

As you work through each of these steps, you create systems along the way. These systems may include:

• Procedural documents that you give to a manager to follow

• "House rules" that you give your tenants in order to avoid questions, discrepancies, and behavioral problems
 • New fee structures to cover rents, parking, utilities, paying late, and calling you in for maintenance items that the tenant is responsible for 

• Automatic methods of receiving money from tenants and paying bills 

• Maintenance schedules in which each item has a date and a delegation 

You can put in some one-time effort to create a landlord system for your rental properties, and then leverage this effort by stepping out of the day to day operations completely. Systemizing your properties and their operations frees you up to focus on important matters such as: 

• Evaluating deals 

• Fine-tuning the cash flow at your existing rental properties 

• Increasing your equity through careful capital improvements 

• Figuring out creative financing strategies for acquisitions 

• Re-financing existing properties to create cash for down payments 

• Relaxing and enjoying your free time!

When you allow yourself to get caught up in the "busy-ness" of the day to day operations of your properties, you don't have time to "mind your own business." Things slip through the cracks, tenants get away with things that they otherwise shouldn't because you're too busy to worry about the details. Soon you're not making as much money as you could be.

Paying a little too much on expenses coupled with losing a little bit of money to a bad tenant is a double-whammy! When your cash flow wanes a small amount, the impact is more significant that you think. Remember our earlier analogy about putting grains of sand on the scale to tip it in our favor? Taking grains of sand away can just as easily tip it out of our favor.

Create your systems, line up a team to implement them, and your time will be leveraged to its highest and best use!