How to Buy a Property like a Millionaire

Buy Property Like a Millionaire

More money has been made in real estate than anywhere else” – common bullshit expression

There’s a lot of crap out there about real estate but real estate can also be a kick ass investment vehicle.

I’m going to share with you about losing lots of money in real estate, making lots of money in real estate, and having dogs that just haven’t done a damn thing in real estate.

In the end, hopefully you’ll know how to consistently make real estate work really well for you and avoid all the common little mistakes people make that keep them from doing well.


The Journey

This story was inspired by a conversation I had with my mum a few days ago while I’d stopped to visit my parents in the middle of some travels.

Back in 2007 I was green, didn’t know a damn thing about investing but my parents had just finished flipping a small property near the city I’d just moved to.

For decades, they’d faced ups and downs in stocks, bonds, etc.

I’d started my journey back into business and was learning how to make my millions.

It was the height of the real estate boom. A former roommate of mine, an average guy made $100k in a year doing next to nothing off a $20k investment simply by buying a condo and selling it the next year. Dumb luck, but I didn’t know it at the time.

Everyone was making money but I wasn’t in the market.

A new friend invited me out to an investment presentation for a land development project at a fancy office downtown where he was working. They showed how land values rose the most during the development phase from raw land into titled lots and you could invest. Best of all you were getting some end of the line inventory so you’d get even better returns than everyone else (beware when you hear words like that it’s usually smoke and mirrors).

The projected return? 100% in a year.

I was learning then about how rich people knew stuff poor folk like me didn’t know and this is why they were rich. While everyone else was investing at a lousy 10% they were getting 100% (total bullshit but I didn’t know that at the time) but this was one of those opportunities finally!

I didn’t have the money needed to invest so I called my parents. I told my mum “look where you’ve done the best over the years investing…real estate so why not invest in what’s worked for you?” They listened to the story and decided to go for it. After all we were told, it’s land worst case scenario it’s not going to zero. WRONG!

It became the first of 4 troubling investments, 2 resulting in 100% loss for investors, a third around 90% loss for investors and the fourth around 20% loss for investors to date.

What went wrong? Glad you asked but the story isn’t over yet.

After some of these dramatic losses my mum commented to me “well maybe I’ll just not invest anymore”. To which I replied, “that’s stupid you’ve got to invest in something and you just paid $100k+ for an education, the question is what did you learn so you can do better going forward…” Then I shared with her what I’d learned watching not just those but many other investments at the time.

Valuable lesson – when possible learn from the mistakes of others rather than having to make those mistakes yourself, it takes less time and costs less money.

That was the last time we lost money on anything like that time and time again those lessons have served to not just avoid losses but make great returns.


Understanding Real Estate

There’s an amateur way of thinking, which is to think about asset classes: stocks, bonds, real estate, etc.

Why is this amateur? Because the asset class isn’t what makes or loses you money. You can make or lose money in any asset class, which is why anyone who says, “the way to make money is in real estate”, or MLM, or online, or whatever else is clueless. Run away from those people.

Every asset class has different characteristics and if you want to do well in it you should understand those characteristics.

Real estate has some distinct ones:

  1. Intrinsic value – no matter what the land will pretty much always be there (the buildings might not). It’s also easy to get a relatively accurate fair market value for it, which can not be said for say businesses, commodities, or intangibles.
  2. Value is driven primarily by use – this is very different from say stocks, bonds, currencies, etc. which get traded actively as pure investments. Most real estate purchase and ownership isn’t speculative or profit driven it’s for people to use it day to day, which means the markets are very local. There is no Canadian real estate market, or US real estate market, or Australian real estate market. It could be booming in NYC and crashing in Detroit or even vary by neighbourhood

There’s lots more we could understand but first let’s explore some natural consequences of those two factors:

  • Slow moving – real estate prices aren’t going to change dramatically like most financial instruments are. Whereas a 50% move in a stock could happen in days real estate will rarely move than much over a few years
  • Easy to leverage – this is super important. Because it’s relatively safe and stable it is cheap and easy to borrow money to finance it

Usually it has four other characteristics:

  1. High transaction fees – this is especially true if you need to use realtors, which doesn’t mean you shouldn’t as they are often worth it though expensive
  2. Productive – meaning you’ve got renters, which are paying you money or crops you’re growing or something. This is very important as we’ll see later and makes it very different from a commodity like gold, silver, oil, uranium, etc.
  3. Doesn’t grow – just as you aren’t going to have less of it you’re not going to have more of it by having it sit there
  4. Needs management but not much – bonds are productive (pay you cashflow) but don’t need management and frankly the management is a pain in the ass. Yeah you could hire a property management firm but you’ve still got to manage them

Alright, I realize this stuff might seem boring but it’s super important if you’re going to make lots of money and making lots of money isn’t boring it’s the new cool!

All of the above is going to help us figure out how to avoid losing money at it and how to make lots of money at it.


It’s SUPER Hard to Predict the Future

Our rules for buying real estate are super simple. You’ll be able to catch them in a flash. But to understand why they are brilliant it helps to start by understanding investing vs speculating, why it’s hard and what to do about it.

I call this The Barbell Strategy (credit to Nassim Taleb), which is a cornerstone of success in any area of life but especially finance and investing and something we talk a lot about as a core principle in Richucation.

To understand let me tell you about my conversation with my mother yesterday.

We sat around the living room, kind of a dreary day, discussing a trip to Portugal and Spain she wants me to go on with her and I’m feeling reserved about because it will mean cutting a trip to the Balkans short.

For whatever reason conversation turned to a property my parents own in a town called Airdrie, outside of Calgary in Canada, and comparing it to the first property I bought a couple years after they got that one.

Please note, both are real estate, one did about a 300% return in 5 years, the other is 0% return in 7 years. Yes, you heard that right, you want to be the former not the later and I’m going to show you how along with showing you what went wrong on the former so you can avoid it.

The property in Airdrie is a townhouse they purchased because they’d lent money as a second mortgage against a development project and if they didn’t buy it they would have lost about $30k of their principal. That’s all fancy talk for saying the amount the project ended up selling for wasn’t enough to pay them back.

Because they lent the money they had the first option to buy it and the developer who we trusted recommended it. At the time, I thought it was dumb but didn’t know enough to say for sure or communicate it. This is great because it’s another lesson learned off someone else’s mistakes.

The developer recommended it saying it was a good property and he figured the values would go up. Turns out 7 years later the values are almost exactly what they paid for it.

Big lesson – it’s hard to predict the future.

Buying based on trying to predict the future is what we call speculating. Buying based on present realities for long term gains is what we call investing.

Back to the Barbell Strategy…

The Barbell Strategy is all about the idea of protecting against low risk, while positioning yourself to take advantage of good luck if it comes your way and real estate is a perfect example of how to do this if you do it well.

The problem with the Airdrie townhouse was it was PURE speculation. How so?

The rent barely covered the monthly expenses so there was zero monthly profit. In other words, if the market didn’t go up there was virtually no return.

There was no built-in equity when they bought it because they paid full retail price.

Both of these things were huge mistakes and big things you’ll want to avoid (more on this later).

Here’s the beautiful thing about properly purchased real estate. If the market doesn’t do anything special you’ve got some built in equity and you get monthly cashflow out of it at a decent rate (probably better than you’d get buying bonds). If the market does go up you can make some big returns thanks to high leverage.

To take advantage of it though it needs to be PROPERLY purchased.


Real Estate’s a Shitty Investment

Say what?

Wait Michael didn’t you just tell us how wonderful it could be?

Yes, yes I did but here’s what you need to know. What makes real estate fabulous has very little to do with the real estate itself and everything to do with the financing.

What?

Alright let me do some boring (but actually kind of exciting) numbers for you.

Let’s say you buy a new rental property and you pay all cash…Cash means no financing, not literally bringing a big bag of unmarked bills down to the seller.

Let’s say you follow Richucation’s buy like a millionaire rules for real estate and buy it for 10% or more less than it’s worth. So, on a $300k property this means it’s worth $330k the day you buy it, a $30k increase to your net worth…I bet you feel pretty good about yourself don’t you?

Well not so fast because remember those high transaction fees? Yeah if you sell tomorrow you’ll lose about 5% in fees (realtor, closing costs, etc.) so there goes $15k of the $30k. Then you lose another bunch on tax, there’s the original purchase fees, the cost of having it sitting there while you try to sell and what you’re left with is probably barely worth the time it took you to buy it.

You’re probably left with $5k-$10k in final profit on a $300k investment. About a 2.5% return, in other words you could have done that buying a government bond and getting back to work.

Now, you might be saying “but Michael what about the rental income?”

Yes, yes, we’re getting there let’s consider how rents might work.

Let’s say you again were smart and followed Richucation’s buy like a millionaire rules for real estate and purchased with at least $750/mo. of rent for every $100k of purchase price. This means you’d be getting rental income of at least $2250/mo.

Sounds good right? No, not good and here’s why.

$750/mo of rental income is equal to a 9% gross rental yield but of course we don’t actually get gross. By the time you pay for property management, maintenance, vacancy, taxes, insurance, etc. (Click to download the free real estate analysis cheat sheet) you’re down to about 5.5% return and we haven’t factored in the smaller risks like being sued, extreme damage, etc.

5.5% isn’t a great return…oh by the way it’s fully taxable in most places.

I could show you very solid bank stocks you could buy for zero effort paying you a 4% dividend (usually this works out to about the same after tax as the 5.5% because dividends are usually taxed at a lower rate) where you can get lots of upside, be fully liquid, and have zero headaches.

Maybe you’re asking, “what about principal pay down?” There is no principal pay down because there’s no mortgage.

Wait, wait, this doesn’t sound right hasn’t real estate created more millionaires than any other asset class?

First, get this asset class nonsense out of your head. It’s not about real estate or stocks or bonds, it’s about how you buy and how you manage and how you sell, these are the things that will make you rich not the asset class itself.

Second, yeah real estate actually has made a lot of millionaires but it’s a super deceptive statement. People tend to become millionaires through their real estate because they own their own home and they’ve got a lot of leverage on it. We’re getting ahead of ourselves though so let’s finish the boring math.

There’s one more way you could benefit from this real estate, which is it could go up in value. Here’s the problem. Remember how we said real estate tends to be slow moving? Yeah well it isn’t likely to go up much in a year. In fact, while a great stock can double or triple in a year if real estate goes up by 20% in a year the market is INSANE and won’t last.

Best case scenario you happen to get lucky and do 20% in a year but it doesn’t happen year after year. In fact, the most comprehensive research of historic real estate prices by Dr. Robert Schiller shows over the long term real estate roughly matches the rate of inflation, which makes sense because where is the money going to come from to pay for people’s increased cost of housing? It can’t grow faster than the money supply for long periods.

Bottom line over the long term you’ll likely get say 3% or so annual appreciation.


How to Make Real Estate Awesome

Alright so we’ve established real estate is a shitty investment on its own now let’s talk about how to make it kick ass.

Leverage – remember we said earlier it’s really easy to get super cheap money for real estate compared with almost anything else? Yeah this is the main game if you want to win big.

To understand how come let’s go back to the boring math starting with the immediate boost to your net worth when you buy for below market value…which is legit awesome right?

Before we said well you got that 2.5% return off your $300k. But if you’re smart you’re not going to buy real estate with 100% down, you’re going to use leverage, without leverage real estate isn’t anything to brag about, it’s all about the leverage.

For all our future examples, we’re going to assume a very normal 20% down payment, meaning instead of paying $300k in cash for the house you’re paying $60k in cash and getting a mortgage for $240k.

Previously we assumed you made $7.5k if you’d actually sold immediately. If you did so again (assuming no mortgage penalties, yes, I know we’re simplifying the equation a little here) you’d make the same numbers and suddenly that 2.5% return has become a 12.5% return ($7.5k/$60k invested). Much more appealing.

This is only the start though.

What about the rental income? Before we said 5.5%. We’ll still get this same return on the first $60k but then we’ll get a slightly different return on the remaining $240k of borrowed money.

For simple numbers, I’m going to assume your mortgage rate is 3.5%, which depending where you are in the world right now might be low or high (generally places with higher interest rates will also mean higher rental rates so to some extent it should balance out). This means you make 2% on the $240k remaining between principal paydown and monthly cashflow.

Did you follow this? Ok, there’s 9% of gross rental income coming in. But we said there’s 3.5% of expenses leaving you with 5.5% of net income, which is paid on the portion you did the down payment on. The remainder you have borrowed money and the money is costing you 3.5% in interest so you deduct the 3.5% from the 5.5% to leave you with 2% you get to keep off someone else’s money.

In other words, your 5.5% has grown to 13.5% MUCH better than before. This is now an attractive rate far better than what most people will get in their investments.

Finally, we’ve got the possibility of appreciation.

Let’s look at both the lucky years (20%) and the long term expected average (remember we suck at predicting the future so it could vary some).

If the market happened to go up by 20% in a year what would your return be with leverage? Let’s do the math (for simplicity I’m keeping out the extra 10% below market value it was purchased for).

20% on $300k is $60k…how much did you invest? That’s right, $60k down payment…in other words you just made 100% in a year! This is crazy good.

Say it wasn’t a lucky year it was just an average year of 3% or $9k in appreciation. On a $60k investment you made a 15% return just off appreciation! Is 15% a good return? Hell yes! It’s a great return and it’s on top of the other returns you already made.

Bottom line – leverage is what makes real estate awesome.


A Word of Caution

Leverage seems great the way I just described it. Leverage can also be the bane of your existence because if the property goes down in value instead of up it works against you.

If the property is vacant longer than expected the mortgage payment is working against you.

This is why BUYING PROPERLY is so critical!

If you follow our rules it’s going to make it safe for you and profitable.

For example, say you bought for full retail value and the property dropped in value by 10% what did this do to your return with leverage? 50% decline!

What if you followed our rules and bought for at least 10% below market value? Your investment is secure at what you paid for it.

What if you did like most people and bought low cashflow properties? Leverage creates negative cashflow and headaches every year.

If you followed our rules you’re making money off that leverage and dancing all the way to the bank now take yourself to dinner because the renters are buying!


What to Watch in Real Estate

You might have heard people rattle off this expression “the 3 most important things in real estate are location, location, location”. Thank god Donald Trump corrected that one…well sort of.

In “The Art of the Deal” Donald describes the three most important things as “Deal, deal, deal”.

In truth, both are partially correct. There’s four quadrants we like to pay attention to when buying real estate:


A great location will correct a lot of errors if you’re lucky but if you’re relying on luck you’ll probably end up broke.

The deal is arguably the most important consideration but a great deal can get sunk by bad management or a crap property. Then again great management means low vacancy and high rents with few headaches.

What do we mean by property? We don’t mean the location of the property we mean what is it you’re getting for your money? Is it great construction? Will it last? Is it attractive? Is it the largest property on the block or the smallest or something in between?

You want to make sure you nail all four of those quadrants to really do the best possible.


The Millionaire Rules to Buying Real Estate

Wow! We’re finally here some great simple rules for you to follow to make it easy or at least avoid the dumb mistakes people make.

Keep in mind you’ve got to put the work into applying these, I looked at 108 properties before I made my first purchase decision so I knew what I was doing and could actually buy right. If you don’t want to put any effort in…

Here we go:

Rule #1 – Buy for at least 10% less than it’s worth with a margin of safety

This means if a property is worth $330k you’re never paying more than $300k for it.

This has a whole range of benefits:

  • Your net worth goes up the day you buy it
  • If it drops you’re usually still safe
  • Easier to get higher rental return on your invested cash
  • Easier to refinance for higher leverage

Note the comment about “margin of safety”, what’s this all about? You’ll never know for sure exactly what the property is worth you’ll have a ballpark range.

When estimating you don’t want to be optimistic. If you think it’s worth $340k you should probably say it’s $330k. Always include a buffer a little below what you think the property is worth as what you’re saying it’s actually worth.

For me, the property was probably worth around $345k-$350k on the high end (assessed at $380k). I estimated it was worth $330k and bought for $300k. It was pretty easy to do well on those numbers.

Obviously, the lower the better as it’s a pure boost to your net worth right off the bat.

Note, this and a couple other reasons almost always mean you won’t buy a brand-new place unless you’re getting a presale because brand new usually means full retail or close to it. NEVER buy retail.


Rule #2 – Buy with $750/mo. of rental income per $100k of purchase price

For a lot of people this number will seem super hard to hit…probably a sign you should keep looking.

This being said there are lots of strategies to increase the rent beyond what it would normally be such as:

  • Furnished rental
  • Short term rental (at the extreme end Airbnb, VRBO, etc.)
  • Adding suites
  • Renting out by the room

Some of these strategies will require more management so you need to factor those costs into your projections and raise your standards accordingly.

Also note, these numbers might need to be higher in higher interest rate environments so keep those in mind. The key is you want your rental income after accounting for all expenses (not just mortgage, etc. but also vacancy, maintenance, management, etc.) to provide you with some positive return on top of the leverage.


Rule #3 – Buy a property where you can force appreciation

This means you should have the ability to renovate and increase the value of the property if necessary.

Significantly, you want to be able to put in $1 to renovate and get $2-$3 back in increased market value.

Once again, this is a reason buying brand new usually doesn’t make much sense since you’re usually talking about immediate depreciation from use.

What’s the idea here?

  • In case the market goes down this allows you to protect your initial investment
  • It allows you to increase the value then refinance for higher leverage
  • If the market is stagnant you can control whether you get a return

You might never renovate but the ability to renovat​​​​e gives you a lot of security.


Rule #4 – Never buy the most expensive/biggest building on the street/area

The value of real estate is typically set by properties around it. This means either the properties around yours can raise yours up…or drag it down.

If you buy the most expensive property on a street the others around your place are bringing yours down. I made this mistake by getting a property almost 50% larger than anything around it. Surrounded by different properties it would be worth a lot more.

You could take this to the extreme by buying the cheapest property on the block but it’s not usually necessary.


Rule #5 – Buy in an area with positive population dynamics

Ok, now you’re just speaking Greek Michael wtf does that mean?

Remember how we talked about real estate primarily being used by people to live in rather than speculate on?

This means the value of real estate in an area is going to have a HUGE amount to do with what’s going on with the population in the area:

  • Is the population increasing or decreasing?
  • Is it stable and sustainable?
  • Is there good long-term job growth?

Look, if the market goes crazy it will be lucky but there are some things you can do to increase your luck and putting yourself in the way of this trend is a pretty good one.


Rule #6 – Buy inline with growth and NEVER after it

You’re confusing me again Michael what’s this nonsense?

Ok, remember how we talked about real estate rarely jumping up by say 20% in a year? Well usually this means if it’s just jumped up by a large amount it at best isn’t going to do so again and at worst could fall back quite a lot.

Take a chart of property prices in an area. If they’ve just gone up dramatically in the last little while stay away from that market. You might miss some wins but you’ll miss a lot more losses and that’s important.

On the other hand, if property prices around where you want to buy have just gone up a lot and where you’re looking hasn’t that’s a great sign because there’s a decent chance the local rising tide will come to your area.

It’s really hard to predict the future but at least stack the odds in your favor.

Tons of people make the stupid decision to chase returns, meaning they see something went up and they go buy, this is a good way to lose money. When things fall a lot that’s a much better time to buy.


Conclusions

There’s lots to this, I get it but that’s only because it seems new. Yes, it’s been deliberately simplified somewhat to make it easier to digest.

What you’ve got here are some very simple easy to apply guidelines and if you follow them you’ll be in a MUCH better position than if you don’t.

These allow you to position for the big upswings without taking a big risk in case you’re wrong.

I’ve watched so many people over the last few years make dumb mistakes and lose tons of money or tons of opportunity off real estate. I don’t want it to be you.

Real estate is remarkable for how comparatively simple it is to learn and apply. By contrast business is a hundred times more complex and more work.

No, not everything is in here. Unfortunately, there’s way too much for a blog post.

If you’re interested in learning more please download the Free Real Estate Investing Cheat Sheet and consider signing up for our complete training masterclass.

I was fortunate enough to learn from the mistakes and wins of others this is your opportunity to learn from mine.

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