Hello friends, and welcome to another episode of Ask Marco on the Passive Real Estate Investing show. I wanna begin today with a text I got last night. I was texting one of our investor clients and a person who’s become a friend. I really respect him. He’s a very successful entrepreneur and real estate investor. His name is Steven. I actually asked him, he made a comment to me in a text and I actually asked him, I said, would you mind if I shared this on the next recording of my podcast? And I was thinking of my Ask Marco episode here this morning, and he said, that’s fine, because he was really passing the message onto me that he felt would be an important reminder for other real estate investors to understand the power and benefits of real estate investing, especially in today’s environment and climate. And looking at how prices have appreciated so much over the last few years.
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So he said, yep, go ahead. You know, ignore the grammatical errors, but his text is actually pretty straightforward and clean. So with that, I’m gonna read what he sent me and just make a quick comment about it. So Steve texted me last night. He says, I was sharing with someone today, episode number 299. I listened along with him as a side note, the name of that episode or the title is The Real Returns of Real Estate Investing. Steven goes on to say, I have invested in nearly 2,250 unit or more class B plus properties. So that’s a lot of property, a lot of units, probably in excess of 12 million in cash. I don’t consider myself someone who needs a lesson like the one in episode number 299. While I listened along, I did not learn anything new. But as you came towards the end, I did get a good reminder.
I was fortunate enough to have refinanced plenty of money before interest rates began to jump. I received millions in proceeds, and as you know, I was looking for cash flowing investments, something that’s getting harder to find these days. Near the end of the episode, you grounded me by reminding me what I already knew from my years of experience, the true value of these investments, the appreciation, amortization, and tax benefits gone are the bonus. Instant cash cashflow deals. It’s time to adjust my thinking out of 2015 and get my money working through these times and appreciate the true benefits of the assets I wish to purchase. I can’t be the only one who can benefit from this reminder. It might be a good idea to remind all of your cash flow hungry listeners that though times they are changing, there is still great wealth creation to be made with unrealized gains in low cash flowing properties.
This is an incredible reminder. It’s a great point. It’s really summarized in the last part of the last sentence. There are still great wealth creation opportunities to be made with unrealized gains in low cash flowing properties. So this is true. I mean, there are five pillars, as I call it, with real estate. And Steven points out appreciation, amortization and tax benefits, you know, being three that are very important to him and something that had helped him not only create a lot of wealth, but preserve a lot of that wealth. So keep that in mind when you’re investing in real estate, especially if you’re focused on markets that have appreciated quite a bit and are still somewhat pricey relative to where they were in 2015. And your cash flows aren’t as sexy or as high. Your cash on cash returns aren’t that high. Just remember that this is the long game, not a short game.
So if you’re in it and your property is carrying itself, it’s paying for itself. Even if you don’t have a lot of cash flow, at least not today, that may change in 3, 5, 7, 10 years from now. You’ve got to keep in mind the benefits of that real estate. You have the tax benefits that lowers your taxable income in terms of gains that you make across the board. If you are classified as a professional real estate investor, then you can apply that not only to passive income sources, but your active income sources as well. So it becomes even 10 times better. The appreciation and and amortization. That just means every month and every year your net worth is increasing because the equity in your properties are increasing. This looks slow like a snail in the beginning, but as time goes on, as the months and years go by, it becomes very powerful.
It magnifies itself. It’s impressive. And especially if you build a portfolio, if it happens with one property, it’s great, but if it starts happening with 2, 3, 5, 10 properties or more, it becomes very exciting. And I mean, I’ve witnessed this, you know, firsthand frontline, but a lot of our clients and investors, as they grow and invest, they experience the same thing. So again, you know, I’ve thanked Steven for sharing this with me, and I thank him again for allowing me to share that. So for those of you who haven’t listened to episode number 299, it’s titled The Real Returns of Real Estate Investing. I would go and check that out. Listen to it. It’s probably worth listening to, you know, twice. But to summarize Steven’s Point, he’s really just saying this. He’s saying that there is still great wealth creation to be made with unrealized gains in low cash flowing properties.
And that’s true in many markets that we’re in today. And that might be the case for a little while. Prices will adjust, rents will adjust, things will normalize. Everything works in cycles, sometimes short, sometimes long. But that’s just the nature of the beast. As I was telling my cousin last night, you know, I look at real estate like a pendulum. It’s always swinging one way or the other. It’s rarely, if ever, in a state of equilibrium. So the pendulum is always swinging one way or the other. Or you’re in an up cycle or a down cycle. You’re in a buyer’s market or a seller’s market. But things are constantly changing. It’s always a state of flux. Fortunately, real estate is a slow moving asset class. You can see things coming. You can make predictions, you can make some intelligent decisions, but you can actually bank on that.
It’s all about what is going on in the market, the economy, a cycle, local or macro. And the trends, I mean, I’m a big believer in trends unintentionally. I’m kind of teeing up something I’m working on here in the, in the weeks and months to come related to real estate market trends. So I’ll just leave you with that teaser. So subscribe and stay <laugh>. Stay tuned. I’ll share more with you as time goes on. So today I wanted to cover some people’s questions. I’ve got a bunch of them in front of me. I’ll see how many I can take. Try and respect the recording time here. Try to keep it to about 30 minutes or so for this episode. Okay, let me see. I’m gonna grab the first one here. Ariana sounds like she is a first time investor. She goes, hello, I am 35 and I have finally saved enough in bracket’s, a hundred thousand dollars to buy an investment property.
I’ve never purchased a house before, so I feel I need guidance. I am contemplating two options. First, buy a duplex or triplex in California. My home state, I would live in one unit for a couple of years until I save enough for another property. This option will most likely eat up most of my savings since property values are so high, so true. Second option, buy a turnkey investment out of state and continue to rent in California. I will most likely be able to buy a second turnkey property in less than two years. Final question, should I create an LLC before buying my first property? Any advice will help. Thank you for your time. Very good question. I remember answering a similar question at least once or twice in years past. So to your first question about your two options, loosely speaking, it depends. But generally speaking, if you’re in an expensive state like California or coastal California, you are gonna get more often than not more bank for the buck renting then buying.
This is not always true, but generally speaking, you’ll get more square footage for the dollar if you are renting, because there are a lot of good deals out there where you can get properties that are, you know, 2000 square feet or more for a pretty attractive rate if you were to buy, especially now with interest rates the way they are. I will almost guarantee that you’re gonna be spending more in principal interest tax insurance than you would if you were just renting a nice property in the location that you want to be in. And that’s not permanent. You’ll just rent for as long as you want to until you can afford to buy something. And maybe it’s not even in California. Who knows? You might end up moving. So based on that, I would say, and I’m not giving you financial advice or telling you what to do, run your numbers.
This is all about math and data and trends, but run your numbers and take a look at what you can get by renting here. Even though you’re not building any equity, it might be the right time. You know, prices, depending on where you live in California, prices have have actually either stalled or have been correcting. So there is an adjustment going on. So it may not be an optimum time to be buying. Again, it’s all about trends and timing with this type of question. But to your second option, that makes a whole heck of a lot of sense to me because you can continue to live the lifestyle that you are living now in the location you’re living now or where you want to live. Remember my my saying, live where you want, invest where it makes sense. This is where, you know that trademark saying comes in, buy one or two turnkey investment properties in markets that make sense, that will provide you stability, growth potential, some cash flow.
Take advantage of what Stephen was talking about, you know, five minutes ago in his text to me last night. Take advantage of that amortization. The appreciation, the tax benefits you get from the real estate, whatever cash flows you can get now, which will over time grow and increase. So it becomes a growing source of passive income. Your second option sounds like to me the best option. Again, look at what’s out there and run your numbers. But just knowing what I know is out there in terms of turnkey, out of state investment property, I know you’re gonna find one or two properties that will kickstart your real estate investing career and allow you to still live in your home state of California and do the things you like to do. So hopefully that answers your question, Ariana, to your second question there. No, you do not need to set up an LLC beforehand.
You can. It’s quick, easy, inexpensive, you’re welcome to do it. And the fact that it’s quick, you might as well just take care of it. But you need to know what state you are investing in with that real estate before you set up the llc. Because again, not you know, legal advice, but if you listen to the stuff I’ve talked about in many, many episodes about asset protection, generally speaking, you want an LLC set up in the state where you are going to hold property. So again, hypothetically, if it’s in Florida, you’ll have a Florida LLC title will be held in that llc, that disregarded entity for asset protection purposes. So you don’t need it beforehand, but it’s easier if you have it set up beforehand. All right, thanks for the question. Ryan writes in, he says, hi, I am 21 years old with no experience in real estate investing.
I’m getting a lot of these lately, you know, a lot of new investors. I see an opportunity to have some income here and want to know more about short-term rental properties or other ways to build a cash flow. I am interested in the Nevada area in Lake Tahoe, but do not know where to start. Thanks. Well, you start with a question of where should I invest? Now I, I assume you’re listening to podcasts, you’re educating yourself, you’re reading books, you’re learning what you can, that’s really the starting point, always the starting point. And that really is never the end point. You always wanna be a student and continue learning. But you know, if you’re just getting started and this great, you’re only 21 years old, you have time on your side, that’s your most valuable precious asset time. And if you’ve got time on your side and time working for you, you’re gonna create tremendous wealth as you start to invest and build hard assets in your investment portfolio.
And real estate is ideal for this. So identify, I’m gonna assume you have investible cash savings. If and when you do, then you’re ready to move forward. But in the meantime, identify the markets that make sense for you. As a suggestion. Contact one of my investment counselors and have this discussion because if you’re there, if you’ve got credit and investible cash, then the question becomes, where’s the best place for you to be investing at this point in time? I know you’re interested in Nevada. I don’t know a lot about Lake Tahoe. I don’t, from what I saw, prices are pretty frothy there. So I’m not sure if the rent to price ratios pan out, meaning you won’t get a very good cap rate or cash on cash return. So it might not be the best place to invest or start. I don’t know where you live, but if you live in the area, you need to kind of change your thinking and mindset.
You gotta start thinking in terms of where in this country is the best place to invest my hard earned capital and put it into income producing real estate and get the best returns, both realized in unrealized gains. So be market agnostic. Again, I don’t know where you live, but don’t be married to a market. Learn to be market agnostic. Ryan, I appreciate the question. Let me move on to another one. All right, so Elvin writes in. Hi Marco. I recently came across some info on the debt shredder. I do not know what the debt shredder is, although I did do a Google search. It sounds like it’s kind of a, a program or a piece of software that allows you or shows you how to accelerate your debt payments if you’ve got multiple loans such as credit cards and otherwise. But anyway, that’s kind of the gist of it.
Those folks say that it is better to pay down your loan and then use the equity to scale. While I’d understand you trying to understand your email here, while I’d understand you that it is better to do just the minimum payment each month and save for another down payment, I’m confused, which is the fastest way to scale. The fastest way to scale, regardless of whether you have this debt shredder thing or not, is this, you want to focus on your top line income or revenue. If it’s a business, you wanna build as much income as fast as possible. So you have the most amount of deployable capital to invest at any given time. So you can cut expenses and you can cut down on debt service, which would be loans and credit cards. That’s fine. But if you are throwing big chunks of cash to pay down debt that you could use to invest in income producing assets, that’s something you should focus on.
Because what you can do is build a portfolio and then take cash flows from your assets, your investments, and apply those to paying down your debts. So this is again, you know, a numbers based question. I think long term, and you know, numbers show me this, that you’re better off investing in assets like real estate that generate income and generate equity, which is wealth creation, and do that well and significantly over time than to focus short term on paying down debts. Now, unless you have a ton of debt and you know it’s, it’s really affecting you financially or in your ability to qualify for mortgage financing, then you need to focus on paying down your debt. Because if your debt to income ratio is too high, you might not be able to qualify for mortgage loans, mortgage financing. So you gotta look at your situation and what you’re capable of doing and if it’s holding you back from doing anything.
But you know, again, this requires more discussion. There’s not enough information here to really make a decision, you or I or anyone else one way or another. But again, generally speaking, I think it would be better to focus on deploying your capital on income producing assets like real estate. So hopefully that’s not confusing. But the fastest way to scale again, is to grow your income as fast as possible. All right, next question from Steve. He’s asking about analyzing numbers for newbies. Marco first, love what you do and how you do it. Well, thank you Steve. You add so much value to those who of us who are feeling our way into the rental real estate world. Thank you for all you do. I learn a lot from you and appreciate what and how you do it. I appreciate that. Thank you, Steve. So besides my primary home, I have two rental properties both performing well.
I have some ownership in a few large syndicated deals with investors, but my goal is to build my portfolio of rental properties for the long term hold. I want positive cash flow not to live on now, but hopefully in 15 years from now. My long term goal is 10 to 15 properties more if all goes well. I currently have cash to add three properties in the next three to four months. I do recognize the acquisition costs are higher, but I am looking at purchasing price budget of about $130,000 each. If the market doesn’t collapse, my plan would be to leverage these into 12 to 18 months with cash out refinances to add more to the portfolio. Okay, that makes sense. Like you said, quote, the best time was 10 years ago. The next best time is now close. Quote, my goal for a single family rental properties to provide between two to $300 cash flow per month, well that is actually quite reasonable and doable, especially in the $130,000 price range.
That’s my commentary. Steve goes on and say, having followed you and your podcast for well over a year, I have connected with Melissa. She is awesome. Well, <laugh>, thank you. She’ll be glad to hear that. I’m currently in the pre-approval process to begin closing deals utilizing the expertise and connections of Norada. However, analyzing the numbers as a newbie is a bit frightening cap rate, NOI, IRR, et cetera. Any advice you can give to me in how I can better understand the numbers to know if a potential deal will yield the results I want? Yes, I can. And then he goes on to say, the second question is, I was previously quote unquote burned on a property in the Detroit area. I’m sorry to hear that. I thought it was a B minus neighborhood on the trend up, but it wasn’t. How do I get back to the point of trusting the low B or even high C to mid sea neighborhoods?
It seems as if the acquisition costs are typically lower in these areas, but come with more risk. Well, that is a hundred percent true. You just hit the nail on the head, my sincere thanks and appreciation for how you help others achieve their dreams. Steve, Steve, thank you for the question. I appreciate everything and the kind words. You’ve got two good questions in here. How do you better understand the numbers? Well, let me keep it simple for you. So first and foremost, my litmus test. The first thing I look at, and this is I don’t make decisions based on, the rent to price ratio or rent to value ratio. What, you know, we often refer to as an RV ratio, that’s simply the monthly rent divided into the purchase price or the value. If you’ve held a property for a while, the example I use for simple math is a property that’s a hundred thousand dollars that’s renting for a thousand dollars a month, divide the thousand into the a hundred thousand and you get 1%.
That’s known in the industry as the 1% rule. It was more of a truism and an easier target in years past. Um, you know, in the mid 20, 20,000 year range. So 20 15, 20 13, 20 17, as the years have gone by, properties have been appreciating faster than rent. So that RV ratio has been dropping across the board more so in some markets than others. The thing is, is those 1% RV ratio properties are the 1% rule. Properties still exist. They’re out there, they’re typically in tertiary markets or markets that haven’t appreciated as much or as fast as other markets. They’re nice to have. You can certainly find them if you downgrade your criteria, and this is not something I recommend anybody do. If you are looking for properties in like BBB plus or a class neighborhoods, don’t downgrade your criteria and go into c class neighborhoods or even worse d class neighborhoods, which I would consider more or less war zones just to get that higher rent to price ratio.
You will get it by downgrading your neighborhood quality or criteria, but as you said it yourself, you know, you may be taking on more risk. The demographics are different, the acquisition costs are typically lower. But you’re taking on more risk because not only of the environment, the community or neighborhood, but the, anecdotally speaking, the neighborhood demographics, you, you’re just dealing with a different type of, of person or tenant base. So if you wanna go down that road, that’s fine. Just understand what you’re getting into, have thick skin and have a really good property management company and knows how to deal with, you know, the lower income demographic that you find generally speaking in, you know, these C-class neighborhoods. But the litmus test is the rent to price ratio. That’s where I start following that. I look at the cap rate and then the cash on cash return.
The cap rate is, you know, what the rate of return is on that property here and now based on whatever down payment you put. Actually, I take that back. The cap rate is not based on the down payment, it’s based on the purchase price as a whole. If you look at it in light of your down payment, now you’re talking about your cash on cash return. So it’s basically the cap rate leveraged. So if you put 20% down, whatever that property’s generating per year divided into your down payment, gives you the cash on cash return. Now, your net operating income is really just all your income minus all your expenses before debt service. That’s something that is good to look at, but that’s not something you really base your decision on. You calculate your cap rate based on the net operating income. So the cap rate is really the percentage measure of that net operating income or noi.
Now, the internal rate of return, or I rrr, is something good to look at. This gives you the true return on that property over a period of time looking at that property at a point in time. So if you were to hypothetically buy a property holder for let’s say five years, doesn’t matter what the number is and sell it, whatever your total gains are, cash flows and equity taken out of the property, you take those numbers, adjust for inflation or time and look at that in light of the down payment that you’ve made. It’s a complicated formula. This is why it’s kind of hard to explain in words, but essentially what you’re getting is your internal rate of return. This is adjusting for time over a period of time and looking at all your gains as if you had liquidated or sold or realized all those gains.
It is good to google that. We also have articles on our website at noradarealestate.com that explain IRR, but is, getting into the weeds a little bit to answer your question. My advice to you to better understand the numbers on a potential deal is quickly look at the RV ratio. If it’s over 0.7%, continue doing your due diligence. You can go lower if in highly appreciating strong growth markets because you’re gonna make up in those gains. The unrealized gains on the appreciation or the equity gains far more than what you were going to get in the cash flow or actually going to get in the cash flow because those areas tend to cash flow very poorly, but they’re very, very strong in terms of gains. So look at the RV ratio, look at the cap rate, look at what your potential cash on cash return is, as if you were putting 20 or 25% down, and then run your numbers.
At the end of the day, you want to have that proforma in front of you. You could use the ones on our website. Every single property has a proforma attached to it. Just again, side note and a quick reminder, we only post about 10% of the properties available to you that are in our pipeline on our website. So don’t think that what we have on our website is everything. It’s not, it’s not even close, but you can use that dynamic calculator that we have on our website with any property because you can change all the variables and numbers and create your own scenario. So you can actually use that as a calculator for yourself. I am working to create that same thing as just a publicly available page where you can just go and plug in the numbers you want and use it as a tool.
It’s not live yet, it’s in development, but that’s what you need to do. You just need to run the numbers and look at your annual proforma. What is the proper gonna do in year 1, 2, 3, 4, 5? Of course, you’re making assumptions for anything beyond the first year, but that’s how you do your analysis. Okay, Steve, to your second question being burned, look, again, like I said, if you need to define what your investment criteria is, if you wanna stick to, you know, b b plus or a minus or even eight grade neighborhoods, that’s what you need to stick to. You know, eight class neighborhoods are your higher quality, more higher priced for that market type of neighborhoods and areas. They tend to have really nice malls, more boutique type stores. Definitely you’ll have everything from Starbucks there to let’s say Macy’s or even Nordstrom’s. Those are your eight class areas.
Your B class areas are your middle income kind of mid-market demographic. Your bread and butter communities, it’s predominantly either blue collar and a mixture of white collar employees that live there and work there. So again, you’ll find a lot of good stores in those areas and smaller strip malls. You will find Starbucks and all that kind of stuff, but that’s typically your B class neighborhoods. As you start to drop below that, you get into your lower B or or C class neighborhoods. This is where you start to see your Dollar Generals, you know, your 99 cent stores, your thrift stores, your bond stores, you know, I sell bonds, jail bonds and all that kind of stuff. You get the idea. So you know, this is a personal preference. I like to stick to upper B and a class neighborhoods as much as possible because I just know that they are gonna perform well long term and they are more stable.
They have greater appreciation potential, and less headache over time for my property manager and for myself. All right. Let’s see. Can I take one more question here? Maybe what I’ll do is I’ll just wrap it up here for today and just do another Ask Marco episode and drop these other questions into that one and I’ll maybe release them close to each other. All right, well, that is it for today. Thank you for tuning in. I appreciate your time. If you haven’t subscribed already, do remember to subscribe. It only takes you a few seconds. We appreciate ratings and reviews, whether that be on iTunes or anywhere else where you’re listening or watching to this. Thank you for the questions. If you have another question in mind or you haven’t ever sent me a question, go to Passive Real Estate Investing. Click on Ask Marco and I will take your question. Thank you for listening, and I will see you all on our next episode.
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