Know Your Investments

Warren Buffett takes a buy-and-hold strategy, favoring investing within his own circle of competence. He’s been quoted saying, “We’re going to be in this business for 100 years, so it doesn’t really make any difference what oil and gas does in the next year.” [source] All of Buffet’s greatest investments have come from one of four different industries—media, consumer staples, financial and insurance. He’s rich because he knows what he’s doing. The fact is, no matter what you are investing in, you are heading for trouble if you don’t know what you’re doing.

When it comes to multi-family real estate, I know what I’m doing. To know is the only way to take risk out of the equation. Buying apartments can be the best investment you can make over the next 20 years. If you’re new to the space, get the real deal on real estate on GCTV each Monday as I will take your questions and give you all the details of my deals.

Here are eight reasons I suggest your only smart options is to invest in apartments:

1. Positive Cash Flow—Even during 2008-2011 and the worst real estate crisis in American history, apartments that were in the right neighborhoods and bought right continued to provide positive cash flow. One of the biggest benefits to income producing real estate investments, unlike personal residences, is that leases generally secure the assets—meaning the income provided by renters should exceed the cost of operating the property leaving enough cash to pay debt and provide investors with a positive return on their equity (cash). This provides a regular income stream that is significantly higher than the typical stock dividend yield. I look for properties that can provide 10-12% return before I consider any ways to improve either the income or reduce expenses through smart management.

2. Leverage to Multiply Your Money—This is the 4 to 1 Rule. Another important characteristic of commercial real estate investing is the ability to place debt on the asset, which is several times the original equity. In today’s market you are typically allowed a 4 to 1 ratio. This allows the investors to buy four times the assets, leveraging currency which every believes is going down in value to buy 4X the amount of property that most people believe will go up in value. I have a property I’m currently purchasing for $20m where I and accredited investors are putting up 25% of the total price. $5m is buying a $20m asset.

3. Low Cost of Debt Multiplies Cash Flow—Investors are paid the difference between cost of debt and the cap rate. So while cap rates may be going lower raising the price of the deal, the spread allows a return of 2-4% on money that is being borrowed. I’ve done deals in every cycle including the worst. You have to know what you are buying, where you in the cycle and have long term vision. Placing “positive leverage” on an asset allows for investors to effectively increase positive cash flow from operations by borrowing money at a lower cost than the property pays out. For example, if a property generating a 6 percent cash-on-cash return were to have debt placed on it at 4 percent, the investors would be paid 6 percent on the equity portion and approximately 2 percent on the money borrowed, thereby leveraging debt.

4. Inflation Hedge—Money is going down in value, property goes up. Stocks, bank accounts, credit cards, valuations—they are all imagined. What’s real is real estate that produces income. Not all real estate is protection against inflation. A house has been considered an inflation hedge but the fact that you have to pay for the house means you are paying for the hedge. In apartments the renter is paying you while the property inflates. Real estate investments have historically shown the highest correlation to inflation when compared to other asset classes, such as the S&P 500, 10-year Treasury notes and corporate bonds. As countries around the world continue to print money to spur economic growth, it is important to recognize the benefits of owning income producing real estate as a hedge against inflation. Generally speaking, when inflation occurs, the price of real estate, particularly multi-tenant assets that have a high ratio of labor and replacement costs, will also rise. If Rents rise the value of the property will increase because the property is valued based on its rents.

5. Physical Assets Better than Paper—Paper assets are a risk. If the apartment burns down, insurance covers it. Your dollars are not even accessible at the bank—it’s turned into electronic digits. Ask the bank to give you $10k of your money and you will have to fill out a form and probably have to give the bank a notice to withdraw. Income-producing real estate is one of the few investment classes that, as a hard asset, has meaningful value. The property’s land has value, as does the structure itself, and the income it produces has value to future investors. Income producing real estate investments do not have red and green days, as does the stock market.

6. Tax benefits—The US Tax Code benefits real estate owners in a number of ways, including unlimited mortgage interest deductions and depreciation accelerations that can shield a portion of the positive cash flow generated and paid out to investors. This is probably why Donald Trump doesn’t want to release his taxes—no one understands how good the benefits are until they start investing in real estate. I just sold a property that made $14m profit and all of it will be reinvested into another property deferring ALL income taxes until a later date. The IRS allows investors a 1031 provision, where investors are able to exchange into a like-kind instrument and defer all taxable gains into the future.

7. Asset Appreciation—Over time, inflation, which is considered the hidden tax, enters into the economy, reducing your purchasing power. You can make the same amount of money today as 20 years ago and see you have less money left over. However, income producing real estate investments have historically provided excellent appreciation in value because the property value is based on rents increasing not just property values. Properties historically increase in value as the net operating income of the property improves through rent increases and more effective management of the asset.

8. Pride of Ownership—I don’t think much of pride of ownership—I invest to make money, because apartments simply make sense long term. Home ownership is at the lowest levels in history. Why? Many don’t have the down payment or the credit to qualify for a home. I would rather own 4000 apartments that produce income for myself and my estate forever than four of the nicest homes in the world. I can take pride in that.

Both Warren Buffet and I know what we are doing when it comes to investing—that’s why we both are wealthy. If you want to be wealthy, you have to first KNOW.

Be great,

GC

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